On improving Finland’s startup ecosystem

Posted: March 20, 2011 in Ecosystem

Earlier today, Taneli Tikka and Lasse Männistö published a proposal to renew startup financing in Finland. Please find below my quick comments on this proposal.

First, I fully agree on creating “market-driven” incentives for angel and seed funding and simplifying the public system.

Regarding incentives for private investments, I would prefer a model where early-stage private (angel, seed and even corporate) investments in growth companies are matched by public money with a certain multiplier (e.g. 3-5x as in many of the countries you mentioned), and the private parties could later buy the public shares with e.g. the original purchase price + a good interest, generating a good ROI for public money.

The advantages of this model would be as follows:

  • Private investors could make significant returns from successful early-stage investments and the government would make a decent profit from them as well, as opposed to e.g. a grant that is “money lost”.
  • Public money wouldn’t skew the valuations of the startups or prefer any investors, assuming that this vehicle would be open for all the domestic and foreign investors.
  • If the company is sold or goes bankrupt, investors don’t get any returns unless the government gets them as well (it would have the same shares and associated preferences as private investors).
  • Managing this system wouldn’t require that much public resources, because the private investor could represent the government in “monthly decision making” and their incentives would be quite nicely aligned.

I’m intentionally limiting this mechanism to early-stage investments to growth companies, because I think the market works well in later-stage deals. In addition, matching later-stage investments would require much more capital. Seed and especially angel investments, on the other hand, are relatively local and, unfortunately, it will take time – as it did e.g. in Israel and even in the Valley (DARPA projects etc) – before the ecosystem matures and the government can selectively withdraw its support. I believe the biggest problem with this approach is defining an “early-stage growth company”, but this is still easier than trying to allocate public subsidies to the best companies. (We all know how hard it is to forecast which startup is going to succeed.)

Regarding R&D-related tax breaks, I’m not sure whether they would be very helpful. True growth companies are rarely profitable at the time the tax breaks would make a difference and, at a later stage, one shouldn’t encourage them to invest in unnecessary R&D activities, compared to investing in, let’s say, customer acquisition.

Although the discussion around the public financing system is important, it’s way too often used as an easy excuse for us having too few growth companies. In fact, I think most of the people focused on bashing the current public system are missing the key point:

We don’t need to renew startup financing in order to create more growth companies: instead, we need to found and fund more growth companies.

Good entrepreneurs don’t depend on public financing. If it is available, they naturally use it as their advantage, but in the end it is just a bonus that doesn’t make or break a startup. In addition, currently, all the decent (in terms of the team and business idea) growth companies can get at least a Tekes R&D loan/grant by filling a few forms, which should enable most companies to prove themselves in order to attract private investments. Actually, despite of its obvious weaknesses, our public financing system performs relatively well. It’s true that it should be improved, and Taneli and Lasse summarize well the discussion within the startup community, but it’s not the core problem we need to work on.

What we need to do is to create a culture that encourages founding ambitious, born global startups: we need public discussion on the importance of growth companies and the joys of being an entrepreneur or working at the startup; we need experienced entrepreneurs to mentor the younger ones; we need to “expose” students to startups, like the AaltoES Enternship program is doing; we need, and we will have(!), an increasing number of success cases similar to MySQL, F-Secure or Rovio; we need more angel and seed investors; and, most importantly, we need a huge number of new startups to reach a critical mass that attracts VCs, international media and partners to Finland.

So, if you want to improve the Finnish growth company ecosystem (and save the welfare state as a by-product), found a startup, apply to work for one or invest in one. It’s that simple, really.

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Comments
  1. Taneli Tikka says:

    Hi, good thoughts and alternate views, thanks! It’s vitally important to keep the discussion going and to demand action from the decision makers. Now when the topic is hot and current it should not be abandoned until things change.

