From zombies to unicorns: the struggles of Romanian startups

Anca Alexe 10/04/2018 | 09:30

“Startup” has become a very popular term both globally and here in Romania. Many believe that just having a good idea for an app or programme one day can gives you a good chance of becoming a millionaire in a matter of months.

However, even if a few startups have had fast, almost miraculous growth seemingly overnight, it is wrong to think that this happens very often in the startup world. Most of these companies really struggle to get off the ground, and their survival and success are simply the result of hard and continuous work.

There are private organisations that help startups grow, called business accelerators, which usually offer financial support and guidance to help a startup develop. Business Review spoke to Jennifer Austin, a founding partner of the Risky Business Accelerator in Cluj-Napoca, who offered insights into the Romanian startup world and the threats startups in the country face, both from the outside and from within.

When did you start working in the Romanian startup scene and how has it evolved since?

In 2014 I moved from California to Cluj, Romania. Since then the startup ecosystem has matured considerably. At the time, there were few legitimate startup investors–especially in early stage. On the other hand, there were countless “hypothetical angels” attending pitching events, giving seminars, and generally seeming important while never investing. Investment terms were often so toxic they killed the startup from the beginning, with investors demanding excessive equity or ridiculous controls.

I remember hearing over and over that Romanians won’t invest (properly) in Romanian startups–now we have active angels, privately funded investment groups for early-stage, and we have even seen investments from the universally conservative banking institutions.

Despite this progress, the Romanian startup ecosystem is still extremely nascent and the reality is far from the rainbow and unicorn prospects the hype around it presents. Going from high potential to high result will require overcoming a number of challenges, including cultural/mentality, structural, education, and policy.

What is the overall quality of Romanian startups? How many of them fail, and is the failure rate higher than in other European countries/the global average?

This is quite difficult to accurately to assess because there is no well-researched global resource for this to benchmark against. Even if there were a global resource, it would be challenging to assess Romania because there is not much transparency here. Many investors and startups don’t disclose the relevant terms of investment–namely cash invested vs. services/advising equity, and valuation.

“Some founders tend to have unrealistic expectations about their investment prospects, and expect that an investor is willing to take more risk than them. An investor won’t risk their money on a startup whose founders are not first willing to risk their own time.”

There have been many announced “investments” that were actually service investments–that is, IT companies investing development services. While this can be valuable for startups, it distorts the public understanding of the investment scene. There are also many zombie startups that are around forever, but never get investment or meaningful traction and quite a few flatlined startups that get a round of funding, are never able to secure a second round or grow meaningfully, but maintain a web presence despite being essentially defunct.

This is a problem in many startup ecosystems, but seems greatly exacerbated in Romania by stigma around admitting failure. We see a lot of people who have had the same startup for 4 years, yet have full time jobs, and the startup is nothing more than a landing page or skeleton app, plus a pitch deck. Of course, it can often be hard for anyone to admit failure, to ourselves let alone others, when we’ve invested so much of our own and others’ time, energy, and resources.

Startup vs. new small business – what’s the difference?

There is confusion in some circles between a “startup” and a “new small business.” Especially in Europe, I’ve noticed the terms seem to be used interchangeably, especially by government organizations and researchers. The distinction between the two is so critical, not because one is better or more important than the other or a more worthy endeavor, but because they have different needs, impacts, and growth patterns.

While there is some debate around the precise definition of a startup, it is generally agreed a startup is a scalable company with an end goal to be disruptive and large, or “take over the universe.” Of course, this is just an expression–there are many good startups that target regional markets, not global. Still, they seek to dominate whatever their market is.

Startups are not initially driven by profitability, but by growth. They take venture capital with the goal to have an exit, whether an acquisition/merger or an IPO. Startups don’t generally hire people until seed financing. On the other hand, a new small business is a profit driven, independently owned company. They need to focus on profitability from the beginning, and their financing usually begins with loans from friends, families, or banks.This means you can’t really assess the number of startups by number of companies registered, even if they are in a tech domain since it could be a development or outsourcing shop.

The team at Risky Business Accelerator, working with startup teams in Cluj-Napoca

A startup aims to disrupt and dominate the market with a scalable business model, while a small business owner (or lifestyle business) aims to be his/her own boss, secure a place in the local market, and grow larger but at a much less accelerated rate than a scalable startup.

Examples of startups are software products, like Zonga or Frisbo. Startups may rely on non-scalable elements, such as Uber relying on cars and AirBnB relying on apartments and homes, but their product is the software, which means it is highly scalable. New small businesses include grocery stores, agencies, outsourcing firms, consulting firms, etc. This distinction is very important from a policy perspective, since the needs and impact of startups vs. new small businesses are quite different.

