Cicero Policy Briefer

Issue 4, September 2006

Europe needs to get up earlier

By Jacob Coy

Drawing on its own steeped national tradition of research and development, the Finnish Government has put innovation at the centre of its Presidency of the European Union. The rather stark lack of progress on the Lisbon agenda to date has given many across the EU a wake-up call that much more needs to be done to fulfil the untapped potential of the single European economy.

One important area identified by commentators in recent years has been the dearth of seed funding for new ventures and ideas. The lack of venture and early stage capital to further develop these is seen by most as a truly significant handicap to the European economic growth. Without the funds to start enterprises, fund scientific research or conduct research into new IT solutions, Europe will inevitably be following in the footsteps of its American and (to a much lesser extent) Asian counterparts.

Yet this lack of early-stage funding is best understood within the broader context of the European private equity market—a rather complex matrix of investors, capital, and enterprise entries/exits. A recent report by the European Commission’s Alternative Investments Expert Subgroup on Private Equity provides an outstanding overview of the European market and the challenges to further expansion.

The European private equity market has made a resurgence in the post dot com era, despite some rather lean years in 2002-2004 in terms of fundraising, investment and divestment. The fundraising from 2005 outstripped that of each of the three previous years by over 250 per cent per annum. Likewise, 2005 investment increased over 50 per cent in comparison to the previous three years’ average.

However, while these numbers are encouraging for the whole of the European private equity marketplace, closer examination reveals that the majority of the funding increases are concentrated in later-stage funding (buy-outs and expansion capital). There are relatively little proportional increases in venture capital and seed funding. Funds for early stage investments still only account for 6 per cent of funds raised.

This problem was recently brought to the fore at the Open Hearing on European Investment Funds in Brussels on 19 July. Participants noted that even in mature economies with extremely well-developed capital markets and institutional investors, like Germany, funding for early stage projects is quite low at only €60m (according to Thomas Pütter, Chief Executive of Allianz Capital Partners). Predictably, the problem is even more acute in the new Member States. Speaking at the hearing, special adviser to the Polish Ministry of Finance, Beata Topa, said that her country has taken steps to address the issues by setting up national capital fund to assist with R&D intensive products and had relaxed regulations regarding investment of pension funds into venture capital. However, she warned that this will not be enough—more needs to be done without harming the existing arrangements.

Some have suggested that individual Member States follow the UK’s Enterprise Investment Scheme (EIS) model. This provides very generous tax relief to investors and shields them from capital gains tax. Ilkka Harju from the Finish Ministry of Finance has made reference to EIS schemes as the kind of national solution that his country would be exploring and encouraging during its EU Presidency. But, he was quick to point out that it would not simply be a national issue—it is one which is fundamentally important to the whole EU.

Responding to this, the Enterprise and Industry Directorate has launched a Competitiveness and Innovation Programme (CIP), through which €1,000m will be made available for SME funding between 2007 and 2012. Additionally, the Commission has launched a new Joint European Resources for Micro and Medium Enterprises (JEREMIE) in order to help SMEs in less mature markets. These funds will be mobilised though financial institutions and administered by the EU in conjunction with national authorities.

These measures will help, but they cannot and will not adequately compensate for organic, market-driven investor appetite for early-stage investments and venture capital. Without a solution to this quandary, Europe is likely to continue to lag behind in innovative developments, enterprise ventures and, ultimately, in global competitiveness across the single market.

Jacob Coy can be contacted on +44 (0)20 7665 9535 or click here to email.

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