Seed capital to support eco-innovations

Seed capital to support eco-innovations FINAL REPORT Jan-Frens van Giessel Geert van der Veen 26 January 2006

Samenvatting Tijdens de bespreking van de VROM begroting 2005 (vergaderstukken Tweede Kamer 2004/2005, 29800 XI, nr. 83, 13-12-2004) werd, naar aanleiding van een vraag van Tweede Kamerlid Paul de Krom (et al.), door staatssecretaris Van Geel toegezegd een onderzoek uit te voeren naar de mogelijkheden om de beschikbaarheid van durfkapitaal (venture capital) voor eco-efficiënte innovaties te vergroten, in het bijzonder voor kleine ondernemers. Overweging daarbij was dat de beperkte beschikbaarheid van durfkapitaal een belemmering is voor kleine ondernemers om te investeren in innovatieve eco-efficiënte technologie. Het ministerie van VROM heeft aan Technopolis 1 gevraagd om de financieringsproblemen van kleine bedrijven en innovatieve starters op het gebied van milieutechnologie (eco-efficiënte innovaties) in Nederlands nader te onderzoeken. Tevens is het ministerie van Economische Zaken (EZ) betrokken geweest bij dit project 2. De belangrijkste resultaten van deze studie zijn in dit rapport weergegeven. Uit de studie blijkt dat durfkapitaal investeerders (formele Venture Capital verschaffers) niet (of slechts zeer beperkt) geïnteresseerd zijn in seed en early stage financiering omdat de risico s te groot zijn, de verwachte opbrengsten onzeker en de kosten en tijd voor het uitvoeren van due diligence hoog. Echte interesse begint veelal pas bij investeringen groter dan 2.500.000. Deze situatie geldt voor alle technologieterreinen en is niet specifiek voor Nederland, hoewel de beschikbaarheid van seed en early stage kapitaal in Nederland lager is dan het Europees gemiddelde. In het algemeen geldt dat Europa meer risicomijdend is dan Noord-Amerika. Voor de seed en early stages van technologische start-up bedrijven lijken informal investors wel van belang te zijn. Statistieken hierover zijn echter niet bekend. Het gaat daarbij in het algemeen maar om beperkte bedragen (i.h.a. < 200.000), die onvoldoende hoog zijn om bij hoogtechnologische ontwikkelingen een goede start te kunnen maken. Er bestaat derhalve een financieringsprobleem ( equity gap ) voor bedrijven met een kapitaalbehoefte tussen de 200.000 en de 2.500.000). Durfkapitaal voor seed investeringen in schone technologie Investeringen in schone technologie of clean tech (dit zijn technologieën met een beter milieuprestatie dan huidige vergelijkbare technologieën) kunnen als een indicator worden beschouwt voor investeringen in eco-efficiënte innovaties. Uit de statistieken blijkt dat 5-6% van alle durfkapitaal investeringen in Noord Amerika wordt gedaan in de clean tech sector, waarvan 1-2% seed investeringen zijn. Als we deze percentages vertalen naar Nederland dan blijkt dat de hoeveelheid durfkapitaal (formeel VC) voor seed investeringen in de clean tech sector verwaarloosbaar klein is. Dit beeld wordt ook bevestigt in interviews met durfkapitaal investeerders in Nederland. 1 2 http://www.technopolis-group.com Begeleidingscommissie: Just van Lidth de Jeude (Min VROM) and Jan Dexel (Min EZ) ii

