General Catalyst, a Silicon Valley venture capital (VC) veteran, is on the brink of raising US$6 billion (£4.8 billion) to support new companies. This news is sure to excite technology entrepreneurs. It follows the recent announcement of a new US$7.2 billion investment fund by Andreessen Horowitz, another prominent VC. These are some of the most significant fundraising efforts in recent years, occurring during a period in which the venture capital sector has experienced a period of stagnation. The total global investments have decreased from US$644 billion in 2021 to US$286 billion in 2023.
The unfortunate reality is that the majority of the proceeds are likely to be invested in the United States, depending on your location. Approximately half of all global VC funding is allocated to American businesses, while Europe and the United Kingdom are fortunate to receive a quarter. This is despite the fact that the United States and the United Kingdom have a marginally smaller share of the global GDP than the European Union (17% versus 16%).
VC investment by country (in US dollars)
This explains why the three largest technology companies in the United States, Microsoft, Apple, and Nvidia, are valued at approximately US$7.5 trillion, while their European counterparts, ASML, SAP, and Prosus, are valued at approximately US$700 billion. Therefore, what actions can be taken to rectify this situation?
Edge of Silicon Valley
A variety of mutually reinforcing factors, many of which were established decades ago, have contributed to Silicon Valley’s success. Among these are the accumulation of wealth and talent from tech titans such as Apple, Nvidia, and OpenAI, as well as lucrative government contracts and entrepreneurial universities in the vicinity. Replicating this type of advantage is exceedingly challenging.
US investors frequently invest millions of dollars in relatively early-stage companies, a total that is unmatched by other ecosystems. However, startups must initially establish traction with customers, typically through sales revenue or user counts. This is in contrast to tech investment hubs like Berlin and Scotland, where investors typically only require a strong team and an idea for a startup to be considered to have high potential for investment. Our research indicates that this may be an underappreciated explanation for Silicon Valley’s prosperity.
After conducting in-depth interviews with 63 entrepreneurs and investors in Silicon Valley and Berlin, it is evident that investors have varying expectations. For example, the founders of AirBnb, a company based in San Francisco, were compelled to use their credit cards to maintain the company’s financial stability and even attempted to sell cereal boxes before securing funding.
In the same vein, the San Francisco-based proprietors of the food delivery app DoorDash constructed a complete prototype and conducted deliveries independently for nearly six months prior to raising their initial round of funding.
In order to secure funding, US ventures such as Airbnb were required to operate on a shoestring budget.
This is in striking contrast to the ecosystems of Europe. HeyLama, a language tutor marketplace in Berlin, has recently secured funding almost immediately after its inception. In the interim, Rex, a pet care startup, raised over US$5 million within months of its introduction.
Nevertheless, Silicon Valley received US$44 billion in early-stage investments between 2020 and 2022, while Berlin received only US$5.8 billion. Similarly, approximately 31% of seed-stage businesses in the United States and only 19% of those in Europe advance to the subsequent fundraising round.
This does not inherently imply that companies that do not secure follow-on funding fail; however, it may provide insight into the reason why the average exit in Silicon Valley is US$403 million, as opposed to US$53 million in Berlin.
Therefore, why is it not the case that US startups experience greater difficulty when they are required to satisfy higher expectations in order to secure funding? Also, could other ecosystems catch up by implementing the same approach?
The “valley of doom”
The “valley of death” is a term frequently used to describe the transition of a business idea from its inception to early traction. The venture must continue to develop the business, construct the product, and establish a dependable business model during this period. Many companies fail due to the concept being unviable or a lack of funding, as there is no universal blueprint.
The risk of failure for venture capitalists is somewhat mitigated by Silicon Valley’s preferred funding model, which involves investing in enterprises with traction. Over the long term, this will likely lead to an increase in the amount of money available for reinvestment in new businesses, which will support the overall growth of the ecosystem. Entrepreneurs who can postpone fundraising until they can demonstrate traction will also benefit, as the startup is likely to be more valuable. This implies that they have the option of either increasing their income or relinquishing a lesser portion of the business.
This would imply that European startup ecosystems should consider transitioning to this model. However, there is a significant drawback to this. The valley of death is a challenging environment for entrepreneurs, as few have the financial resources to sustain their businesses. This period is particularly severe and prolonged for the most innovative concepts. This is especially problematic for entrepreneurs from underrepresented groups, including women, immigrants, and those from lower socioeconomic backgrounds, who are less likely to possess the requisite resources or connections. Consequently, the startup world may become even more inaccessible to them if the American investment threshold is implemented.
In order to capitalize on the advantages of the US system without jeopardizing diversity, it is necessary to establish support structures, including accelerator and incubator programs, to assist businesses in gaining momentum. However, these must be meticulously crafted to guarantee that they convey credibility and, as a result, assist the incubated companies in securing their initial round of investment, rather than impede it.
