News & Analysis

Study: Estonian Science-Based Startups Experience Growth Issues

According to the study commissioned by the state venture capital fund manager SmartCap, access to capital has never been easier for software startups, but at the same time, both startups and investors admit that high tech and science-based startups struggle to find capital.

Sille Pettai, the Member of the Management Board of SmartCap, said that both startups and investors think that, in general, access to capital is good in Estonia, but companies operating in science-based industries find it difficult to grow quickly.

“For a startup still in the concept phase, access to local capital is critical, because it enables to develop the idea into a successful product or service. However, when the company has reached a phase of fast growth and scaling and has paying customers, access to capital starts to depend on global economy, the disposition of investors, as well as the industry where the startup operates in,“ Pettai explained.

Lack of capital is mostly felt by early-stage Estonian startups

Estonian startups who participated in the survey noted that access to capital is crucial mostly in the early stages when the investment need is up to 100,000 euros.

More than half of respondents (55%) have successfully attracted funding from Estonian or foreign investors, 275 million euros in total. In most cases, local investors invest 100,000-500,000 euros (40%). Startups get funding from Estonian angel investors (60%), various funds (54%), business partners (30%), as well as family members and close friends (28%).

The survey respondents were mostly early stage startups who have attracted foreign investments of up to 100,000 euros, mostly from investors from Finland and the U.K.

Startups estimated their needs for additional funding for the next two years to be on average 2.9 million euros, with ICT startups requiring the largest investments.

Deep tech and science-based startups struggle to find investors

Weak access to capital is mostly felt by niche startups, e.g. software companies and startups from other deep-capital industries. According to the market players, the growth of startups in Estonia is hindered by the small size of the country and scarcity of local capital. Estonian startups often find it difficult to find an investor with the right profile and realistic return expectations.

According to startups who have raised funds from Estonian investors, the local market does not have enough investors for deep-capital industries (71%). Companies who have received funding from foreign investors think that the most difficult problem is to find foreign investors whose investment strategy would match the startups’ profile (49%).

Mari Vavulski, the Member of the Management Board of SmartCap, says that the underfinancing of science-based companies can be explained with fact that they are capital intensive and relatively unknown to investors, and carry a high performance risk. “These companies grow more slowly and their expected return period is longer. At the same time, investors said that if the team and the idea are good, getting funding is very much possible,“ Vavulski added.

Estonian investment funds focus on software-based industries

The study included interviews with 12 investors, which showed that Estonian investors are less active in science-based industries, e.g. life sciences where the need for capital is extensive, but at the same time, the development cycle of a product or service is longer, technological risk is higher, and local investors have less experience in the field.  

“Today we see clearly that funds focus on software-based industries. The Estonian startup ecosystem has witnessed many success stories coming from the ICT sector, and thus there is plenty of critical business experience in the field of ICT,“ Sille Pettai comments.

According to Pettai, the state should continue to offer cornerstone investments for software-based companies in order to facilitate raising capital from private investors, but it also necessary to attract investors from outside the software-based industries. “The state must offer cornerstone investments for other industries as well, and first steps have already been taken in that direction. Today, SmartCap is working on launching the deep tech fund with the focus on developing science-intensive business areas. Additionally, we are currently analyzing investments possibilities and needs in science-intensive future key areas, for instance green technology,“ Pettai points out.

Additionally, the results of the study show that in addition to problems with access to capital, the other high-priority area of market failure is related to constraints emanating from regulations. Both startups and investors have emphasized that regulative constraints reduce the attraction of Estonia in the eyes of foreign investors and startuppers. The solution would include changing the legislation related to investments or relieving constraints. Last but not least, the ambiguity related to plans to reform the pension system and general uncertainty on the Estonian venture capital market makes it more difficult for venture capital funds to find investors and undermines the sustainable development of the startup ecosystem.

Read the summary and full study on the availability of capital to startups (in Estonian).

The study was commissioned by SmartCap and conducted between October 2019 and January 2020 by Civitta Eesti AS. The study included 101 startups from 16 sectors who participated in an online survey. Most of the startups (70%) were in the kickoff stage. Additionally, the study included expert interviews with 12 investors who have invested in startups in Estonia. SmartCap is a partner of Startup Estonia in the field of capital accessibility and cost. The study was funded by the Startup Estonia program.