Policy support to Venture Capital during crisis times and beyond

Madrid, September 7th, 2011

Andrea Montanino, Ministry of Economy and Finance, Rome*

andrea.montanino@tesoro.it

*Views are personal and do not necessarily reflect those of the Ministry of Economy and Finance

What crisis means (data related to EU27)

2

-5

-4

-3

-2

-1

0

1

2

3

50

55

60

65

70

75

80

85

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Public debt/GDP (LH scale)

Output gap(RH scale)

Source: MEF

Consequences for VC

– Lower availability of public support (either as public expenditure or tax incentives)

– Overall drop in private capital availability

– Reduction of international investors’ commitment (extra EU)

– Shift towards less risky and smaller investments (i.e., reduction of investors’ risk propensity)

3

Focus on Italy (1)

4

1.200

957

2.267

3.028

2.275

2006 2007 2008

987

2.187

20102009

Amount of capital raised in private equity and venture capital Italian industry

Euro millions

• Apart from Fondo Italiano di Investimento the amount of capital raised is much lower than pre-crisis level

Fondo Italiano di investimento

Source: AIFI

Focus on Italy (2)

5

50 43

8268

98

2006 2007 2008

1001002

100

2009

100

2010

100

5057

1832

Geographic origin of the capital raised in Italian PE and VC industry

Per cent

Foreign capital

Italian capital

Source: AIFI

Focus on Italy (3)

6

30

52 3549 20

10

2009

27

100

2010

100

15

2008

17

100

2007

100

6

2006

1004

14

61

3

3841

26

222 50

50

0

Distribution of the capital raised in terms of target investments (Italy)

Per cent

Source: AIFI

Others

Buy-out

Expansion

Early stage non H-T

Early stage H-T

Need for public support?

7

Lessons from VICO:

1. Importance of framework conditions: targeted incentives not sufficient2. Not clear positive impact on the growth of firms3. Weak managerial competences in PVC4. Difficult to define objectives of public schemes

However:1. European (and particularly Italian) rate of economic growth has to be enhanced2. The lower propensity to risky business by the private sector in the years ahead must be

compensated, in order to make these risky activities profitable3. Positive externalities are big enough to justify the public intervention4. The available toolkit is wide, not only public VC5. Firm investment in R&D could be lower than the optimal level6. The capital market for high tech is characterized by several imperfections

Focus on 5. and 6.

• Firm investments in R&D could be lower then the optimal level:

– R&D activities may be considered a “public good” (non rival and non excludable good: difficulty for firms to appropriate the economic benefit of R&D investments); social externalities and spillovers

– “intrinsic riskiness” of R&D investments (even higher in SMEs’ start-ups).

• The capital market for high tech is characterized by several imperfections:

– information asymmetry between demand and supply of capital due to track record absence (adverse selection and moral hazard issues: how to understand if a project is a lemon or a potential success?);

– too high costs of investment evaluation compared to investment dimension; – mismatch between perceived risk and expected return.

Therefore, YES, need for public support

8

Public support to VC: the available toolkit

Support measures matrix1

Demand-side

Target of intervention

Supply-side

Ind

ire

ct

Typ

olo

gy o

f in

terv

en

tio

n Dir

ect

• Public incubators • Public sponsored VC

1 European Investment Banks (2001)

2 In downside scheme, the public investor covers partially the investment losses (first loss mechanism) while in up-side leverage scheme the returns

for the public investor has a cap and all the extra-return is given to the private investors

9

What tools must be used in crisis times?

• Promotion of enterprise and entrepreneurship

• Management and skilled workforce improvement

• Business incubators, science parks and clusters

• Tax incentives

• PPP in VC

• Incentive scheme in PPP (downside and up-side leverage scheme2)

• Fund’s operating cost scheme in PPP (lowering of search and abort costs)

• Tax incentives to equity investors

Public support to VC: some principles from best practice examples

• The international best practice examples share several common characteristics that could be extremely useful for the future:

– presence of Public-Private Partnership and networks among public and private leaders (e.g., Israel and USA);

– predominance of supply-side interventions (risk sharing) with slight presence of demand side measures, too.

• Moreover, the European Commission expressed a preference for:

– establishment of Funds in which the State is sponsor, partner or investor;

– state grants to cover operating costs (e.g., abort costs);

– tax incentives to equity investors.

10

In crisis times, the public budget constraints are tighter: need to foster PPP framework and attract foreign investors

The role of the State for VC in crisis times: a possible new paradigm

1. Focus of the resources on a limited set of initiatives

2. Temporary support by the State and taking over by the private investors

3. Policies based on the convergence of public and private interests: the “State-promoter” takes the place of the “State-investor”:

a. State as facilitator/promoter of a process, sponsor, regulator (makes laws/regulations to encourage private sector’s interventions), in charge of strategy setting and operating indirectly by means of its “Agencies” (e.g., in Italy SACE, CDP);

b. private sector as investor/financer of the initiatives;

c. need to create an effective public-private “network of leaders”.

4. (Quasi)-neutrality in terms of public deficit of the support measures

5. In case of State owned resources involvement, preference for upside leverage scheme and support measures aimed at lowering search and abort costs

6. Full independence of the management companies

7. In case, tax incentives on supply-side to boost private investors equity commitment

11

Main principles inspiring a possible new paradigm derived from best practices

Some recent steps in Italy (1)

• Creation of “Venture Capital Funds”: common EU harmonized investment funds investing at least 75% of capital raised in non-listed companies in seed financing, start-up financing, early-stage financing and expansion financing

• The target companies must:

be owned mainly by natural persons (not firms);

be founded by less than 36 months;

have an overall turnover of less than 50 million Euros.

• The law provides for a full tax exemption for natural and legal persons1 on capital gains

Better only for legal person?

12

1) Article 31 of Law-Decree n. 98, July 6th 2011, Urgent

measures for financial stabilization

1 For legal persons, the tax exemption is subject to

European Commission approval

Some recent steps in Italy (2)

13

2) Possibility for Cassa Depositi e Prestiti (70% owned by the

State) to invest in SMEs through PE Funds

3) Investment by Sace in pre IPO SMEs to be listed in dedicated

stock markets (AIM Italia)

To sum up, and trying to answer to some questions ….

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1) Public support is needed due to lack of private capital at

current economic conditions

2) Public support should be as much as possible “indirect”

without State ownership of invested firms (see James

Meade)

3) As public support, either tax incentives (but EU harmonised)

or

4) PPPs between private VC and governmental agencies

managed by private managers and not civil servants

Several other examples sharing the same intervention approach

a. National Guarantee Fund (Fondo Centrale di Garanzia) (extended in 2009)

b. CDP – Financial resources for indirect finance to SMEs (2009)

c. Italian Investment Fund (Fondo Italiano d’Investimento) (2010)

d. Social Housing Fund (Fondo Investimenti per l’Abitare) (2010)

e. Foundation for the university students’ merit (Fondazione per il merito) (2011)

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Thank you!