Merits and possibilities of a European fund structure for venture capital funds

Transcription

1 Directorate-General for Enterprise and Industry Merits and possibilities of a European fund structure for venture capital funds Report from a workshop held on 21 June 2005 in Brussels European Commission

2 About this report This report is based on the work of experts attending the workshop on Merits and possibilities of a European fund structure for venture capital funds, organised by Directorate- General for Enterprise and Industry of the European Commission. This report does not contain the complete and verbatim text of all presentations and interventions during the workshop. The contents of this report do not necessarily reflect the opinion or position of the European Commission. Neither the Commission nor any person acting on behalf of the Commission is responsible for the use, which might be made of the information contained herein. More information For further information about this report, you can contact: Ulla Hudina Financing SMEs, entrepreneurs and innovators Directorate-General for Enterprise and Industry European Commission BE-1049 Brussels Belgium Fax entr-finance-smes-entr-innov@cec.eu.int Small businesses can obtain further information about European Union programmes from their local Euro Info Centre (EIC). The addresses of all Euro Info Centres can be found at A great deal of additional information on the European Union is available on the Internet. It can be accessed through the Europa server: 1

3 Contents 1. Introduction 3 2. Consensus on the major obstacles 4 3. Possible scenarios for improving the situation 6 4. List of actions for European Commission to consider 7 5. Conclusion 8 6. Follow-up 9 Annex: List of workshop participants 10 2

4 1. Introduction Functioning private equity (PE) and venture capital (VC) markets provide strong impetus for a competitive, entrepreneurial and innovative Europe. Venture capital funding contributes to creation of new jobs, design and use of new knowledge and technologies, and has thus become an essential ingredient in economic development. Venture capital funds face obstacles when investing across borders at the same time when innovative firms with high growth potential in Europe face difficulties to access equity because of the fragmented market. Further development of the venture capital industry in Europe requires actions to take in order to reduce the existing market fragmentation for the PE and VC industry and the support of various industry players is necessary. In this context, Directorate General for Enterprise and Industry organised a workshop on the Merits and possibilities of a European fund structure that aimed to: identify the obstacles to cross-border investments, examine various proposals to improve the situation, discuss the merits of developing an European fund structure. Participants in the workshop represented a wide range of stakeholders from VC fund managers and industry representatives to academics and policymakers. The stakeholders considered that the development of private equity, especially of venture capital, is one of the drivers for the creation and transmission of businesses, development of high-growth firms and creation of jobs and design and use of new knowledge and technologies in Europe. In general, workshop participants agreed that insufficient attention has been paid to the importance of the PE/VC industry up to now. Member States have to know that off-shore funds are not there for the sake of tax avoidance but because they are often the only way to structure international operations. Two principal problems in fostering the integration of European VC markets were identified by the stakeholders: 1. From the supply perspective, venture capital funds face obstacles when investing across borders in Europe. Venture capital funds are often liable for separate registration or establishment in each Member State, which is both expensive and time consuming. Some larger VC funds that are nevertheless operating cross-borders are investing through complex and costly parallel vehicles established in non-home countries. Consequently, there is a need to adapt the regulatory framework to the market needs. 2. From the demand perspective, many innovative and high growth firms face difficulties in accessing equity finance. Although external equity capital is the only source of financing only for a limited number of these firms, it is very important for a rapid growth of innovative firms. Fragmented European capital markets are currently not providing basis for such a rapid expansion of high-growth firms. Therefore, industry needs improved conditions for cross-border investments so that 3

