Can the local business culture determine where the next startup hub will be?

Can the local business culture determine where the next startup hub will be? Valithea AdvisoryAs many world economies develop and join the ranks of developed countries, and as many third-world countries develop fast and start bringing unique innovations to world markets, it’s fair to wonder if their startup hubs can ever reach the level of Silicon Valley. Maybe that would be a stretch, but there are new startup ecosystems that have received a lot of attention lately. Is it important for a business to be in an efficient startup ecosystem to represent a good investment? How do we determine whether a new country can create a thriving business environment for both startups and businesses: is it the level of income, the available capital, the transactions or is there more that determines success? Is there such as thing as an entrepreneurship culture?

The best startup hubs in the world also tend to be in some of the countries or cities with the highest income per capita and with a developed private business sector. However, startups have been highly concentrated in few places, whereas there are many wealthy countries with profitable private sectors with not very famous startup hubs. It’s not necessarily a negative thing, as it’s unclear how much disruptive startups contribute to the economy compared to more traditional business industries. However, many new businesses nowadays are brought on the market in the form of a scalable startup, even though not all of them will be: that’s because most new businesses use or produce modern technology, and by tweaking their business models to appeal to institutional investors, especially when they do not have a wide network, business owners can access larger amounts of capital, which can appear as an advantage. Also, because companies in many fast-growing sectors receive large amounts of capital, new companies entering these sectors are forced to do the same to be able to compete. In the future, therefore, the countries that have the most active startup hubs may also correspond to the countries with a thriving private sector.

Most startup hubs are concentrated in the USA, while London, Tel Aviv and Toronto often figure among in the top positions in most startup ecosystems rankings. Berlin, Moscow, Beijing, Stockholm, Bangalore, Amsterdam, Sydney, Tokyo and Singapore are also worthy mentions that usually make the top of the list. StartupBlink ranks the ecosystems according to Quality, Quantity and Business Environment. Startup Genome‘s ranking methodology is instead based on 7 key criteria: Performance, Funding, Market Research, Connectedness, Talent, Experience, and Knowledge. All these factors are connected to each other; some of the fundamental factors of a thriving startup ecosystems are usually:

  • the availability of capital
  • the ability to hire talent
  • access to know-how and support from institutions
  • participation of other local businesses in the promotion of startups and in innovation
  • an active exit market

The more some of these elements are presents, the more they attract new talent and new capital. Also, once a startup ecosystem develops, talent and startup experience increases as employees and founders move from one startup to another. Local support, education and know-how, instead, are slower to develop, while businesses get involved only once they find increased innovation and collaboration to be profitable for their growth. Once the first pioneers start trends and set up events, they give an opportunity for businesses to start collaborating. An active exit market, instead, develops over longer periods of time due to an increasingly globalised economy that can attract foreign buyers and thanks to structural reforms in the country that allow for easier transactions.

The most important factor for the development of a startup hub is the availability of capital. Capital not only gives a chance for new businesses to scale and compete internationally, but also decides on what types of companies and technologies have more potential. Venture capital works on establishing connections, provides know-how and investors can push for faster growth and an early exit, changing the strategy of companies that receive funding. Does a country’s economy determine the availability of capital? Yes, partly, as many of the countries with the highest GDP, or GDP per capita, especially countries that appear at the top of the list in both categories, figure among the countries with most venture capital investments, but not all. There is a strong correlation, but for example the number and size of investments in the United States is more than half the total VC investments according to many statistics (OECD, Statista); Israel has the highest startups per capita and the highest VC investment amount per capita, $674, more than double the US figure ($303). It is clear that the investment industry in these countries is not an afterthought, but rather it was driven by a variety of private and public initiatives to develop new technologies, to develop businesses that can compete internationally and put the country on the map. In fact, we see many wealthy countries with less political stability and less initiatives to develop the private sector and compete internationally that do not have relevant startup hubs. It is true that early-stage investments usually takes place locally, but there is an increasing trend for cross-border startup investments in markets that have produced technologies that can compete internationally, and capital can move quickly when new opportunities arise.

