Three countries, three attempts
Growth Analysis has been tasked with evaluating the initiatives implemented with a view to increasing the regional range of equity capital for the period 2009–2014 within the scope of the eight regional structural funds programmes.
Swedish regional venture capital funds – a few reflections at half time
The initiative involving Swedish regional venture capital funds formally began in 2009. There were no criteria for full operation at that time. The work has increasingly taken shape thanks to the funds’ own work and with constructive support from the Swedish Agency for Economic and Regional Growth and evaluators. Knowledge and understanding of the regulations have grown, structures have been developed and the rate of investment has gathered speed.
In 2011, attention has been paid to the funds’ rate of investment in connection with the risk of repayments to the European Commission. All indications are that the funds have managed this in terms of volume. The most recently available figures (September 2011) indicate that 127 investments have been made thus far. In total, SEK 957 million (c. 105 million euro) has been invested, including both public and private capital.¹ Of the available European Regional Development Fund (ERDF) financing, around one third or SEK 178 million (c. 20 million euro) has been utilised.
Expectations on levels of return differ between the funds and the private co-investors. It is likely that the funds’ lower expectations, at least partially, reflect the broader target structure to which they must relate.
The issue of additionality is methodologically difficult to manage. From the material available, a cautious interpretation may be that the endeavour to-date appears to have been leverage for private investments that have thereby shifted up. Additionality appears to exist for a bare majority of the investors. Potential displacement effects (for private investors) cannot be assessed, but nor can they be ruled out entirely. The Swedish Agency for Growth Policy Analysis (Growth Analysis) ² believes that it is important that these surveys are carried out regularly and with underlying data which is as good as possible.
The accuracy of the funds in terms of investments at an early phase is considered to be well within the intentions of the initiative.
The arrangement of regional venture capital funds tied to a specific programme area makes the geographical dimension important. The conditions for every individual fund are far from identical.
Experiences from Norway and the previous Swedish pilot study indicate a number of deficiencies in terms of cooperation between the funds themselves and other stakeholders. Consequently, it is important for cooperation and experience exchange in the current initiative both to be encouraged and to actually take place. A common target is important to facilitate cooperation, but not simple to achieve.
One of the issues that will become increasingly important over time involves exit options. This can be a concrete issue where experience transfer between the funds may have a significant part to play.
In general, there is a shortage of systematic evaluations of State initiatives on the capital supply market. The Swedish initiative has the potential to contribute a wide range of experience. This naturally requires high quality data. It is therefore very important that the conditions for such data collection are secured.
The half-time report produced by Ramböll in its capacity as a procured evaluator doing “ongoing evaluation” includes many relevant aspects. It is hoped that the stakeholders involved will study the report in earnest and that the initiated cooperation will continue to be developed.
International case study
The main purpose of this study has been to map experiences with hybrid seed funding models in Finland, Norway and Scotland. More specifically, overarching goals, organisation, effects, incentives and geographical distribution have been under scrutiny.
In Scotland, the Scottish Co-Investment Fund (SCF) was established in 2003. Based on an already established initiative that aimed to develop business angel networks (BANs), this programme established a co-investment model whereby Scottish Enterprise approves the partners that will take part in the programme. The programme partners (typically investor networks and venture funds) are responsible for identifying, evaluating and negotiating deals with potential portfolio companies. When investing, SCF will co-invest up to 50 per cent of the investment amount under the same conditions as private players. Therefore, the decision to invest is made by the programme partners. There are no other risk-reducing elements in the programme, but it is necessary to bear in mind that the United Kingdom offers very attractive individual tax incentives on both invested capital (front end) and any returns (back end). Studies have shown that this programme has been important in building robust investment networks that invest in the early stages of the company life cycle. Moreover, these investors often take on a strategic role, and sometimes even an operational role, in the companies in which they invest. The economic effects of SCF are as uncertain at present as only a small number of companies have exited at a significant rate of return. This must be viewed in the light of the financial crisis, and the fact that it often takes seven to ten years to develop profitable new growth companies. However, it is reasonable to question whether there has been sufficient emphasis on exit, and whether the relatively young investment networks established have the necessary experience to facilitate successful exits.
