Fueling the Hungarian start-up ecosystem

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The world economy is contending with several challenges: swelling inflation, an unclear recovery from the pandemic, war in Ukraine, and a resource-intensive energy transition in Europe. Most academics and think tanks agree that an extended period of challenging macroeconomic conditions is on the horizon.

Yet diamonds are formed under pressure. Many of the world’s greatest start-up successes were born and built during economic downturns. Challenging times force entrepreneurs to take risks and test innovative business models. Slow movers tend to retreat during economic downturns, while opportunities open for more ambitious risk-takers—especially start-ups, whose successes benefit their national economies. At a time when many governments hope to soften the impact of a possible slowdown, catalyzing a thriving start-up ecosystem could be one of the more promising paths.

The state of Hungary’s start-up ecosystem

Hungary now has around 2,900 start-ups, according to data from Dealroom, a global provider of information on start-ups and venture capital (VC) activity.1 Collectively, these start-ups employ some 10,000 to 15,000 people and have raised over €1,400 million in funding.2 Hungary’s economy has several strengths, such as a culture of scientific innovation, innovative talent, and proximity to large European markets. All of these strengths could help to create a thriving start-up ecosystem. Combining them with the best practices of other countries would give Hungary a real opportunity to increase the resilience and competitiveness of its economy.

To identify opportunities for Hungary’s start-up ecosystem, we compared its key metrics (including value creation, financing, and the number of start-ups per capita) with those of successful ecosystems in Europe, the Middle East, and Africa. This comparison revealed opportunities for improvement across almost all dimensions (Exhibit 1). We also benchmarked other countries in the Central and Eastern European (CEE) region by talent, funding, and early-stage start-up activity.

Hungary seems to be on par with the region as a whole in many things usually regarded as a basis for successful start-up life cycles. It produces a number of start-ups comparable to that of the other CEE countries, is on par with the Czech Republic and Poland in venture funding (an estimated €40 to €80 per capita), and has a largely similar talent pool. In some aspects and segments of the start-up ecosystem, Hungary is even ahead of its peers; for example, it has the region’s highest share of information and communication technology specialists—3.6 percent of the total workforce, compared with an average of 2.8 percent in the CEE as a whole.3The Rise of Digital Challengers: Perspective on Hungary, McKinsey, 2018.

However, a start-up ecosystem’s health is generally measured by successful, high-valuation exits (the acquisition or IPO of a start-up), both in number and in value. Benchmarking revealed that the start-up ecosystems of the Czech Republic and Poland generated the largest number of unicorns4 in the CEE region—four and 11, respectively. But Hungary has so far produced only one, LogMeIn (Exhibit 1). Given the low number of high-valuation exits, aspiring Hungarian entrepreneurs have fewer role models, on both the investing and the start-up sides, than some of their counterparts in more successful start-up nations. In particular, Estonia and, most recently, Romania have been able to build on their internationally successful unicorns: for Estonia, Skype, with a buyout value of $8.5 billion in 2011; for Romania, UiPath, with an IPO valuation of $31 billion in 2021. Hungary has not had similar exits in the past five years.

While Hungary has high start-ups per capita in Central Eastern Europe, Czechia and Poland have two to four times as many exits.

Looking at conversion rates across the start-up maturity funnel can help to further illuminate opportunities to advance the start-up ecosystem (Exhibit 2). We compared Hungary’s maturity funnel with that of Germany, which has one of the top three European start-up ecosystems.5 Hungary had less than half as many start-ups (proportionally to population) at the beginning of the funnel: 305 start-ups per million people in Hungary, versus 616 in Germany. There are significant gaps in conversion rates at almost all stages of maturity.

Overall, this finding indicates that Hungary has room for improvement by focusing on levers that increase the number of start-ups founded and on levers that improve the start-up scaling success rate.

The impact of start-ups in Hungary is realized through more start-ups being launched and closing the gap with Germany in funding funnel conversion.