    You are very much correct in saying that the culture is the main thing. That’s also the most demanding to change. No journalist is interested in writing about entrepreneurial culture and decision makers renounce their responsibility in making change happen. The most apparent display of this unwillingness to change can be seen in education and the school system, from kindergarten to universities. They would have such a big role in changing the attitude and the culture, but their whole reward mechanisms and structure isn’t geared to this at all. Also people in charge of education policy are totally absent from this discussion: not there to hear, not there to comment and certainly not there to be a part of the change. Since we need to start from
    Somewhere we felt that this would be a realistic place to start, and hopefully we can even get all the way to attitude and culture somewhere along the way.. I suggest that you try to touch this topic on the Monday’s event: ask from the audience how many of them are from the ministry of education or from the board of education. And how many of them are involved in any kind of initiative to introduce a cultural change into education towards more positive entrepreneurship. I bet both figures (people present and people involved) is very close to zero. They are absent from the whole debate – and in this we miss out on a lot.

  2. Taneli, you’re right about both the media and educational system.

    I’m seeing signs that media is once again starting to cover startups, although the difference between e.g. ArcticStartup and mainstream media is still huge. A few individual, “high-profile” journalists are excited, but critical and careful, which is the way it should be.

    As a father of two elementary school students, I really like the teaching and books compared to both the UK and the old days in Finland. In addition, at least my daughters’ school gives students a lot “entrepreneur-like” responsibilities and challenges.

    On the other hand, universities have sucked, and still suck, in anything entrepreneurial. Luckily, students have started to rebel against that, Aalto Entrepreneurship Society being perhaps the best example of this. In addition, the current Rector of Aalto University seems quite radical compared to her predecessors and has protected the student initiatives, but she has a big ship to turn… (This topic would be too massive to even blog about 🙂

    Thanks for the suggestion: I’ll definitely try to raise this topic tomorrow, especially since the audience is student-focused and AaltoES has arranged the event.

  3. Regarding seed and early-stage funding, it is also essential to emphasize the other ways to fund the start. Investments require paperwork and take a lot of time and one should seriously consider is it worth of the effort when in Finland we are mostly talking about tens of thousands, not hundreds of thousands or millions.

    Aside of the investments there is even greater need for loans and grants that would allow the garage-based company/community to buy their first Mac and other tools and to pay the rent. In many cases it also wouldn’t hurt if the startup had another source of revenue. It may be consulting or something else. It would be great if the public tendering system wouldn’t block out startups offering fresh ideas. Currently, public tenders may have terms that require certain (high) revenue or the projects are just so huge that they automatically go to the biggest IT integrators or consulting houses.

    However, the first and the most major question to the entrepreneur is whether a company is needed at all to drive the concept? Everyone knows Ruby on Rails. Most people don’t however know that there is no company behind RoR. It is ‘just’ a trademark owned by David Heinemeier Hansson. In the software business it is also an important question to ask whether one product idea is enough to run a company. Software products are coming closer to games and media in terms of production: platforms, processes and engines are what makes a company, not just a single product idea.

  4. Timo, an investment to a garage startup can be done in a few days: e.g. http://SeriesSeed.fi docs can be used for this. Assuming that we’re talking about a small, but ambitious team I’d go for a proper paperwork from day one to avoid a big mess later.

    I agree that many ideas could and should be tested before founding a company. However, almost all the great companies have originated from a single product ideal; some of them, e.g. Twitter, have later become platforms. In addition to the product, the culture needs to be in place from the beginning.

    Regarding alternative revenue sources, having founded a company that tried to balance between product development and consulting, I wouldn’t recommend this approach. The culture needed is so different. In general, if you have something good in your hands, raise some capital to move faster.

    Regarding public tendering, I also believe that it would be a great idea from the government to make the tendering process very accessible to startups, even favoring them in the selection process. I actually “twote” about this earlier today.

  5. Jaakko Särelä says:

    Regarding alternative revenue sources, I totally agree with Petteri: if you have something good, just go for it. It is possible to succeed in it, but very difficult, especially when you’re in a situation where both the consultation and product business could fly.

