22 Sep 2016   |   News

Can EU’s new investment vehicle deliver?

The European Commission is hoping a new public-private fund of funds can bolster venture capital markets and funnel money to start-ups, while providing competition to the dominant European Investment Fund

The European Commission will start seeking offers in the coming months from fund managers to manage its new investment vehicle, a fund of funds, as it looks to draw more capital to promising technology companies.

Inspired by a similar initiative in Canada, this solution to Europe’s meagre venture capital (VC) market would see banks and pension funds invest alongside member states in a large public-private pot, in the hope of growing companies on the same scale as Facebook or Google.

Risk will be spread by guiding money into an assortment of promising private equity or hedge funds, and profit weighted towards private investors.

The goal is to make VC funds across Europe bigger on average, and so more attractive to pension funds, sovereign wealth funds and academic endowments.

“There’s almost no institutional investors looking at European VC at the moment,” says Mark Whittle, a partner at the UK’s Centre for Strategy & Evaluation Services, who headed a Commission study on the issue. “American investors are very difficult to attract as well.”

US funds tend to be much larger than European ones, so institutional investors can better justify the resources necessary to monitor and invest in them.

When the government puts money in first this is generally seen as a good deal for the private sector, which is more likely to follow with its own cash, says Gordon Murray, emeritus professor of management at Exeter University. “The only danger is if programmes demand rapid investment, you can have a recipe for rapid losses. Venture capital really is a long game,” said Murray.

Fund of funds also have some well-known disadvantages, such as a double fee structure, and historically lower performance returns.

Once the Commission picks an experienced investor to manage the fund, there will be an 18 month window to raise the money, with the fund targeting a total size of between €500 million and €1 billion.

The EU contribution will draw money from the current research programme, Horizon 2020, the European Fund for Strategic Investments and perhaps the European Investment Bank.

Details such as which managers will be tapped to manage the investments, what conditions the funding comes with and an exact timeline for the deployment of the capital remain scant for now.

Early stage finance hole

Though hubs like Stockholm, Berlin and London rival other major centres such as Silicon Valley and New York in terms of start-up activity and innovation, they still lag behind in terms of access to capital.

The real gap is early stage financing, the period where “it’s hard to tell if an entrepreneur is a genius or a lunatic,” said Murray.

European start-ups are particularly cash-starved, with most VC money going to larger, late-stage companies. "It’s typically hard for small companies to get backing of €15 or €20 million in Europe, so you have the most ambitious entrepreneurs packing their bags for the US, where they can quickly get that,” says Sophie Manigart, a partner at Vlerick Business School in Belgium.

The US VC market is five times bigger than the EU’s. If European VC was as flush as the US, about €90 billion of extra funds would have been available over the past five years to finance young companies, according to EU data.

Europe’s 800-odd VC funds are also heavily concentrated, with the Commission’s analysis showing that around 90 per cent of all EU venture capital is raised in eight countries: the UK, Germany, France, Sweden, the Netherlands, Finland, Belgium and Spain. The UK alone accounts for about one-third of Europe's VC activity.

Competition for the EIF

The shortfall in VC money in the EU is covered by government agencies, which have more than doubled their investments in VC funds since 2008.

“European VC is strongly dependent on public money,” says Manigart. The European Investment Fund (EIF), a development-finance body which invests in venture capital and growth funds with member states’ money, is the biggest player. “Without it there would be no market,” Manigart said.

EIF has poured up to €5 billion into around 500 funds, reaching over 4,000 European companies. However, there are different views on whether this high level of activity is a good thing.

“It definitely needs the competition from the new fund of funds,” says Manigart. “I’m not saying the EIF is not good, it is, but it’s too dominant.”

In addition, being backed by government money, there is an onus on the EIF to focus on certain favoured sectors, which some investors fear can lead to inefficiency and inappropriate allocation of capital. “Ascribing social goals to commercial deals is generally a problem for investors,” said Murray.

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