The value at stake

Our analysis indicates that over the coming decade, a more advanced start-up ecosystem could contribute to Hungary’s economy in three major ways.

1. Financial value added

Increased maturity along the start-up funding funnel (for instance, an increase in the share of start-ups converting from the pre-seed to the seed stage) could generate €2.5 billion to €5.0 billion in additional funding. That in turn could create €0.6 billion to €1.3 billion in additional direct local spending for the economy. The resulting job creation could generate up to some €2.2 billion in employment taxes from 2025 to 2030.6 Further upsides include higher corporate income and other tax receipts.

2. Talent

A more advanced start-up ecosystem could generate almost 30,000 high-value-adding jobs in Hungary. These jobs, in fields such as software engineering, R&D, and product management, could be an opportunity to retain talent within the country and to attract lost talent back to it. In addition, boosting the start-up ecosystem would help to create additional top (digital) talent, thereby increasing the talent pool and thus benefitting not only start-ups but also established corporations in their quest for renewal and innovation.

3. Digitization

McKinsey’s report Digital challengers on the next frontier in Central and Eastern Europe (2022) includes a deep dive on Hungary. It shows that a more advanced start-up ecosystem to drive the commercialization and advancement of new digital solutions can promote digitization on a nationwide level. The potential economic and development benefits of such a nationwide digitization campaign could be as much as €9 billion in additional GDP by 2025.

Besides boosting innovation and entrepreneurship across the entire economy, digitization could reinvigorate traditional industries, allowing them to leapfrog to state-of-the-art technologies by collaborating with local start-ups that can design products and services for those industries’ specific needs. Many great examples already exist. Turbine, for instance, is using AI to develop new digital platforms that streamline the oncology R&D process in Hungary and globally. Starschema provides data-warehousing, business intelligence, and big data services to many Fortune 500 companies.

A successful start-up ecosystem is also a sustainable one—it has a positive scale effect when successful founders create, reinvest in, and spread their knowledge to new start-ups. Early signs of this effect can already be observed in Hungary, where data from a recent survey by Startup Hungary7 suggest that about one in four founders has previous start-up experience.

Seven common attributes of success

To find the common attributes and underlying ways in which countries fuel their start-up ecosystems, we interviewed a broad range of McKinsey global start-up experts, as well as several stakeholders in global and local ecosystems. These discussions helped us identify the seven key attributes of most successful start-up ecosystems (Exhibit 3).

Successful start-up ecosystems have seven common attributes.

In addition, we found specific levers, structured by those seven attributes, that countries can use to increase both the number of start-ups founded and their success rate in scaling up such companies (Exhibit 4).

1. Ease of incorporation and liquidation

Globally renowned and successful start-up ecosystems have regulations that not only help founders, start-ups, and investors but also give them incentives to adopt the right policies and approaches. Furthermore, rules and administrative processes are constantly adapted to evolving economic conditions.

One core element is a transparent and simple yet fraud-resistant system for incorporating and liquidating ventures. Overly complex, time-consuming incorporation processes may hinder ambitious start-up founders, while a highly bureaucratic liquidation process can prevent founders of failed start-ups from moving on to the next venture without excessive delay. Very few founders get it right on the first try—many created unicorns by building on their experience from prior failures.

Hungarian corporate law, and therefore the ease of incorporation for start-ups, is not yet in line with international best practice—Hungary ranked 87th in the World Bank’s 2019 Starting a Business ranking.8 Given the resulting administrative challenge for local founders, more than 25 percent of existing Hungarian start-ups have created foreign entities for their main operations. These companies hope to benefit from a transparent regulatory environment, simplicity, and better access to funding, according to a Startup Hungary survey.

