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From different starting points, we as co-authors have come to focus on the same problem: How can we help alleviate the fragmented nature of European early stage investment? 

The development of cross-border angel and venture capital investment within Europe would help companies reach the stage where they can secure global investors. It would also help them expand internationally, since engaged foreign investors can play a key role in facilitating an emerging company’s international expansion.

Our conclusion: both public policy changes and private sector initiatives can make a difference, including:   

  • Modifying existing European Union (EU) direct and indirect support for emerging companies to encourage cross-border investment; and
  • Tailoring EU state aid exceptions permitting national support for emerging companies to encourage such investment. 
  • National angel syndicates collaborating and co-investing on deals together across Europe.  

I.              What is the problem? 

Early stage European startups are at a significant disadvantage to their US competition in securing capital investment.  Of course, the European angel and venture capital markets are newer, and not as deep, as their US counterparts in Silicon Valley, New York and elsewhere. However, the problem is exacerbated by some special factors in Europe that fragment early stage capital on national, regional and even hyper-local lines. 

Of course, early stage startup investment is predominantly local, since investors (both business angels and early stage venture capital investors) want founders nearby, to benefit from their network and experience. This phenomenon is not limited to Europe.

Additionally, some portion of European fragmentation, driven by differences of language and culture, is perhaps unavoidable.

On the other hand, some of these problems are of our own making. For example, the view that European countries are in competition with each other to establish “startup supremacy” is a barrier to the development of European-wide early stage investment markets. While we cheer on the efforts of European cities to develop their ecosystems, the true competition, of course, comes from outside of Europe, particularly from the United States and China. 

While these issues become less significant for emerging companies as they enter the growth stage and their investor base becomes international/global, many good European startups fail before they even reach that point.  

II.            How do our existing policies affect the problem?

So what are the structural issues and policies that contribute to European investor fragmentation, and what can we do about them?

A.   European Union funding mechanisms

The EU has played a very significant, positive role in jump-starting venture capital and, to a more limited extent, angel investing in Europe, especially through its direct and indirect investment in private venture capital funds and co-investment funds via the European Investment Fund (EIF) While some might see this as unnecessary governmental intervention in private markets, this activity has played an important role in establishing European venture capital given the historic absence of a true venture capital culture in Europe. Indeed, such intervention can also be found in other markets, such as China and even the US, particularly in verticals that might otherwise not attract sufficient investment, such as healthtech and life sciences.

We are not experts on the EU funding mechanisms, which to an outsider can seem very complex indeed. However, we have seen many instances where the restrictions that the EU has placed on the use of these funds has contributed to market fragmentation.  For example, some of this funding has been provided in the form of regional development grants that the venture capital fund is required to spend in the region. This distorts the fund investment process. At the very least, it would make sense if the VC was also free to invest in other less-developed regions that qualify for such grants. 

Other EU funds and programs are subject to less restrictive, but still relevant, limitations, such as in terms of the countries where funds can be deployed.

We understand the political and policy considerations that drive these limitations. However, the more geographically neutral (at least within the EU) the EU can be, the more success the EU will have in building globally-competitive tech companies from startups 

B.   Investor incentive programs

Investor tax and other incentive programs, such as the seed enterprise investment scheme (SEIS) and enterprise investment scheme (EIS) in the UK, which have played a leading role in promoting early stage investment, have also contributed to market fragmentation.  It is perfectly understandable for governments to limit incentives to investments in companies that are located in those jurisdictions. The UK has handled this better than some other European countries by not insisting that the startup holding company be a UK company, but simply requiring that the holding company have a permanent establishment in the UK.  

Some of the requirements of SEIS and EIS, however, such as the requirement that only ordinary shares be issued to investors, make it more difficult for companies to raise investment on a cross-border basis, since investors in other jurisdictions are likely to seek preference shares. These issues are manageable, see, but startups cannot afford high-cost lawyers, nor are they generally familiar with the more complex structures. 

Additionally, the incentives of SEIS and EIS are only available to UK investors – no incentives are available to European investors from other countries that invest in companies with a UK permanent establishment. In this respect, the German INVEST funding program, for example, would seem to make more sense in terms of lessening market fragmentation, in that provides grant benefits to investors from all European Economic Area countries who invest in companies with a German branch. 