The Finnish government has experimented with different programmes to stimulate the emergence of new high growth ventures. Examples of such programmes are include different types of monetary contributions to potential growth ventures, programmes for stimulating the creation of new ventures, and various types of governmental seed funds. Realising that projects with significant growth potential need more capital, the VIGO programme – which was very much inspired by the Yozma programme in Israel – was established in 2009. The intention of this programme is to provide a fast track to finance and competence for companies. A key component in this programme is the use of incentivised business developers with international experience. The programme began by choosing six specialised accelerator networks (VIGOs) consisting of serial entrepreneurs, investors and business developers with international experience. The rationale behind the establishment of the VIGOs was that the competence, experience and network inherent in these could contribute to the realisation and of more, better ideas. The programme is still at an early stage, but a number of projects have already succeeded in attracting significant amounts of capital from international venture capital funds. At the same time, several of the VIGOs have expressed frustration with the fact that the public players Seed Vera Venture and Tekes make independent assessments of individual projects in addition to the evaluations conducted by each VIGO network.
In Norway, two rounds involving regional and national seed funds have been set up by the Norwegian seed capital programme. The programme has been organised as a traditional venture capital model with general and limited partners. The government has committed liable loan capital equal to the private capital infused. Additionally, a fund that is subject to claims from realised losses has been established, where 25 per cent of the loan capital can be written off (a maximum of 50 per cent of the loss in each project). The first round of seed funds, established in 1998, has given a non-satisfactory rate of return, and only a few of the investments have given a reasonable return. When evaluating the first round, the following explanations were found for the non-satisfactory returns: insufficient risk-reducing mechanisms, lack of competence among fund managers, funds that were too small, and an unsatisfactory liable loan capital model. In the second round of seed funds, established in 2006, a total of nine regional and national seed funds were established. Attempts were made to rectify some of the shortcomings in the first round by focusing more on the choice of fund managers (requiring competent fund managers), much larger funds, and facilitating the sharing of experiences between the various funds. Moreover, the liable loan capital was offered with slightly better conditions. However, there is still much grappling with the fact that with this model, private players have to bear the cost of fund management, making this management expensive as far as private investors are concerned. Furthermore, the funds have been criticised for not actually making many “real” seed investments. According to the funds themselves, this is due to lack of predictable governmental regulations. The seed programme in Norway is not a “permanent” model, and at present the fund managements are waiting for signals from the Ministry of Trade and Industry as to whether or not the programme will undergo further development. This uncertainty implies a lack of dynamic and makes the seed programme a modest contributor to the development of sustained, robust networks of fund managements.
All three of these programmes are attempting to involve private capital in order to increase emphasis on investments in companies with genuine growth potential. This illustrates the following dilemma between the main objectives of the programmes:
- Firstly, attempts are being made to involve private players so as to ensure that investments are made in projects with significant growth potential in real terms.
- Secondly, the programmes’ intentions are clearly to encourage investment in projects at a very early phase; that is to say, investments with a genuine degree of uncertainty (possibly involving research-based spin-offs from the university and institute sector). However, this intention is not always aligned with the risk profiles of private investors.
- Thirdly, there is quite clearly a desire to develop “thin” capital markets so as to increase the strength of these markets with the supply of additional capital and competence (particularly with regard to phase and industry, but also to regions to a degree).
Clearly, addressing all these primary goals in a single programme is very demanding. In the three programmes explored in this report, the goals are weighted differently; and as a consequence, the programmes have different characteristics. In the study, the VIGO programme places the greatest emphasis on the competence dimension. It is emphasised here that the VIGO accelerators should be involved in a very early stage of a company’s life. Partners are more or less expected to involve themselves in operational matters within the companies in order to place the companies in a position to benefit from domestic as well as foreign investments after a period of one to two years. A key objective in the Scottish programme is to engage business angel networks that can supply strategic and operational competence to portfolio companies. The competence dimension is also emphasised in the Norwegian model, but the involvement from general partners in individual seed funds is more strategic than operational.
