Wednesday, August 21, 2013

From Seeds to a Whole Ecosystem, Poland Showing how it's Done

Seeding a Silicon Valley: How Poland is creating a startup ecosystem from scratch
By Theresa Bradley  September 23, 2012

Billions of the EU dollars that pour into Poland each year are intended to promote entrepreneurship and innovation. As Warsaw rushes to dole out the cash, a startup boom has been born–but can state subsidies really act as seed capital, and what will happen when the EU turns off the spigots?

WARSAW—As communism crumbled in Poland, Szymon Slupik was 9,000 miles away in Australia, picking oranges and asparagus and saving up for a computer. Slupik followed news of the democratic transition in clippings that his mother sent monthly to outback post offices. Within a year, he was back at the University of Krakow and using his new PC to launch a software company with two friends.
Today Slupik is building his third business, having sold the first for 10 million zlotys ($3.2 million) and leaving the second in investors’ hands. His journey in many ways mirrors his nation’s: Poland has evolved from a resource-strapped Soviet client state into Europe’s fastest growing economy.
Poland was the only EU country to avoid the recent recession and is expected to expand (pdf) 2.7% this year, having averaged 4.5% since 1995. A member of the union but not the euro, it is partly shielded from the region’s current troubles, free to adjust interest rates to boost exports and growth as it chooses. Signs of that new strength abound across Warsaw, where comfortable family cottages now house young tech startups and the Warsaw Stock Exchange has seen more IPOs than any other market in Europe.
The country’s rich engineering and IT talent no doubt has a lot to do with it. But an even bigger factor has been the €67 billion ($88 billion in today’s terms) in “structural funds” that the European Union has pumped into the country since 2007, part of an effort to balance wealth across new member states.  Some Poles call it a second Marshall Plan, an influx of infrastructure and social spending that is remaking their landscape much as the original plan transformed Western Europe after World War II. Nearly €10 billion of the money is for promoting entrepreneurship, and the government is now rushing to dole out that cash.
The result is a massive experiment in something that many countries have tried and few have truly managed: building a competitive tech startup industry deliberately and from scratch. “Things have been going quite fast, from total zero 20 years ago through today,” says Anna Czekaj, a Polish business coach at the Zurich-based angel-investing firm Go Beyond. “They’re building a whole system overnight that elsewhere took decades to evolve.”

The kombinators

A once-prosperous republic in the heart of Europe, Poland suffered tremendous damage in World War II, losing one in six citizens. The post-war communist government expropriated much of what was left standing. Trade stalled, goods grew scarce and people improvised. “The only way to survive was to network,” says Anna Hejka, who still runs the Warsaw-based merchant bank, Heyka Capital Markets, that she founded just months after the fall of communism in 1989. Even then, “life required being extremely entrepreneurial, creative, smart, and everything else that you need to be a good businessman.”
Poles call this mix of hustle and black-market barter kombinowanie, and in the offices and alleyways across Warsaw, they say they still know how to do it. Poland’s communist regime was less restrictive than some, allowing citizens out on short trips to study or work. By the late 1970s, thousands of Poles regularly drove to Germany and loaded their trunks with blue jeans and car parts to sell back home. The authorities usually turned a blind eye, making these “trading trips” a key source of both supplies and entrepreneurial spirit.
With the democratic transition, economic activity exploded. The newly-open market needed everything. Even government agencies bought computers from small-time traders who piled onto new bi-weekly flights to Singapore or Beijing, stuffing their luggage with electronics and PC parts to sell at home at three times the cost, Slupik recalls.
But unlike in Russia, where a handful of men became ultra-rich oligarchs by staging a grab of state assets, today’s richest Poles began as more typical entrepreneurs. Jan Kulczyk and Zygmunt Solorz-Zak, now first and second on Poland’s Forbes list (Polish), started businesses importing cars and car parts from Germany in the 1980s, and in time built empires in telecoms, insurance and pension funds.
For the first few years, Poland’s government largely kept out of the way. Business spread faster than rules could be written to regulate it; registering a company was said to take less than a day. Over the next decade, though, bureaucracy flowered, and with it loopholes and regulatory contradictions. By 2000, the market was maturing and most of the early opportunities had been seized.