C.  Competition within Europe for “Startup Supremacy”

If this was not already complex enough, the view that different cities within Europe are competing for startup supremacy is counterproductive from the standpoint of building a competitive European startup ecosystem.

That ecosystem needs to continue to include the UK. The UK is the leading source of venture capital in Europe, and has provided significant funding for companies, and teams, that have grown up elsewhere. If, for example, EIF funding is no longer available for UK-based funds, the losers will not simply be home-grown UK companies. 

But the issue is broader than the position of the UK. Even within the continental European countries, there is a general perception that Berlin is competing with Paris is competing with Stockholm etc. to build successful startups.  The true competition is not between these cities and, e.g., London – rather, Europe can only compete in building globally-competitive startups at a European-wide level.  The startups themselves recognize this – for example, many of the UK-based startups have centered their tech development in southern, central and eastern Europe. 

Nonetheless, we still see startups that go to the US rather than expand in Europe due to: (i) availability of funding; (ii) perceived ease of addressing a broader market (common language, common culture, common legal systems etc.); and (iii) perceived greater receptivity of customers to doing business with startups. Points (ii) and (iii) above are longer term issues that the EU is seeking to address. Below we suggest a couple of solutions to point (i):  

III.          What can be done to improve the European funding landscape?

A.   Support cross-border angel investment 

Building cross-border angel investment is a very useful first step to building a more unified EU funding market.   

On the private sector/trade association side, organizations such as the Business Angels Europe (BAE) and the European Business Angels Network (EBAN,  and cross-border angel groups like the European Super Angels Club (ESAC), with which James is affiliated, all have a role to play in breaking down national barriers.

At the EU level, mechanisms for governmental co-investment can play a key role in breaking down national barriers. For example, the European Angels Fund (EAF), which is an angel co-fund initiative advised by EIF, is described as promoting cross-border collaboration between business angels. However, the implementation to date is in specific countries (presently, 7 countries are listed on the EIF website), and seems to focus on country-by-country investments in those countries. The EAF concept is terrific, but it would be further improved if one of its requirements was that the angels be free to invest in companies in any EU country.

Additionally, specific EU initiatives to fund co-investment with cross-border angel groups would also promote the development of those groups. More cross-border angel groups will lead to more cross-border angel investment, since local angels in those groups will be in a position to identify opportunities and lead on investments.

B.   Support cross-border VC investment

The structural barriers to cross-border VC investment suffer from some of the same issues as described above in respect of angel investments. A key EU objective should be the development of a venture capital community in Europe that invests across Europe and is also free to make a proportion of non-European investments. Some EU initiatives, such as the Pan-European Venture Capital Fund(s)-of-Funds program, already seem to focus on that objective, at least in principle.

To the extent that EU fund investments are made to promote regional development in developing regions, fund managers should be free to invest in groups of regions (or all regions) qualifying for regional development grants, not simply a single region.

C.  Tailor state aid exceptions to support European cross-border investment 

National incentives for startup grants and investments have played a key role in the development of a startup investment community. Within the European Union, these have required approvals as exceptions to restrictions on state aid, and a number of criteria have had to be met.

As discussed above, however, the existence of such incentives for national investments may, in fact, discourage cross-border investments. There are also significant disparities from country to country in the availability of grant funding.  

Thus, the EU guidelines could usefully be adjusted to facilitate at least a proportion of cross-border investment. For example, national tax incentive programs could also be required to apply as well to investments in developing regions outside of the home country. Similarly, broader permissions might be made available for grant and co-investment programs that allocate a portion of the grants or co-investments to EU companies from outside of the home country. These changes might also promote more cross-border founder teams, and enhance the cross-border success of these businesses on the customer side.

There are different ways that these issues could be approached, and we are not looking to dictate any particular solution. Rather, our point is that it is time to consider whether these support and incentive programs can be used to promote cross-border activity within Europe. The current programs do not facilitate, and may actively discourage, the development of cross-border European angel syndicates and early stage venture capital investments.

III.      Conclusion 

Europe needs early stage cross-border startup funding if we are going to succeed in building more world-class startups and successfully compete with the United States and China. Business angels and early stage venture capital firms can play a critical role in building cross-border financing markets, but we need to help them by building appropriate European-wide grant and incentive structures.

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