    Would somebody have some cases where profitable consultation business has been successfully turned to a product business?

    • Jaakko:

      It is a classical management text-book example that turning consultation business into products never work. My understanding is, though, that F-Secure started very, very initially from consultation to find its core products. But it took time.

      Timo

      • Jaakko Särelä says:

        We started with consultation business. But from the start, the purpose of that was to find the most prominent product value proposal and market segment in robotics. As soon as that was found, we killed the consultation. Not that it was an easy decision ;). But I think we managed very well because we hadn’t yet grown a big team around it.

  6. […] The startup world around us is getting ever more opinionated – perhaps as the April parliamentary elections approach. To warm up for tonight’s fanfare, take a look at e.g.  Taneli Tikka’s Proposal to Renew Startup Financing, as well as panelist Petteri Koponen’s response. […]

  7. Jani Hursti says:

    Guys,

    Interesting discussion and a great and warmly welcomed initiative from Taneli and Lasse. I’ll have to comment a couple of points though.

    1) Funding “innovation”. This is probably one of the biggest sources of distortion to public policy ever. That’s because from a startup funding point of view, the whole word “innovation” is an oxymoron. Innovation means a new way of doing business that has been successfully commercialized. It is an ex-post definition of success. Applying such a definition to a pre-funding stage idea only causes confusion. No wonder those “innovations” are so damn hard to find.

    Because we cannot find innovations directly, we have to define proxies. Such as “innovative technology” i.e. an invention that could maybe be commercialized. But wait, we can’t just look at inventions because an “innovation” could also be a business model, a distribution channel, etc. So basically an “innovation” becomes anything that could be potentially successful in the future. Geez, that’s really, really helpful…

    The result: we’re essentially chasing a ghost. No wonder the results of the “Finnish Innovation Policy” are so limited.

    Because we cannot find a proper proxy for innovation, we resort to equating “innovative” with “new”. But that is just betting on the wrong horse. Just look at the companies we nowadays take as benchmarks of success: Google, eBay, Microsoft, Facebook, Apple. What was the “new” thing they brought to the market? Essentially nothing, they are all second (or later) movers who simply made their products and services more consumer friendly than their predecessors. It does not matter if you copy your concept from Xerox, Altavista, MySpace, Nokia, or someone else, making things better creates successes, not making new things.

    So suggestion number one: please get rid of that damn innovation crap. Leave it to Ghostbusters or someone else who is as fictional as the results of that policy.

    2) I’m definitely pro-tax breaks. Why?

    First, I do acknowledge that development intensive startups might not get much out of tax cuts if they remain loss-making. But the tax cuts would give an incentive to thrive towards profitability, which is never a bad idea. True, some startups produce losses their whole operative history, targeting just that one transaction to sell the assets to the highest bidder. But that is not the objective of a government that tries to create jobs (and also collect taxes).

    Second, tax cuts would finally move public financing from supporting losers to rewarding winners. Financiers in general hate government grants because they are available when the company is still in dire straits but easily pulled out when a company becomes profitable because no-one can get rich with taxpayers’ money. At least not in this country. A tax cut could however be used extended beyond this point.

    Tax breaks must still be consistent with the target. It is very easy to fall into a common pitfall: first arriving to the conclusion that Finnish companies are too engineering oriented and then, as a remedy, proposing a tax cut on R&D (=engineering) costs. Spot the problem? Consistency, please.

    The core of the problem is that both the analysis and the remedy are “too easy”. We say Finnish companies are too engineering oriented because that’s what has been taught to us for 20+ years. Tax cuts are easy to apply on R&D costs because R&D is easy to account for and measure and its politically easier to give tax cuts to “those who spend money and therefore can’t benefit from it”.