Enter the big spender

To keep the economy growing, the Polish government created PARP: The Polish Agency for Enterprise Development. After Poland joined the EU in 2004, it became the main funnel for €7.2 billion in EU funds aimed at promoting an “innovative economy.” One of its main missions today is no less than to seed an entire startup ecosystem—the full chain of elements needed to nurture a venture from idea to enterprise to the “exit” point when founders and early investors can cash out.
The aim is not just to create jobs, but to make small firms more innovative. Some 96% of the country’s 1.7 million registered businesses have fewer than nine employees, according to an Economy Ministry report (p. 35), the highest ratio in Europe, where the average is 92%. These micro-ventures yield little innovation, with large companies more than four times as likely to be engaged in “innovative enterprise.”
To change that, PARP sponsors tech parks and venture incubators; it runs programs to boost research and development, to advise entrepreneurs and link them to investors; and, once a business has grown, it even pays for the paperwork that the firm needs to go public. At its townhouse-like Warsaw headquarters, scores of grant pamphlets are displayed on a round rack in the lobby like greeting cards. Some 68% of PARP’s 2007-2013 budget had been allocated as of June 2011, according to an agency report (pdf), with €3 billion more to be disbursed before the EU funding cycle ends next year. But giving away that much money so fast isn’t easy.

A mixed bag of tools

Like any big agency, PARP has a labyrinthine array of programs, some more successful than others. Of particular interest to the Polish press has been the “8.1″ program (named for the EU initiative that finances it), which gives out grants of €5,000-€170,000 and requires no equity in return.
To hear critics tell it, though, it’s a model for how not to do things: an initiative in which bureaucrats without business sense pay hobbyists to run “projects” rather than viable ventures, requiring them to report back so often that they spend more time on paperwork than on product development. And the program often locks grantees into terms that prevent them from adapting their businesses to market conditions, says Dariusz Dziurzanski, a startup founder whose wife received 8.1 backing. Still, 1,800 ventures have won the funding, so far collecting nearly two-thirds of the €390 million flagged for the program since 2009, according to PARP. Free money, after all, is hard to turn down.
More promising is a €160 million initiative that has funded the launch of 43 business incubators. Staffed by investment professionals, not public officials, the incubators give fledgling companies coaching, contacts and up to €200,000 in seed capital. In exchange, the startups hand over an exorbitant amount of equity—up to 50%—giving both sides a stake in success. The incubators must exit each business within 10 years and reinvest the proceeds in new companies. In essence, they act as small venture-capital (VC) funds; but with free cash up front, they can take more risks.
PARP’s incubators have invested in 270 startups since 2009, mainly in information-technology, mobile and biotech, as well as healthcare, renewable energy and aviation, says Michal Banka, who runs the program. By late 2014, he expects that total to reach 600. “We think we’ve created an instrument that will keep financing new ventures into the future,” Banka says. “It’s not a simple grant; here the money keeps working,” even after PARP exits the deal.