Attempting to drive immediate job creation through public sector financing of startups isn’t well aligned with the realities of how startups grow. Public sector financing for startups should focus on driving innovation and competitiveness, while public sector financing for new small businesses should focus on driving employment, local economies, and sustainability.

Another confounding problem in Romania is that there seem to be many companies opened solely for the purpose of accessing state funding. This distorts any attempt at analyzing new businesses, because most funding schemes require the firms to be kept open for a certain period to avoid clawback of the funding. But a discussion on that particular issue could take an entire book.

Expectations vs. reality

In Romania (and many other early startup ecosystems), it seems like many people declare they have a startup because they made a landing page at a hackathon; or because they have a side project they invest a few hours in a week. These are generally doomed to stagnation and eventual death. These founders tend to have unrealistic expectations about their investment prospects, and expect that an investor is willing to take more risk than them. An investor won’t risk their money on a startup whose founders are not first willing to risk their own time.

In the first investment rounds, founders shouldn’t expect to set themselves a market salary. An investor isn’t paying you to build your dreams. When we ask how much investment a startup needs and for what, and we see a founder set their salary at nothing without having any savings, we are skeptical they will be able to sustain themselves to build the company.

When we see them set their salary the same as their corporate salary, we are skeptical that they understand how startups and investment work, and moreover whether they actually believe in their startup if they aren’t willing to sacrifice and risk for it.

Getting funding does not necessarily equal success

In the past Romanian startups secured investment from experienced funds and angels tend to be quite competitive, since there was historically little funding available in Romania. There are of course exceptions. We also see a lot of “bootstrapping” mentality in successful startups. Bootstrapping is basically “finding a way to operate on minimal cash/resources.”

In the past, with limited financing available, many startups had to balance precariously between building and growing their product with a side business of outsourcing or consulting. While some startups, like the Romanian founded unicorn UiPath, were able to eventually focus on their startup business fulltime and ditch the outsourcing/consulting, it is extremely difficult for teams to wean themselves from their cash cows and focus on the startup business full time.

“When you look at successful startups, you see that eventually the CEO and executive team aren’t the founders. This is something many Romanian startups seem uncomfortable with. But if you business is growing exponentially, it means that your skills to manage it must grow exponentially.”

In the coming years there will be more funding available in Romania. This does not necessarily mean that there are more investable startups. Most funds in Romania have immense pressure, either due to their mandate, the partners’ incentive structures, or both, to invest a certain amount each year regardless of the quality of startups. Startup funding in Europe doesn’t seem as market driven as in other regions, with many state actors and programs involved in financing and supporting startups.

20 startups receiving pre-seed investment or a handful receiving seed doesn’t necessarily mean the Romanian startup ecosystem is doing well; we have to look at what happens in the long run. A single or even several funding rounds does not make a startup successful. It is important to keep an eye on the percent of initially funded startups that receive next round funding that includes different investors than the previous round (versus previous investors doubling down to keep the startup alive), how valuations grow, and of course exits and exit terms, and so forth to really evaluate the state of the startup ecosystem.

Do Romanian startups fail for the same reasons as in other countries or are there unique factors here that threaten the success of a new company – such as lack of financial education/support from the state or the market/legislative issues?

Besides lack of entrepreneurial mindset and lack of know-how in building and selling products, it often seems like Romanian founders don’t think big and lack an understanding of the motivation of investors.

A common problem we encounter with high-potential products is that the founders want investment to build the startup to become a lifestyle business—not to grow it large and then sell it. Lifestyle businesses (businesses that provide sustainable and reliable income to employ some people and support the lives of the owners) are wonderful and great drivers of local economies and employment, but they are not suitable for startup investors, who seek a liquidity event to get a return.

Related to legislative issues, the Romanian business law makes it difficult to do some basic things common to startup investing and formation like vesting and convertible notes. Lack of framework for vesting makes it even more challenging to motivate early employees, since it makes it more difficult to give equity to incentivize them.

Of course an ongoing challenge for Romania is that startups are seen as a kind of game. Serious founders who can both talk the talk and walk the walk are quite scarce.

Startup founders: education, mindset, age

Romanian startup culture seems to have lionized the sporadic self-made young dropout who gets funded and hits it big as the norm. While this does happen occasionally, the vast majority of people who receive VC funding in the USA come from relatively elite schools and families that are at least comfortably middle class or above (providing strong safety nets), and have quite a bit of practical experience.

