Europe needs to halt its startup brain drain to the U.S.

The startup community in Europe is well accustomed to the limitations of its local investment community, which, although growing steadily, can never quite match that of Silicon Valley. In fact, for founders of startups in especially dicey emerging sectors like VR/AR, Europe’s risk-averse investment culture makes it exceedingly difficult to survive, let alone thrive, without seeking investment from the U.S.

Yet raising capital from U.S.-based venture funds is often tantamount to becoming “Americanized,” since any deal you strike will invariably entail the mandatory condition that you incorporate as a Delaware-based entity, a move that uproots your startup by rendering your EU-based entity a subsidiary. Indeed, as a Portugal-based founder who has been working out of the Bay Area for the past month, this demand seems all but inevitable.

U.S. investors have good reason to push

Silicon Valley insists on this model of converting foreign startups into U.S.-based ones for good reason. Marco DeMiroz, general partner at The VR Fund, a U.S.-based VC that targets VR/AR startups, shares some of the key reasons why a U.S. move its strongly recommended if not an outright precondition for investment:

1. IP protection: U.S. laws are world standard.
2. Legal and taxes: U.S. investors know a lot about U.S. corporate law and little about local legal frameworks in other countries. The same is true for tax regimes.
3. Syndication and venture alignment: The U.S. has the most robust venture market, so collaboration among VCs to build a syndicate for the current and follow-on rounds is very important. U.S. VCs pretty much follow the best practices per the NVCA, thus term sheets and key points for negotiations with a company are more streamlined and effective.
4. Ease and competition: The sheer volume of U.S. startups and the robustness of the market means that a startup based in another country has to be truly unique and outstanding to get VC attention.
5. Risk: All of the factors listed above add to the risk profile of a non-U.S. startup, making them less competitive.

Likewise, here’s how Ben Gamble, a serial entrepreneur who has worked in startups in both markets, and is currently the CTO at UK-based Quincus, observes the landscape from a European lens:

1. Protection: U.S. investors want the company to have a U.S. presence in case of legal action to protect their investment or to force changes.
2. Influence: They want to be more connected to their investment. In theory a good VC provides more than just money and pressure.
3. Simplicity: International investment is a legal quagmire that no one wants to deal with for smaller rounds. Unless the VC has a EU arm, it just does not happen.
4. Market size: With technology, the U.S. is a very large homogenous market. If your product is launched there, you have only got one language to deal with and millions of wealthy customers. This is the lowest risk way to get a large audience, and the VC’s are right to insist you should try it in the U.S.
5. Everyone else is doing it. So it must be right. VC are a cargo cult.

The EU-based startup in question has to make the Faustian bargain of trading in its cultural sovereignty in exchange for the opportunity to pursue its dreams and ambitions in what is often the only chance to move forward. However, to the EU tech community, each new deal of this kind is yet another blow to its efforts to develop the local ecosystem. The ever-expanding funnel of U.S. investment is carrying some of the EU’s best, brightest, and most innovative people, ideas, and companies to the U.S.

So the trend is disruptive and counterproductive to the unique community and ecosystem that EU countries are trying to evolve on European soil.

A vicious cycle

Gamble describes the vicious cycle that is currently wrecking the EU startup ecosystem:

1. The relative ease of raising money drags startups to the U.S.
2. Fewer A and B rounds are raised in the EU, as there is a fear the company will up and leave.
3. There is less money around and it gets harder to raise A and B rounds in the EU.
4. The lack of A and B rounds mean late-stage investment dries up as the pipeline stops flowing.
5. Founders, whose companies need a lot of money to get going, move to where the money is.

This cycle is particularly aggravating for EU founders, like myself, in the VR/AR scene, which is currently going through a rapid regional growth spurt led by the United Kingdom, France, Sweden, and Germany. The right allocation of resources could position Europe as one of the global hotbeds for the mixed reality industry. If, however, these startups fail to raise in their home court and instead have to convert into U.S.-based companies by raising capital from across the Atlantic, this momentum could be stalled or even permanently stunted.

As for those VR/AR startups that neither receive funding locally, nor seek it out in the U.S. (or try to but fail), they suffer a fate worse than simply dying out; they convert to the unscalable but survivable agency model.

Good omens on the horizon

That said, there is cause for optimism on the VR/AR front. We have seen some positive traction over the past couple of years that might help balance the otherwise lopsided tug of war in Europe’s favor. Last October, we saw the announcement of the XR Basefund, a €50 million VR/AR fund based in Amsterdam that is dedicated solely to European-based startups. Aside from helping to fill the capital gap in the region for the mixed reality industry, it could serve as a catalyst for other regional funds.

Also, some U.S.-based venture funds have shown a willingness to stretch beyond the standard Silicon Valley model by being much more flexible in their approach to investing in foreign startups. For example, while some accelerators like YCombinator make conversion a hard rule, others like Boost VC, while still encouraging it, don’t go as far as making it conditional to their investment.

Finland-based Vizor raised $2.3 million in seed funding last May led by DeMiroz’s VR Fund and Finland-based Inventure and wasn’t required to uproot from Europe as a condition of the deal. “We invested in two companies in Finland, Varjo and Vizor, and one in Japan, InstaVR,” DeMiroz told me. “We are open to investing in outstanding companies outside the U.S. as long as we have local VCs to collaborate with and we are comfortable with the basic investment and legal framework of that country.”

These kinds of cases set positive precedents for an altogether new trend where Silicon Valley meets Europe half-way. Whether they encourage more EU venture funds to step out of their comfort zone is an open question. But the EU’s startup community is certainly counting on it.

Amir Bozorgzadeh is cofounder and CEO at Virtuleap, the host of the Global WebXR Hackathon and the startup powering up the Gaze-At-Ratio (GAR) XR metric.