Incubation period 

One of the best-respected incubators, Ventures Hub (Polish), sits in a neighborhood of shiny glass office parks, on a leafy corner lined with banks and bakeries five miles from Warsaw’s downtown. Co-founders Wojciech Przylecki and Maciej Hazubski made their money as IT entrepreneurs before setting up Ventures Hub and another incubator, InQbe. In total they have invested in more than 50 early-stage Internet, mobile, and e-commerce companies—nearly 20% of all the startups to date funded through PARP.
Compared with the lengthy, personalized pitching ordeal common in the US or Western Europe, Ventures Hub’s application process is fast and automated. It starts with a five-line online form (Polish) and a nine-point questionnaire, describing the team, technology, market, and funding needs. An outside expert scores each proposal to determine who gets a meeting, and the staff work with approved founders for up to six months before delivering cash at two key milestones.
Two of Ventures Hub’s beneficiaries give an idea of how different the routes to success can be. Bartolomiej Lozia was an economics student who spent 10 years in organizational management. When he heard about PARP’s incubators, he shopped five different business plans; in the end he chose Ventures Hub because, he says, it seemed the most professional. Lozia was willing to give up a 49% stake in his company for that, and to avoid the bureaucracy that he’d heard he’d face elsewhere. As a result, it was easy for his venture, JOJO Mobile, to pivot when needed, switching from writing Windows phone software, to making iOS and Salesforce apps for third-party brands across Poland, Germany and even the US. JOJO’s products have been downloaded 900,000 times, last year drawing $100,000 in sales and an expected $1 million next year, Lozia says.
Dariusz Dziurzanski, cofounder of language-learning site Langloo (Polish), has a more traditional story. Like Szymon Slupik, he bought his first computer in the late 1980s with money made picking strawberries and soon after launched his first software company. The translation program he released in 1997 sold 200,000 copies, earning his team about $200,000, which helped him to later seed three more e-learning endeavors. He sought private investors, but one went bust with Enron and another backed out during the 2009 financial crisis. In 2010, he accepted €200,000 in public funds from Ventures Hub to launch Langloo—and now participates in two other ventures that received some €350,000 more. Langloo took 11% of its shares public on Warsaw’s New Connect stock exchange, one of the easiest spots for a small company to list in the EU.

Half-baked ideas

The problem is that such success stories are too few. Poland’s top graduates still prefer the corporate jobs and safe salaries that suit the country’s current consumer boom, says Lozia. And in contrast to the US, where investors have famously warned that 30 may be too old to launch a venture, Polish founders often come to entrepreneurship a bit late. This does mean they have more industry experience, says Ventures Hub’s investment director, Magda Narczewska. But the EU financing has also created a “why not?” air: “People are just saying: ‘Hey, let’s try to get this free money; nothing will happen if I fail.’ There’s not much risk involved, so there’s not much pressure,” Slupik says.
As a result, Slupik says he’s often approached by new entrepreneurs looking to partner up on derivative or half-baked business ideas. “I ask if they’re prepared to concentrate 100%, and they’re not,” he says. “They still think you can start a business and do other things, like take fulltime vacations and have a salary. They don’t understand that when you set up your own company, you have to put aside everything.”
Similarly, the mentoring and community that are common in more developed startup ecosystems are still largely lacking in Poland. Ventures Hub provides a co-working space for investees, but few really use it, Narczewska says. Founders meet investors for advice while perfecting their business plans, but after getting the money, may only touch base once a quarter. Many entrepreneurs draw a blank when asked to name a role-model Polish startup, and questions about “meetups” or networking groups can elicit confused looks.
The investor community is more developed. PARP supports the private Lewiatan Business Angels Network, Poland’s biggest group of “angel investors”—mostly ex-entrepreneurs who’ve made it big and want to invest in building something new. But Polish angels face the same pipeline problem as the incubators: there is too much money chasing too few deals. Because it’s so easy to get funded, startups aren’t forced to innovate or to hone their business plans as much at the outset, which can get them into trouble when their products have to compete on the market.
Even Ventures Hub finds itself scrambling for viable ventures these days. Since its start, the incubator has had a roughly 1% acceptance rate, funding 18 of about 1,700 proposals, Narczewska says. Now, it takes meetings with many times more applicants, because there simply aren’t enough good ideas coming in. And if an entrepreneur with a good business plan doesn’t like one incubator’s conditions, he can ask another for the same cash on better terms. It’s a far cry from the competitive fundraising slog that new ventures in most countries face.

