The combination of government initiatives and private sector support is key to developing the innovation and startup ecosystems, as highlighted by a new report from Compass on the startup ecosystem in Estonia. The country also benefits from a global outlook of startups from day since the local market is limited for companies looking to scale up rapidly.

While small, the Estonia startup ecosystem is growing very rapidly, building on several success stories – including Skype and TransferWise. The former is often considered the trigger of Estonia’s emerging startup ecosystem; Skype’s acquisition by eBay for $2.6 billion in 2005 put the Baltic state on the global map of innovation and fueled it with financial resources and startup experience.

A key to the success in this country is the government support for the ecosystem, helping it gain momentum. Initiatives such as e-government, the digitization of public agency processes, and e-Residency, offering foreigners a government-issued digital identity and the opportunity to run a trusted company online, have been well-received by the startup community. Accordingly an impressive 66 percent of Estonian startup founders expressed satisfaction with regards to the national government whereas the global average lies at only 25 percent.

The private sector has been very active as well. The establishment of many accelerator programs and co-working spaces as well as the development of a growing investor community have been crucial in fueling the ecosystem with know-how and capital. The contribution of Skype alumni is notable, with several early employees becoming angel investors and the co-founders starting an active venture investment group.

The Estonian Business Angels Network now counts more than 100 members. While this has meant improved funding for startups, the average investment amount for seed rounds is, at $0.45 million, still significantly below the European average of $0.62 million. Additionally, SmartCap, the investment arm of the Estonian Development Fund, invests up to €3 million in startups with high growth potential on equal conditions with a private co-investor. The fund has so far invested in 22 startups.

The growing appetite for starting and developing their own high growth businesses but with only a small network of local funding sources has meant that many startups choose to raise money in other ecosystems such as London and Silicon Valley. For this reason Estonian startups receive on average $4.75 to 5 million for Series A, only slightly less than the European average ($5-5.0 million).

In addition to VC financing, Estonian startups have to focus outside the country for two other key elements. First for customers—in comparison to many other ecosystems around the world, its local market of just over 1 million people forces startups to think global from the onset. As was explained in Compass’ Startup Ecosystem Report on Waterloo, Canada, this can play to an ecosystem’s advantage.

Estonia’s early-stage startups have an average 60 percent of foreign customers, which is 4 percent higher than the European average. However, considering its local economy is even smaller than Israel’s, a percentage equal to or above Tel Aviv’s (74%) would correspond to a healthier level of global focus.

Secondly, Estonian startups have to look outside their country to find talent. Estonia has produced some great entrepreneurs and top talent but across skillsets stakeholders agree that the quantity is insufficient to meet the growing need. In order to close that gap with a small population, immigration must be part of the solution. With only 24 percent of foreign employees versus 53 percent for London, much can still be done.

Having achieved a high immigration success rate and short visa response time, efforts have turned to attracting high-quality technical talent, especially from Russia and former Soviet Bloc countries where large pools of top quality talent are looking for exciting startups to join. The last two years have seen an increased influx of such talent. However, Andrei Korobeinik, entrepreneur and board member of the Estonian Business Angels Network, explains, “There is a lot to do to ensure that our ecosystem continues to grow sustainably. Latvia and Lithuania have much better immigration policies in place, which is going to hurt Estonia’s competitiveness if we fail to take immediate actions.”

The Compass report says that in conclusion, while Estonia has some of the special ingredients that make an ecosystem successful, more work needs to be done to close its funding and talent gaps so that high potential startups can grow without moving to the US and London.

The full Estonia report including ecosystem metrics and benchmarks can be downloaded here.