Thinking of going international? For startup entrepreneurs, the European Union-based ones in particular, Eastern Europe is one of the most popular directions. But what country should they choose?
This article examines the current European business conditions. It also aims to assess the threats and opportunities that the Bloomberg’s three Eastern European Best for Business countries provide to the entrepreneurs. The conclusions are based on the data provided by ESM, GEM, and WEF, as well as (of course) Bloomberg (European Edition).
Other sources were quoted as needed.
Time To Go International
In 2015, European startups raised — on average — 2.5 million Euros in external capital. More than half of them were operating on international markets. 8 out of 10 of the remaining half were planning further internationalization in the next 12 months [ESM 2015 REPORT, pg 7]. As of 2016, their earnings have risen up to 2 billion Euros. 77.7% were operating on international markets or planning further internationalization [ESM 2016 REPORT, pgs 6 to 7].
More than 90% have rated their current business situation as good or satisfying [ESM 2016 REPORT, pg 7].
Interestingly: 47.0% of those planning further internationalization intend to expand to other European countries [ESM 2016 REPORT, pg 33].
The meaning behind these statistics is simple:
THE CONCEPT OF INTERNATIONALIZATION ITSELF IS NOTHING NEW IN BUSINESS. IT IS THE OPPORTUNITIES THAT THE EUROPEAN UNION PROVIDES THAT MAKE THIS OLD CONCEPT ATTRACTIVE ANEW.
Some more numbers. 2015 saw 7.6% of startup founders coming from EU countries other than the location of their startup [ESM 2015 REPORT, pg 7]. 2016 saw the share increase by 8.6 percentage points to 16.2%. “79.6% of male founders formed their startup in their country of residence”, the European Startup Monitor 2016 report states, “This is only the case for 75.8% of the female founders”. Meanwhile: The share of non-EU founders has grown from 4.3% to 4.8%. “The percentage of female founders from non-EU countries (5.5%) is slightly higher than the percentage of male founders from non-EU countries (4.6%)” [ESM 2016 REPORT, pg 42].
“The highest share of non-EU founders was found in Poland (33.3%)” [ESM 2016 REPORT, pg 42].
The pros of well-prepared-well-executed internationalization seem obvious. The reasons to go international — both strategic and financial — are there. The question Should I go international? is no more. The question is: Where to?
For the EU entrepreneurs the answer is simple:
Eastern Europe is the place.
Place To Go International
Eastern Europe is the place indeed. That being said: Some locations are preferable to the others. Some countries can prove to be better.
There is a number of factors that are worth taking into consideration before expanding. The things to consider are numerous and varied. Depending on the profile of their startup, entrepreneurs might find themselves looking into things as far from each other as workforce costs and road infrastructure, not to mention various costs, taxes included. Some of these factors matter more, others — less. Some are important. Others are trivial. The general rule is that the more things we take into account, the better our chances of succeeding. Besides that, there are no rules, there are only pros and cons, differences, threats, and opportunities.
The most attractive Eastern European directions for expansion are Poland and the Czech Republic, with Poland named Bloomberg’s Best for Business in East Europe, Czech Republic its close peer. What makes Poland stand out among the other Eastern European countries is — Bloomberg’s Piotr Skolimowski reports — its fast-expanding consumer market and fast-improving infrastructure (this includes roads and bridges). The same goes for the Czech Republic. The difference between the two is — the conclusion can be drawn — that the later has suffered much more economic damage due to the global financial crisis of 2008 and the following recession.
The third Bloomberg’s Eastern European Best for Business is Hungary. Whether or not it is as good as Poland and the Czech Republic remains questionable. There are reasons to doubt it (some of them — political). That being said: Hungarian regulators are doing a lot to strengthen the bonds between the government and the entrepreneurs. Numerous tax breaks and low workforce/workspace costs do a lot to make up for political problems. Still: It might be better to start there — rather than to expand there.
Map of Europe + three Bloomberg’s Eastern European Best for Business countries.
Funding vs. Expenses in Poland and Czech Republic
Let us take a look at Poland first.
In 2015, 34.3% of Polish entrepreneurs had financed their startups with their own savings [ESM 2015 REPORT, pg 51]. 18% have claimed to have enough resources and thus have not planned to refer to the other — external — sources of capital within the next 12 months [ESM 2015 REPORT, pg 55].
64% were going for small to medium amounts of it [ESM 2015 REPORT, pg 55].