In addition, this study shows that the historical context needs to be taken into account when introducing and developing different programmes. For instance, the SCF programme in Scotland would obviously not have been as successful without the existing tax incentives and investor networks. In the absence of this infrastructure, players would not have been able to exploit the benefits presented by the initiative. In this case the introduction of the programme has enhanced the effects of existing means. On the other hand, Finland has faced challenges when trying to operationalise the programme within the scope of the current means, although the various players mean well.
Another central finding in this study is that the focus on hybrid seed capital models must maintain a long-term perspective and involve a high degree of predictability in order to maintain the interest from private players. A lack of predictability may persuade private players to terminate their investments, behave more cautiously or reduce their planned investment activity. Maintaining a long-term perspective is difficult for the government as it wishes to see quick results so that it can be sure that public money is being invested well. Given the fact that it could take up to 15 years for a satisfactory evaluation of these types of programmes to be undertaken, this is an obvious dilemma. Moreover, it is difficult for evaluations of such types of programmes to gauge the economic effects of public funding employed to develop capital markets. However, it is entirely possible to undertake partial evaluations over time. Such evaluations should be conducted in close cooperation with fund managers in the various programmes as these managers regularly collect data for internal use. By using this data, it is possible to conduct follow-up evaluations that can provide public authorities with far better decision data for development of new programmes or adaptation of existing ones.
The Swedish model is in many ways similar to the Norwegian seed model, but the regional dimension is even more evident. With this study and previous research in mind, there is every reason to question whether this model would be a good solution for Sweden. A number of studies have shown that regional seed funds struggle to succeed commercially. When a regional model has been chosen, it is important for the programme to be flexible and possible to tailor to the regional context. It is unlikely, however, that a regional programme without some kind of risk-reducing mechanism will deliver reasonable rates of return to its private and public owners. At the same time, it is clear that many of these funds could play a central role in regional development as fund managers gather competence and experience that is not present in many of the regions. Another question involves whether establishment of such funds is capable of engaging serial entrepreneurs in the different regions. Serial entrepreneurs are the people who, in many cases, can provide the operational and strategic involvement that is invaluable in the very earliest phases of a company’s development. This ability to contribute on both an operational and a strategic level is what determines, in many instances, whether a prospective growth company is able to realise its potential.
In the three initiatives studied, the experiences of the involved stakeholders and the structures are described. In all three cases, the government is trying to involve private capital.
From an evaluation perspective, notable deficiencies can be confirmed in systematic evaluation theorems. Few evaluations have been done and they provide more of an impression of individual studies than parts of a cohesive, long-term evaluation systems.
The study by Sørheim and Rasmussen emphasises the significance of long-term rules and predictability. Government initiatives at irregular intervals, uncertainty regarding extensions and potential changes to structures and terms risk influencing stakeholders’ willingness to invest (in volume and phase) and make the building of competent environments more difficult.
One lesson that can be learned from the above is to shift the initiatives from short, direct policy measures to more long-term, indirect and system-impacting venture capital strategies, such as incentive structures and regulatory changes. The long-term challenge is, however, to build up and maintain an institutional structure that is stable and long term on one hand, and stimulates learning and innovation on the other.
The three case studies clearly indicate the significance of context. An overwhelming majority of the issues we face in Sweden are internationally applicable. This means that methods and solutions from other countries are highly relevant to us as well. The challenge is to take in these foreign experiences and at the same time take into account the context in which they have developed. In this case, initiatives in the capital supply field have to be interpreted on the basis of factors such as history, the nature of the financial market and differences in the business structure.