While there are a lot of smart kids in Romania, the education system does not push for practical projects as it does in the USA. In American schools, we do “public speaking” almost every day and projects at least every month from a young age. Public speaking, working in teams, managing projects that require different inputs, etc. push kids to develop soft skills and the basics of management from a young age. These skills are instrumental in building a startup. Integrating more project-based work at an early age into the Romanian curriculum would greatly improve the entrepreneurial and even job skills capacity of youth.

In Romania, startups are seen as a young bro’s game in Romania. “Hustle” is overhyped, as if working harder or longer can make up for lacking insights, no experience executing or leading, or quite frankly dumb decisions.

“Founders that have relevant experience in the industry their startup is addressing are infinitely more investable than a startup in the latest buzzword.”

Around the world the average age of a startup founder receiving investment is late 30s-mid-40s. This is the age and professional stage that you develop broad management skills, strong industry skills and connections, and the focus and discipline for the hard work to get a startup off the ground. The average age of a startup founder at their first exit is 47.5 years old.  Of course, there are challenges to building a startup during mid-career–it is hard to quit your job and take huge risks when you have children and a mortgage. Although youth entrepreneurship is the hot thing to encourage in Europe due to low youth employment rates, we would do better to instead focus policy on developing practical and job skills in youth, and instead encourage mid-career entrepreneurship.

One thing that Romania has going for it is that is a stronger social safety net than many Western countries by virtue of higher rates of home ownership and closer-knit families. When I see a young founder who has real potential a bit afraid to take the risks, I tell them “look, in the worst case, you fail miserably, lose all the investor money and your time, gain a lot of experience and skills in the meantime for your next venture or career step, and stay with your parents a bit and get spoiled with some home cooking while you plan the next steps, which probably include a higher salary than you had before because you can say you have “product” experience now. Oh, and maybe you feel a bit embarrassed.”

After getting funding, what challenges do Romanian startups tend to face?

One of the key challenges we see comes after the pre-seed/seed funding, when it comes to scaling the team and product. Lack of experience in international business (especially in marketing and sales) and general leadership are often barriers. Building an MVP is child’s play compared to building and leading a technical team of dozens to build a secure, scalable, engaging product meeting the needs of a growing client base. It requires not just tech skills, but management skills and product skills. Overall lack of financial management experience is also a big problem with many aspiring Romanian entrepreneurs.

Product management requires complex understanding of your users, business model, the market, and the technology. One generally does not learn these skills in a typical outsourcing company, where most Romanian developers work. Because most tech people have worked at outsourcing firms where the specifications are largely determined by the client, there is limited experience creating and managing products from initial idea to success. While some firms have begun to make products, the ongoing conflict between lucrative outsourcing contracts vs. the costs of building a product means that the talent gets shifted to the immediate money maker (external contracts).

Without a sense of ownership and stable team it is very hard to create a product of even mediocre success.  Additionally, Romanian job roles seem very siloed, limiting the opportunity to gain cross-functional skills which are important in general, but crucial to the product management role. Startups cannot succeed with a team that is concerned with whether or not something is in their job description–being able and willing to pick up new roles and skills quickly is crucial.

At some point, founders might find a company grows faster than their skills do. When you look at successful startups, you see that eventually the CEO and executive team aren’t the founders. This is something many Romanian startups seem uncomfortable with. But if you business is growing exponentially, it means that your skills to manage it must grow exponentially. When we advise startups on this, we suggest they think of a business person they most admire, and tell them to focus on building a startup that could attract someone like that to be the CEO.

Finding an internationally capable marketing person is one of the biggest HR challenges of startups in Romania. We know half a dozen exceptional startups seeking such a person. Unfortunately many early startup founders in Romania don’t realize how pivotal this role is. Even if it isn’t on the founding team (ideally it is, but there is no perfect team), the hiring package for such key roles should include equity. Early employees are key to the startup’s long term success, and good founders know and appreciate this. For example, even though Ebriza has been operating for 1.5 years, they are seeking a head of marketing whose compensation package includes salary and equity.

One of the things I am looking forward to in Romania is when the first major exits begin. Romania has had exits, like LiveRail, which sold to Facebook for EUR 500 million or so. But much of the team was in London. The founding team and early employees of major exited startups tend to become powerhouses in the local startup ecosystems as investors, serial entrepreneurs, or both.

Does Risky Business get a lot of applicants in open calls for startups? Has the number of applicants grown in the last few years? Do all applicants come from Romania?

We get a few hundred applications each year for the program with no real marketing effort, from Romania and beyond. However, about half of these are at “idea” stage. While we are generally open to discuss interesting ideas, we do not invest at idea stage. This is a major misconception of many aspiring entrepreneurs in Romania—that an investor will invest before the founders invest themselves. Why would an investor risk money before a founder risks their time? Because we are working with only private investment, we are much more selective than other programs. But this also means we provide much more individualized and more comprehensive support.

