Op-ed: Tear down this wall

Europe must remove barriers to startup financing for its defence industry to thrive

The 21^st century’s first high-intensity war has unleashed a wave of innovation to adapt new technologies to the battlefield, from naval drones to next-generation satellites. The success of Europe’s rearmament drive will depend largely on whether it can scale up these inventions to modernise as well as expand its armed forces.

If Europe is to catch this wave it must first solve a more fundamental problem: how to create a favourable environment for companies to attract investment and scale across borders. The starting position is poor but two regulatory initiatives – a review of venture capital rules and a proposed cross-border incorporation system – offer a glimmer of hope.

Start with the European Venture Capital Funds (EUVECA) regulation. The European Commission is conducting a review of this framework, seeking input from market participants on the obstacles they face.

For years, people in European startups, finance and policy have been saying that the venture and growth capital ecosystem is underdeveloped and insufficiently integrated to meet the needs of ambitious European innovators and investors. Not only does this harm Europe’s ability to scale companies and attract global investors; it often leads the continent’s best innovators to move to the US as soon as they begin to gain momentum.

The Commission’s review acknowledges this reality and proposes policy responses including differentiated regulatory treatment for different sizes and types of fund managers, improvements to cross-border marketing and fundraising, and better calibration of thresholds for alternative fund managers. The aim in each case is to strengthen competitiveness while maintaining investor protection and market integrity.

These reforms should reduce regulatory burdens on fund managers, but that alone isn’t enough to solve Europe’s innovation gap. On the demand side, too, startups and fast-growing firms are subject to a plethora of legal, administrative and operational hurdles as they try to scale from one EU Member State to another. This raises costs, slows expansion and worse, as the data shows, pushes many to relocate outside the EU.

Europe has the right human capital to innovate at the highest level and enough wealth to fund growth, but excessive and misplaced regulations too often get in the way. In the broader economy, that’s a missed opportunity. In the defence sector, it’s an active vulnerability.

One regime to rule them all

Enter the 28^th Regime, a proposed legal framework for companies to adopt an EU-wide corporate form rather than being governed by a single Member State: a sort of “Europe Inc.”, to borrow a phrase from Commission President Ursula von der Leyen.

If done right, and in combination with updated EUVECA rules, this will allow startups to operate seamlessly across the EU. It could shorten company setup times, clarify governance, and enable smoother cross-border growth – all of which are critical if newly mobilised capital is to be deployed efficiently within the Single Market.

Nevertheless, political challenges remain. The proposal is at an early stage, and could face objections from the European Parliament and national governments, which will be loth to give up many of the prerogatives they currently have, such as taxation or liquidation regimes for SMEs.

Eyes on the prize

To find a way through this puzzle, policymakers should step back and think about what this combination of new regulations should seek to achieve. I would suggest that the EUVECA reform and the 28^th Regime, plus a recalibration of threshold rules for alternative fund managers, should aim to do the following:

• Promote cross-border fundraising through the introduction of clear, proportionate rules that make the EU more attractive to both institutional and retail investors.

• Reduce compliance overhead for small and mid-sized fund managers, helping them to focus on investment rather than paperwork.

• Enable startups to scale efficiently across the Single Market through harmonised legal frameworks, reducing their incentives to leave the EU for more business-friendly markets including the US.

• Support strategic priorities including digital, green and defence technologies to ensure that these sectors build a footprint in Europe.

Of course, policymakers must ensure that reforms do not weaken investor protection or systemic safeguards. A nuanced approach that differentiates by fund size, giving smaller investors more leeway to take risks, is a better approach than blanket deregulation. A careful calibration of thresholds, reporting and supervision should balance competitiveness with stability.

Additionally, reforms must integrate a certain degree of screening mechanisms for investment in defence and other sensitive sectors, ensuring that capital inflows support Europe’s strategic autonomy rather than erode it. It’s encouraging to see that the European Commission is already looking into this as part of the European Defence Industry Programme (EDIP) initiative.

Venture capital is fundamentally a business of high risk and high reward. For every successful exit there will be many projects that do not succeed. The payout for those that do must be big enough to offset this downside. For Europe to compete at the cutting edge, entrepreneurs and investors must be allowed to take risks, and indeed to fail.

But most of all, they need to be able to invest and operate across the Single Market unobstructed, accessing all the network effects and economies of scale that accrue to large, open markets. It’s time for Member States to put aside their national interests and build a combined industry that’s bigger than the sum of its parts.

Miguel López Crego is a senior policy advisor at Linklaters focused on financial services regulation.