5 private equity would in a geographically-wider area contribute to pools of capital available for perspective firms seeking for potential investors. 2. Consensus on the major obstacles The innovative and high growth firm sector suffers from problems in raising capital, in particular in those parts of Europe where the venture capital market is less developed. In statistical terms, the private equity and venture capital industry experienced a downturn along with the rest of the European economy in the early 2000s, but the situation has improved since then. Encouragingly, recent statistics have shown an upward trend for venture capital and private equity as a whole in Europe since Although the number of pan-european funds has increased, this could have been more pronounced if regulatory requirements had not complicated cross-border investments. Following in-depth discussions and presentations of various examples from daily practice, the stakeholders participating in the workshop shared the view on several obstacles resulting in fragmented markets. The major identified obstacles to the creation of an integrated VC market are as follows: 1. Inexistence of the single market in the field of PE and VC Lack of a single, effective vehicle for operating across Europe is related to the inexistence of the single market in the field of PE/VC: various layers of fragmentation of capital markets (at the level of investors and investments) exist due to differences in regulation and taxation between the Member States and reasons are also of a technical nature. 2. Legal regulatory environment is to be addressed Number of funds with a pan-european perspective is rather limited due too various regulatory impediments that are complicating cross-border investments. Legal and tax regulatory frameworks are in general considered to be the key barriers. Since taxation policy remains in Member States jurisdictions and thus cannot be easily regulated at the EU level, legal regulatory environment should be addressed. 3. Existing cross-border structures are not recognised Funds can have different structures when established. In most of the Member States, a limited partnership (LP) structure is the main one, whereas alternative corporate or similar vehicles also exist. There is no standard definition of limited partnership, neither a EU-wide standard approach. In addition, only in some Member States is limited partnership treated as a legal personality. This means that a fund raiser in one jurisdiction cannot expect the same treatment as in his local jurisdiction. Obtaining information how certain jurisdictions treat funds is time consuming as well as costly for a small venture capital investor, who cannot afford to employ armies of lawyers. Such difficulties that fund raisers face before launching a fund everything but stimulate allocation of cross-border funds (or decisions of investors to embark on an entrepreneurial career). When analysing the growing number of venture capital funds, a very diverse industry is reflected (in terms of size, capitalisation, management and investment strategies), though European VC funds do have some similarities and are above all facing similar problems. 4

6 There is no simple solution despite various structures (LP, FCPR, SICAR ) that already exist and are in general not recognised outside local jurisdiction. 4. Foreign versus local A number of frictions and technical problems that arise between the different Member States should be solved. At present EU Member States have a rather country-centric perspective, preferring national specific solutions without facilitating cross-border fundraising. Foreign investors are discriminated in comparison to local investors investing in their home countries. Local structures are often preferred. A local structure tends to work for local solutions and is focused on local investors. Different Member States do try to stimulate venture capital funds, but often limiting such a preferential or transparent tax treatment only to domestic funds, whereas foreign funds have to overcome considerable barriers. As a consequence, complex management structures and high costs aggravate venture capital investments. 5. Private versus public Stakeholders attending the workshop emphasised that another kind of discrimination exists: private equity is discriminated against other asset classes; i.e. private equity investors and investments are not treated equally as public equity ones. 6. Permanent establishment for management company A specific problem is the concept of permanent establishment for management companies which implies in general that a management company is liable for separate registration or establishment in each country where the fund is investing. 7. Complex and costly parallel vehicles At present, a fund structure allowing fundraising and investing in different EU countries requires establishment of additional intermediary or parallel vehicles and consequently results in additional costs and complexities. Due to the sizeable costs and uncertainties only larger VC funds manage to set up such intermediary funds, by which they overcome double (or multiple) taxation of the investors returns. Complexities and burden of parallel structures exclude smaller investors. 8. Increased tax burden and double taxation A complex regulatory environment that differs a lot in various tax jurisdictions causes the existing fragmentation. Investing across borders provides a diversified portfolio and reduces risk but most importantly increases the tax burden on VC funds that produce lower returns. 5