That was possible because of two reasons. One: The workforce in Poland is relatively inexpensive. The average Polish annual wage is more or less 22.000 Euros. Two: It is inexpensive to rent the workspace. Even in the biggest cities, the rent is rarely more than 1.000 Euros per month. Although the average annual startup revenue is not the biggest one — 53.9% of Poland-based startups have made less than 50.000 Euros/12 months in 2016 — it should be enough to double (or even triple) the costs with ease (taxes included) [ESM 2016 REPORT, pg 75].
The percentage share of Polish startups earning more than 50.000/12 months has risen from 26% to 46.1% in the last 12 months. 7.7% earn more than 500.000 [ESM 2016 REPORT, pg 75].
This rapid growth is supposed to stabilize in 2017.
The percentage share of Polish startups that have already received external capital as of 2016 is 69.2% [ESM 2016 REPORT, pg 79]. 82.6% seek to raise additional external capital within the next 12 months [ESM 2016 REPORT, pg 81]. The most important sources of external financing for Polish startups are: EU funds, VCs, business angels, and Polish public funds (e.g. the National Centre for Research and Development and the Polish Agency for Industry Development) [ESM 2016 REPORT, pg 9].
The numbers for the Czech Republic are similar. In 2015, 47.6% of Czech entrepreneurs had financed their startups with their own savings [ESM 2015 REPORT, pg 51]. 15% have claimed to have enough resources and thus have not planned to refer to the other — external — sources of capital within the next 12 months [ESM 2015 REPORT, pg 55]. 85% were going for small to medium amounts of it [ESM 2015 REPORT, pg 55].
Although the average Czech annual wage is lower than Polish — it is more or less 20.000 Euros — the minimum monthly wage is higher. The wage gap is also lesser (making the general costs of maintaining the workforce higher). The costs of renting the workspace are closer to the Western European standards as well. That being said: The accommodation standards are also better. It is also v. popular to share office space. This makes it less of a problem for sociable entrepreneurs to find their place there. Besides: Shared office spaces have been proven to stimulate creativity.
But there is also the pros side. The higher general costs are balanced by the higher general income. The percentage share of Czech startups earning more than 50.000 Euros/12 months is 59.1%. This is 13 percentage points more than in Poland. Additionally: 27.3% earn more than 500.000. This is over three times more than in Poland [ESM 2016 REPORT, pg 75].
The percentage share of Czech startups that have already received external capital as of 2016 is 66.7% [ESM 2016 REPORT, pg 79]. 68% seek to raise additional external capital within the next 12 months [ESM 2016 REPORT, pg 81]. The most important sources of external financing for Czech entrepreneurs are the same as for Polish.
The conclusion? Poland is less expensive to expand to. Expanding to the Czech Republic might require a larger initial expenditure. That being said: The return of investment might prove larger as well.
The following infographics represent the most important differences:
Percentage of entrepreneurs that have financed their startups with their own savings in 2015: Poland: 34.3%, Czech Republic: 47.6%.
Percentage of entrepreneurs that were going for external capital in 2015: Poland: 82%, Czech Republic: 85%.
Percentage of entrepreneurs that have received external capital as of 2016: Poland: 69.2%, Czech Republic: 66.7%.
Startups seeking to raise external capital in 2017: Poland: 82.6%, Czech Republic: 68%.
Percentage of startups earning more than 50.000 Euros/12 months: Poland: 46.1%, Czech Republic in 2016: 59.1%.
Avg. ann. wage: Poland: 22.000 Euros, Czech Republic: 20.000 Euros.
Sources: ESM 2015 REPORT, ESM 2016 REPORT.
Funding vs. Expenses in Hungary
The big Eastern European number three on the Bloomberg’s Best for Business list is a little bit different. Let us take a look at it.
In 2016, 20% of Hungarian entrepreneurs have financed their startups with their own savings [ESM 2015 REPORT, pg 78]. 29.3% have claimed to have enough resources and thus have not planned to refer to the other — external — sources of capital within the next 12 months. The remaining 70.7% were going for various amounts it [ESM 2016 REPORT, pg 81].
This is where the things are getting interesting.
