Nothing ventured, nothing gained

Date: 13/09/01

Venture capital is meant to be the lever cranking the engine of growth in the EU - a fact not lost on the politicians who promised at Lisbon last year to make Europe the most dynamic economy in the world by the end of the decade.

But, as stock markets go south and the north winds of recession blow in, parts of that engine threaten to chill over - making that goal look rather optimistic.

Unfortunately, according to industry experts, the EU is doing little to get the wheels turning again.

Behind the rhetoric of the speeches and action plans still lies a veritable barrage of regulatory road-blocks. Worse, they warn, more are being planned.

As the pain from the collapse in markets and investor confidence starts to make serious dents in the profit margins of venture capitalists, the industry has drawn up a hit list of barriers stopping it from promoting exactly what the Union economy needs right now: innovation, entrepreneurship, jobs and wealth.

Javier Echarri, secretary-general of the European Private Equity and Venture Capital Association (EVCA) - which includes firms active in all parts of the market - says his members are unhappy about the level of obstacles they face. "I don't think there is a single market for private equity in Europe," he says.

Typically, special regimes granted by governments for investment in venture capital end at national borders.

More costly still, double taxation is commonplace. At the same time, Echarri laments the failure of governments to agree on a draft directive designed to rid occupational pension schemes of red-tape when they operate across borders.

The directive could be a boon for venture funds because it would free up pension fund managers to plunge some of the billions of euro at their disposal into the sector.

The European Commission favoured letting fund managers invest where they want, according to the 'prudent person' principle. That means they would be free to plough as much as they wished into private equity funds provided there was a rational case for doing so.

But the measure was blocked after 'Club Med' countries lacking a private sector pension culture objected.

The list of regulatory headaches does not end there. Taxes on share options, used by start-up firms who can't afford fat salaries to lure talented managers, are seen as draconian in many member states. Taxes are often levied before the options are cashed in. Rather unfair, claims the industry, if share prices collapse.

Bankruptcy rules that offer few second chances for entrepreneurs who fail first time around are also seen as a barrier to innovation. Liz Hewitt, a director of UK venture capital giant 3i, says two Commission initiatives are providing new thorns in industry's side: one a draft directive on prospectuses, the other a review of merger law.

The prospectus directive, intended to simplify EU rules for sales of stocks and bonds, threatens to impose disproportionate costs for small firms entering markets. That's because all companies - from an FTSE100 giant to a SME minnow undertaking an

IPO - would be forced to comply with the same rules. The extra costs would make it more costly for funds - which must eventually sell the shares in the firms where they have invested - to get their money back.

Changes to merger rules currently being considered could be a problem if the Commission tries to broaden the scope of deals which fall under its jurisdiction by lowering the annual turnover thresholds that would trigger merger probes. "We think that could stifle innovation," said Hewitt.

Venture capital funds would get more and more embroiled in costly and lengthy clearance procedures, even when they invest in relatively small companies.

That is because the Union executive takes into account the turnover of the venture fund and the underlying investors in it when they examine a deal. Hewitt says it is pointless to examine these cases because they have no impact whatsoever on competition.

Venture funds are not in the business of stitching-up markets from competition or adding a firm to their portfolio in the same way as an industrial conglomerate - all they are doing is providing capital for the companies in which they invest.

These worries are aired this week at a Brussels conference launching an EVCA 'white paper' on the regulatory environment faced by the industry.

Commission experts overseeing policy admit critics are right to grumble. And in private they make no secret that the EU has little chance of topping the economic league by 2010. Although feeling the recessionary chill, the US is still miles ahead when it comes to backing budding entrepreneurs with cash. "To do that means you would have to beat the Americans, if you look at the figures, I don't see how it is going to happen," said one Commission insider.

But, half way through a six-year 'venture capital action plan' encompassing industry-friendly policies, officials insist the EU executive, at least, has done more to encourage the sector than anyone has. (And for the most part, industry agrees.)

The chilly climate owes more to the lack of will of member states or MEPs rather than Commission officials.

Admittedly, after a summer of turbulent press reports and heavy lobbying, Single Market Commissioner Frits Bolkestein knows his prospectus proposals are in for a choppy ride when they go to the Council of Ministers and European Parliament for approval.

But it is the member states and not the Commission which are to blame for the stalled pensions directive - intended to lift barriers to cross-border provision of occupational pensions.

Other key legislation setting up a simple, cheap and effective pan-EU patent system has also hit the rocks thanks to member state infighting. And the lack of laws on tax, bankruptcy and stock options owes more to the realistic assessment that governments are unlikely to swallow legislation in these areas, which for the time being at least require unanimous votes in the Council of Ministers.

However, that does not mean they have been tucked under the carpet.

Insiders say studies, policy papers and reports are planned in a bid to give the issues a leg-up onto the agenda. Unfair tax treatment of funds and stock options are both included in a study on corporate taxation set to be unveiled by Bolkestein's tax department; Erkki Liikanen's enterprise directorate is expected to launch a study on how bankruptcy rules may be reformed to give entrepreneurs a "fresh start".

Officials rather modestly admit that their policy can only go part of the way to help Europe in its forlorn attempts to overturn US dominance. The tougher job is outdoing centuries of entrepreneurial American culture.

In the meantime it is not all doom and gloom, despite the collapse of the IT and telecoms sector - a prime target for investment in the past. For canny managers, when markets are down, opportunity knocks. "It's not going to be a bad year," says EVCA's Echarri. "People will suffer, but in difficult times the business plans you get [from entrepreneurs seeking capital] are more mature...and cheaper."

Major feature on the challenges facing the venture capital industry in Europe.