7 Double taxation acts as an effective deterrent for cross border VC investments. However, in practice national governments do not benefit from taxation of original investors because when entering a market, foreign funds create parallel structures, by which they are investing directly in the respective country as domestic funds and do not pay taxes applicable for foreign funds. 9. Lagging behind the US Despite the PE/VC industry claims about enough funding being available, it is not clear that the European market functions well enough for innovative enterprises to get enough equity funding. Many European companies continue to face substantial problems in accessing finance. Complex and costly VC parallel fund structures limit the ability of European funds to access global markets and to compete with their US counterparts. In addition, European funds are small and have been unable to benefit from economies of scale. The stakeholders believed that differences with the US should be narrowed down. Example of a complex environment in Europe in comparison to the US: If investors in a fund (such as pension funds, foundations, etc) come from several countries and its management team decides to invest in several different countries, within the EU, there are literally tens of dozens of possible permutations to structure and manage a fund on a cross-border basis. This is in contrast with the USA, where it is rather simple; actually when US management team is investing in US companies there is just one basic permutation. 10. Understanding PE/VC industry? In general, a lack of understanding about the PE/VC industry exists at various levels. In some parts of Europe, particularly in the new Member States, PE/VC market is less developed. While governments are becoming aware of the stimulating venture capital trends in Europe, some attempts to profit from these trends have resulted in even more complex legal and tax requirements and more costly fund raising. 3. Possible scenarios for improving the situation and creating an integrated PE/VC market Although the issues are complex, the positive impact of private equity and venture capital on the whole of the European economy is important in terms of jobs, and the creation, expansion and transmission of businesses. A stable and harmonised framework of laws and regulations that would allow full developments of integrated VC market should be established at the European level. Investors should not be worse off by investing through a VC fund than they would have been investing directly in the underlying companies. Workshop participants urged for simplifying the regulatory requirements for fund structures so that investors would not have to spend excessive time on analysing various requirements 6

8 for establishing a fund in a non-home jurisdictions. Such a simplified regulatory framework would attract more investors and enable more pronounced number of funds. Exchanges however pointed out that PE/VC industry is quite regulated in various Member States. Tackling the issues at stake only with a regulatory approach might cause even more regulatory complexities. A common European definition might be another solution. However, creation of a single European fund structure does not seem achievable in the short term, but the stakeholders agreed that it should be considered as a long term objective. Requirements for such a pan-european fund structure: Should be either a transparent tax structure or exempt from tax. Not a taxable permanent establishment of management company in host country. Enhanced rules for a recognised custodian. No VAT on management charges. Carried interest should be taxable as capital. A potential pan-european fund structure could combine characteristics of the already existing structures such as Limited Partnership in the UK, SICAR in Luxembourg, FCPR in France and others. The goal would be that open competition between different national solutions could contribute to identifying a perfect structure and could help to propose to the Member States merits of a pan-european structure. However, stakeholders emphasised that the competition between various jurisdictions that is already happening should be sound and should not lead to extreme situation of 25 perfect domestic fund structures allowing investing only in local environment and further hampering cross border investments. Stakeholders recognised urgent need for a mutual recognition at various levels: A harmonised definition of a fund structure and of a sophisticated PE investor. A passport for management company that would allow cross border operations. For a custodian that is regulated and recognised in one jurisdiction should apply the same rules in other jurisdictions. Private placement regime to allow funds to sell around Europe. Alleviating permanent establishment requirements. Private equity = public equity. Any PE investor should be treated as a direct investor. Stakeholders concluded that these proposals should be presented to the Member States and proposed to set up working groups in the Council that would address these market-driven initiatives at a political level. 4. List of actions for European Commission to consider: There was agreement among the VC industry, academics and policymakers that the time is right to address some of the identified challenges. Political will is needed to build on 7