Tegelijkertijd wordt de schone technologie sector door de VC fonds beheerders als een veelbelovende en opkomende sector beschouwd. Verwacht wordt dat het aantal durfkapitaal investeringen in deze sector de komende jaren sneller groeit dan investeringen in ICT en biotechnologie. Er is dus wel degelijk interesse om te investeren in de clean tech sector, maar in hoeverre dit ook zal leiden tot meer durfkapitaal voor seed investeringen in schone technologie starters is twijfelachting. Seed investeringen in schone technologie door informele investeerders Momenteel zijn informele investeerders (o.a. business angels) de grootste leveranciers van seed kapitaal voor technologie georiënteerde ondernemers, maar cijfers ontbreken hierover, zeker voor seed investeringen in eco-efficiënte innovaties. Aan de ene kant wordt in de interviews gesuggereerd dat sommige informele investeerders, naast financiële criteria ook ideologische criteria gebruiken als ze besluiten tot een investering. Dit zou betekenen dat investeringen in eco-efficiënte innovaties een bonus hebben ten opzichte van normale investeringen en dus makkelijker seed kapitaal aan te trekken van deze groep investeerders. Aan de andere kant geven sommige geïnterviewden aan dat ontwikkelingen op het gebied van ecoefficiënte innovaties meer onzekerheden vertonen dan gewone ontwikkelingen (o.a. door overheidsbepaalde markten, gebrek aan ondernemers met ervaring met het starten van bedrijven in de clean tech en gebrek aan financieel trackrecord van startende clean tech bedrijven). Dit maakt het moeilijker om kapitaal aan te trekken voor een clean tech start-up. Overheidssteun voor seed investeringen in technostarters Marktfalen (de mismatch tussen vraag en aanbod van kapitaal; de equity gap) rechtvaardigt ingrijpen en steun van de overheid voor seed en early-stage investeringen in (techno) starters. In Nederlands is door de overheid het TechnoPartner programma ontwikkeld dat zich specifiek richt op het stimuleren van technologie gebaseerde starters, onder andere door de beschikbaarheid van seed kapitaal voor deze groep te vergroten. Dit heeft tot nu toe geleid tot de oprichting van zeven nieuwe durfkapitaal fondsen voor techno starters. Geen van deze fondsen richt zich echter specifiek op schone technologie (clean tech) of eco-efficiënte innovaties. In dit report concluderen we dat de schone technologie (clean tech) sector niet fundamenteel anders in dan andere technologie gebieden en dat er daarom, vooralsnog, geen reden is om buiten het TechnoPartner programma om een specifiek stimulering programma op te zetten om de beschikbaarheid van seed kapitaal voor jonge ondernemers die zich richten op schone technologie te vergroten. De extra problemen die bedrijven in de schone technologie sector ondervinden (zoals gebrek aan trackrecord, serial entrepreneurs, markt informatie, etc) en de positieve milieu effecten voor de maatschappij rechtvaardigen echter wel enige extra steun van de overheid (binnen TechnoPartner). Daarom wordt aanbevolen om binnen de TechnoPartner Seed Facility specifieke marketing activiteiten te ontplooien die gericht zijn op het opzetten (met hulp van technopartner, onder dezelfde voorwaarden als andere TechnoPartner fondsen) van een speciaal durfkapitaal fonds dat zich richt op seed investeringen in de schone iii

technologie sector, en eventuele andere activiteiten voor het bevorderen van ondernemerschap in de clean tech sector (bijv. specifieke netwerkactiviteiten voor jonge ondernemers op dit gebied). Steun van de overheid om het aantal seed investeringen in jonge technologie gebaseerde bedrijven te vergroten is alleen effectief als deze bedrijven niet alleen de seed fase overleven, maar ook genoeg kapitaal kunnen aantrekken in vervolg fase van hun ontwikkeling (doorgroei en expansie fase). Hoewel deze latere fasen van financiering buiten de onderzoeksvraag aan Technopolis vallen, werd in de interviews voor dit onderzoek opgemerkt dat in deze fasen minstens even grote financieringsproblemen bestaan in de clean tech sector als in de eerdere fasen, waardoor de mogelijkheden de sterke Nederlandse technologische positie (op sommige terreinen) van de clean tech te vertalen naar economische bedrijvigheid zouden worden beperkt. Het wordt geadviseerd deze problematiek en mogelijke oplossingen daarvoor (bijv. met middelen van Waddenfonds en/of Borssele fonds) nader te onderzoeken. iv

Summary As a consequence of Parliamentary questions the Dutch Secretary of State for the Environment Mr. van Geel promised to research the possibilities to improve the availability of Venture Capital for eco-efficient innovations. Specific attention was asked for small and medium sized enterprises. Basic assumption was that the limited availability of Venture Capital hampers (small) entrepreneurs in realising ecoefficient innovations. Against this background, the Dutch Ministry of Environment (VROM) has asked Technopolis 3 to study the financing problems of start-up companies in the clean technology area (eco-efficient innovations) in the Netherlands. The Ministry of Economic Affairs (EZ) was also involved in this project 4. This report presents the results of this study. In this study it is concluded that formal venture capital (VC companies), generally speaking, is not committed to seed investments, because risks are too high, costs for due diligence high, and profitability highly uncertain. VC interest only starts at investments above 2.500.000. This situation is valid for all technology areas and not specific for the Netherlands, although risk aversion in Europe is higher than in North America and availability of seed (and early stage) capital in the Netherlands is lower than the European average. Informal investors seem the most important source for seed en early stage capital for new technology based firms. Statistics on informal investments do not exist, but it is generally considered that the investments of informal investors are limited (general < 200.000), and insufficient for a good start. As a consequence of the above there is an equity gap for companies with an investment need of 200.000 to 2.500.000). Seed investments in clean tech by venture capitalist Clean tech (e.g. technologies with a better environmental performance than current benchmark technologies) investments, which can be taken as a proxy for investments in eco-efficient innovations, account in North America for 5-6% of all venture capital investments. Seed investments are only 1-2% of this in North America. If we translate these figures to the Netherlands the amount of venture capital used for seed investments in clean tech is almost negligible. This picture was confirmed in interviews with venture capital providers in the Netherlands. Clean tech is however a hot and emerging sector for (venture capital) investors. It is expected that the average growth in the clean tech markets in the coming years will exceed the growth in ICT and life sciences. Therefore the interest in clean tech is present. Whether this will also mean that there will be more seed capital available for venture backed investments in clean tech is doubtful. 3 4 http://www.technopolis-group.com Begeleidingscommissie: Just van Lidth de Jeude (Min VROM) and Jan Dexel (Min EZ) v