Another important factor that is specifically important for startups is the size of the country’s population. Scalability is key to any startup model, and expanding abroad involves costs and adaptation for all new countries entered, in many cases. This is an obstacle that can be overcome: for example Israel is one of the smallest countries on the list, but many there have developed networks and strategy to quickly scale internationally, particularly in the US.

There are now many markets in regions such as South East Asia, Sub-Saharan Africa or South America that are becoming increasingly interesting for new business. The demographic make-up of these countries, with a younger population, as well as a growing middle class thanks to increasing income per capita, offer many opportunities, as well as the possibility to introduce totally new business models. Is this enough to attract early-stage capital? All of these regions certainly have a growing venture capital industry.

But there is also an important factor that is key to the success of a venture capital investment: the exit. The timing and size of an exit, and whether an exit materialises in the first place, will determine the risk and return profile of the investment. Even in the US, many companies do not meet the exit expectations set by VCs, and many startups do not end up being acquired or going public. Even if they survive and become somewhat profitable, for an investor it still represents a failure as the investment did not generate a return. The likelihood of an exit does not only depend on the quality of the company itself, but to a large extent also on the market. Aspects that facilitate an exit are:

  • Companies in the country that are acquisitive, since most acquisitions are domestic, or regional (which increases where there is a better know-how on acquisitions and post-merger integration, or where there is a culture more open to risk-taking and fast-growth)
  • An acquisitive sector, meaning that there is a higher gain and synergies from purchasing a company than developing the same capabilities internally
  • An active international acquisition market, which is respectively helped by a growing tech economy, barriers to entry, the ease of integrating a local company, and examples of other large successful acquisitions
  • The ease and speed of carrying out an acquisition, investors’ rights and the absence of legal barriers

The latter point is also a reason why many companies set up their headquarters in Western countries and subsidiaries in countries where investor rights are less certain, to reduce the risk and attract additional investments. In short, the lack of significant exits would usually scare away institutional investors, unless the opportunity is big enough to risk complications (or by planning a later move of the company’s headquarters). We can certainly say that when it comes to exits, culture does play a role, even though it is hard to measure to what extent. Acquisitions that involve the integration of teams and management work best when there is a cultural fit, and a more risk-taking or trusting CEO could be more likely to expand through acquisitions, while a more conservative approach is that of developing capabilities internally, which in turn influence the structure of the economy.

Entrepreneurship likely has its roots in culture as well. How do we determine a population’s drive for growth? We could, for example, measure the number of businesses, or new businesses for every 1,000 individuals as an effect of entrepreneurial culture. Most businesses are not startups, but these sources help determine the level of entrepreneurial activity globally and what influences it (Global Entrepreneurship Monitor, OECD Entrepreneurial Determinants, Global Entrepreneurial Index or GEI). Many of them mention, and measure through surveys, factors of entrepreneurial culture such as perceived opportunities and capabilities, fear of failure, entrepreneurial intentions, status: these factors likely originate from the entrepreneurial history of the country itself. Other economical factors are the necessity to introduce certain products to solve specific problems, the job market, regulatory framework, market conditions and access to finance. Capabilities and the sharing of knowledge vary from country to country for a variety of reasons, but they can also develop quickly once opportunities start becoming available. The GEI also mentions factors such as the ability for product and process innovation, the intention to grow and expand internationally: in my opinion, these factors are the ones that are most rooted in culture and not always dependent on the current state of the economy. How far someone goes to in terms of developing a product or to grow a business, as well as hiring a team, depends on the initial intentions and drive of the individual.

This drive for innovation and growth may find its perfect breeding ground where there is a good balance of negative and positive aspects, where on one side there is a low fear of failure and developed entrepreneurship system with a potential for high income, and on the other side where there are problems to solve and a not very developed welfare state. In other words, the drive for entrepreneurship can be noticed in places with high rewards for entrepreneurship due to low structural barriers, but it is also less prominent in places where quality of life is the highest. The top ten cities with the highest quality of life do not have the biggest or most relevant startup hubs: they don’t score too bad, but the cities that score best among these is Vancouver, at place 24-25 of startup ecosystems rankings. In the end, startup entrepreneurship is aimed at solving problems, and the ability of solving problems may well be a muscle that needs to be trained.