In addition, bureaucratic day-to-day operations can limit foreign investors’ access to a domestic start-up ecosystem: according to Dealroom’s data, only around 16 percent of total start-up funding in Hungary comes from foreign investors, versus an average of 40 percent in Europe as a whole and up to 70 percent in leading ecosystems, such as those of Germany or Israel. In Estonia, the government has acted as a catalyst for the ecosystem by starting a number of legal and administrative initiatives, such as those for e-government, public-agency processes, digitized incorporation, and e-residency. Such initiatives can increase both the number of start-ups founded and their success rate.

To facilitate the adoption of the most suitable regulatory principles, several countries have put in place start-up committees. These coordinate between local and national decision-makers and key stakeholders in the start-up ecosystem and advocate on behalf of start-ups whenever new rules and regulations affecting entrepreneurs are considered.

2. Support in securing talent

Once a start-up is up and running, it needs to attract top talent: people who are ambitious, live and breathe the start-up’s mission, and capitalize on their experience to help the company scale toward international success. In the global race for talent, most successful countries have initiatives that simplify the hiring of employees by start-ups.

One lever is ease of attracting international digital talent. Ambitious start-ups must generally hire foreign tech and business specialists who, thanks to their market knowledge and language skills, can help start-ups expand into new markets and scale up on a global level. In many cases, a simplified start-up visa process supports the hiring of foreign talent.

Experts and founders told us that another key lever for hiring talent was the ability of start-ups to give employees stock options easily and transparently. Founders can hardly compete with the salaries of large corporations. They can offset this problem only by involving employees in the future success of the business.

3. A favorable tax environment

Examples from countries around the world show that tax policies can ease the financial burden on start-ups, encourage better conversion throughout the funding funnel, and create incentives for investors and founders who exit to reinvest in the ecosystem. Direct tax benefits to start-ups could come through income tax reductions or through cuts on taxes paid on the salaries of employees, as the Netherlands has done with a 30 percent ruling.9

Tax policies to encourage investment can take the form of income tax benefits tied to investing in private shares. One example comes from France, where exiting founders receive tax relief on the proceeds they use to fund holding companies that reinvest in start-ups. The UK Enterprise Investment Scheme offers tax relief to individual investors who buy new shares and allows those investors to claim an individual income tax deduction of 30 percent of investments in the start-up. Similar structures exist in Belgium, Germany, Ireland, Italy, Portugal, Spain, and Sweden, among other countries.

So far, Hungary has granted no benefits to founders or employees via income tax reductions. Corporate tax deductions for corporate start-up investors are capped at 20 million forint (some €0.05 million) over a four-year period.

4. Direct incentives to encourage an entrepreneurship culture

Our previous research has shown that in some cases people from nontraditional backgrounds (women or minorities) have a higher interest in founding a company than their nonminority peers but are less able to act on their intent. This is also true for midcareer founders (ages 35 to 45) who have the right combination of experience and knowledge but may be risk-averse as a result of their comfortable corporate jobs and family priorities. Many successful ecosystems have support programs targeting such founder segments and can help increase the overall number of start-ups.

Who starts companies in Hungary? For one thing, the gender gap is significant: only around 25 percent of start-ups created from 2010 to 2020 had at least one female founder.10 Yet as we have noted, some people from nontraditional backgrounds have a higher interest in founding a company than their traditional peers but are less able to do so. Two approaches might make a positive contribution toward closing this gender gap: encouraging mentoring programs for potential female founders and increasing public awareness of gender bias in funding processes.

On average, in Hungary 70 to 75 new start-ups a year have female co-founders. Increasing the share of female founders to even 30 percent could roughly translate to an additional 15 to 20 start-ups.

5. Strategic allocation of public financing

Public funding for ventures is a powerful tool, though one that requires efficient, well-monitored distribution. In successful ecosystems, sectors strategically important to the economy receive research grants and other forms of financing that are not preconditioned on profit. Equity funding from public sources is granted in a way ensuring that the state’s position is equal to that of any other investor, with strict due diligence and investment KPIs.

