1. finance
2. investing
3. venture capital

Q15: How can the EU further develop private equity and venture capital as an alternative source
of finance for the economy? In particular, what measures could boost the scale of venture capital
funds and enhance the exit opportunities for venture capital investors?
The venture capital and private equity industry is a major investor in SMEs, which in turn is a key
driver of economic growth. In the UK, industry has invested £30 billion in over 3,900 UK-based
companies over the last five years. Companies backed by private equity and venture capital in the
UK employ around 790,000 people and almost 90% of UK investments in 2013 were directed at small
and medium-sized businesses.
Encouraging venture capital is a domestic priority for the UK, which is highlighted through a range of
support measures, particularly at the seed stage. Succeeding on venture capital will also be key if
Capital Markets Union is to deliver on growth in Europe as SMEs contribute about 85% of the net job
growth in the EU (European Commission, 2012,”Do SMEs create more and better jobs?”).
Importantly, venture capital aims to specifically target high growth SMEs.
This response sets out a number of initiatives that could be carried out on the European level to
foster venture capital investment across the EU. It also sets out three UK initiatives that have worked
particularly well: Fiscal incentives for venture capital investments, venture capital schemes of the
UK’s development bank, the British Business Bank, and Tech City UK as an example for successful
sector specific support programmes. Each of these measures are supported by case studies.
While we appreciate that these UK initiatives may not easily be reproducible in other member states
or indeed at European level, as they are tailored to fit specific market conditions in the UK, we hope
our experiences will be useful to other Member States when designing their own initiatives.
(A) Suggestions for action at the European level
Continued public support is vital for European venture capital. There is still a lack of private early
stage venture capital investment in Europe; there is also a case for public support for the industry
more broadly when investors continue to be uncertain about investment in an asset that is often
seen as ‘difficult’ to understand fully. But support should be targeted at the parts of the market not
served by private investors and seek to attract new, sustainable investment into those parts of the
market.
The ultimate goal of public support must of course be to create a self-sustaining market, with
government support targeted carefully at the specific areas that the wider market is not serving. But
in that context, the Commission could consider the following areas for action. The suggestions are
listed in the order of priority.

The Commission should seek to establish best practices for government support for the venture
capital industry across Europe. Different member states take very different approaches to
supporting venture capital, but there has been little independent study of comparing
experiences in different member states about the most effective interventions. Below we have
outlined successful initiatives in the UK.

The Commission should take measures to minimise barriers, which make it harder for fund
managers to market Alternative Investment Funds, including venture capital and private equity
funds, cross border, leaving the market fragmented and leading to complexity, increased costs
and greater geographic concentration. This should be carried out through a consistent
implementation of the marketing passport under AIFMD (see Q11). Further, steps should be
taken to enforce key elements of the Directive so that host member states are not able to
require additional charges from AIFMs marketing in their territory. European investors should
have access to the broadest range of fund managers so that they can match their risk appetite,
seek the best opportunities, and ensure they have the right exit opportunities to maximise
returns. Under the current regime, barriers to cross border marketing under AIFMD mean
investors do not always have this access, which is critical to enable cross border capital flows.

The Commission should seek to establish much greater transparency of venture capital returns
across Europe. One of the issues reducing institutional investment in European venture capital
is a perception of poor returns from venture capital investment. There are surveys on returns
compiled by venture capital trade associations, but the Commission could undertake a wider
independent review of venture capital returns across Europe. As a significant investor in the
sector, the EIB and EIF should publish details and analysis of their VC investment returns to the
fullest extent possible under their transparency framework.

The Commission should consider the effectiveness of current European interventions to support
venture capital across Europe. There are a number of excellent European programmes. But our
impression of the programme with the largest budget – the Risk Capital Mandate from the EIB to
the EIF – is that this has resulted in investments in lower risk funds rather than the parts of the
market that need greatest support. For example, we are aware of a number of investments
made through this mandate to mid-market private equity firms, which is not a part of the market
that is an obvious priority for active public sector funding.

The Commission should look to maximize the effectiveness of future new support for venture
capital in Europe. The European Investment Package may include new support for European
venture capital. If it does, it will be important to ensure that it is targeted at particular segments
of the market where funding is needed the most. For example, the Commission should consider
whether new funding targeting specifically innovative companies could be made available
through the EFSI along the lines already being contemplated from the Horizon 2020 budget. It
should also consider whether new mechanisms could target that funding more effectively. For
example, the UK is a founder member of EVFIN (European Venture Fund Investor Network)
which has established a company ready to play a role in a joint fund of funds initiative which
could cover a number of members.

The Commission should consider issuing a call for evidence about the administration involved
with current European venture capital schemes from all sources of funding (including ERDF).
Market participants have cited the administrative requirements associated with publicly
administered venture capital schemes as an administrative burden. It is important to maintain
strong oversight of these schemes, but it is also important to encourage feedback from scheme
users about how to improve the day-to-day requirements of these schemes. A call for evidence
would be a good way of revealing these issues.

