BR Analysis | Startup funding to get bump from interest rate cut

The decision of the European Central Bank (ECB) to cut the key interest rate for the first time since 2019 is set to improve the financing picture for startups, including early-stage firms in Romania.

By Ovidiu Posirca

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Locally, the central bank also moved to reduce the key interest rate to 6.75% as of early July in response to the falling inflation.

“What we can already see is a market getting out of a frozen period,” Dan Mihaescu , Founding Partner of GapMinder VC , tells BR. He adds that we are currently experiencing a reversal of the major decline of technology IPOs from USD 216 billion in 2021 to just USD 19 billion in 2023.

Across Europe, venture capital (VC) investment into startups reached USD 29.2 billion during H1 2024, compared to USD 27 billion in the same period of last year, according to Dealroom.co data. Of the total amount, Romania-based startups attracted USD 41.2 million in the first half of this year.

“We can already see a high inbound interest of various US or European investors towards Romanian and SEE-born startups,” Mihaescu adds.

Financiers say that if interest rates were indeed to start dropping in Europe in the second half of 2024, this could have several implications for the startup financing ecosystem.

Lower interest rates typically make borrowing cheaper, potentially increasing the demand for loans from both businesses and consumers. This scenario could benefit financing startups that offer lending services, says Carmen Sebe , the CEO of investment platform SeedBlink .

“However, startups that rely on interest income, such as peer-to-peer lending platforms, may experience a decline in revenue as interest rates drop. For our platform and similar startups that provide infrastructure for alternative investments, lower interest rates could lead to increased investor appetite for riskier assets in search of higher returns,” Sebe tells BR. This shift could create opportunities for startups specialising in alternative investments or innovative financial products.

The ECB’s key policy rate was cut by 0.25 points, down from 4% where it had been for nine months. At the same time, inflation fell to 2.6%—but European Central Bank Head Christine Lagarde said the fight against inflation was not over yet.

“Our future policy decisions will hinge on three things: whether we continue to see inflation returning to our target in a timely manner, whether we see overall price pressures easing in the economy, and whether we still see our monetary policy as effective in taming inflation,” wrote Lagarde in a blog post on the ECB’s official website.

Funding growth to keep momentum by year-end

For Catalyst Romania Fund II, the startup financing outlook is seen as positive in H2 2024, as interest rates are starting to fall in Europe and the appetite for VC investments is gradually returning.

“One good signal is the fact that, after a very dry season in terms of disbursements by venture capital funds throughout 2023 and continuing into Q1 2024, Q2 2024 has seen more money finally being invested in startups and significantly more new equity investment transactions eventually announced by a number of funds from Europe and particularly from CEE,” Marius Ghenea , Managing Partner at Catalyst Romania , tells BR.

On this backdrop, Catalyst Romania is planning to announce two new investments in the coming months: one in a fintech and the other one in a robotics startup.

Dealroom.co data shows that on the European market, the sectors that attracted most VC investments in 2023 were energy, health, and transportation.

“I could characterise H2 2024 as a period of thawing and a bit of confusion driven by a large number of startups repositioning into the AI wave,” adds GapMinder’s Mihaescu.

During Q2 2024, the biggest funding round—worth USD 1 billion—was attracted by London-based Wayve, a startup working on autonomous vehicle technology. Second was French startup Mistral AI, which raised USD 502 million to further develop its generative AI platform. Third was DeepL, a German startup using AI for language translation, which raised USD 300 million.

EU to roll out world’s first AI law

While AI has been one of the growth engines for the European startup ecosystem in the past few years, future investments could be shaped by the EU’s AI Act, the world’s first AI law.

The Parliament adopted the AI Act in March 2024 and the Council followed with its approval in May 2024. It will be fully applicable 24 months after entry into force, but some parts will be applicable sooner.

The new law has a risk-based approach that classifies AI systems into four categories. The riskiest systems pose a threat to individuals and can threaten fundamental rights and freedoms of individuals or society.

Generative AI, like OpenAI’s ChatGPT, will not be classified as high-risk, but will have to comply with transparency requirements and EU copyright law.

The European Parliament says that the law aims to offer startups and small and medium-sized enterprises opportunities to develop and train AI models before their release to the general public.

“Organisations need to start preparing now by ensuring they have regularly updated inventories of AI systems being developed or deployed, assessing which of their AI systems are in-scope of the legislation, and identifying their risk classification and relevant compliance obligations,” said Vermeer-de Jongh, Partner in AI and digital law with HVG Law LLP, part of the global EY law network, quoted by Thomson Reuters.

French President Emmanuel Macron, who aims to turn France into an AI powerhouse, said at the end of last year that new law should "regulate the uses rather than the technologies themselves."

“Regulation must be controlled, not punitive, to preserve innovation," added Macron.

As part of the AI Act, all high-risk AI systems will be assessed before being put on the market as well as throughout their lifecycle. In addition, people will have the right to file complaints about AI systems to designated national authorities.