Innovative companies: Going for broke?

It’s never been an easy ride, but in the wake of financial meltdown, high-risk, innovative start-ups are finding it tougher than ever to bridge the funding gap and get products out of the lab and onto the market, or at least advance them to the stage where large companies will pay to take them on.

Banks aren’t lending, venture capital funds have dried up, and now as austerity measures kick-in, public venture funding is getting exhausted too.

All of which presents a huge barrier to the EU’s new Innovation Union strategy for reshaping our busted economies. As Maire Geoghegan-Quinn, Commissioner for Research, Innovation and Science said when she launched the strategy in October, Europe has an “Innovation Emergency.” At the heart of that emergency are the ongoing difficulties Europe’s entrepreneurs face as they try to get good ideas to market.

The question of how to remedy this growing problem was tackled in a roundtable meeting on November 17, when Science|Business brought together policy makers, government officials, financiers, researchers and industry players, to discuss how to help small, innovative companies find the financing they need to get moving towards the market.

Among the topics debated:

• Would it be useful to define what’s meant by an innovative SME, and accord these valued entities some special status?
• What current and future role should be played by the European Investment Bank and in particular its Risk-Sharing Finance Facility (RSFF)? 
• How can governments’ massive public procurement budgets be deployed to foster innovation?

Ideas put forward

Ideas put forward by participants at the meeting included:

1. Create avenues by which young, innovative companies have the opportunity to meet public procurement needs.
2. Persuade the European Investment Bank to develop more SME-friendly financial instruments.
3. Redirect up to 10 per cent of structural funds towards research in any part of the EU where there is a promising innovation-related idea to pursue.
4. Develop a comprehensive portfolio of financial instruments, including grants and loans that will cover the whole development cycle from seed funding, through growth and deployment. 
5. Encourage a more risk-taking culture in Europe.
6. Collect detailed data on early stage companies, including an output indicator, to highlight weaknesses and provide EU policy makers with the evidence they need to formulate policies.
7. Focus on ways to bridge the long-standing valley of death that persists between grant funding of projects and the point where the market takes over.
8. Use the tax system to encourage innovation – for example through R&D tax credits

Public procurement accounts for some 17 per cent of the EU’s gross domestic product and the EU’s Innovation Union strategy highlighted this as potential tool to spur innovation. This is not the first time that a call to direct public procurement to promote innovation has been made, and the meeting discussed the nature of the ongoing barriers – perverse incentives that favour low-risk products; a lack of the knowledge and/or capability needed to procure new technologies; and the fact that there is no alignment between public procurement and policy objectives.

However, the Innovation Union policy document highlights the UK and the Netherlands as two member states that are beginning to make some progress, saying they are, “Pioneering ways to support innovation using pre-commercial procurement and approaches that adapt the successful [US Small Business Innovation Research (SBIR)] scheme to the EU context.”

The results to date are “encouraging”, particularly for SMEs, and Allyson Reed, Director of Strategy and Communications at the UK Technology Strategy Board (TSB), described her experiences so far with the UK programme, the Small Business Research Initiative.

The objectives are twofold: providing business opportunities for innovative SMEs and early stage businesses, and solving specific public sector needs. As Reed noted, this is the third time the UK has attempted to emulate the SBIR scheme, which has been running successfully in the US since 1982. “You can’t just bring an idea over from the US and imitate it. It needs to be looked at in context,” Reed said. “This time it looks like it is third time lucky.”

The difference on this occasion is that the problem has been addressed from both ends. The TSB has put great effort into encouraging SMEs to get involved, whilst working with government departments to identify their requirements.

Departments are encouraged to identify a problem that needs to be addressed and then launch an open competition for ideas, offering short-term development contracts. SMEs are attracted because the programme provides 100 per cent funding. Companies get to advance the development of their products and at the same time bask in the kudos and validation of having won a public sector contract.

Linking to the marketplace

But what happens when the contract expires? How do companies then make the leap to the commercial marketplace? “It is the role of the innovation system to help catalyse that subsequent connection and stimulate new markets,” Reed said. The contracts are not exclusive and there is scope to build links with the outside world.

Any grant-funded project faces a similar challenge: what does a company do to link up to the next – capital intensive- stage of their development? There is a big gap between grants funding excellent projects and the point where the market takes over, noted Martin Koch, Policy Officer in DG Research. “How can we close the gap? With which instruments? Public intervention should stop at some point, but how do we make a link with the market?” Koch asked.

This is the longest-running problem in the history innovation and - evidently- there is no single fix. Koch suggested a funding approach that combines first-phase public grant funding and second-phase follow-on finance, in the shape of equity and mezzanine capital, into one package.

Another suggestion from the floor was to introduce tax breaks, along the lines of the ‘Jeune Entreprise Innovante’ (Young Innovative Company) programme in France, which offers tax exemptions for SMEs that invest 15 per cent of their budgets on R&D. As participants repeatedly underlined, no one solution can work in isolation. A range of financing instruments is needed to cover the whole cycle from start-up to market.

Next week part two of this report will look at risk-sharing schemes that allow companies to finance R&D through debt.

Links

• European Commission’s communication on the Innovation Union.
• UK Technology Strategy Board
• France’s Jeune Entreprise Innovante tax-incentive programme