Having almost all Romanian LPs (investors) is a source of pride for us and part of our overall mission. Risky Business is focused not just on creating opportunities and supporting local startups, but also doing so for local investors. We were very happy to see an organization based on our model, TBNR, emerge in Iasi, and hope to see other cities developing local investment capacity. Developing a local investment community is key to the long-term growth and viability of an ecosystem. This is also a source of pride for our startups.

Meeting with the Ebriza team after their second round of investment, which was participated in by Banca Transilvania, Risky Business, and Romanian horeca entrepreneurs Dan Isai and Marcelus Suciu, one of their lead developers told me “I’ve worked for several startups in the past years, but none with substantial Romanian funding. Usually startups had to go abroad to seek larger financing rounds on reasonable terms. Seeing local investors believe in and risking their own money in Romanian startups, plus a major influencer like Banca Transilvania investing, makes me optimistic about the future of Romania.”

The Ebriza team, which has grown from a team of 3 to a team of 11 in the past 2 years.

For Startup Avalanche, the startup competition inside Techsylvania, we also get a few hundred applications each year. In the past two years of the competition, the startups that have joined have come from all around the world, including countries like Estonia, Russia, Serbia, etc. as well as countries like the UK, France, USA, and Columbia. In addition to the chance to showcase their startup to major funds and angels from all around the globe; media like Tech Crunch and Tech.eu; plus potential clients, partners, and collaborators; the startups get access to VIP networking areas, events, and dinners.

Each year Techsylvania brings thought leaders and innovators from all around the world, and the event has been a major driver of the startup ecosystem here through the exposure, knowledge, and opportunities it brings. It is without a doubt the best conference for tech entrepreneurship in Romania. Our startups have really appreciated that it is big enough to bring diversity and engagement, while attracting great speakers, but also not so big that you don’t have an opportunity to engage with the speakers and investors. Because the competition only accepts 10-14 competitively selected startups, they really get attention.

What predominant industries do startups that apply come from?

There is no clear specialization of startups applying. However, because Romania has not yet developed a clear specialization, it tends to trail behind the fads. Many aspiring entrepreneurs focus on creating a startup in whatever seems to be trending recently, rather than focusing on an area they have significant and relevant experience in. We call this “Startup by Buzzword.” Last year, it was all about drones, AR/VR, and chatbots. Now “everybody” is doing an ICO to blockchainifying their Big Data leveraging IoT AI.

On the other hand, Ebriza, which recently received a second investment round from Banca Transilvania, is a cloud-based POS for horeca and SMEs. Besides having strong technical expertise to build the product and lead a tech team, the founders had many years of experience in horeca—they owned bars, and one of them was one of the most popular DJs in Romania. Founders that have relevant experience in the industry their startup is addressing are infinitely more investable than a startup in the latest buzzword.

Besides the obvious technology trends, we really like biztech–that is, startups solving problems for SMEs.  This is in part because of our team’s considerable experience supporting non-tech businesses as well as tech, and because we see this as a high potential area.  In addition to the strong team and innovative product, we were very attracted to Ebriza because we saw that it could bring meaningful innovation to solve problems for horeca and retail, which are backbones of local economies. Personally, I worked in restaurants to put myself through college (college is quite expensive in the USA). If the places I had worked at had Ebriza, the staff and operations would have been much more efficient and much less frustrated.

As great and profitable bleeding-edge technological innovation can be, it is often hard to see how it impacts the majority of society or brings meaningful improvement to the lives of the masses. Perhaps the reason this “biztech” area seems underexploited is because we can only create solutions for problems we know about. For many reasons, it seems people in Romania stay in a very limited professional bubble most of their life, and often even an industry bubble.

When the majority of aspiring tech entrepreneurs have worked in the same companies, in the same culture, socializing with the same people, with limited exposure to much else, it is normal to see the same ideas over and over again. This is part of why we see so much “tech for tech sake” startups–just kind of cool widgets that nobody needs, solving nothing except the apparent immense time on the founders’ hands. (I’m not exaggerating when I say that over the course of my 4.5 years in Romania, I’ve been pitched at least 10 apps for finding the quickest pizza around you.)

While this is also a problem in other ecosystems, it is quite extreme in Romania. This won’t change until startups stop being cast as a young tech-bro’s playground. So bring on the middle aged founders, with experience beyond tech, whose major problems do not include speed of pizza, who are willing to invest more than a few weeks before they seek investment.

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