In conjunction with the launch of two new state venture capital instruments, a “green fund” and a holding fund (fund-of-funds), the Swedish Agency for Growth Policy Analysis, Growth Analysis, conducted a focused international study in the field. We have collected international experiences through interviews and studies of documents concerning similar activities from France, Great Britain, the Netherlands, Denmark, Bulgaria and Canada.
The purpose is to contribute knowledge that can lead to the development of the Swedish initiatives and generally promote learning. The study is part of Growth Analysis’ framework project What lessons can be learned from the state venture capital initiatives within the European Regional Development Fund (ERDF)?
The study shows that such venture capital instruments are in several cases combined with other types of initiatives, both financial and non-financial. A need to include other types of financial instruments such as loans and securities has been identified since the target companies’ financing needs proved to vary widely. By being able to offer a variety of tools, more companies can be reached in a coordinated initiative. It has also been viewed as a necessity to offer advisory and coaching measures of an “investment readiness” nature to companies seeking investments to improve their competence during the investment process.
Investment-ready companies’ possibility to find financing for their operations is important when it comes to growth. The financial market, however, can sometimes fail in this respect. There may be many reasons for this, factors such as high risk due, for example, to uncertainty as to expected return in investment, particularly as regards companies in early phases. Long lead-times are another factor, that is to say that it takes a long time before the project generates any return. State financing measures can therefore in some cases be motivated for growth policy reasons. We find examples of such policy measures both in Sweden and in other countries.
In Sweden, the green investment fund is intended for small to medium-sized enterprises in an early phase with innovative services and products with a direct or indirect greenhouse gas reducing effect. The fund invests directly in firms, rather than through an intermediary. The total amount of investment is estimated to be in excess of SEK 1 billion. The holding fund is also called a fund-of-funds, that is to say it finances other VC funds (in this case three) that in turn invest in high-growth small and medium-sized enterprises. This initiative will in total comprise at least SEK 1 billion. Both funds co-invest with private investors.
The international examples show that there are very often no advanced needs-analyses to clarify the real need for the measure or discuss conceivable negative consequences. Such an analysis might concern how needs vary based on what phase the companies are in, their sector or geographical location, as well as potential conflicting policy goals, or deadweight or ousting effects. A good, thorough ex ante analysis is an important element in this context, in order to create a clear picture of any problems that in turn can be linked to clear and concise goals. This makes both implementation and evaluation easier at a later stage.
We can also see that the reason often given for launching green funds is that it is difficult to attract investors to the industries in question due, for example, to uncertain potential yield. The conclusion is then that a measure to complement the market can be justified. At the same time, the green funds system is often based on co-investment with private players on equal terms (pari-passu). This contains a challenge – at the same time as the initiative is introduced for the very reason that there are too few private players, it has been designed in a way that demands their participation.
In preparation for its continued use in Sweden, there is thus good reason to carry out a detailed needs-analysis and make clear the precise objective, or objectives, of the initiative. The latter tends to control how the players act in practice. Is the objective maximised yield, to bring about a changed market for private players (so that the measure is not needed in the long term) or is the goal to achieve certain environmental targets? In cases where there are several objectives, it is also important to define a clear hierarchy among them. This will also be of importance as regards future evaluations being able to provide as clear a picture as possible.
In the international examples it has not been possible to find any explicit descriptions of how environmental benefit and financial yield are weighed against each other in a green fund. The British Low Carbon Innovation Fund (LCIF), however, has developed a tool for estimating what greenhouse gas reducing effect an investment may have. In the Dutch fund, an environmental target has been quantified (a reduction of the region’s emissions by 5.4 million tons of CO2).
In several of the international fund initiatives, venture capital has been judged to be too narrow a tool. By increasing flexibility and offering more types of financing (such as loans and mezzanine financing), the players in the funds judge that they have greater likelihood of reaching a wider group of companies with different needs. The importance of the companies having access to not only capital but also to knowledge, networks, mentorship and skills is emphasised in this context. The objective is to raise the level of “investment readiness”, that is to say make the companies better prepared for investment through non-financial values, for example professionalisation of the business and contact networks. Denmark has for example worked with a combination of evaluation and education for the companies. Advisory and coaching measures are sometimes also offered after investment with the purpose of improving their chance for success.
Several of the international experiences emphasise the importance of a long-term approach – that there must be an understanding that it takes time to build deal flow (potential flow of investments), build up knowledge and achieve effects in the company. The goals should therefore be set at a realistic level, without the players being forced to show results too quickly. The state’s ultimate objective should be to bring about a changed market and a change in behaviour on the part of private players so that the initiative is no longer needed in the long term. The question of what is needed for development to move in this direction is therefore central.
Other experiences concern among other things the fund’s size and the risk of making it too small in respect of capital, since this can for example mean too few portfolio companies over which to spread the risk as well as difficulties in obtaining follow-up investments. The choice of target group / industry is also of importance since it may be more difficult to find financing if the target group is too narrow because there will be fewer potential companies to invest in. The choice of co-funders can also be important since it may be easier to achieve consensus in a narrower, more homogeneous circle, at the same time as there is an added value in collaborating with different categories of investors (for example business angels and foreign investors).
We also note that EU funds (with the exception of Canada and the Netherlands) are an important feature of financing in the international funds, at the same time as several of the examples show that the greater the composite nature of a fund (the larger the number of different players) the more difficult it can be to put the puzzle together with different regulatory frameworks and requirements to take into account. Many of the funds have for example been forced to invest within a certain time frame because of the EU funds’ regulatory framework, which can lead to insufficient flexibility.
As regards implementation, several of the examples show that the success of the fund is strongly dependent on access to skilled personnel and relevant knowledge. Professionally run, projects can more easily attract capital from private investors and banks. The companies also expect active ownership on the part their investors – including public investors – which demands more time and resources but strengthens learning.
In venture capital initiatives, the exit phase can be seen as the “harvest” from the work put in and thereby an important stage. In the international examples, however, there does not seem to be any thoroughly developed exit strategy. Our recommendation as regards the Swedish initiatives is to work in a more exit-oriented fashion throughout the entire investment cycle.
Our impression is also that a structured evaluation mindset does not seem to have been included and integrated in the funds at an early stage or to a sufficient extent. An evaluation strategy needs to be developed early in the design of the initiatives. It is also important to have a long-term perspective in evaluation. The international experiences also confirm that regular follow-up and a clear goal structure are very important pieces of the puzzle in building a success concept.
Looking abroad – lessons learned from public-financed green funds and holding funds