With this in mind, it can be confirmed that the Scottish experiences point to the existence of business angels and tax incentives as two crucial contextual factors for the Scottish Co-investment Fund’s (SCF) successful implementation in Scotland. In Finland, business angels do not have as clear a part to play, but there is a national business angel network – Investor Extra. In Norway, capital from business angels has constituted a small part of total investments, but is still judged to have played an important role when mobilising institutional capital. The question of tax relief for investors in an early phase was also posed in Finland, but has not yet found sufficient political support. In Norway, the issue has, however, not been discussed to any mentionable extent.
Historical heritage also influences how new initiatives are perceived and succeed in their implementation. In Finland, a structure is being tried that markedly deviates from previous handling. The rapid decision process that is sought for is based on the VIGO accelerators’ valuation being adequate and that public stakeholders automatically comply with their decisions. This is an entirely different way of working for Seed Vera Venture and TEKES than before. The results have also initially become a significantly more sluggish decision process than intended.
The now working Corporate Income Tax Committee in Sweden will probably propose possibilities of tax relief for natural persons for venture capital investments. It is conceivable that we may see an incentive structure in the Swedish tax field in the future, with elements reminiscent of the Scottish system.
On a general level, it can be asked what the actual goal is of the government’s actions? Or, to put it another way, what is the public undertaking? Is there a long-term ambition to develop the capital supply market to the furthest extent possible so that the need for government market intervention and selective measures can be reduced? Or should the goal be viewed as more short term, focusing on the promotion of a smaller number of growth companies in specific initiatives? Although both aspects can naturally be said to be significant to a country, how they are prioritised and communicated plays a role.
In very simple terms, some differences can be identified in the overall objectives of the three cases studied. Finland is making a stake on few selected growth companies at a very early phase, with business development, rapid access to financing and international connections as main points. Norway has a traditional venture capital model where the government participates by contributing lending capital. The emphasis is on innovative growth companies, and a clear geographical dimension is added through regional funds. Scotland’s SCF more seeks to develop the market, increasing capacity and competence among private investors. All initiatives concern an “early phase”.
Geographic delimitations or objectives have been included in various ways in the three countries. Finland’s VIGO system is entirely divided by industry and consequently only has an indirect geographic dimension. In Scotland, there are no express geographic considerations. However, at the same time, it can be noted that the stimulus of business angel networks has also meant that investors in rural areas have become organised and entered the market. Norway has a clear geographic character in its initiative involving four national and five regional funds. The goals for the latter are challenging: to infuse capital, competence and networks to knowledge companies with considerable growth potential in the areas characterised by depopulation and a weak economy. In practice, these funds can reasonably be considered to be more regional development players than distinct seed financing funds and should perhaps also be judged based on this.
Investors would like to invest in their geographical local area and have portfolio companies within “reach”. The reasons are intuitively easy to explain – it is easier to find cases and easier to take care of and monitor them.
If the political objective is to improve the supply of venture capital in the entire country, the above experiences are an interesting background. Two conceivable policy implications can be made. A first alternative is to assign venture capital funds strict geographical delimitations to ensure where investments are made. The second alternative is to work with national funds and supplement these with non-financial promotion initiatives in respect of players, known as investor/investment readiness programmes. Well implemented initiatives increase the likelihood of investment action, enhance competence and reduce the search costs for both groups. The likelihood thereby reasonably increases that active informal investors meet investment-ready companies in their local area. Growth Analysis deems the latter alternative to be considerably more attractive than the former.
Informal investors stand out as an important group, not least in terms of early initiatives and a geographic presence. Unfortunately, this also coincides with an unclear statistical situation. Growth Analysis therefore proposes an in-depth international study where experiences of promotional measures in respect of this group will be studied more closely.
¹ Exchange rate Swedish kronor (SEK) → euro as at November 2011 (throughout the report).
² In Swedish: Myndigheten för tillväxtpolitiska utvärderingar och analyser (Tillväxtanalys).