Setting the entrepreneurial table

The moral: there’s more to seeding a startup ecosystem than pumping it full of cash. So says Josh Lerner of Harvard Business School, who has written a lot about public sector efforts to promote innovation. Governments can’t focus on “the ‘fun stuff’ of handing out money,” he warned in his book on the subject, Boulevard of Broken Dreams, without first taking time to “set the table”—creating an environment in which innovation and entrepreneurship thrive.
What has to go on the table? For one thing, “technology transfer” systems to move promising research from academia to the marketplace. For another, tax incentives for venture investors; along with stable regulations and clear contract law. And then, governments shouldn’t just spend public money ad infinitum, but use it to draw private investors, to whom they can pass the baton.
Poland has begun to do a fair bit on technology transfer and regulatory reform. But it’s the last part, the bridge from public to private investment, that may matter most.
One approach that has worked elsewhere is simple in principle: to create a “fund of funds” that matches a public dollar (or zloty or euro) t0 every private one, reducing the risk to investors. Israel’s Yozma Group, launched with more than $200 million in the early 1990s, has since funded more than 40 tech companies now worth billions, seeding an entire VC industry and making Israel home to the highest per capita VC investment rate in the world. Similar funds have been launched in New Zealand and Russia.
Likewise, Poland created its own National Capital Fund, known as KFK, in 2005 with €200 million in EU, Swiss and Polish state money. Anna Hejka, the merchant banker, is in the process of closing a KFK fund, raising the private capital needed to tap that public cash  The investors who pass through her ivy-covered, apartment-style offices were once largely foreigners looking for a piece of the Polish market; now they are wealthy Poles, looking to invest in Polish companies with global potential.
The question is: How many such companies can there be? It’s an issue not just because Polish entrepreneurs have been coddled by the flood of easy money from PARP, leaving them ill-prepared for cut-throat global competition, but because of a very Polish problem: the nation’s size. Ventures from smaller countries like the Czech Republic, Israel or Switzerland think cross-border from the start; their home markets are simply too small not to. But with 38 million people, the same as California, Poland traps some entrepreneurs in a kind of mediocre middle ground: they can survive at home, and so often don’t push beyond the border.
Many compromise by settling on Central and Eastern Europe as a target market. “From the investing point of view, it’s enough,” says Wojciech Szapiel, CEO of Polish Investment Fund, which has put private money into 30 clean tech, IT and life sciences ventures valued at a combined €300 million. “Once a founder understands that he can extend his business over the border, that individual has a scalable mind.”
Hejka is a little less forgiving. “I’m not interested in buying a company that’s going to be the best in Poland, not any more,” she says. “I’m interested in a company that’s going to be the best in the world.”

The kid in the Valley of Death

Young startups generally face a key gap in the funding cycle that entrepreneurs and venture backers alike call the “Valley of Death.” It appears between the bootstrap and early-stage phases, that risky window of time when a founder has spent all his savings, but isn’t yet earning enough to draw investors. Making it through that funding desert without going bust is everything.
In many ways, Poland’s venture ecosystem is now in its own Valley of Death. It is short on domestic resources, but betting that private investors will want a piece—if only it can prove that its startups can scale and generate lasting returns.
When the EU funding cycle ends next year, many expect a second round of cash from Brussels to last through 2020; others expect Poland to step in with more of its own subsidies, replacing direct grants with other funds-of-funds or “evergreen” models that put money to work in a continuous loop of investments and exits. But many also say that an end to EU financing would be a welcome blast of cold air, flushing out the weaker ventures and concentrating private capital on those that really deserve to survive.
“This EU money could’ve been spent more wisely, but it’s not that it was bad money,” says Jacek Blonski, CEO of the Lewiatan Business Angels Network. “As an investor, I still see it positively, because it’s circulating in the country. I’m waiting; I see these weak projects will die and the interesting ones will need a second round. Then you’ll be able to choose a company that’s really strong.”
Hejka concurs. “Things have been growing; people have better knowledge, better understanding and experience,” she says. “It’s like a kid: You send him to school and he doesn’t know what’s happening; but he’s already smart and knows certain things because his parents are smart. He keeps learning.” Hopefully, the EU funding will have paid for a good education.

 This is a repost of an article that appeared on the Quartz website on September 23, 2012

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