Should hubs in less developed economies be overlooked instead? There are many less developed countries that are investing in their future by improving their startup ecosystem. If you had to invest in a startup in one of these new but emerging startup ecosystems, all else being equal, in which one would you invest?

VietnamGeorgiaColombiaNigeria
Main ecosystemHanoi/ Ho Chi Minh CityTbilisiBogotáLagos
GDP per Capital USD  2,600   4,700   6,7002,000
Population    95,500,000  3,700,00049,000,000 191,000,000
GDP Growth6.80%5.00%1.80%0.80%
Ecosystem Ranking StartupBlink2293115299
Businesses for every 1,000 peoplen.a.8.42.30.8
Ease of doing business70767131
Quality of life153187128212
GNI877747101
Sources: World Bank, StartupBlink, Mercer

Taking a representative of developing economies in different regions of the world gives us an idea of how difficult it is to foresee whether any of these countries could produce a future startup hub. While there are some statistics that are skewed by less relevant factors (and inconsistent across different sources in some cases), such as the decrease of Nigeria’s oil market size which affected GDP, and the ease to set up a business in Georgia by internationals, Colombia seems to come out on top. The country has a longer-standing and more developed ecosystem, having also a higher GDP per capita and a more established economy. All of these regions are widely different, but they all have underdeveloped ecosystems with a large potential for growth, while we did not considered countries that still present too many barriers to compete internationally. Georgia would certainly be impaired by its very small size, but it still represents an interesting development as it has introduced measures to allow internationals to easily set up a local business: we will likely see an increase in its startup ranking over the next few years. While Nigeria has had quite an active startup ecosystem and a booming tech sector, Vietnam’s emerging ecosystem may overtake that of Nigeria if it manages to eliminate some structural barriers, also being a much easier place of doing business and with a growing economy, even though strict limits on foreign ownership will remain.

Vietnam is a very interesting case with a still uncertain but potentially exciting future. For example, the country has limits on foreign ownership on certain assets, which could limit growth in certain sectors, particularly if the supply of capital moves to countries with fewer barriers in the future. The highest smartphone and app engagement in the region is contrasted by the low online payment rate due to cultural and structural issues. Recently a well-funded eCommerce startup has closed its doors, which quickly prompted the government to scrap plans to limit foreign ownership in e-payment firms: a very positive sign that shows the commitment to promote local business development for the right sectors. With two major cities and potential hubs, we see many new startups being founded in Ho Chi Minh City, which is typically the favoured destination for young entrepreneurs. The vibrant economy, large population, strong entrepreneurial culture, a growing middle class and increasing quality of life all point to many opportunities potentially originating from or being connected to Vietnam.

So far, there is not clear evidence as to whether tech startups have a considerable contribution to GDP growth, since their focus on revenue and profitability takes place later, but they contribute significantly to job growth. Traditional businesses, new or old, small entrepreneurship and corporations have shown to have a more significant GDP growth contribution. However, in the future, if older business models can be replaced with new ones, and businesses become increasingly more digital and scalable, startups may determine the future of an economy. Sometimes, it takes one success story to spur an increase in entrepreneurship, to increase foreign early-stage funds investments, to encourage acquisitions within an industry and to change consumer behavior. That is why investing in the development of a startup ecosystem can produce many failures with little impact, but it can also produce unexpected successes with large and long-lasting effects for the economy (even though a long time span for results is to be expected). Some of the wealthiest countries and regions with a successful private sector do not have the most successful startup hubs, while other countries are becoming more competitive internationally by investing into their tech sector. In the medium to long-term, richness may no longer originate from natural resources, but it could increasingly depend on who owns the most powerful technologies or companies. The availability of capital, a skilled workforce, collaboration and an active exit market may determine which economies will grow most in the future. These factors are facilitated by both economic and structural advantages, as well as by cultural advantages, and therefore progress will not be linear and it will not always be obvious to pinpoint which countries will fare best in the future.