    This is where the proposal fails; it addresses a tough problem with and analysis and a suggestion that are simply too easy off-the-shelf answers. This is a place where that famous innovativeness would be needed. Find a way to measure and account startup company cost base in a consistent way that covers all essential investments, not just R&D, and apply to that a tax break in a way that is valid long enough for those who find success to benefit from it.

    Oh and by the way, I don’t think Finnish companies are too engineering oriented. If it were so despite the fact that everyone has been saying that for more than two decades and nothing has changed, then the problem lies somewhare else. Then in reality companies are just too dumb. And that’s a broader problem.

    3) Finally, government financing is needed to create startups.

    There is a financing gap in early stage financing that cannot be fulfilled by free market mechanisms alone. This is a well established fact, widely researched for decades and practically felt by all entrepreneurs. The government must therefore intervene in one way or the other if a viable startup base is to be sustained. Startup businesses simply cannot be created with just “culture”, “empovernment” and the rest of the “holy spirit” yadda-yadda.

    Public financing must be market driven and various ways to leverage public financing with multipliers is one way to do this. But I’d take it easy with the multipliers.

    Why? Well, it is a big mistake for a company to start to tailor its business to fit the financing requirements of the government, instead of the market. I fully agree with that.

    But it is a colossal blunder for a country to create mechanisms that make financiers fit their investment policies to fit government grant requirements. Why? Because this affects all startup companies, not just a couple who made the mistake.

    When there are only a few VCs and they can bring in the equity needed to match the government grants, that grant becomes a leverage. And because there is only one government, this leads to reduced competition between sources of finance, diminshed skillset in the VC field, and careless investment policies where the rationale is no longer based on the viability of the business but fundability using public grants. And if that does not kill a startup, then nothing will.

    So never, ever try to streamline government funding by outsourcing it to external companies that at the same time act as gatekeepers and consultants/investors to the same companies. That simply creates yet another machine for consulting firms to launder government funded income through startups.

    Trust me, I know. Been doing that for 10 years.

  8. […] entrepreneur and investor, Petteri Koponen also added his viewpoints to the issue in his blog. He was mostly in support of the points Männistö and Tikka raised, but also stated that most of […]

  9. On the need of public funding or not – –

    We grew CRF Health (http://www.crfhealth.com) with Jaakko and Jarkko without any public funding for the first three years.

    That was because we were so enthuastic and driven young entrepreneurs at that time, and did not have time to check what would be available from the slow government. 😉

    Today, CRF Health is (in my understanding, and validated by the comments from many Finnish VC sources) a top three performer of the Finnish VC-funded software companies – all time – by revenue, profit and market share – which are the “real” success indicators.

    Other examples, anyone? Examples on public funding creating a stellar business in Finland?

    • Jani Hursti says:

      Examples of public funding successes? How about the following for starters:
      – WinWinD – growth about 100% per year, annual revenue now about 15 times that of CRF.
      – Elcoteq – funded by Teollisuussijoitus. You should know these guys. They’re pretty big.
      – Aidon – the love child of Tekes and Teollisuussijoitus. Revenue growth about 3000% per year, now at 17 million. Not bad for a firm with public financing that operates in the public sector.

      Its true that these companies are not easily recognized at the startup circles. There is a reason for it: they actually grew to be big.

  10. Tuomas Maisala says:

    Very good discussion on a very important topic. Some comments on evaluation as this has been an area of my interest as well as some other issues raised in the discussion.

    I haven’t deeply followed the implemented policy-level decisions and funding schemes internationally and their impact on start-ups. Thus, I have no strong opinion whether R&D tax cuts vs grants yield better results.

    Evaluation of public interventions on start-ups is difficult, be it business incubators, start-up grants or public VC investments. With my experience, the impact of a policy-change is very hard to evaluate as it will show results only years after and success or failure can be contributed to a number of other things. Typically, there’s a mixture of overlapping interventions (i.e. several support and funding mechanisms).

    If we had a perfect world for evaluating interventions, there would be never a big enough matched group of start-ups that are followed on company-level. Just like one would test if a certain drug works or not with large enough population – too expensive and difficult, won’t happen with start-ups.

