This weekend Nina and I were in Rome. Original plans were just to hang out and enjoy what possibly is the most beautiful city in the world but a fortuitous encounter led me to give a talk to a group of techies in Trastevere on Sunday. The talk was very interactive, with me presenting but mostly asking questions about the Italian start up scene. The event was organised by Johanna of Frestyl, which is a website that brings fans and amateur bands together. Freestyl is currently under development and it is one of the investments of my friend Joichi Ito.
If you have read my article about creating businesses Europe you can probably imagine what I spoke about. It´s a mixed picture. The European scene for start ups is better because there is less competition, salaries are lower and medical and legal costs are much lower but it is worse because VCs are rare, markets are fragmented by language and labor laws make failure, common in start ups, extremely costly. But what I found in Italy was discouraging because, as opposed to Spain, where I live, labor laws are even worse, VCs are even rarer, Internet success stories are few, and the Italian language market is much smaller than the Spanish language market. After asking many questions about the Italian startup scene I reached the conclusion that, even though Spain’s economy is doing worse than Italy’s in general, our technology startup ecosystem is doing better. When we built Ya.com, for example, we invested 38 million euros, and sold it for 550 million. Of those 550 million euros, 70 went to 50 employees thanks to our stock option plans. Jazztel was a similar story depending on when employees cashed stock options after IPO, some did very well some didn´t. But out of all of those who did well many new angels emerged. Jon Berrojalbiz is one great example of a successful entrepreneur who came out of Ya.com. He is currently CEO of the very successful Trading Motion and an investor in other strat ups like Isolee. There is also the case of Miguel Salis, who was CFO at Jazztel and is today CEO of Eolia Renovables. Eolia, which was started when Miguel was the MD of my family office in 2004, is now the biggest independent alternative energy company in Spain. Over $1bn was invested, EBITDA is now over $120M and up 110% from a year ago and many jobs were created tons of carbon emissions saved. There are also many cases of companies that were sold successfully in Spain which had nothing to do with me. In Italy, however, I did not hear stories of 70 million euro stock option plans or cases in which wealth was created and distributed in a way that would create an angel network. As a result, the culture for small investors in Italy is lacking and entrepreneurs have to ask their parents or family for money which I consider in general a very bad idea. The only way to do well in VC type investing is to have a diversified portfolio, asking your parents to invest with you is contrary to that.
And then there is the cost of failure. Most start ups fail and that is true anywhere in the world, but in Italy the cost of failure is enormous. If a company shuts down because, for instance, their product had no demand and this company has say 100 employees, the costs for the entrepreneur can be brutal. In Fon, for example, we began with many employees. Unfortunately we had to lay off half of the team at one point and now that we are profitable we have started hiring again. This situation would have ruined us in Italy, because there they have different laws of forced severance payments for companies under 15 employees and over 15 employees. Significant startups can’t exist in this environment since they never know with certainty how many people they are going to need. On top of this, entrepreneurs who fail are seen as crooks. Not as people who tried to create a good product and create jobs but simply failed. Having an entrepreneur president who has barely escaped jail for many years now has given Italian entrepreneurs a bad name and that is not fair. So, on top of everything, I said before up and coming Italian entrepreneurs confront a mood very different to those of say Dutch entrepreneurs, Netherlands being the European country which in my view respects entrepreneurship the most. Now, to end on a positive mood, Italians are still very creative and have many SMEs who thrive on a European and sometimes global basis and hopefully this will soon also be the case of Italian Tech Companies.
And, in closing, here are some pictures of Rome.
While not all Americans love Europe, many, mostly from the Blue States, do. People in San Francisco or New York City dream of spending part of their life in Italy, France, UK or Spain, and some do make it over. Not many go to the extreme of moving over here and giving up their US nationalities as I did. But after 9 years of being a tech entrepreneur in Europe and being forced to choose between Spanish or US citizenship, I chose Spanish and stayed in Madrid. As a tech entrepreneur, I found Europe, in general, and Spain, in particular, to be a fertile ground for me. The European market is huge, bigger actually than the US market. And over here, I built Viatel in the UK, Jazztel and Ya.com in Spain, Einsteinet in Germany (the only company that I sold at a big loss) and now Fon.
Europe is great for an American tech entrepreneur because wealth here is better distributed, people are more educated and there are less competitors. Since being an entrepreneur is not very well regarded over here, US entrepreneurs find more open niches; but on the negative side, the market in Europe is much less homogeneous than in USA, local cultures make it hard to launch pan European products and there are all sorts of taxes, market distorsions and restrictions that surprise a US entrepreneur.
So let´s go over the caveats. The first one that I would like to focus on, one that is particularly brutal, is the issue of unlimited personal liability of the entrepreneur. On the rest of the article I will refer to laws in Spain, but I do believe that what I am about to tell you about Spain applies to most of the rest of Continental Europe as well.