Only 34.4% of those planning to refer to external capital were going for small to medium amounts of it. The remaining 65.6% had more ambitious plans: 27.6% had planned to raise up to 250.000 Euros within the next 12 months, 6.9% — up to 500.000, 17.2% — up to 1 million. 10.3% had planned to raise up to 2 million. 7.1% — up to 5 million. [ESM 2016 REPORT, pg 82]. These plans can be seen as the response to the new state-funded capital programs that are to open in the second half of the decade the total value of which is 550 million Euros [ESM 2016 REPORT, pg 8]. Compared to the rest of the Europe — that is a lot. That is much more than a lot.
“The relationship between Hungary’s regulators and the startup world is strengthening”, Design Terminal’s Gergely Böszörményi Nagy writes for the European Startup Monitor 2016 report. “With results such as a new angel tax break and a Digital Welfare Program. Regulation tailored to the aims of Industry 4.0 is in the making. This will allow startups to be more integrated. Initiatives, both top-down and bottom-up, are being born all over the country. In the last year, eight accelerators have launched in the countryside and three in Budapest, together with half a dozen new co-working offices” [ESM 2016 REPORT, pg 8].
It is also worth the mention that the average Hungarian annual wage is lower than the Czech one. The wage gap is larger too. The costs of renting the workspace are varied depending on the location (in the biggest cities the rent can be Western European-kind-of high). This makes the overall costs of having a startup lower.
Percentage of Hungarian entrepreneurs that have financed their startups with their own savings in 2016: 20%.
Hungarian startups seeking to raise external capital in 2017: 70.7%.
Percentage of Hungarian startups earning more than 50.000 Euros/12 months in 2016: 45.5%.
Avg. Hungarian ann. wage: 20.000 Euros.
Source: ESM 2016 REPORT.
Tax Breaks For Startup Entrepreneurs
Taxes can be a problem — that is nothing new. The problem is even more serious when it comes to foreign taxation. That is one of the reasons it is advisable to consult a professional tax advisor before expanding (or even — to consult several of them). When it comes to such consultations, one of the most important topics of discussion — if not the most important one — should be tax breaks for entrepreneurs.
There are tax breaks available for entrepreneurs in each of the three mentioned countries. In each of them, they take different form — though — and are based on different law regulations. Technicalities aside — these are the matter to discuss with consultant — the most popular options are:
- tax incentives and special economic zones in Poland,
- foreign tax credits, investment incentives, and research and development allowances in Czech Republic,
- regular corporate tax incentives and breaks in Hungary — as well as the planned tax break for startup entrepreneurs (similar to the one that German government offers to its entrepreneurs).
Normal tax incentives allow entrepreneurs to be exempted from the corporate income tax. Depending on the legal basis of the exemption, it can be either complete or partial, the later being (of course) much more common. Allowances are another thing. The research and development allowance available in Czech Republic is the perfect example. It allows the entrepreneurs to deduce the costs of research and development from the tax base. The costs that can be deduced include — but are not limited to — personnel costs of the R&D engineers (as well as the materials used in the R&D process). Other costs can also be deduced from the tax base. These costs are e.g. telecommunication fees, water, gas.
Each of the mentioned countries offers a number of interesting allowances.
Special economic zones are also interesting. Entrepreneurs that operate within them receive various incentives and breaks. The exact characteristic of each of these incentives and breaks are dependent on the particular zone. To operate within one — however — the entrepreneur has to obtain a permit from the government (which is granted based on whether the business meets the criteria of the economic zone). Though this might sound like it is a lot of a hassle, often it proves easier than it can seem, as the economic zones are established to stimulate the business growth in their region and thus serve both the entrepreneurs and the government.
It is also not unusual for entrepreneurs in these countries to refer to business incubators/builders/accelerators. These institutions allow them to be completely or partially exempted from taxes. All the top three Bloomberg’s Best for Business countries have a lot of business incubators. The solution itself is becoming more and more popular.
The following infographics represent the most popular tax breaks per place:
Most popular Polish tax breaks: tax incentives and economic zones.
Most popular Czech tax breaks: foreign tax credit, investment incentives, and research and development allowances.
Most popular Hungarian tax breaks: regular corporate tax incentives and breaks. Planned tax break for startup entrepreneurs.
Most Popular Sources of European Startup Financing in 2015 and 2016
The following charts showcase the most popular sources of European startup financing as of 2015 and 2016.
Savings of founders (private capital of founders): 69.1% in 2015, 84.5% in 2016.
Friends and family: 25.1% in 2015, 29.6% in 2016.
Government subsidies (governmental funding): 21.9% in 2015, 26.5% in 2016.
