Spain’s tech sector offers a view into Draghi’s ‘Innovation Gap crisis’

This month, the European Commission published Mario Draghi’s long-awaited EU competitiveness report. Its key finding? The EU must overcome the innovation gap to prevent economic slowdown. According to the report, only four out of the 50 leading tech companies across the globe are based in Europe.

In his address to the European Parliament, the former Italian premier said:

“The core problem in Europe is that new companies with new technologies are not rising in our economy. In fact, there is no EU company with a market capitalisation over €100 billion that has been set up from scratch in the last fifty years. All six US companies with valuations above €1 trillion have been created in that period of time.”

As a result, many European entrepreneurs prefer to seek financing from US venture capitalists and scale up in the US market, Draghi added. “Between 2008 and 2021, close to 30% of the “unicorns” founded in Europe — that is to say, startups that went on to be valued at over $1 billion — relocated their headquarters abroad.”

How can Europe prevent these future big tech potentials from heading to greener pastures?

Perhaps the experience of Spain’s fledgling tech hub Valencia can provide a view into what lies behind this “soonicorn brain drain.”

Valencia’s fast-growing startup ecosystem

Valencia, Spain’s third-largest city, has been hard at work over the past few years transforming itself into a tech and innovation hub.

Despite getting an average of 300 sunny days a year, the city had long been overshadowed by its big brothers Madrid and Barcelona when it comes to tech… until now.

According to the Startup Observatory, the number of startups in Valencia increased by 16% over the course of 2023. Meanwhile, Seedtable’s startup ranking platform shows that 139 of the city’s startups have collectively secured $824m in funding this year so far.

“This growth is due to a combination of a solid support environment, access to financing, qualified talent, and favourable public policies, as well as Valencia’s ability to attract international talent and adapt to emerging technological trends,” says Nacho Mas, CEO of Startup Valencia.

In 2017, Startup Valencia was formed as a non-profit on a mission to turn the city into an internationally recognised tech hub by supporting the growth of entrepreneurship, leveraging the science and tech talent coming from its universities, and finding ways to scale digital projects.

Alongside these initiatives, it organises an annual tech event, VDS, to bring international VCs, speakers, and entrepreneurs together with the minds behind Valencia’s fast-growing ecosystem.

Now in its 7th edition, VDS2024 taking place on 23 – 24 October, will see 12,000+ attendees, 2,500+ startups, and 700+ investors managing assets exceeding 200 billion euros join them at the futuristic City of Arts and Sciences under the theme Embracing Evolution: Invest in the Leaders of Tomorrow.

But despite the leaps and bounds the city’s tech leaders have taken to create growth in a short period, Mas believes that more changes need to be made at the policy level to support tech hub initiatives such as theirs.

In an interview with Business Insider in June, Mas argued that, “In Spain, there is a lack of culture of supporting innovation,” citing various shortcomings he’s seen in the country’s recent Startup Law, including benefits and support for later-stage startups.

Spain’s Startup Law

Enacted on the first of January 2023, Spain’s Startup Law had been in the works since 2018. Some of the key features included in the finally approved legislation are aimed at improving tax incentives and grants and making it easier to attract top talent. These include:

• A reduced corporate tax rate of 15% (down from 25%) for the first four years, starting from the first profitable year and a deferral of tax payments for up to 12 months without incurring interest, helping with liquidity in the early stages.
• Tax exemption on stock options (used as employee compensation) is raised from €12,000 to €50,000 per year, making it more attractive for startups to reward employees with equity.
• Easier access to public funding and innovation grants, especially for research and development (R&D) projects and enhanced tax deductions for R&D activities.
• New schemes and tax incentives for foreign talent including the Digital Nomad Visa, Remote Work Visa, Entrepreneur Visa, and a five-year Non-Resident Income.

The Startup Law also defines what the government considers to be a startup, assigning an age limit of less than five years from its inception (extended to seven years for companies in sectors like biotechnology, energy, and industry).

This is one area where Mas believes the Law has failed to make a significant impact. In his view, while early-stage startups are catered for, later-stage startups with the potential to make it big suddenly find themselves without support after the five-year period.

“A more flexible and prolonged tax policy would allow startups not only to grow, but to become key drivers of sustainable economic development in Spain,” explains Mas. “Expanding tax incentives based on the size and age of startups would greatly benefit the Spanish innovation ecosystem, promoting scalability, talent retention, and international competitiveness.” In addition, Mas says, it would encourage greater investment in innovation, promote the creation of qualified employment, and reduce the risk of business failure.

Indeed, Draghi’s report highlighted the lack of late-stage capital and argues that more European funds should also be made available to boost and reward startups that have achieved the success they need to get to the next level.

Mas has also noticed that established companies are not seeking partnerships with startups often enough. Such partnerships could in fact be mutually beneficial, with the former providing capital and commercialisation expertise and the latter providing innovation and agility.

Patricia Pastor, founder and general partner at NextTier Ventures and chairwoman at VDS, sees the difference in funding models and ecosystems contributing to the gap between European and US tech brands achieving international status. In a recently penned opinion piece, she states that while early-stage capital is easier to come by in Europe, US-based startups must prove their value to investors early on:

“As a European startup scales, it faces other challenges, like finding growth-stage funding and attracting investors and talent that’s bottled up in singular hubs like London. In the US, these things may be further apart geographically, but they are in the same country.”

In her view, adopting a revenue-first funding model would help European startups prepare to scale across the region by focusing first on dominating local markets and then gradually rolling out to new ones across the bloc.

Draghi’s report also puts forth the idea for an EU-wide legal statute (named the “Innovative European Company”) aimed at supporting rapid growth within the European market. This status, the report states, would provide companies with a single digital identity valid throughout the EU and recognised by all member states and provide access to harmonised legislation concerning corporate law and insolvency, as well as a few key aspects of labour law and taxation. It would also allow them to establish subsidiaries across the EU without incorporating in each member state separately.

Attracting talent

As Barcelona deals with reports of backlash from residents against the growing number of digital nomads that have moved there as a result of the new visa opportunities, Valencia is embracing them with open arms.

“The situation in Valencia is not comparable to what is happening in Barcelona. Citizens are very clear about the richness and diversity that digital nomads bring and the positive impact it has on the economy and society,” Mas says.

However, he is concerned about the ability for later-stage companies to retain and continue attracting the talent they need to grow. In his view, extending the deferral period on taxation of stock options to 10 years would help later-stage startups not only attract, but also retain talent.

Startup Valencia has been working to facilitate the soft landing of digital nomads by providing advice on everything from taxes, immigration, and banking to networking opportunities.

“In this sense, VDS plays a fundamental role as it is one of the most important international tech events in southern Europe and a platform that transforms Valencia into a global technological hub.”

Join Nacho Mas, Patricia Pastor, and more thought leaders from Europe’s tech ecosystem as they come together at VDS2024 from 23 – 24 October to discuss the policies and initiatives that could help Europe close the innovation gap.