9 initiatives already taken and the European institutions and national regulators should cooperate when taking action. The workshop participants agreed that the following actions are something the Commission should consider: In order to reduce the existing market fragmentation for the PE and VC industry, the Commission should foster a further dialogue with the Member States and industry. The Commission should act as a catalyst to stimulate efficient use of the existing single market legislation (rather then amending it or proposing a new legislation). The Commission could propose a mutual recognition principle for harmonisation of a common definition for a private equity investor, or a passport for management companies (like for a UCITS fund), or a custodian and private placement regime. This might be achieved through open method of coordination and Member States should be willing to work on a basis of mutual recognition principle in order to progressively harmonise various rules for VC fund structures. The open method of coordination might help in making all Member States conscious of the complexities that the funds are facing if investing cross-borders. The Commission services could set up an expert working group, organised into subgroups of different Member States, in order to define a perfect fund structure that would allow investing in various jurisdictions within Europe and internationally. Further collaboration with the OECD, notably in tackling the permanent establishment issues, by adapting to the OECD definitions of a fund and investor. The Commission should help raising awareness about private equity, particularly in the new Member States, in order to make issues understandable for non-experts. It is very important to educate and communicate with the regulators and general public about the functioning of the PE/VC industry and the essential role that it plays in stimulating growth and creating jobs. The Commission should advance progressively in addressing the mentioned tasks. Whereas industry urges for a market-driven approach to create a structure that could be operating cross borders, a pan-european fund structure within the single European marketplace is achievable only in a long-term. 5. Conclusion The central question that was addressed during the workshop was whether there is a lack of a common vehicle or a lack of a single market for PE and VC. Following in-depth discussions, stakeholders concluded that the lack of a single, effective vehicle for operating across Europe is related to the inexistence of a single market for private equity and venture capital and to discrimination as against other asset classes. The reasons are technical, in principle, but in this instance, most Member States continue to work on national solutions and do not incorporate the possibility of efficient pan-european solutions. Moreover, venture capital funds have been facing difficulties in investing across borders without being liable for separate registration or establishment in each EU-25 Member States. There is a strong urge from the industry to reduce the existing fragmentation of the markets 8

10 along national lines and to improve the opportunities for such cross-border investments. In order to overcome current market impediments, creation of a European fund structure for private equity and venture capital investment funds has to be considered. A pan-european fund structure would avoid inefficiencies such as multiple taxation and it would reduce complexities of operating and managing parallel funds in various jurisdictions. In addition, such a workable single structure would reduce costs and time-consuming procedures associated with complicated cross-border vehicles. 6. Follow-up Based on the workshop recommendations as well as on supplementary research carried out by the Commission services, the main findings identifying obstacles and outlining solutions for PE/VC funds operating cross borders will be presented at the conference The Risk Capital Summit 2005 organised by the European Commission and the UK Presidency of the European Council in London on 4 and 5 October Discussions and conference conclusions will be then taken into consideration in developing further Commission work and policy addressing risk capital issues. 9

11 Annex: List of workshop participants Mr Uwe Bärenz, P+P Pöllath + Partners, Germany Mr Travis Barker, Investment Management Association (IMA), UK Mr Jonathan Blake, SJ Berwin, UK Mr Fabio Brunelli, Di Tanno e Associati, Italy Mr Javier Echarri, European Private Equity and Venture Capital Association (EVCA) Mr David Huff, 3i, UK Mr Alain Kinsch, Ernst& Young Luxembourg Ms Susan Lloyd, Susan Lloyd & Assoc., Channel Islands, UK Prof. José Marti Pellon, Universidad Complutense de Madrid Ms Barbara Nowakowska, Polish Private Equity Association Mrs Marie-Annick Peninon-Bernard, EVCA Mr Justin Perettson, European Private Equity and Venture Capital Association (EVCA) Mr Claude Rosevègue, Apax, France Mr Daniel Schmidt, European Private Equity and Venture Capital Association (EVCA) Mr Ulf Söderholm, Andulf, Sweden Representatives of European Commission services: Mr David White, Directorate General for Enterprise and Industry Mr Jean-Noël Durvy, Directorate General for Enterprise and Industry Mr Vesa Vanhanen, Directorate General for Enterprise and Industry Ms Ulla Hudina, Directorate General for Enterprise and Industry Mr Jean-François Aguinaga, Directorate General for Enterprise and Industry Mr Vilmos Budavari, Directorate General for Enterprise and Industry Mr Rolf Diemer, Directorate General for Taxation and Customs Union Mr Eric Fitzgerald, Directorate General for Taxation and Customs Union Mr David Reed, Directorate General for Internal Market Mr Patrice Berge-Vincent, Directorate General for Internal Market Mr Peter Parlasca, Directorate General for Economic and Financial Affairs Mr Carlo Pinto, Directorate General for Competition 10