Money, money, money: Europe has the science but lacks venture financing to create technology champions

Physicist-turned-entrepreneur Hermann Hauser has no doubts about the entrepreneurial potential of Europe. He’s dug deep into his own pockets over the past 20 years to fund more than 100 European start-ups. But to survive and grow fast, young technology companies need large pools of capital - and smart management. And both are lacking in Europe. 

Giving the first annual Science|Business lecture in the European Parliament on 12 November, hosted by MEP Andrew Duff, Hauser argued that Europe has failed to tap equity as the most effective financing tool to grow its innovative small and medium-sized companies. 

“The EU has €2.7 billion earmarked for financial support for SMEs in the Horizon 2020 research programme. That support is useless as debt,” Hauser said. “Normally companies who innovate have no assets - hence they can’t take debt. The right way to do it – there is a market mechanism – is fund-of-funds, which then channels the capital to successful venture capital teams in different sectors.” 

Such fund-of-funds are one of the key drivers of the vibrant US venture community. Each holds a portfolio of equity investments in other venture funds, rather than investing directly. “The EU continues to lack this kind of approach,” Hauser said. “If Europe invested half billion euros into equity [in technology spin-outs] through a fund-of-funds, it would have a real multiplier effect. Probably 75 per cent of the total capital would be [matched] by the market. That gives you 3-to-4 times leverage of the capital invested.” 

Hauser said the creation of an EU fund-of-funds is, “the single most important thing that needs to be decided on [in] Horizon 2020.” Anyone who knows how financing works knows the only way to finance innovation is equity. “At least €1 billion in EU funding should go into equity,” he said.

The EU currently channels significant venture funding directly to SMEs through the European Investment Fund (EIF). However, Hauser said this is undercutting private venture capital players. “The EIF has become so dominant they invest 60 per cent of the total VC – so there is no diversity – there is no competition. They have become a gorilla,” he said.

The dramatic collapse of Europe’s venture capital community in the wake of the financial crisis underlines the need for a new approach. In 2000 there were some 400 venture capital companies actively investing across Europe. Years of negative returns have now shrunk the number of VCs with money to invest to about 40, Hauser noted.

 

VCs that survived the shakeout are particularly skilled at ferreting out promising technologies and supporting their investee companies with management expertise. Such expertise is decisive, Hauser said, noting that only one company of the 100 or more he backed failed because the technology didn’t work. The rest flopped mostly as a result of management issues.

“There is no silver bullet to creating high-tech companies. There are different approaches that work in different sectors,” said Hauser. As the author of a recent report on innovation for the UK government, he canvassed start-up hotspots in Korea, Japan, Germany, Holland and the US. “The way Rolls Royce works is not a template that works for pharmaceutical, energy or Internet companies,” he said. “Each sector needs different expertise and different ways of getting innovation to the market.”

Hauser said his experience of investing in start-ups does not make him smarter, but gives him “more data” about what works and what doesn’t. One conclusion he draws is that innovation happens in clusters of universities and companies that have world-class expertise. 

Cutting-edge science is vital to developing vibrant start-up ecosystems in Europe, he believes. “It’s not a matter of filling in holes; it’s a matter of building on mountains.  If a centre is not leading it has no chance of competing on global scale,” Hauser told the audience, which included MEPs, Commission officials, university administrators and innovation experts. 

Building on the findings in Hauser’s report, the UK government is in the process of setting up seven Catapult centres, modelled on Germany’s Fraunhofer centres, each with a brief to provide the resources and support that SMEs need to translate specific research programmes to the market. 

The stakes are high when it comes to getting innovation right in Europe, Hauser said. “It’s clear this has become a race – a race between nations… Those that are well-organised translate [research] quickly into companies.  We have no option but to participate in this race and organise our affairs to do this efficiently,” he said.

“Innovation is the single most important subject for support in Europe,” Hauser said. But the support needs to be selective, “Only do it in clusters of expertise where we can build world-class companies.”

As an example, his home turf in Cambridge is benefitting from three entrepreneurship-friendly policies implemented by the UK government to help innovation clusters. First, in common with governments elsewhere in Europe, the UK introduced R&D tax credits.  “If companies spend a lot on R&D you get back in tax credits (cash) what you spend,” said Hauser. “My companies live on this cash for an entire quarter.”  

Second, the UK government allowed institutional investors such as pension funds to put a small portion of their capital in risky investments. “When they work, they deliver higher returns,” Hauser said. “Pension funds in the UK were not allowed to invest in risky investments. They now can.”  Third, there has been a change to the way options in tech companies are taxed, reducing the tax rate from 60 per cent to 10 per cent.

In aggregate, 1,500 Cambridge spin-outs now generate revenues of £13 billion. This outstrips the £12 billion annual turnover of one the UK’s leading manufacturing companies, Rolls Royce. The spin-outs also employ more people and export more than Rolls Royce. “You need to see it in that context. Governments always see the needs of large companies as more pressing than small ones,” Hauser said. 

In that light, the EU’s long-standing budget priority for agriculture is particularly incomprehensible. “If ever there was a political scandal of looking backwards instead of forwards it’s … EU spending on agriculture.” Despite commanding such a huge chunk of the EU budget, it represents only 1.6 % of total EU employment.

Rather than subsidising farmers, innovation is the answer to Europe’s unemployment dilemma, Hauser argued. “Small companies create jobs. Big companies create wealth. But they do not create jobs at the same rate as small companies.”

The UK chip design company ARM, which Hauser co-founded in 1990, became the first UK technology spin-out to reach £1 billion in revenues and sold 10 billion of its microprocessors this year. These processors power 95 per cent of smartphones on the market currently.

Of the many lessons he learned along the way, Hauser said providing spin-outs with management expertise is absolutely essential to creating technology champions. His first company, Acorn Computer, which went from zero to £100 million pounds in five years, stumbled when it came to going global.  “I never knew anything about stock control, I’m a physicist,” Hauser said. Errors in managing growth and logistics led to serious financial difficulties. “We were very successful in the UK, but it was a global game.”

On a positive note, Hauser noted that the growth of global markets now gives Europe a better shot at producing its own crop of technology winners. In the past, the US dominated technology sectors because buyers tended to assume the best products were produced in America. Now people no longer care where the products and services come from. Witness Skype, a disruptive Estonian start-up that has transformed voice communication on the Internet. 

“The EU always had spectacular strength in technology and expertise. We have enough start-ups now. The problem is that we don’t grow them fast enough,” Hauser concluded.