“The small size of the [Bulgarian] market doesn’t reflect the level of companies’ competence and sophistication,” says Mr Elvin Guri, founder of Empower Capital, one of few Bulgarian venture capital funds. Early-stage companies in Bulgaria are struggling due to a shortage of funding, but their untapped potential may be released with effective incentivising by the Bulgarian government and the European Union.
In 2016, foreign direct investment (FDI) in Bulgaria was €701.7m, a 72% decrease from 2015, according to the Bulgarian National Bank. FDI peaked in 2007 and foreign investors have been reluctant to invest in the country in the aftermath of the financial crisis.
Corruption in the political and judicial systems has also deterred investors, and in fact, Bulgarian lawyers advise their foreign clients to include in their business contracts a clause permitting arbitration outside Bulgaria in the case of a dispute. They also recommend establishing an investment partnership abroad, so that only the operating company is based in Bulgaria.
The majority of partnerships between Bulgarian and international businesses now function more smoothly than previously, however, as international chambers of commerce, sectoral business associations, and western diplomats lobby actively on behalf of investors facing problems.
EU Promotion for Bulgarian Start-Ups
The European Union has sought to promote investment in the South East Balkan country via the Joint European Resources for Micro to Medium Enterprises (Jeremie), an initiative of the European Commission developed together with the European Investment Fund. It promotes the use of financial engineering instruments to improve access to finance for SMEs via Structural Funds interventions.
One Bulgarian official says that €120m+ has been invested since 2013 in companies backed by Jeremie, via four Bulgaria-based venture capital funds, and the market has room to grow: Empower Capital’s Mr Guri puts the potential for private equity investment across south-east Europe at €5.6bn.
Cause for Concern
Not everyone is optimistic, however, about the flood of capital brought about by Jeremie. Imre Hild, chief executive of iCatapult, a Budapest-based accelerator, says too many VC fund managers have private equity backgrounds and do not understand the mindset or needs of entrepreneurial start-ups: they acquire majority stakes and then micromanage the companies, almost certainly stripping them of their creativity and innovation.
The Bulgarian government is also working to attract foreign investors: in regions of high unemployment, investors enjoy tax breaks on reinvested profits and subsidies on social insurance payments. In addition, investors can take advantage of low wage costs (€4.40 per hour) and a flat tax rate of 10% on corporate profits and personal income, the lowest in the EU. The government is also actively reducing red tape for investments in manufacturing and services.
These incentives are key to securing funding for start-ups, as increased amounts of private financing will be critical to making small businesses sustainable in the longer term. Otherwise, they will move to the UK, Germany, or the US, where venture capital and private equity funding are readily available, warns Evgeny Angelov, chairman of the Bulgarian Private Equity and Venture Capital Association and former Economic Advisor to the President of Bulgaria.
Low Labour Costs
Low labour costs in particular set Bulgarian start-ups up well in terms of competitiveness. As an example, take the following two small high-tech companies: MClimate, based in Sofia, and tado°, based in Munich. They are both Internet of Things firms focusing on smart homes and offer similar product suites that include smart thermostats, controlled via apps, that adjust to the real-time behaviour of residents of private homes and small businesses.
The difference in funding between the two is significant: tado° just closed its Series C round, bringing its total funding to $56.29m. MClimate, on the other hand, is operating with only seed funding, which totals US$690.82k. Note that tado° is a few years older. MClimate reviews on Google Play are 3.4 stars, while tado° reviews are at 4.1.
While the difference in rating highlights a customer preference, the low costs of MClimate allow it to operate healthily in the market, and it’s possible that with more funding Bulgarian companies like MClimate would compete more aggressively against their more capitalised counterparts.
Bulgarian startups have so far proved competitive in the tech sphere: “These are companies that have developed world-beating technologies. They have tremendous possibilities,” stated Mr Mark Crandall, founder of PostScriptum Ventures, a venture capital group that specialises in start-ups and niche investments mainly in the energy sector.
This sector specialisation could prove useful for future EU funding, as the union emphasises the need, through structural and investment funds, to make the EU’s single market fit for the digital era by removing regulatory walls and merging the existing 28 national markets into one robust market place. The European Commission claims the move could add €415bn to the EU’s economy annually while creating hundreds of thousands of new jobs.
While Bulgaria hopes to position itself as an information technology leader in Southern Europe, businesses are finding it difficult to keep up with accelerating demand for skilled workers: although around 2,000 IT and computer science graduates enter the labour market every year, few of them have the specific skills that businesses need.
“The success of Bulgaria’s high-tech industry will depend on our ability to generate the necessary capacity of relevantly educated engineers,”
states Mr Roddy Dervishev, chief executive of Sibiz.
“If we are not able to build sufficient engineering capacity, this may lead to stagnation, withdrawal of investments and Bulgaria will not establish itself as a high-tech destination.”
Both the private and public sectors are attempting to change this situation with appropriate training, but the results will take time to show.
In conclusion, the economic conditions of Bulgaria are improving, but the country’s vibrant start-up environment will suffer unless capital inflows continue to grow and quality in the labour market holds up. The attempts of the government and the EU may be the key to helping SMEs prosper, and the result may be a sea of opportunity for venture capitalists and innovators.