Where your competitors in Europe may be getting their funding:

A recent EU initiative provides funding for European VC funds investing in, and guarantee facilities to banks making loans to, SMEs in Europe. Pending future harmonization and integration, the current fragmentation of the European VC market may create interesting business opportunities as EU Member States compete to get their fair share of VC investments.

The “CIP” and the European Investment Fund:

With a view to stimulating economic growth and innovation in Europe, the European Union (“EU”) adopted its Competitiveness and Innovation Framework Programme (“CIP”) for the years 2007-2013. As part of this Programme, the EU provides funds for risk investments facilitating the start-up and growth of European SMEs (small or medium-sized enterprises), a cornerstone of European economic activity and policy. With a budget of over €1 billion, EU policy makers expect that the CIP financial instruments will leverage around €30 billion of new SME finance. About half of these EU funds are to be allocated to support venture and risk capital investments, with the other half being allocated to bank loan guarantee facilities.

The CIP financial instruments are managed by the European Investment Fund (“EIF”), a “fund of funds” type financial institution set up by the European Investment Bank (“EIB”), the European Union, and a number of European banks and financial institutions from the public and private sector. There are 3 distinct CIP financing schemes:

  • the High Growth and Innovative SME Facility (“GIF”): the EIF uses GIF funds to make investments in European specialized venture and risk capital funds (“VC funds”) that in turn invest in eligible European SMEs undertaking R&D and other innovation in their early stages (“GIF 1”) and/or in their expansion stages (“GIF 2”); the duration of GIF investments typically consist of 5 to 12-year positions, and the size of any individual GIF investment by the EIF shall not exceed €30 million;
  • the Seed Capital Action: the EIF provides capacity building grants to European venture capital and incubator companies to recruit expert staff enabling them to pursue investments in seed capital (grants are € 100,000 per staff member recruited, with an overall maximum per beneficiary of up to € 300,000 (3 staff members); these grants are only available to companies in which the EIF is also making an equity investment;
  • the SME Guarantee Facility: the EIF provides loan guarantees or co-guarantees to European banks to reduce banks’ risk exposure in mezzanine and other finance operations supporting eligible SME development.

GIF Process and Eligibility:
GIF funds would be granted in the form of EIF equity or quasi-equity investments in VC funds, which in turn would have to invest in SMEs established in the European Economic Area (EU plus Norway, Iceland, Liechtenstein) and certain candidate countries for future accession to the EU. Eligible SME activities should relate to technological innovation/development, technology transfer, and cross-border expansion. Investments in SMEs in the area of ecological technologies may attract higher GIF funding ratios than those available for other sectors. An SME is defined as a company with less than 250 employees, a turnover of less than €50 million, and a balance sheet total of less than €43 million. Participating VC funds must undertake to comply with detailed reporting, auditing (including access by EU officials), and visibility obligations (reference to EU funding sources).

Applications for funds from the CIP GIF program must be lodged by the applicant VC fund with the EIF, which submits suitable requests for approval by the EU Commission. Applications are informal but must include a detailed investment proposal providing information relating to the relevant assessment criteria. Those include, among other things: catalytic effects, balanced geographical distribution of grants in EU, quality of the VC fund’s management team, growth potential of SMEs in the target market, deal flow aspects, investment strategy, geographical focus, exit routes, size of the fund, proposed investment terms and expected returns (market conditions for GIF funds returns), and investor base details. GIF funds are intended to complement majority investments by private sector investors in the applicant VC fund, and not more than 50% of the capital of the VC fund may be held by a single investor.

Other EFI Funds:
The EFI has €2 - 3 billion of other funds from the EIB group which are not subject to all of the restrictive specific rules applying to the CIP funds, but eligible VC funds still must target European early-stage SMEs in advanced technologies sectors, focus their investments mainly in the EU and accession countries, and as a rule be majority funded by private sector investors. The EIF would generally take a minority position of between 10 and 35% of the VC fund’s total capital. Applications to the EIF need not specify whether assistance is sought under the CIP or more general EIF funds, as the EIF will allocate the application according to its merits.
In addition to the aforementioned measures at EU level, EU Member States may establish varying national incentive or funding schemes, which frequently have a more general application. Such incentive schemes would need to be examined on a country-by-country basis.

Fragmented VC Market / Opportunities:
The general venture capital environment in Europe continues to suffer from fragmentation and varying regulatory requirements and registration processes in European countries. Policy makers are aware of these problems and continue to work towards a solution, which might involve a future mutual recognition of venture capital fund structures, eventually permitting them more easily to do business across the European Economic Area. But new regulations move slowly and for now one must continue to deal with different local risk capital frameworks. In the meantime, however, the lack of uniformity may serve to create competitive opportunities as various EU countries design their local regimes so as to attract as much investment as possible.

This article originally appeared in Dorsey's Private Equity Newsletter. Complete newsletter can be viewed at PDF download above.