Investment Blogger Joachim Klement: Cost of Capital for Small European Businesses Exceeds That in the US, with the Gap Widening as Size Decreases
Citing research by Becker et al., Klement points out that the cost of capital for European firms is actually higher than for their US counterparts, and the size premium is particularly severe for small businesses. This provides another layer of explanation, beyond funding supply, for why European startups struggle to grow into super-unicorns.
Klement admits his previous judgment was wrong. He had assumed that lower interest rates in Europe meant corporate borrowing costs should be cheaper than in the US; according to Pablo Fernandez’s annual survey, equity costs in Europe and the US were also roughly comparable. However, research by Bo Becker, Efraim Benmech, and Joao Monteiro provided an unexpected answer: the cost of capital for European firms is actually higher, and this gap widens the smaller the firms are.
The original question of this study was to explain why almost all of the world's largest trillion-dollar companies are in the US—there is not a single one in Europe. The researchers found that the gap does not stem from fundamentals, but rather that there are fewer new companies in Europe, newly listed firms have valuations lower than their US peers, and they grow more slowly after listing. The key variable is the size premium within the cost of capital: for small European firms below the median market capitalization, the size premium in their cost of capital is far higher than for similar US firms. In the latter half of the 2010s, this gap continued to widen, making it even harder for European small companies to obtain the capital necessary for growth.
Klement acknowledges that Becker et al.'s study only covered listed companies, but he believes the same issue applies to private companies that have not yet gone public. This inference itself is not a finding of the study, but rather the author's own judgment. However, if the cost mechanism indeed exists prior to listing, it can supplement the earlier OECD research findings on funding supply: the problem for European startups is not just that top-tier capital is hard to reach, but that every step of expansion from small to large faces higher financing costs than US counterparts.