European Innovation Council makes first equity investments in start-ups

The European Investment Council (EIC) fund is poised to directly invest around €178 million in 42 start-ups, acquiring 10 - 25% stakes for between €500,000 - €15 million each.

These will be the EU’s first ever direct investments in SMEs, marking a step towards the EIC becoming one of Europe’s biggest venture capital funds.

Until now, EU funds, such as the European Fund for Strategic Investments, have shied away from directly investing in start-ups and only provided grants, loans or guarantees, while the European Investment Bank has put money into venture capital firms’ funds, but has not taken a direct role in deciding how this is invested.

The move to make equity investments is driven by the ongoing problem that while it has world-leading science, Europe has consistently failed to translate this through to commercial success. One of the key reasons for this is seen as the lack of venture capital available for start-up companies to scale up.

“We came to the conclusion that it was time to test something else in comparison to what we did until now,” a senior Commission official said. “That is not just to invest in VC [venture capital] funds like we already do, but […] to provide direct investments in these companies to de-risk them by taking the first risk and attracting investors.”

EIC, in pilot mode since 2016, gets properly off the ground in the 2021 – 2027 research programme, Horizon Europe. The Commission estimates that over the next seven years around €3 billion will be directly invested in start-ups. That “make[s] this fund one of the biggest funds you will find in Europe,” the official said.

The goal is to leverage three to five times the initial EIC investment by attracting private capital. In subsequent funding rounds EIC will maintain its holding but will not follow-on. Exits are likely to take from seven to ten years.

Matti Hiltunen, senior advisor at Business Finland, the country’s agency for innovation investment and trade promotion, says the EIC promises to deliver much-needed muscle for Europe’s start-up ecosystem. “These companies when they start to scale up need a lot of money and here, we have a lot of money,” he told Science|Business.

The key to success will be treating companies on a case-by-case basis, Hiltinen believes. Equity funding should support companies that are further away from the market and having any turnover, meaning they cannot attract investors. “Every company is different and has to be looked at on an individual basis. One size does not fit all,” said Hiltunen.

The secondary goal of the fund is to act as an anchor investor that can pull in more private investment, growing Europe’s venture capital market as a whole.

That requires the Commission to strike the right balance, and not squeeze private money out of the most attractive opportunities. “The EIC Fund is a lot of money when you look at the whole picture of the European VC market. If its run badly, it could adversely affect private VCs,” said Hiltunen.

Håkon Haugli, CEO of Innovation Norway, an innovation agency, hopes the new fund will facilitate more cross-border investments and “draw in large numbers of private investors from all over Europe, introducing them to companies they otherwise would not be exposed to.”

This way, the EIC Fund could help private VCs, which today largely operate national or even regionally, to expand “beyond their normal operating theatre,” says Haugli.

Norway also welcomes the new approach of mixing grant and equity financing. While grants can boost development, the promise of an equity investment allows the entrepreneurs to focus on bringing their products to the market without the added stress of searching for investors. Enabling investors to come in, “the EIC Fund should act as a safe guard and guarantee for the investment, giving the companies the clarity and runway they need to succeed,” said Haugli.

The EIC selected the first investee companies in December 2019 and has 159 companies lined up for equity investments. One company has already have received the new type of funding, after the Commission acquired €15 million worth of shares in CorWave, a French developer of novel implantable heart pumps.

Securing the funding

SMEs can request either grant or blended, meaning grant and equity, support. But to receive funding, they first must go through a tough selection process.

From the applicants, the EIC picks out the most promising ones and invites the CEO to an interview with six investment, technology and law experts. The panel then makes it recommendations to the Commission, which then selects the winners.  

The next step is deciding on the mix of funding and how much, a decision made by seven investment experts and a Commission representative, which then must be again approved by the Commission.

The company is finally ready to receive investments. The first of the investment in convertible stock comes with no strings attached, but after 18 months, to get the second tranche, a company must show that it has attracted a similar amount of money from private funds.

“Our intention is not to replace the market, crowding out private investors, but on the contrary, to attract private investors and to create crowding-in conditions,” a senior Commission official said.

The process for securing grants will be changing in Horizon Europe. The extent of the changes is still being discussed with member states, but the goal is to make the process simpler and shorter.

For one, the applicants will submit a short pitch, which will be used to draw up a shortlist. In the second round, selected start-ups will submit a full application with the help of the EIC business acceleration service,s.

The Commission is also considering changes to the due diligence process but what these will be is still unclear.

Hiltunen believes the Commission is heading in the right direction. The only potential hurdle he foresees is the lack of clarity in the selection process. SMEs applying for funding must know exactly what the process is and how to prepare for it, he says.

Golden shares

In most companies, the EIC will acquire up to 25% of the shares. However, in certain strategic companies, ownership could go over 50% to secure golden shares, that give the Commission a veto right in the company.

While the EIC is unlikely to do this in the very beginning, “We reserve the possibility. It doesn’t mean that we will do it each time,” said a Commission official.

Whether and when to invoke the option will be decided on a case-by-case basis, by monitoring the origin of the different investors in EIC-funded companies. If investors from countries that do not partake in the EU’s research programme, Horizon Europe, have significant influence in any given company, the EIC may step in and purchase more shares.

The aim is to ensure foreign investors do not have the last say in the future of strategically important companies. “If the only way to do that is to acquire a golden share, we are going to do it,” the official said. But this is the last resort and only meant for companies that work in strategic sectors, such as cybersecurity.

Hiltunen says the right to reserve golden shares is “a wise precaution” that could be invoked if the EU is about to lose an important asset. “In principle, we should not be naïve. It is wise there are possibilities to intervene,” he said.

Haugli acknowledges the EIC Fund could play an important role in the interest of Europe but warns “it is a tool that should be used with caution and not risk disenfranchising entrepreneurs”.