Barriers to corporate venture capital investment in Europe should be removed. Corporates are
an increasingly important investor in venture capital. However, the current European definition
of ‘SME’ does not recognise corporate investors as potential venture capital investors. As a
result, SMEs that have received between 25-50% corporate venture capital investment are not
considered as ‘SMEs’ as part of the European definition, whereas SMEs that received between
25-50% non-corporate venture capital investment are considered as SMEs. The Commission
should consider whether this anomaly can be corrected.

As discussed in Q14, the Commission should consider larger fund limits in the EU Venture Capital
Fund Directive. Larger fund limits would extend the benefits of the directive to more funds and
promote scale, which would be desirable. (http://www.esma.europa.eu/page/Venture-Capitaland-Social-Entrepreneurship-Funds).

On private equity, it is important to differentiate between the different stages of development
of private equity markets in the EU. The UK’s private equity market is the most developed in
Europe, representing 0.84% of GDP in 2013 (source: EVCA). This is proportionately more than
double the size of all but one of other member states (Denmark). We recognise that measures
are needed to support particular parts of the market in the UK, particularly for smaller
businesses, and that measures may be appropriate to support private equity more broadly
across the European economy. But it is important that measures are targeted appropriately in
order not to displace current private sector activity in private equity. It is therefore important
that the Commission avoids a ‘one size fits all’ approach to any new interventions being
considered in private equity but to target interventions at under-served parts of the market.
(B) UK best practice
Best practice sharing of successful initiatives by member states is a promising approach to increasing
venture capital investment in the EU. In recent years, the UK government has successfully supported
venture capital investments, through the combination of targeted fiscal incentives, support through
the British Business Bank, and sector-specific knowledge-sharing initiatives. Three measures that
have worked particularly well in the UK are outlined below, including case studies.
1. Fiscal incentives for venture capital investments
To encourage venture capital investment in the UK the government provides three tax-advantaged
venture capital schemes for investments in small and growing companies; the Enterprise Investment
Scheme (EIS), the Seed Enterprise Investment Scheme (SEIS) and the Venture Capital Trust (VCT).
The aim of these three schemes is to improve access to capital for small unquoted companies
considered to be high-risk which are therefore unable to raise relatively modest sums of risk capital
due to market failures that create an 'equity gap'.
These schemes tackle this market failure by providing various forms of tax relief to incentivise
individuals who make direct investments (EIS and SEIS) or indirect investments via intermediaries
(VCTs) into small companies that meet set qualifying criteria. Qualifying companies for EIS and VCT
cannot be listed on regulated exchanges, must have fewer than 250 employees and gross assets of
less than £15mn.
Since EIS was launched in 1994, over 21,000 companies have benefited from the scheme and over
£10.7 billion of funds have been raised. Since the VCT tax relief scheme was launched in 1995,
over £5 billion of funds have been raised and industry figures suggest that VCTs currently have
investments in over 1,000 early stage companies. Around 11,000 investors invest in VCTs each year.
The government believes that the schemes play an important role in encouraging the provision of
private investment to smaller, high-growth and innovative companies that need support.
The Seed Enterprise Investment Scheme (SEIS) was introduced in 2012 in response to particular
difficulties start-up companies can face in obtaining seed finance. SEIS offers investors 50% income
tax relief to encourage investment into start-ups which would otherwise struggle to access finance.
These are companies with 25 or fewer employees and assets of up to £200,000 at the point of
investment. In its first year, SEIS enabled over 1,100 companies to raise over £80m of funds. By July
2014, over 2,000 companies had benefited from SEIS investment of over £175m.
Case study VCT: DiGiCo
Over 10 years ago, the CEO and founder of the business identified an emerging niche market for
digital as an alternative to analogue sound-mixing desks for use in live music performance. The CEO
built up a management team and business, growing from scratch the digital console division that
became DiGiCo. DiGiCo consoles have become an integral part of the audio production for some of
the world’s leading artists.
VCT funding supported the management team in the research and development of a new suite of
sound-mixing desks which has enabled the company to grow rapidly. It is now a very successful
exporter, with approximately 85% of all sales being outside the UK. In total, DiGiCo has sold into
approximately 85 different countries. Turnover grew three-fold from £8m in 2007, when the first
investment was received, to £24m in 2013.
2. Venture Capital schemes of the British Business Bank
Venture capital investment is further supported through the British Business Bank, the UK’s
economic development bank. With more than £3bn of public funding commitments it aims to create
a more diverse and vibrant finance market for smaller businesses, with a greater choice of options
and providers, while increasing the total supply of finance available to smaller businesses where
markets do not work well. This will help businesses prosper and build economic activity in the UK.
It is not a bank in a conventional sense: it does not finance businesses directly, it operates a range of
debt, equity and guarantee programmes, working with private sector partners, such as high street
and challenger banks, fund managers and alternative finance providers, to increase the supply of
finance to small businesses. Additionally, it ensures that businesses have access to better