USA has a lenient view of failure. Failure in America is not seen as a lifelong chronic disease but as a test of character. VCs in the States look for people who have had a combination of successes and failures, as they are more prepared to deal with the tough realities of business life. In Europe, however, failure is seen as just that, failure, a stigma that stays with you for the rest of your life. So far, I have never managed a business that had to liquidate. In all cases, even during the crash of 2002, I was able to refinance, renegotiate and keep companies going. Even at Einsteinet we were able to preserve most of the jobs. We sold the company at a loss, but the loss was limited to the capital invested by myself and my partners mostly at Goldman Sachs. Recently, thanks to the crisis, I have been hearing horror stories of what happens to entrepreneurs who fail in this Continent vis a vis personal liability. It is not nice.
The basic problem for start up entrepreneurs in Spain (and probably most Continental European countries) is that there is no such thing as “bankruptcy”, in the legal sense of the word. This is a huge problem for start ups because, as we know, most of them fail. So, for example, if you start a company in Europe, try hard for five years to make it, but run out of money in the end, the company is not perceived as a bankrupt company in the American sense of the word. In Europe going bankrupt is the same as firing all the employees and you as the founder, PERSONALLY owe the money that has to be paid to the employees for letting them go, even if the business has done nothing wrong. I know, it sounds crazy, but this is the case. So Spain, for example, had a construction boom for the last 5 years that ended in a bust, and now entrepreneurs are having to close down businesses. But when they do, they have to sell their home or do whatever to pay the severance pay of the employees. Because in this case not only the employees can sue you (through the Seguridad Social) and force you to sell your home, car, and deprive your own family of whatever they need, but if you don’t have money to pay now, they can hunt you down for the rest of your life. You never recover, you can never declare bankruptcy. You can never start anew. If you start a new business and begin to do well, whatever you make then goes to pay for your past losses in your past business. Spanish law ties your future endeavors to your past endeavors. You never get a clean slate. If you had say 1000 employees, which is what I have had in my other companies, you could owe tens of millions of euros for the rest of your life to them. Even though you did not do anything wrong other than failing to generate a profit, you are held personally liable for poor market conditions. This is an enormous risk for a start up entrepreneur. A risk that grows larger, the longer you are in business, as severance liabilities are not related in any way to employee performance and only related to their duration with the company.
And even if you are lucky enough not to go bankrupt in Europe there are other conditions that dissuade an entrepreneur from starting a business. One of the reasons of the higher unemploymentin Europe than in America is the extremely high social charges. These are 50% higher than in the States. In Spain, a starting level employee who takes home 1000 euros after taxes costs the entrepreneur almost twice as much. In Europe the government takes so much money in between the entrepreneur and the employee that, while take home pay is many times absurdly low, employee cost is generally high. And not only are social charges very high, but salaries are deceiving because, by law, in Spain and in general in Europe you are forced to pay employees 13 or sometimes 14 months for 11 months of work (a year minus a month of mandatory vacation plus an extra month or sometimes two of a mandatory state bonus regardless of performance). So if you are an American entrepreneur and you come to Europe and find out that there are no stock options and bonuses and want to pay them as I have done, you should realize that, even though it appears that there isn´t additional compensation, in reality there are hidden forms of compensation such as extra months and accumulated liabilities through mandatory severance and these are secured by none other than your own children´s college funds, your home and your car. And this is not all.
In Europe for example, medical doctors play a hard to explain role in business. If, in America, the ghosts for entrepreneurs are injury lawyers, in Spain, France and Italy they are medical doctors. How? If a person does not feel like working, they go to a friendly doctor who declares them “depressed” and they can stop working and still get full paid for up to 18 months. At Sybilla, a company that I invested in, we now have many of such employees, all declared depressed by their friendly doctor, and company productivity is seriously suffering. Interestingly the same law does not apply to entrepreneurs. As an entrepreneur you are not allowed to be depressed. This is illegal. If you are nobody pays you. And even when your business fails, you, the entrepreneur (or admistrador in Spain), are not allowed to collect unemployment insurance even if you contributed to the Seguridad Social. In Spain and some other countries entrepreneurs are presumed guilty by default and, in case of failure, everything is seen as their fault even if they truly had a case of mental illness. Mental illness or depression cannot get an entrepreneur away from his obligations to pay, but very commonly gets employees away from their obligation to work.
So while some European countries do have great advantages to start businesses among them, no capital gains tax on businesses owned and sold in over 5 years, starting a business in Europe is riddled with danger. Having built businesses in the States as well, I know that USA has its negative aspects. One would be the “legal tax” of doing business. Legal expenditures for the average business in Europe are in my experience 70% less than in USA. Moreover in Europe you don´t need to worry about frivolous lawsuits nor insure yourself against them. But in Europe we have all sorts of entrepreneur obstacles such as net worth taxes, which are as high as 2% of your global net worth per year, we have a medical system in cahoots with employees, we have social charges that are twice as high, and lifetime liability for business failure.