Two key levers emerged from our investigation of best-practice examples of efficiently allocated public funds. First, research grants for areas in strategically important sectors are a proven way of supporting both the domestic start-up ecosystem and the national capacity for innovation. Targeting research grants to specific sectors in this way has two key benefits: a higher likelihood of success for start-ups that can operate in domestically strong end-markets and an improvement in the international competitiveness of a nation’s key industries.

Second, experts agreed on the most efficient way of allocating public funds to the start-up sector: a government-backed fund of funds that co-invests (along with private investors) in reputable and professional VC funds that already have a track record of strong returns. This approach is generally perceived as more efficient than direct government involvement in venture funding, because professional private funds have the necessary experience and rigorous, market-oriented KPIs for returns—the best way to ensure the efficient allocation of the investors’ money. Although this type of funding has no strings attached, venture capital funds need clear and transparent reporting on the way they allocate resources. A successful example from the CEE region is the Polish Growth Fund of Funds, a fund with over €3 billion under management, intended to stimulate equity investments in growth-focused enterprises in Poland through the professional VC sector.

6. Transparency and access

Leading ecosystems ensure top-notch transparency and access, typically through start-up platforms: databases and digital tools that serve as the single source of truth on a nation’s start-ups and provide guidance on founding and scaling. Our research shows that no digital platform now serves as a single source of truth on Hungary’s start-ups or their performance, or provides guidance for those who might wish to found such companies.

Stakeholders in the current start-up ecosystem could work jointly to create a platform that would, among other things, provide information and services for start-up founders and investors, as well as structured mentoring and networking for entrepreneurs. The platform’s goals would be to enable access to experience and capital and, ultimately, to increase the number of start-ups founded and scaled.

7. Access to educational opportunities

Established investors and successful founders in Hungary say that its entrepreneurs seem to have generally low levels of risk-taking and may lack the willingness to boldly internationalize in time. A 2018 Oxford University study found that Hungary ranked fourth lowest of 77 countries on a risk-taking index.11 To quote the CEO of a Hungarian start-up, Hungary is the “country of inventors”—it has a strong cohort of technically proficient entrepreneurs—but when it comes to business building, they appear to lack the drive or capability of their counterparts in other CEE countries.

Successful ecosystems use three main levers to ensure that potential founders of start-ups and their employees have the right skills. First, founders get free access to digital, coding, and business courses through a start-up platform or subsidized courses at existing local providers. One good example of a step in this direction is Hungary’s program to sponsor digital education at existing coding schools.

The promotion of an entrepreneurship culture in academia, usually by supporting nation-wide digital entrepreneurship curricula at universities and other academic institutions, is a typical trait of successful start-up ecosystems. Hungary already has an example of its own: the Hungarian Startup University Program (HSUP), kicked off in 2020 with more than 2,000 participating students. This was the country’s first unified curriculum in start-up entrepreneurship.12

Finally, Hungary could use the proven lever of international networks and know-how from collaboration with start-up–focused foreign universities, like Stanford in the United States and the University of Aachen in the European Union. Such schools could be encouraged to create incubators or research departments in leading local universities; for example, the Stanford Technology Ventures Program (STVP) forms partnerships with universities around the world to develop programs and curricula for entrepreneurship education. The program is designed to maximize the impact that partner universities create in their respective regions.13

If Hungarian universities and other educational players can not only continue but also expand their efforts to educate founders, promote entrepreneurship, and build international networks, the number of start-up founders will probably increase substantially.

There are 15 identified levers for improvement along the seven key attributes of successful start-up ecosystems.

Compared with global leaders and most regional peers, Hungary’s start-up ecosystem has multiple gaps. Yet it also has some intrinsic strengths, such as its tradition of scientific innovation, that can serve as a building base. Our research identified seven key attributes that influence the number of start-ups founded and their scaling success rate. Among the seven key attributes, we identified 15 levers and highlighted several that could help Hungary advance its start-up ecosystem. With strong cooperation among all stakeholders, the country could create a blossoming start-up culture that helps fuel broader economic growth going forward.

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