    Apparently, TEKES NIY-program and Vigos are a move in the right direction and comments and first results are positive. We will really see the results years after.

    Big ships turn slowly – I welcome suggestion for small, incremental changes towards a simpler and better start-up funding in Finland.

    I fully agree with right start-up culture – in research called percieved desirability of the intented action (founding new start-ups).

    what I know from the history, CRF Health got an exceptionally fast start due to being able to raise 1Meur private funding round with a great team and merely a business plan and simple prototype. 10 years back, there were a number of active high-tech focused VCs (most of which have ceased to exist by 2011). Now as there is lack of early-stage VCs, I believe a CRF-type start-up would raise funding thourgh angels and NIY-program.

  11. Markus Ahonen says:

    To Jani’s #1 point – about funding innovation, and why that’s a problem. First, I agree. Second, I’d propose an alternative: That when making funding decisions, rather than looking for traces of ‘innovation’, the existence of solid consumer data and in-depth understanding would be the primary driver.

    I’d argue that a focus on the market – consumers, buying patterns, competitive behavior, feedback on product concepts – would yield far better results than simply looking for a new technology. Because we all know what happens when you have a technology looking for a problem to solve…

    • Jani Hursti says:

      True, for the most part. Its good that the concept of knowing the market was raised. Its absolutely true that it is vital for startups to understand their market. But it is critical for financiers to understand _how_ that market should be understood.

      The problem is still that one thing: “new”. When a policy equates innovation with new, it forgets the market. As you know all too well, the market has different stages of maturity. One must understand the level of maturity to understand the market. Not all levels can be analyzed with similar accuracy.

      The early adopters, the nerds/geeks/etc, are after something “new”. But the mass market is not interested in “new”, they look for something “better”. Similarly the late adopters look at something “cheaper” and the laggards of a declining market something “more reliable”.

      Because those early adopters are hardly ever more than 5% of the market, by funding innovation and equating that with new, we miss 95% of the market. What gets funded is ideas that please tech savvy geeks who like new stuff. So no wonder Finnish companies are so engineering oriented. Sadly, you get what you pay for.

      If funding focuses on only what is new, it misses everything that is better, and therefore misses the mass market. Finnish engineers are taught in their Mother’s milk that building a better mousetrap just leads to failure. So we never make anything better.

      Apple is a stunning example of how to build better mousetraps. They are so good at it that every year they announce a new generation of products that comprises better versions of their old ones. What is “new” in an iPhone compared to a Nokia one? Nothing. It is a “better” phone, that’s why I want one. What’s new in iPad2 compared to iPad1? Essentially nothing. Line up all iPad owners, you just have to throw away the old one and get the latest one, because its better.

      By nature, a human being thrives for stability, familiarity, predictability. We don’t want to live in a “new” world. We want to live in a “better” world. That is, our current world, but just slightly improved. Why is it so hard to improve it?

      • Markus Ahonen says:

        Agreed – *how* the market is understood is key. As is how that understanding is used. We tend to look at product features that match user needs. In these cases you get into arguments of whether user insight can even be created if it’s such a “new idea”. And then some wise-ass will mention Henry Ford and his “faster horses” quote. And then the whole team is happy to not conduct consumer studies, because “they can’t understand it anyway”.

        My test of a great idea is not the innovation itself, but the message it’s sold with. Can the product and its benefits be communicated in a way that resonates with your target market? Or, to quote: “how does the startup establish memorable concepts that speak to problems buyers have?”

        From a VC’s point of view, you’d look for convincing pitches toward the user grounded in observed problems and verified responses to messaging about the product. It can often be done even before you start actual R&D, so it’s actually quite cheap.

  12. Martin-Éric says:

    The Finnish government is factually unable to understand entrepreneurship. This much I’ve been able to verify first-hand while doing a training at the Ministry of employment and the economy last autumn.

