Public funding of tech startups is on the rise across Europe. In the UK, Germany and France, billions of euros are being poured into the tech ecosystem.
It is a noble gesture, and it is in all of our interests to have successful companies in key enabling technology areas like artificial intelligence, semiconductors and security.
But while startups in this sector receive grants and financing from governments, for many companies, it is not really necessary. It is the government’s job to provide necessary regulatory frameworks, but startups can still raise VC or private equity money.
What startups need is for governments to use the technologies it funds and enables.
We need to get our act together when it comes to sourcing and adopting technology. Because China certainly is. VCs have begun to understand this and started funding topics like defence, which was previously deemed taboo or too complex. Now it’s up to governments to give those companies what they need: contracts.
The public sector’s purchasing approach has traditionally been to buy the solution when it is 100% complete. If a startup is 90% complete at the time of the tender, it would be unlikely to win the project. Even if it was on track to complete it and could do, given the chance.
This all or nothing approach fails to appreciate that it is at the growth phase where value is created, and governments should be role models in adopting new technologies and products rather than going on a quest for the perfect solution. It can be a beacon for others.
After all, if the government uses it, it can’t be that bad.
The innovation gap
The Covid-19 pandemic showed how badly authorities needed digital health solutions for test tracking and new ID-solutions to keep the government open to its citizens in lockdown.
During the ensuing supply-chain crisis, they recognised the importance of increasing resilience and reducing reliance on foreign suppliers such as China.
And the war in Ukraine has demonstrated that the traditional weapons industry is unable to innovate fast enough to keep up with costs of asymmetrical warfare, costs that startups could reduce were they to get through the traditional sales process.
In many countries, the public sector has a huge backlog of things that need digitising, be that in infrastructure, public services, education, security and much more. It takes years to implement rudimentary digital tools. Bureaucracy kills innovation. Procurement processes are becoming more complicated and lengthy.
Another example is risk aversion.
Take defence tech: the biggest problem for any defence startup is not a lack of government funding, but a lack of governments as customers. States still rely on old economy relationships and procurement systems to equip armed forces and develop new technologies, rather than using off-the-shelf systems built by smaller, specialised players.
Incumbents, who are not under pressure to innovate, still win the majority of contracts. This means that the best innovation doesn’t always win, putting everyone at a disadvantage.
Buying from startups shouldn’t come as a compromise in quality
A common misconception in the public sector’s relationship with startups is that this is more about experimenting or compromising on quality. The result is often a half-hearted technology rollout. This is misguided. Any startup that wins a big government contract is always committed and highly motivated to get the job done because at this stage the company’s survival is at stake.
The greatest mutual benefit is achieved when purchasing processes are optimised for real quality. That way, everyone gets exactly what they need.
Some do well, others don’t: defence techs Helsing and Anduril have won big government tenders, Ukraine’s MoD has accelerated and diversified its procurement tremendously, there was fruitful co-operation of public health services with telemedicine providers during Covid-19, many of them startups.
But when it comes to government and big tech-backed initiatives like the European cloud initiative GAIA-X in which startups also bid for, it becomes a mess. Or Germany’s endless attempt to digitise electronic patient records, which could use some startup spirit.
Essential is a change in mindset: for a solution to work there needs to be a constant dialogue between buyer and seller. Startups are great at implementing feedback quickly, iterating and working on tight loops.
Better than money: partnerships and contracts
Instead of — or in addition to — funding, a customer relationship is particularly valuable and value-creating for startups. To put it simply, one euro of turnover is worth more than one euro of investment because the state as a customer ensures greater trust and credibility.
If the government is the only buyer, it has more leverage as a customer than as an investor. Startups can still raise money from the private sector. What helps them is the trust and credibility of long-term government contracts, which any private investor would love to see.
Non-dual use startups relied on government funding and grants because their sales cycles to governments were so long that it was very difficult for VCs to fund them.
These sales cycles usually used to be longer than the runway VCs give them between rounds, which is about 18 months. Some governments, especially in the defence sector, have got better at this — which suddenly makes it viable for VC funding again.
Having the government as an investor can also sometimes deter others from investing. But the government benefits more from having lots of profitable startups where it is also a customer. Those startups grow into mature companies that create more jobs in return.
Governmental customers + startups = more tech sovereignty
Apart from defence and security industries, this is true for almost all government-startup relationships, be it in healthcare, energy, mobility or citizen services. The main problem remains a structural one rooted in opposing mindsets, organisation and procurement deficits.
Governments should allow for more of that 90% solution and develop the rest in healthy customer relationships with startups. Ultimately this also increases tech sovereignty.
If you’re thinking about strengthening supply chains, making infrastructure more resilient, and reducing the region’s dependence on foreign systems, the best way to do it is to award contracts to those who are highly motivated to make a difference and don’t care about maintaining the status quo.
A long-term relationship also assures the government that the company will be a reliable partner, stay in the region and still be around in 10 years’ time. In addition, the transparent, open bidding process for government procurement gives startups and scaleups with real technological advances a fair chance.
Promoting and scaling university spinoffs is also key. These startups often cannot turn innovative technology into a solid product-market fit. Governments should make it easier for them in terms of reducing bureaucratic barriers. Investors can render operational support and help researchers-turned-founders build their organisations.
Then there is the dual-use advantage: there are commercial startups solving a problem that might also exist in the governmental sector.
No need to reinvent the wheel and develop government-specific solutions. These dual-use startups can offer cheaper off-the-shelf systems at a higher volume, while at the same time reduce risks for investors due to being open for business to the commercial side as well. Governments would be well advised to make use of those homegrown, sovereign solutions within the circle of democratic partners to increase their tech resilience.
So, governments: invest less in startups. Instead, be a better customer to them.
