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Hungarian Startup Ecosystem has High Potential, With Room for Improvement

Ecosystem

The McKinsey startup ecosystem conference on January 31.

Although Hungary has a solid basis for building a strong startup ecosystem that can drive the economy, it lags behind its European and regional competitors. A McKinsey study has identified seven areas that would lead to a more robust startup sector, accelerated digital transformation, increased employment, and public revenues.

If domestic startups could grow at a rate and scale comparable to other European countries, they could attract up to EUR 5 billion of additional resources to the sector. A significant share of this, EUR 0.6 bln-1.3 bln, would be used in the local economy, McKinsey told a conference on January 31. A more developed startup ecosystem would increase tax revenues, help the uptake of digital solutions and boost the digital transformation of the economy.

According to the study, Hungary is well placed to achieve the goals outlined in the above forecast: it has a sufficient number of startups, the venture capital available is within the average of the Visegrád countries, and there is a skilled workforce. In addition, the number of professionals in the IT sector exceeds the regional average, with 3.6% of the total workforce employed in the IT sector compared to 2.8% in the region.

Despite this, Hungary lags behind its neighbors in the number of so-called “unicorn” startups with a company value of at least USD 1 bln: 40 unicorns have reached this level in the Czech Republic and 11 in Poland, while only one, LogMeIn, has done so in Hungary. The number of startups reaching the mature stage of their development in Hungary is also significantly below that of developed European economies, with half the number of startups per capita seen in Germany.

McKinsey found seven factors that significantly influence the number of startups that are formed and how many of them succeed in reaching a mature stage, possibly becoming unicorns.

Founding Businesses

Transparent, simple regulation that facilitates business creation and raising capital while preventing abuses is essential for a flourishing startup ecosystem. In this respect, domestic practices are not in line with international examples: in the World Bank’s “Starting a Business” ranking, Hungary was placed 87th in the world. Bureaucratic difficulties also play a role in the fact that more than a quarter of domestic startups are registered abroad.

Around 16% of Hungarian startups receive foreign investment, compared to the European average of 40%; by comparison, Germany and Israel, which have the world’s most successful startup ecosystems, see up to 70% of companies receiving foreign working capital investment.

“Israel has achieved significant economic success over the past decade in part due to its impressive startup ecosystem,” McKinsey partner Márta Matécsa told the conference. “Hungary has the potential to show similar results and catch up with the countries with the most successful startup ecosystems: it can build on Hungary’s internationally recognized scientific innovation and its highly skilled workforce.”

The second factor is the supply of experts. The involvement of professionals with the right skills who can identify with the founders’ mission is essential for the development of startups. Knowledge of foreign markets and language skills will quickly become critical, as growth ambitions are unlikely to be achieved without international expansion. However, this often requires innovative solutions: for example, startups can compete with multinationals in terms of compensation by offering an equity stake. A good example of ensuring skilled labor is the French “tech visa,” which facilitates the establishment of startups by professionals from outside the EU. 

Another essential factor is a favorable tax environment for founders and investors. A tax system that encourages business creation and venture capital investment should increase the number of startups. There are successful practices in several European countries: in the United Kingdom, investing in startups is partly tax deductible from income tax. In Hungary, similar incentives are limited for founders or people working in startups.

Incentives to foster an entrepreneurial culture are also necessary. Research by McKinsey has shown that, while there is often a willingness to start a business, it is much more difficult for entrepreneurs from specific social groups to reach the mature stage.

By contrast, potential mid-career founders, who often have both the experience and the financial backing to launch a successful startup, are often risk-averse and find it harder to start a new business with their families. Specific mentoring programs and campaigns to promote entrepreneurial diversity can significantly increase the number of successful startups. 

The State’s Stake

Zoltán Birkner, president of the National Research, Development and Innovation Office, told the conference the state could play a role in boosting risk-taking and could also play an umbrella role in smoothing the ecosystem. Still, the market will decide what will be commercially successful. He also highlighted the Israeli model, where it now seems that the state has started to retreat after an initial “enrichment” of seed money.

Strategic allocation of public funding is also a significant factor. In addition to venture capitalists, the state typically plays a role in recapitalizing startups. One successful example is the Polish Growth Fund of Funds; the state does not intervene directly but through private equity funds based on strict return principles, thus indirectly financing the ecosystem.

Transparent knowledge sharing is another essential element. A common feature of the most successful startup ecosystems is full transparency, such as databases and digital platforms that provide reliable and credible information about startups and practical assistance in creating and developing new businesses. An example of this is the Startup Estonia platform, which has significantly boosted the ecosystem in that country.

To achieve success, coaching for founders and professionals needs to be available. In successful ecosystems, founders have access to a wide range of digital and business training, while startup skills are part of the curriculum at the high school and university levels. In Hungary, such education would be particularly important because Hungarians are extremely risk-averse, and Magyar startups are reluctant to compete internationally.

“If we can make progress in the areas we have identified, with close cooperation between the stakeholders in the sector, Hungary has the potential to create a thriving startup culture that will drive the whole economy,” Matécsa added.

This article was first published in the Budapest Business Journal print issue of February 10, 2023.

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