COMMENT: The Hungarian state has poured so much money into the start-up ecosystem that it has drowned

COMMENT: The Hungarian state has poured so much money into the start-up ecosystem that it has drowned
More than a third (37%) of VC funding does not come from the market, but from the state.
By Peter Bucsky in Budapest July 15, 2022

Viktor Orbán’s Hungary is a Potemkin village of economic success and in no area is this more apparent than in venture capital investment, where at first sight it leads the rest of Central Europe in VC investment to GDP.

In 2020, venture capital investment was a respectable 11th highest in the EU as a share of GDP, with a value 40% higher than the European average. On paper, Hungary had more venture capital than innovation powerhouse Estonia. Over the last five years, HUF430 billion (€1.072bn) of capital has been raised by Hungarian private and venture equity funds.

However, more than a third (37%) of this funding does not come from the market, but from the state. This is massive when compared with other countries. In the UK state funds are 1% of VC funds, in the Nordics 6%, and even in Southern Europe it is less, at 28%.

It should also be added that much of this has also been provided directly or indirectly by the European Union, thanks to Orbán’s customary flair at milking EU funds for his regime’s own purposes. HUF159 billion – calculated from the statistics of the Hungarian Private Equity and Venture Capital Association (HVCA) – is a low estimate for the EU’s footprint on this market over the past five years.

Moreover, it is hard to see any real successes from this flood of venture capital investment. From VC investment in 2017-21,  the market value of the Hungarian startup ecosystem is estimated at only 0.9% of GDP, far less than in Estonia (20.6%), Czech Republic (8.4%), but also Bulgaria (1.6), and leading only Slovakia (0.5%) and Slovenia (0.7%).

In fact, when comparing the amount of venture capital invested in CEE countries between November 2017 and November 2021 and the value of startups, Hungary ranks among the lowest. Most of the countries created startups that are 5-10 times more valuable than the investments. Hungary’s startups’ valuation is only 3.4-times bigger, one of the worst figures in the region.

It is a well-known economic phenomenon that when the state plays a significant role, it can crowd out market players – and this is precisely what is visible in the Hungarian venture capital and private equity markets: the state has crowded out foreign professional investors. In 2016, foreign funding amounted to HUF18.4 billion, half of all non-state funding. By 2020, overall non-state funding has fallen to HUF5.8 billion, with foreign funding accounting for only 16 percent of the funds' resources.

What is more, foreign funding is important not only because it provides additional capital, but also because foreign (co-)investors in venture capital markets play a key role in accessing international markets, securing international contacts, and introducing new technologies and management skills. Hungary is starved of these additional benefits.

There is perhaps no better illustration of the state of the Hungarian ecosystem than the fact that the National Research, Development and Innovation Office and the Ministry of Technology and Innovation are the bodies that talk continuously of Budapest as a startup capital – but not the VC funds or the startups themselves.

Crucially, the state-funded investments have not produced a single unicorn, despite the exceptionally high level of support. A semi-exception is LogMeIn, which originally started in Budapest, but is now a US company worth $4.3bn - but it is not the Hungarian founders who have largely benefited from this.

By contrast, there are several examples from the region that have managed to reach this level – none of which show any evidence of having been boosted by government funds.

The biggest unicorns in the CEE region are:

- UiPath (Romania and the US) – last known value $29bn

- Vinted (Lithuania) – $4.5 billion

- Rohlik  (Czech Republic) – $1.2 billion

- Infobip (Croatia and UK) – at least $1 billion

- Bolt (Estonia) –  at least $1 billion

- Pipedrive (Estonia, United States) – at least $1 billion

- Printful ( Latvia) –at least $1 billion

The Romanian success story of UiPath has been widely reported, its founder is now the richest man in Romania. His fortune – on a market basis – is now five times that of the richest individual in Hungary, Lőrinc Mészáros, whose wealth has been built almost exclusively on public procurement tenders under his friend Viktor Orban.

Instead of seeding successful startups, the state and EU money often seems to have been frittered away on helping Orbán’s favourite oligarchs. In many cases, these funds are being channelled through a paper trail, rather than actually being given to firms. This is what has happened for instance with the largely misspent HUF130 billion of Jeremie funds for startups, which are financed from EU transfers. Scientific research have shown that the EU’s Jeremie programme to fund SMEs through venture funding delivered very poor results in Hungary (see 1, 2).

What is more, it has been widely reported in the Hungarian independent media (see 12345) that a far from insignificant proportion of the funds do not act like standard VC funds and, for example, either sought kickbacks from the startups they financed, or supported firms in their own networks.  

Another interesting trend has been observed as the role of the state has increased: the volume of sales has become smaller and smaller alongside new investment. HVCA data on Hungarian start-ups and target companies available from 2017 show that in the domestic market there were HUF246 billion of investments and HUF113 billion of sales.

If we look at domestic fund managers, the data available since 2018 shows that there were only HUF13 billion worth of sales for HUF129 billion worth of investments. Given that in the last decade EU funded Jeremie and sovereign wealth funds alone have spent close to HUF200 billion in the domestic market, these results show that they have made some very poor investments.

This emphasis on state funding is not just a Hungarian phenomenon, though the country’s record is the most eye catching. The CEE region has seen a very significant increase in the role of the state in private equity and venture capital markets in recent years. This is rare in Europe. In other regions the role of the state is much smaller. In particular, the UK and Scandinavia, which are strong in technology companies, are following a dramatically different path.

The excessive presence of the state has already had such an impact that those entrepreneurs with truly internationally marketable, innovative ideas are no longer setting up their companies in Hungary, but are going abroad, or are seeking funding abroad. The main attraction there is not simply the availability of funds, but market knowledge and professional expertise.

If Hungary really wants to create a strong start-up culture it would need to rely on investors who have business experience and have to deliver results.

It should also completely redirect state funding. Although the world's most advanced technology-based economies also have government programmes in place to support high-tech industry, these support research, universities and research institutions, or back specific orders for private companies to develop a specific technology.

Hungary, on the other hand, is taking a different path: The state is cutting research facilities, underpaying university professors and researchers, making it harder to get into higher education, withdrawing financing from higher education, and in effect encouraging many talented young people to leave the country. All in all, it is doing everything it can to hinder the institutions that are the engines of progress.

Péter Bucsky holds a PhD in Geography from the University of Pécs. He has extensive experience across multiple fields of transport policy including infrastructure development, public transport and railway freight, public investment. He is also an experienced commentator for major Hungarian business newspapers and a freelance journalist since 2007, writing for since 2017.