The EU Capital Markets Union - Recent developments on Venture Capital

On 31 January 2017 the call for expression of interest for selecting a fund manager of the Pan-European Venture Capital Fund-of Funds closed; and tax incentives for venture capital and business angels are expected to be proposed in the course of 2017 to foster investment in SMEs and start-ups, close the funding gap and thereby remove obstacles to economic growth in Europe.

This Legal Insight is part of our dedicated newsletter series on the CMU. We will provide regular updates on CMU related topics. See also our further CMU related briefings "The EU Capital Markets Union – European Commission establishes expert group to develop strategy on sustainable finance" and "Protection of new and interim financings in restructuring? - The European Commission's proposal on early restructuring and second chance".

Background

Key elements of the European Commission's Action Plan on Building a Capital Markets Union, launched in September 2015  ("CMU"), are now beginning to take shape. In autumn 2016 the European Commission ("Commission") called for certain CMU priority areas to be accelerated, such as supporting venture capital and equity investments in Europe. Improving access to financing, in particular for start-ups, SMEs, and young companies with innovative growth plans, is one of the key objectives of the CMU Action Plan. Historically, European SMEs have been primarily dependent on bank finance. This source of funding is however restricted by banks' refinancing capacity, risk appetite and capital adequacy – restrictions that the real economy has in particular experienced in the aftermath of the financial crisis. Alternative sources of finance, while having the potential to supplement bank lending for growing and innovative businesses, are relatively underdeveloped in the EU compared to the US. 
Since launching the CMU Action Plan, considerable progress has been made and it looks like 2017 will see further activities to promote venture capital and equity financings in the European Union.

Consultation on the capital markets union mid-term review

In its public consultation on the CMU mid-term review launched on 20 January 2017, the Commission states that "Good Progress has been made on the venture capital package of the CMU Action Plan" but that "other options could also be explored" given that "venture debt (…) is well developed in the US but is in its infancy in the EU." The aim of the consultation is to seek feedback on how the current CMU programme can be updated and completed so that it represents a strong policy framework for the development of capital markets, building on the initiatives that the Commission has presented so far, with results expected to be published in June 2017.

CMU Venture Capital Package

The cornerstones of the CMU Action Plan to stimulate private venture capital funding in the EU consist mainly of the following initiatives:

• revision of the EuVECA and the EuSEF regulation to remove the greatest hurdles to kick start this class of investment;
   
• proposal for a Pan-European Venture Capital Fund-of-Funds; and
   
• study on tax incentives for venture capital and business angels.
   

1. Status of Revision of EuVECA and EuSEF

In summer 2016, the Commission proposed amendments to the EuVECA and the EuSEF regulations. The Commission had identified that the three main obstacles for investment in young and innovative companies (EuVECA) and enterprises aiming to achieve a positive social impact (EuSEF), are limitations on the type of fund manager, product rules and varying application of regulatory fees in Member States for marketing and managing funds covered by these two regulations.

Originally due for review in the course of 2017, the Commission decided to bring forward that review with the aim of removing any barriers which have so far held back development of EuVECA and EuSEF funds. These are now addressed in an amendment proposal agreed with the Council of the EU in December 2016 and propose the following changes to the current framework:

• extend the range of managers eligible to set up, market and manage EuVECA and EuSEF funds, to all managers authorised under Directive 2011/61/EU on Alternative Investment Fund Managers ("AIFMD") - compared to currently, managers who do not manage a portfolio in excess of EUR 500 million; 
• expand the class of EuVECA eligible assets to allow investment in small mid-caps, i.e. unlisted undertakings that employ up to 499 employees and small and medium-sized enterprises listed on an SME growth market - compared to currently SMEs[1] only in which an EuVECA must invest at least 70 % of its assets;
   
• harmonise initial capital at EUR 50,000 and own funds requirement at one sixth of the preceding year's overheads of the manager (and, if the qualifying venture capital funds managed exceed EUR 250 million, an additional own 0.0.2 % by which the total value of the qualifying venture capital / social entrepreneurship funds exceeds EUR 250 million) - which currently vary across Member States; and entrusting the European Securities and Market Authority ("ESMA") to develop regulatory technical standards in this respect; 
• restrict the ability of the host Member States to impose any requirements or administrative procedures, including fees or charges, in relation to cross-border marketing of EuVECA and EuSEF funds; and
   
• set up a publicly accessible central database on EuVECA/EuSEF funds and all qualified managers, managed by ESMA. 

Next steps:

 
On 13 December 2016, the rapporteur of the ECON Committee published her draft report proposing amongst others the following amendments:

• clarify that the EuVECA and EuSEF frameworks provide for both a marketing and a management passport;
   
• differentiate on own funds requirements between funds managing less than EUR 250 million for which the amended regulation should set the level of own capital at one eighth of the previous year's fixed overheads and funds exceeding this amount for which ESMA should draw up regulatory technical standards, prescribing the methodologies to determine sufficient own funds;
   
• task ESMA with registering EuVECA and EuSEF funds and entrust it with supervising compliance of EuVECA managers with the uniform requirements set out in the regulation;
   
• with regard to EuSEF only, lower the threshold of required minimum investment ('entry ticket') from currently EUR 100 000 to EUR 50 000 for non-professional investors.

On 31 January 2017, amendments were tabled in the ECON Committee of the European Parliament. The vote in the ECON committee, 1st reading/single reading is now scheduled for 22 March 2017.

2. Pan-European venture capital fund-of-funds

On 31 January 2017, the call for expression of interest from private sector asset managers interested in managing a fund-of-funds investing in European venture capital closed.

The Pan-European Venture Capital Fund-of-Funds programme of the Commission and the European Investment Fund ("EIF") aims to overcome market fragmentation of venture capital funds which so far typically operate in only one Member State, increase the size of venture capital funds in Europe, and attract additional private funding from institutional investors because 50 % of the investments must be sourced from private capital. Under this programme, the EU will provide seed investments of up to EUR 300 million in one or more independently managed individual venture capital fund-of-funds, up to a maximum budget of EUR 400 million for all fund-of-funds.
The Pan-European Venture Capital Fund-of-Funds is a targeted imitative to address Europe's equity gap and develop a European venture capital culture which is so far lagging behind its US counterpart. The idea is to create a fund that is sufficiently large to attract private sector institutional investment, e.g. from pension funds or insurance companies, who usually invest a minimum of EUR 100 million into venture capital (the average size of a venture capital fund in Europe currently being EUR 60 million compared to about EUR 120 million in the US).

17 applications were submitted by the deadline, promising feedback from the asset management industry. The Commission and EIF are currently assessing these applications and will subsequently select the respective promoters.

3. Tax incentives for venture capital and business angels

In parallel, in January 2016, the Commission launched a study on the effectiveness of tax incentives for venture capital and business angels, to assess how favourable tax treatment can contribute to increasing investment into SMEs and start-ups. In October 2016, a first workshop with Member state experts took place to exchange information on best practice in this area. A second workshop is scheduled for March 2017, the findings of which are expected to find their way into further legislative proposals by the Commission.

We will monitor those developments and will provide updates on areas of interest throughout 2017.

[1] Defined as unlisted companies with fewer than 250 employees, as well as an annual turnover of less than EUR 50 million or an annual balance sheet of less than EUR 43 million.

Further reading:

Boost your Start-Up with an Advisory Board - Points to consider