Angel investor: 21.3% in 2015, 23.8% in 2016.
Internal financing (operating cashflow): 14.8% in 2015, 18.6% in 2016.
Incubator/company builder and/or accelerator: 13.5% in 2015, 16.2% in 2016.
Venture capital: 12.6% in 2015, 18.1% in 2016.
Bank loans: 9.3% in 2015, 14.4% in 2016.
Other capital resources: 4.7% in 2015, 1.8% in 2016.
Crowdfunding/crowdinvesting: 3.8% in 2015, 3.6% in 2016.
IPO: 0% in 2015, 0.1% in 2016.
Sources: ESM 2015 REPORT, ESM 2016 REPORT.
Addendum. Understanding Competitiveness
To better understand the processes behind business internationalization we have to understand what makes some countries better for the companies to expand to than the others: we have to understand competitiveness.
Using the basic framework for measuring the economic growth — the same twelve -pillars -of -competitiveness -based framework that is used in the World’s Economic Forum’s Global Competitiveness Report — we can separate the regional economies into three specific stages: (1) FACTOR DRIVEN, (2) EFFICIENCY DRIVEN, (3) INNOVATION DRIVEN. This diversification is based on their (1) institutions, (2) infrastructure, (3) macroeconomic environment, (4) health and primary education, (5) higher education and training, (6) goods market efficiency, (7) labour market efficiency, (8) financial market development, (9) technological readiness, (10) market size, (11) business sophistication, and (12) innovation.
The EU countries are mostly in the innovation-driven phase. The EU companies compete primarily on the basis of innovativeness. The innovativeness is understood here as the ability to harness the new technological and non-technological knowledge in the process of production. “Innovation can emerge from new technological and non-technological knowledge”, we read in the Global Competitiveness Report 2014-2015. “Non-technological innovations are closely related to the know-how, skills, and working conditions that are embedded in organizations and are therefore largely covered by the eleventh pillar of the GCI [business sophistication]. The final pillar of competitiveness focuses on technological innovation” [GLOBAL COMPETITIVENESS REPORT 2014-2015, CHAPTER 1.1, METHODOLOGY SUBSECTION].
“Technological breakthroughs have been at the basis of many of the productivity gains that our economies have historically experienced, we read further. These range from the industrial revolution in the 18th century and the invention of the steam engine and the generation of electricity to the more recent digital revolution. The latter is not only transforming the way things are being done, but also opening a wider range of new possibilities in terms of products and services. Innovation is particularly important for economies as they approach the frontiers of knowledge, and the possibility of generating more value by merely integrating and adapting exogenous technologies tends to disappear” [GLOBAL COMPETITIVENESS REPORT 2014-2015, CHAPTER 1.1, METHODOLOGY SUBSECTION].
This is no different when it comes to the startups. According to the ESM 2016 REPORT: Most [European] startups (89.5%) consider their products to be novel in the market. More than half say their products represent an international market innovation [ESM 2016 REPORT, pg 29].
Furthermore: 64.7% believe their business model to be innovative. 70% claims the same of their tech. 66.4% — of their processes [ESM 2016 REPORT, pg 29].
Which countries are better to expand to for these startups: the ones that are in the innovation-driven phase of development — or the less-developed others? Although the answer seems obvious — it is: the less-developed others — we should not trivialize it. There are pros and cons to each direction. Each location has its share. What is interesting is not whether this particular location is preferable for the entrepreneurs to expand to or not — it is the reason it is. This is where the understanding of the twelve pillars of CGI becomes useful.
It is understandable that the companies that originate in the innovation-driven regions have an edge over those originating elsewhere. But the innovativeness of our product can sometimes prove to be its limitation: Who is going to use our top-notch high-tech mobile if there is no proper telecommunication infrastructure in the region to begin with? This example can be a little bit too bright — there is no disagreeing — but the general rule applies. This is one of the reasons behind the fact that the innovation-driven economies-based companies prefer to expand to regions on similar level of development. Eastern Europe is perfect for Western European companies for this exact reason: there is a market for their products there, but there is no competition — or at least no direct one. Eastern Europe is read for Western European innovations — but it is unable to outcompete them itself.
Whether or not it is as close to closing this gap as it is believed to be remains to be seen.
The following infographic showcases how the level of regional competitiveness & development is dependent on the twelve pillars of CGI:
The twelve pillars of CGI.