5 reasons for angel investments in CEE region
I have been active investing in early-stage startups through Contrivance Ventures in the past year. In this post I want to lay out the reasons for focusing on Central and Eastern Europe (CEE) as a region.
In an ever-connecting world, the location of a startup matters less and less. While Silicon Valley remains the classical hotbed of innovation and startups, it isn’t what it used to be. Startups are leaving Silicon Valley due to its high cost of living and the disadvantaged tax environment. At the same time, investors are realizing the value and potential of new talents from lesser-known regions around the world.
If both talent and smart money are leaving the Silicon Valley, where should they go? Among other places, we have recently seen many unicorns from the CEE region, such as Spotify and BOLT from Estonia, Vinted from Lithuania, InfoBip from Croatia, and Grammarly from Ukraine.
Furthermore, we invest in startups from the CEE region for these reasons:
1. Low labor cost and low cost of living
Compared to the US and Western Europe, labor and living expenses cost significantly less in CEE. While the development of an enterprise software MPV costs about EUR 10K, an equivalent MVP developed in Western Europe would cost around 10 times that. This means funding goes further and for startups, this gives them the edge compared to peers located in the US or Western Europe.
Take Ukraine for example, when compared to Western European countries (Germany, Switzerland, UK, etc.) and the United States, low labor cost and low operational cost give Ukrainian startups a significant advantage in expenses [1], [2], [3]. This fact is most visible in the stark differences of GDP per capita:
For startup investors, their investments will have a greater impact on their portfolio companies, by leveraging CEE’s competitive labor market.
2. Favorable tax structure
CEE also enjoys favorable corporate tax rates ranging from 9% in Hungary, 15% in Russia, 18% in Ukraine, and to 21% in Slovakia. Compared to its Western European counterparts, which ranges from 12.5% in Ireland, 22% in Sweden, 29.9% in Germany, and to 31% in France. [4].
3. High-skilled technical talent
CEE countries have strong education systems, particularly in the fields of STEM and medicine, which is part of the Soviet legacy. This is reflected in the number of technical talents that graduate in engineering and sciences every year from the CEE region universities. According to a study by HackerRank [4], Czech Republic(9), Hungary(5), and Poland(3) rank among the top 10 best countries with the best developers.
Another proxy for the same metric is educational achievement, as measured by the PISA test. Even though the GDP per capita is significantly lower (and with this also the education spending per child, CEE countries hold up well in international comparisons. The below graph shows mean performance of high-school children in science
The yellow-marked CEE countries hold up well against other European countries, with especially Estonia, Poland and Slovenia in the top five European countries. An early and broad understanding of STEM-subjects is a good indicator for people who go on to build good products later
4. Underserved market compared to EU and US:
Compared to Western Europe and the US, where angel investing is mostly structured, institutionalized, and well funded, angel investing in the CEE region is much more unorganized, sparse, and random. Reasons include local legal environments and limited public information on startups.
In most CEE countries, angels do not have investor accreditation due to the absence of legal certification similar to that in the USA, which makes the investment process difficult and deters angels from publicizing their investments. Additionally, most angels in the CEE region largely depend on their networks to find investment opportunities, which results in a small number of investments, usually 3–4. With the lack of portfolio strategy due to limited investments, few angels make it with satisfactory returns over the years. While limited data is available, we suspect most CEE angels are shielded from investment opportunities due to the above factors.
While the amount of venture funding has grown to an impressive €338 million across 369 deals as of 2019(see graph), the CEE region is still significantly underfunded compared to its counterparts in the EU/US, €28.81 billion across 2215 deals in the US, €12.05 billion across 1425 deals in the UK, and €5.6 billion across 444 deals in Germany, and €3.7 billion across 424 deals in France.
The disproportionate amount of funding versus the amount of talent in the CEE region led to our belief that the CEE region is underserved and full of potential [6].
While the trend is growing nicely, the total investment of 338m in early stage and venture stage is very small. As a comparison, the figure including the rest of Europe comes in at more than 10 billion:
This is another indicator that the CEE region is getting too little attention from investors.
5. Closeness to Western Europe:
While China or India may have even lower labor costs and on par with talent, CEE countries are positioned uniquely with its cultural similarity and physical locality closely correlates with Western Europe. These similarities produce business cohesion and promote team efficiency.
Culturally, English is widely spoken in the region and CEE founders are familiar with common business practices in Western Europe. Additionally, more than half of the CEE countries have adopted the Euro as their main currency.
Physically, CEE countries are located closer to Western Europe compared to China or India, which enables both parties to be in the same if not near the same time zones, faster and easier travels, and overall more efficient in terms of communication/mobility.
For the reasons above, we are investing with a focus on the CEE region. We are open to partnerships & co-investing. Contact us via info@contrivanceventures.com.
Sources:
[2] https://www.daxx.com/blog/development-trends/average-rates-offshore-developers
[3] https://www.statista.com/markets/414/topic/460/real-estate-rental-leasing/
[4] https://blog.hackerrank.com/which-country-would-win-in-the-programming-olympics/
