January 28, 2011
As mentioned in my previous post (The Innovation Union Will Require Public And Private Money), I had the role of Moderator this week at an event about Venture Capital held in Brussels by Eureka. The overall aim was to help bring together some members of the Eureka network, EU policy makers and some involved in the venture capital industry.
Lets be honest, if the EU is to live up to the ideals of the ‘Innovation Union’ and evolve into the competitive economy (or economies, if you prefer) that those involved in policy making believe is necessary, there needs to be an event like this every day somewhere in Europe!
Like the EU, Eureka has a rotating Chair. Unlike the EU, it lasts for 12 months and not 6. The current holders are Israel (Eureka does not just contain EU nations) and the aim is to bring financiers into the Eureka fold much more. It is a great idea and I’m sure it would add substantially to their work.
That being the case, when you think of financing business start ups, R&D projects and new inventions, most people would think it is a role for venture capital. The reality, of course, is that this is not what venture capitalists think!
To my mind, the participants at the event raised two main themes which were answered partially by some of the speakers. They were:
Venture capital tends to be available too late for many businesses and tries to exit to early from many of those that it does invest in.
– How can we get them to invest earlier?
– How can we keep them invested for longer so that the business has the support it needs to become a world-class operation?
And, How can we connect entrepreneurs to capital more effectively?
The last of those was not answered, of course. I am sure that it must be the most important question the industry faces – and has faced. Therefore, it isn’t a surprise that this event was unable to provide a response…
As for the first two questions, the event offered a number of possible solutions.
Firstly, an idea offered by the Israeli’s – we need a mixture of government and private sources of capital. The interview with Yigal Erlich last week raised this as a solution.
But is it really? Time limited us from really testing this theory thoroughly in the room, but it does appear to have some credibility. To my mind, the real problem with venture capital is that of scale. Most funds would want to have perhaps five to ten investments. A bigger fund would have ten to fifteen. That isn’t really very many and Europe would need an awful lot of them to make it work.
I would also question whether venture capital funds could ever be incentivised to do it. Smaller funds need lower running costs and are therefore more likely to be a success. If that is the case, it is not in their interests to provide the kinds of access to capital that Europe would require.
In his presentation, Mr Erlich pointed out that funds would need incentives to invest in ideas at an earlier stage. The earlier they invest, the less of a sure-thing the ideas and companies are and the more risk they take on. In the current climate of banker-resentment, it seems unlikely that providing financial incentives to fund managers would get political approval anywhere in the world. Anywhere other than Israel perhaps…
In addition, Prof Ulrich Hege (from HEC School of Management in Paris) used the following phrases in his presentation: European VC is limping along; returns are not great; at the bottom of the heap; and, not attractive. Those were my notes of his presentation anyway! If returns really are that bad and life is that tough, it would seem reasonable to presume that funds are struggling, which would not be the scaling up that Europe needs either.
Earlier in the day, Claire Munck (from EBAN) told us that, “Business angels are more important than venture capital”. I, for one, am inclined to agree with her. The experiences that I have heard of via friends that have looked for funding suggest that even getting an appointment with a VC requires a minor miracle.
Legendary investor Warren Buffett describes investment as baseball and that an investor should wait at the plate for the perfect pitch and only swing at a very small number of balls. Everything I know of venture capital fits into that description. It is not in the best interests of a fund to invest too early, that is very risky – so they don’t do it. It is also in the best interests of the fund to ‘exit’ as soon as reasonably possible to bank profits – so they exit when they can rather than holding on forever.
I find it difficult to believe that any amount of government incentive will overcome those hurdles.
Therefore, it was to his credit that the representative from the European Commission, Jean-David Malo, described the goals of DG Research and Innovation as creating “more funding from whatever mechanism works”. It is, “demand driven” he told us.
Perhaps this was a shot across the bows of the venture capital industry that we will find a solution, with or without you.
In many ways, this confusion reminds me perfectly of a previous Eureka event about venture capital that I attended (EU Innovation Policy Needs A Treasure Map).
I also wonder whether a simple misunderstanding is to blame here. Is it possible that policy makers do not really understand what venture capital is and does?
The thing is, VC is considered ‘high risk’ and only for sophisticated investors. But this is a relative standard. It is considered high risk when compared to a normal investment fund that a pension fund or private investor might use. The aim is to look for opportunities that investment funds would avoid. But that does not mean that their goal is to take on risk. Far from it! Their job is to generate the best returns possible by taking on the least risk possible. This is the same as any other investment fund, they just look in riskier places (off-market companies) for the investments.
Perhaps then, this explains the fascination with venture capital?
Or, perhaps VC is simply the best option that policy makers can find. Other than business angels, it isn’t really very clear where else the funding might come from in the private sector. And private sector money will be vital.
Does VC have a place in financing the Innovation Union? I’m sure it does.
Can Europe rely on it for the kind of risk taking that would require? I’m not very sure at all…
(The presentations of speakers can be found here).financialguy