    First of all, entrepreneurship is seen as nothing more than an alternative means of employment, as a means of getting a few people off the unemployment statistics. The government doesn’t see the connection between company funding and the company’s ability to create more jobs. For instance, the employment office will gladly fund someone’s trip to a job interview at the far end of Lapland, but they’ll refuse to do the same to someone being considered to take over a company and manage it on its owners’ behalf, because TE-center’s instructions are explicitly to not support entrepreneurship in matters of mobility benefits and relocation benefits.

    Likewise, social security simply isn’t designed to support entrepreneurship or part-time work, rather, it is envisioned for a bureaucratically ideal world where people are either gainfully employed and fully able to support themselves or otherwise unemployed and flat broke. For instance, if someone accepts a freelance gig, all unemployment benefit payments stop until a copy of the paycheck stub has been forwarded to KELA. As experience shows, salary payments typically happen one month after the gig, which, in practice, usually means that KELA withholds payments for about two months. Needless to say, people don’t want to end up completely penniless for two months, so they soon learn to avoid doing freelance gigs. This obviously doesn’t encourage people to take initiatives and build their business.

    Taxation is also a problem, because everything is seen as a secondary income slated for taxation at the double percentage. This is already a problem for people who are gainfully employed and who are thinking of starting a business on the side, but it’s an even bigger problem for unemployed people because, as far as the taxation office is concerned, KELA benefits are the primary source of income and everything else is secondary income.

    While the TE-center’s stupid policies are already bad, to me, the worst result is the combination of KELA and taxation policies, because they go a long way towards discouraging freelancing or building a business on the side. This, coming from a government whose stated goal is to support innovation and growth sectors. *sigh*

  13. Hi,

    IMHO two things stand out in particular. And I could not agree more. Thank you for putting it so succinctly:

    1. “We don’t need to renew startup financing in order to create more growth companies: instead, we need to found and fund more growth companies.”

    2. “So, if you want to improve the Finnish growth company ecosystem (and save the welfare state as a by-product), found a startup, apply to work for one or invest in one. It’s that simple, really.”

    Really a nice write up! I sincerely wish it motivates people to go from the talking about start ups to the, well, starting (or joining) start-ups stage.

    Best wishes,
    Oliver – a founder2be

  14. […] edistämiseksi tehdä. Tuota päättäjille suunnattua viestiä enemmän pidin kuitenkin Petterin ohjeesta koko kansalle: So, if you want to improve the Finnish growth company ecosystem (and save the welfare state as a […]

  15. Olli Laaksonlaita says:

    Thank you for an outmost interesting discussion. Here some Swiss reflection in order to point out alterernate views – using Jani H:s classification above. This might give some food for thought:

    1) Funding innovation/R&D: Swiss government limits its funds to universities. Swiss CTI has less funds than TEKES. Universities serve as a native « proxy ». Companies collaborate strongly with universities. University spin-offs get VC from various (private) sources – or they die !

    2) Tax-breaks : cantons have regional tax-break systems, not limited to R&D. There exists « cantonal competition » (and substantial community level competition on taxes).

    3) Government in Switzerland is not allowed to finance private companies – not even start-ups. A common understanding prevails that government financing would distort the market. However, cantons and communities provide tax benefits (like tax-breaks) and various foundations provide VC. In Switzerland, there exists a strong view that innovation and entrepreneurship is something that happens bottom-up, not top-down as ordered.

    Please, note that Switzerland was newly ranked by far the most innovative European country (European Innovation Scoreboard 2009). This has not always been so. The vision of „Innovation Host“ since some five years has included: market oriented frame conditions, infrastructure, (tertiary) education, research landscape, and propagation of entrepreneurship and international R&I networks as well as attractive living environment. Small countries like Finland and Switzerland might have more in common to collaborate than we think?

    Please note, that the Swiss often have been pretty envious of the Finnish innovation ecosystem as a whole. So, there exists no one truth.

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