information about the finance options available to them.
The British Business Bank’s venture capital solutions address the recognised equity gap affecting
some viable SMEs with the potential for high-growth. There are 480 businesses currently benefiting
from the support of the Bank’s venture capital programmes, and in the year to the end of December
2014, the programmes facilitated £125 million of investment.
a. Enterprise Capital Funds (ECFs)
ECFs are the bank’s main intervention for early stage venture capital. The programme has an overall
investment capacity of over £500m. Funding is used alongside private sector funds to establish ECFs
operated by private sector fund managers targeting investments of up to £5 million in SMEs that
have the potential to provide good financial returns.
Performance to date has been strong – in the year to end December 2014 the programme facilitated
£51.5 million of investments.
Case study ECFs: Sirigen
Based in Ringwood, Hampshire and with an office in California, Sirigen has developed technology
that improves the diagnostics of clinical tests. ECF funding enabled Sirigen to launch the product and
start sales, while investors also provided strategic direction to the business. Two large commercial
contracts followed and the company was successfully sold in September 2012 to Becton Dickinson
for a significant undisclosed sum, generating up to a 4x return to investors.
b. Venture Capital Catalyst Fund
The Venture Capital Catalyst Fund makes investments on the same terms as private investors into
private sector-led venture capital funds, helping those funds to reach a satisfactory first close and
enabling the funds to commence investment sooner than they otherwise would. It is designed to
address the current problems in the venture capital market which is that venture capital funds have
moved out of investing in early stage venture capital and new entrants haven’t yet emerged in their
place. The Venture Capital Catalyst Fund addresses this problem by making investments into funds
of £5 million - £10 million. In June 2014, the total investment capacity of the fund was extended and
it can now invest up to a total of £100 million. The programme has shown strong early performance,
at end December 2014, the programme facilitated £22 million of new investments for 12 smaller
businesses.
c. Angel CoFund
The CoFund makes equity investments alongside syndicates of Business Angels in order to allow
Business Angels to invest in a greater number of investments within the equity gap. The CoFund
invests in smaller businesses identified as having high growth potential and makes investments of
between £100,000 and £1 million. The objectives of the Angel CoFund go wider than simply making
investments and it is structured to encourage syndication and properly structured, well researched
investment. The Angel CoFund has been showing a strong performance – as at end of December
2014, the CoFund supported £109 million of investment in 55 SMEs. An early evaluation of the
Programme will be published later this year.
d. Investment Programme
The British Business Bank’s £400 million Investment Programme aims to promote diversity of supply
of lending by encouraging new entrants and the growth of smaller lenders in the market. It operates
as an open competition which allows the British Business Bank to invest into a variety of finance
providers alongside private sector match-funding. The Investment Programme has made
investments into a range of finance providers including debt funds, asset-finance providers and peerto-peer lending platforms.
So far performance has been strong – in the 12 months to the end of December, the Programme
facilitated loans worth more than £1 billion into more than 4,300 businesses. However, the
programme will be subject to a full evaluation by the end of 2015.
Case study Investment Programme: Funding Circle
Funding Circle is a peer-to-peer platform which allows savers to lend money directly to small and
medium sized businesses.
The British Business Bank has committed £ 20 million to Funding Circle via its BFP Small-cap and
another £40 million via the Investment Programme. In 12 months to December 2014, Funding Circle
provided £160 million of loans to 2,730 small businesses thanks to the British Business Bank
financing.
3. Sector specific support programmes
One successful initiative to help emerging digital enterprises in accessing the finance they need to
grow is Tech City UK.
Tech City UK was launched as a publicly funded organisation in 2010, with a mission to support the
emerging tech cluster in London. It has since grown into an organisation, which delivers programmes
focused on accelerating the growth of digital businesses in London and cities across the UK, at all
stages of their development.
Tech City UK’s flagship programme is Future Fifty, which offers support for selected businesses with
high growth. For example, Future Fifty facilitates access to Government and its support mechanisms
(from legal advice on how to set up a business to support for international trade through UK Trade
and Invest), helps building links to London’s institutional investor base and capital markets and
advises management on funding options and key strategic decisions. Being admitted to Future Fifty
also significantly raises the profile of young companies.
Since launching in October 2013, the Future Fifty team has been working with 50 fast growing digital
businesses. This first intake of companies reached significant milestones in 2014: Four of the
companies have been listed on the public markets. One company has been acquired and 13 of the
companies have raised a total of £260m investment between them. Some of them have crossed the
chasm from start-up to established global business and are now making way for a new wave of
burgeoning digital companies.
Case study Tech City UK: JUST EAT
JUST EAT operates the world’s largest online market place for restaurant delivery. JUST EAT is based
in London and is now active in 13 countries around the globe. Its revenues in 2013 were £96.8m and
it grew 58 per cent in H1 2014, compared with the same period in 2013. In 2014 JUST EAT
successfully listed on the main market of the London Stock Exchange and graduated from Future
Fifty.