Mario Draghi’s report sheds light on the European Union’s and so Hungary’s competitiveness challenges, particularly in innovation, legal and economic frameworks, and capital investments. According to the report, in the competition with the U.S. and China, Europe not only needs to accelerate technological advancements but also modernize its legal and financial structures to foster business growth and the development of the startup ecosystem. Since startups play a crucial role in driving the competitive activities, our article will explore the reasons behind this lag, with a special focus on the differences between the Anglo-Saxon and European (with regard to the Hungarian) legal systems, ESOP programs, the characteristics and challenges of venture capital investments, and examine a new initiative, i.e. the EU Inc. initiative.
The Root of the Problem – Slow vs Flexible Adaptation?
The Draghi Report highlights the need for new prudential rules for banks and institutional investors to encourage riskier but growth-stimulating investments. Draghi warned that boosting the EU’s competitiveness would require €750-800 billion in public and private investments annually. A key statistic illustrates the source of the problem: while the U.S. currently dominates over 40% of the global AI services market, the European Union holds only a 15% share. This gap in AI and other innovative technologies underscores the urgent need for a more flexible and competitive economic and legal environment in Europe. Yet, investment and financing reforms alone will not suffice. The regulatory framework must also support rapid adaptation and risk-taking to foster an innovation-friendly business climate.
Legal Rigidity vs. Business Flexibility
In European legal systems, including Hungary, laws and the principle of good faith play a decisive role, with legal guarantees being strongly embedded in legislation. Nevertheless, the rigidity these legal systems slows down the legislative process, often creating bureaucratic hurdles that make it difficult to adapt quickly to new economic models and technological advancements. In contrast, Anglo-Saxon legal systems (such as the USA’s) offer a more flexible approach to contract formation. Judicial precedents and common law play a greater role in contract interpretation, granting businesses greater contractual freedom. This adaptability allows the legal framework to evolve organically, enabling faster responses to emerging technologies and market demands. This difference becomes particularly evident when innovative companies develop new service models that require novel legal structures. In common law systems, such adaptations can occur organically, without needing to “force” existing legal frameworks into unnatural compliance.
Challenges in Adapting Common Law Investment Structures
Hungary’s venture capital investment tools differ significantly from the best practices in Anglo-Saxon markets. The domestic startup ecosystem would greatly benefit from a more flexible application of investment structures. However, several factors slow down this process—but what exactly are they?
Employee Stock Ownership Plans (ESOPs) – Limited Adoption in Hungary
Despite the numerous advantages of ESOPs for employees, startups, and venture capital firms (VCs), their use remains limited in Hungary. In the U.S., ESOPs are widely used to drive corporate growth and strengthen employee commitment. However, in Hungary, these programs face significant barriers that prevent their broader adoption.
Taxation and Legal Barriers
One of the biggest obstacles is the complex taxation and legal framework. While U.S. ESOP programs benefit from strong tax incentives, employee stock grants in Hungary are often subject to unfavorable tax treatment. As a result, Hungarian companies hesitate to introduce ESOPs, fearing the administrative burdens and tax implications. Nonetheless, recent legislative changes point in a positive direction; with the parliamentary approval of the new tax law, equity acquired by startup employees will be taxed as capital gains rather than income, and the tax will only be payable upon sale, provided that the startup has been operating for a maximum of five years at the time of granting the equity or option. To make Hungary more attractive to startups and top talent, it is crucial to further improve ESOP regulations and create a business-friendly legal environment.
Convertible Loans – An Underutilized Tool in Hungary?
A convertible loan (CLA) is a widely used financing instrument (in addition to SAFE) in the Anglo-Saxon world, allowing startups to secure funding quickly and flexibly without having to determine and give up equity ownership immediately. However, in Hungary, this structure is barely utilized, as most institutional investors still prefer traditional equity investment solutions—even at the pre-seed financing stage, where no one can precisely determine a company’s valuation using an exact methodology. This reluctance stems from Hungary’s legal and regulatory framework, which does not support such flexible financing models. Meanwhile, in the United Kingdom and United States, convertible loans remain one of the most common early-stage financing tools alongside SAFE agreements.
The Pitfalls of Contractual Practices
Another key characteristic of venture capital investments in Hungary is the overly rigid contractual practices. The typical agreements used by VCs tend to be highly inflexible, and investors are rarely willing to deviate from them. A common issue is that they seek to shield themselves from downside risks while trying to maximize the upside potential—often at the expense of the founders. As a result, startups are frequently forced to accept financing under unfavorable terms, as they have little opportunity to negotiate more flexible or advantageous contractual elements. In contrast, in the United States and Western Europe, startup-friendly customized solutions are becoming increasingly common, allowing startups to craft tailored agreements and enhance the flexibility of the investment process. For instance, in the United Kingdom, contract templates developed by the BVCA serve more as recommendations rather than mandatory formats. Meanwhile, in Hungary, the regulatory environment remains less accommodating of individualized agreements, limiting the room for negotiation.
The Absence of Pay-to-Play and Its Consequences
In Anglo-Saxon markets, the widely adopted pay-to-play mechanism allows existing investors to purchase additional shares in subsequent funding rounds. If they choose not to participate, they risk losing certain rights. This model incentivizes investors to continuously support startups, ensuring their sustainable growth. In Hungary, however, VCs often do not apply this mechanism, which can create significant obstacles in later investment rounds. If an existing VC insists on retaining its preferred rights without contributing additional capital, little room is left for new investors who bring in fresh funding—this is typically a deal-breaker in Western markets.
The EU Inc. Initiative – A Path to Unified Corporate Law?
One of the biggest challenges facing Europe’s competitiveness is that its startup ecosystem struggles to retain its most promising ventures. In many cases, the most innovative startups, instead of growing within the European Union, relocate their intellectual property (IP) to the United States, where investment opportunities, regulatory environments, and scaling conditions are more favourable. This trend is particularly visible in the Baltic region, where startups often secure pre-seed investments using convertible loan agreements (CLA) or SAFE structures, only to quickly move their assets to the U.S.. As a result, the economic benefits of innovation and the long-term financial returns end up strengthening the American economy instead of remaining in Europe. This outflow of innovation has raised concerns about Europe’s economic future, prompting the creation of the EU Inc. Initiative. The initiative seeks to establish a more unified, transparent, and competitive regulatory environment that would help European startups thrive within the EU instead of looking abroad for better opportunities. While the diversity of European startup ecosystems is a major strength, the highly fragmented legal and tax frameworks create barriers to growth, making it difficult for startups to operate efficiently across borders.
Although some positive changes have been made in recent years—such as reforms in Hungary’s ESOP regulations and the expansion of startup financing opportunities—Europe still has a long way to go before it can establish a truly globally competitive economic and legal environment. The Draghi Report sends a clear message: for the EU to maintain its global competitiveness, it must undertake structural reforms, create incentives for investment, and foster a more flexible legal framework that supports startup growth and innovation. To achieve this, the EU needs to ensure that European VCs can invest in an EU Inc. with the same flexibility and predictability as US VCs investing in a Delaware-based corporation under tax-friendly conditions. Building a competitive European startup ecosystem requires a legal and financial infrastructure that is transparent, simple, and efficient, allowing businesses and investors to focus on innovation and scaling rather than navigating complex regulatory barriers.