Having access to finance, been considered a challenge by all for a long time, the private and public sectors have been addressing this issue in different ways. One of the most obvious examples is public funding of businesses which has little interest for investors or lacks a market validation approach. The private players themselves have also on many occasions been operating independently (e.g. early stage vs late stage) with the sound example of crowdfunding taking long to be recognised by its peers as a valuable source of funds to startups.
1.1 Co-investment facilities
We propose a framework in which public stakeholders (governmental organizations, development agencies, public venture capital firms…) can co-invest with different investors (crowdfunders, business angels, early and late venture capitalists) to increase the chances for the startup to raise funds across its subsequent developments stages. The participation of public funds for co-investment may be determinant in countries with an overall lack of private funds being invested in startups and particularly in those which are willing to trigger investments from a certain type of investors (e.g. business angels or crowd investors).
Involving early-stage with later-stage investors in the same co-investment fund will also contribute to improved market liquidity for early stage investors and commit investors such as VCs or family offices to diversify their portfolio into startups while guaranteeing these are being closely monitored by the investors which are more skilled in these stages.
Several countries demonstrate best practices in co-investment which should be adopted. Different co-investment models exist and have been extensively implemented and tested in different countries, albeit this is not yet accessible to investors in every country.
In Portugal, an emerging angel community has seen investments by these actors increase from below €0,5 million in 2009 to over €13 million in 2013 almost exclusively due to the creation of a public co-investment facility partially funded by EU cohesion funds. A similar facility is also being used in sign The Netherlands since 2006 and can be replicated to other countries.
1.2 Cross-border co-investment
Despite an emerging early stage investment community, significant discrepancies still exist with funds available in leading economies but lacking in many other regions (e.g. Southern Europe only accounted for 10% of funds invested into VC backed companies ). Entrepreneurs in these regions with less funds can benefit of initiatives which will scale up the local amount of capital available and link their companies with much more capital power and better connected investors in more developed countries.
A Europe-wide co-investment framework that allows and facilitates investors to invest alongside other investors and into early stage companies regardless of their origin within the EU is a key element to attain the European Early Stage Investment Single market. Many European investors already know each other and are connected through international organisations. Despite this fact and knowing no legal constraints stop them from making international investments, many did not yet cross their borders to invest alongside other investors.
A cross-border co-investment facility leveraging investments from investors in different geographies will incentivise investors to search for international opportunities and to commit funds alongside other investors from other countries which is the same as saying investors will be in a better position to search for the best deals in Europe. This initiative demonstrates the potential of the single market per se and should be seen as a measure to invite investors to leave their comfort zone and be challenged to look for deals abroad.
Measures aiming at fostering cross-border co-investment should pay particular attention to drive additional funds to emerging markets instead of concentrating funds into more competing entrepreneurial communities to which funds are naturally attracted to. Cross-border co-investment facilities should work on the principle that capital needs to be available where companies are located so they don’t need to ‘follow the money’ around and lead to potential relocation of startups.
The existing European Angel Fund, an initiative led by European Investment Fund (EIF) which is co-investing with business angels in Germany, Spain and Austria is a recent step towards this goal. The way it is structured should, however, be reviewed to become accessible to investors from all EU member states and accession countries. Action in this area is not limited to public agents and can be extended to corporate investors and international Venture Capital funds. These can set up sector focused funds and co-invest alongside individual investors across the EU to be constantly on top of the latest trends and opportunities. Wayra’s business accelerator is a well-known European example of co-investing in startups across Europe and promoting these to other investors.
1.3 Convert business development grants into financial instruments
Currently, a large part of EU and national funding takes the form of grants. Whilst this is helpful for research focused ventures and companies that often do not yet have relevant revenue streams, it also has disadvantages such as insufficient incentives to commercialise.
Converting public grants targeted to business development into financial instruments (e.g. equity, debt, guarantee, mezzanine) will shift funds awarded to companies into revolving capital which may be used by multiple SMEs in different periods. This re-orientation will also lead to a focus shift from product development to commercialisation and business development. Such public funds should be linked to co-investment facilities as much as possible, in order to ensure public resources are allocated in alignment with the market.
Despite recent positive developments, Europe needs stronger action. Public grants from financial instruments at European level (e.g. Horizon 2020, Cosme...) or at national level, should be mainly transformed from non-refundable capital into revolving capital. But what does it actually change for SMEs? For funded SMEs it means they would still receive the funds they need and may be subject to refund only if they succeed. It will nevertheless mostly impact the SMEs that are currently not receiving grants as more funds will be made available in the following periods. Funds made available through this mechanism can be invested multiple times, transforming €1 of investment into up to €5,55 along a 20-years period. If we assume a 30% loss rate for each round of investment and consider an average of 4 years positions, for every €1 initially invested we will see further €1,77 re-invested. If in addition to this, we consider these investments are made alongside private investors on a 50/50 basis, for every €1 invested we will see €4,55 being re-invested into startups in addition to the priceless free business mentoring provided by early stage investors.
EU Horizon 2020 is for the first time deploying 3,69% of its budget under financial instruments. If we apply the same multiplier assumption to the corresponding 3 billion euros H2020 budget, these funds could multiply up to 5,3 billion euros or 16,7 billion euros if investors could become involved in the process. Leveraging European programmes further or applying the same rationale to national grant mechanisms can increase the sustainability of funding of research and multiply funds available to commercialisation along time.