So what do European entrepreneurs do? Many times they find loopholes but these loopholes even though they are sometimes legal, because we live in the black and white world of Napoleonic laws, they are pathetic to say the least. For example in some case entrepreneurs in Spain are not the legal administrators of their business but find instead people with no net worth to take the job so if things go wrong they are off the hook. And I heard worse things. In some instances, entrepreneurs in the construction industry ask all new employees to sign blank pieces of paper when they join so the entrepreneurs can force them to resign without severance should they need to do so. I know that it sounds insane to an American used to courts that interpret the intent of the law that a simple trick like that would work, but in Spain it works. Another common trick that is illegal but almost normal is that when employees want to resign for their own reasons they ask the entrepreneur to fire them so they can collect unemployment insurance. Another one is that employees who are collecting unemployment insurance offer to work for cash pay but not on the books so there´s no proof that they are working and collecting unemployment and entrepreneurs go along because they save social charges. And this is but a small list of tricks, illegal maneuvers and loopholes that the system of rigid laws, high social charges, and forced severance has created. So when you see unemployment statistics in Europe they tend to be inflated in the sense that there are a lot of people in Europe who are both working and collecting unemployment insurance. The problem is that the employment statistics are also inflated in the sense that there are a lot of fake sick people in Europe who are supposedly employed but who are not working.
Now here is an extreme example. The ultimate American start up, the Hewlett Packard, the company that started in a garage would be illegal in Europe. In Europe everything is regulated. People cannot legally work in a garage. In Germany for example there is legislation that defines what a workplace is. I know that it´s hard to believe but there are even laws that do not allow employees to work further than a few meters away from a window so unless this famous garage has a lot of windows already working in a garage can get your business close. Moreover there is almost a concept of bondage involved in the employee company relationship with a set of rights that creep in and build over time that go against the basic principle of the start up namely of trying new business concepts that may fail. Even eager start up employees who understand that a start up has risks and want to be part of the adventure are not allowed to waive any of these rights. If an employee wanted to sign a piece of paper that said “I declare that I know this is a start up and we don´t have money in this new company to get an office and I accept to work in this garage and I renounce my rights to a window” a government inspector could come and close the whole company anyway. In general I would say that in Europe the concept of trying things out just does not exist, if you try you are liable, if you try you have to behave as an established business. There´s no concept of an incubating business in temporary start up conditions. The moment you are in business you have to abide by the rules of business and this rules are against start ups.
Bottom line, if you are a US entrepreneur or a US company thinking of opening up a branch in Europe you have to learn that while the market here is huge that Europe is a whole new world when it gets to the rules of the game of starting a business. Think less of stock options which in any case are frequently illegal or taxable when they are given out even when they are out of the money, less of bonuses because bonuses are already part of employee compensation and instead interview very very well before you hire because firing is tough and lack of productivity is not reason. In Europe it is not illegal to ask personal questions in an interview, indeed interviewing is much easier in Europe than in America, what is harder is to lay people off. Even if you have a sales person who has been unable to close a single contract it is illegal in Europe to argue that you are laying off this person because he or she produced no sales. In Europe, a sales people are not supposed to sell, they are supposed to show up for work and if they fail to maek sales the fault always, invariably lies with the entrepreneur. When the entrepreneur fires this person it is always a wrongful dismissal that must be compensated for.
Now, to end on a positive note, I can say that in my 13 years of building businesses and managing people in Europe my personal experience has been good. While in one of my portfolio companies there is a high number of people who declared themselves depressed this has only happened with one of the managers who ever reported directly to me. Also, because I never had to close a business, I was not caught personally owing a lot of money to former employees. Employee morale at Fon for example is great and I have not seen any cases of people abusing the system. Moreover, in Spain, and in Europe in genera, there are fortunately very many highly ethical people who don´t abuse the system even if they could. As a result there are many successful entrepreneurs and successful businesses in Europe. But, overall I would say that European society is not business friendly and especially not start up entrepreneur friendly. If you come over, create jobs and do succeed don´t expect the recognition that you get in the States. In Europe, as an entrepreneur, you are much less likely to be seen as an engine of economic growth and more as a person who gained unfair advantage over average folk who are struggling to make ends meet. And, if you are American, even more so. So American entrepreneurs coming to Europe, beware!
Today Expansion, Spain´s equivalent of the Financial Times, has a poll among university students whose results I found surprising. In general, I believe that somehow I can understand and predict how people in Spain think. Here, had I been confronted with the questions beforehand, I would have failed miserably. Students are asked to rank ocupations from the most trusted to the least trusted.
The Spanish papers dedicate about 3 pages everyday to the Basque Country debate, and some days, even more. The Spanish people are obsessed by the situation in the Basque Country, in part because of terrorism. However, just the other day I found out that every year in Spain more people die in car accidents than have died in the entire history of ETA, yet, I don’t see as much ink spilled to cover that story.