Seed investments in clean tech by informal investors Nowadays informal investors are the main suppliers of seed capital for technologybased entrepreneurs. Statistics are, however, not available on these investments, and certainly not on informal seed investments in eco-efficient innovations. It is suggested in the interviews that for some informal investors eco-efficient investments have a ideological bonus over normal investments, because of the positive spillovers to society, and therefore less strict financial criteria may be used. On the other hand it is also indicated eco-efficient developments show more uncertainties than normal developments (government influenced markets, lack of serial entrepreneurs in clean tech and lack of track-record) and are therefore even harder to finance than normal developments. Support for seed investments in techno starters by the government Market inefficiencies (mismatch between demand and supply of capital; the equity gap ) justify government intervention and support for seed and early stage investments in (technology-based) starters. In the Netherlands the government has developed within the TechnoPartner programme a specific facility for promoting availability of seed capital for technology-based starters. This has recently led to the start up of seven new venture capital funds. None of them is however aiming at clean tech or eco-efficient innovations specifically. In this study we conclude that the clean tech area is not fundamentally different from other technology areas and therefore dedicated initiatives towards clean tech, outside current programmes like TechnoPartner, is not needed. However, the extra problems clean tech is facing over other technology areas (lack of track-record, lack of serial entrepreneurs, lack of market information, etc) and positive spillovers to society (because cleaner products and processes are realised with lower environmental impacts than the current technologies) do present an extra market failure that justifies government action (within TechnoPartner). Therefore it is recommended to start specific marketing actions for a clean tech venture fund within the context of TechnoPartner Seed Facility to explore whether a specific market interest in this area can be developed. Furthermore it is recommended to have specific attention (within TechnoPartner) for the promotion of entrepreneurship in the clean tech sector (networking activities for clean tech starters, etc.), and have attention for the development of markets for clean tech. Government support for companies in the seed phase is only effective when companies supported do not only survive the seed phase, but also succeed in attracting additional capital for further development (early-stage financing) and expansion. Although these later stages of financing are outside the scope of the research question of this project, it was mentioned often by those interviewed that financial difficulties for clean tech firms are at least as large in this later stage, and this does hamper the translation of the strong Dutch technological position to economic activity. It is recommended to research the problems in these later stages further and find possible solutions. vi

Table of Content 1 Introduction 1 1.1 Overview 1 2 The equity gap and rationale for government funding of seed capital 3 2.1 Equity gap 3 2.2 Rationale for government support for seed and early stage financing 5 3 The role of Venture Capitalists in seed and early stage financing 7 3.1 Investment criteria 7 3.2 Overview of venture capital markets in the US and Europe 8 3.3 Seed and early-stage investments in the Netherlands 10 3.4 Summary 13 4 Venture capital investments in clean technology companies 14 4.1 Drivers for clean technology investments 14 4.2 Main challenges for clean tech 17 5 Conclusion and recommendations 20 5.1 Government initiatives to support seed investments in clean tech 21 5.2 Seed financing is only a first step 22 Appendix A Appendix B List of interviewees European equity schemes vii

1 Introduction Developing risk capital markets in Europe and improving access to risk capital for entrepreneurs and innovative, technology-based companies is one of the main policy challenges to stimulate innovation and competitiveness and achieve economic prosperity in Europe 5. At the same time there is also a growing emphasis among policymakers on sustainability and environmental and clean technologies or ecoefficient innovation as a driver for European economic growth. See for instance the efforts of the European Environmental Technologies Action Plan (ETAP), Informal Environmental Council 2004, etc. As a result the Dutch Ministry of Environment has asked Technopolis BV to conduct a study to explore the need for and the availability of seed venture capital for ecoefficient innovations and to assess whether there is a role for the government to increase availability of seed capital for companies developing eco-efficient innovations. The research question is focused on seed capital provided by venture capital. Informal investors and government funds are however an important source of seed capital for (clean) technology based companies and have, to some extent, been taken into account in this study as well. In the financial world eco-efficient innovations or sustainability is mainly referred to as clean technologies (e.g. clean tech). We have used clean tech as a proxy for ecoefficient innovations. The category clean tech is not specific to a particular industry or sector, but includes sectors as air and water purification, advanced materials, clean production technologies, renewable energy, distributed power generation, etc. This makes investments in clean tech difficult to track. The study is based on a number of literature sources and telephone interviews. For this research we have conducted interviews with private investors from the Netherlands and Belgium active in the clean tech sector (and one Dutchman from Canada), representatives from NVP and NeBib (representing informal investors) and government fund managers, as well as two entrepreneurs in the clean tech sector 6. 1.1 Overview The results of the study are presented in this report. It starts with aspects of start-up financing that are not technology or sector specific. Section 2.1 briefly explains the equity gap which many technology-based starters face. The rationale for government support for seed and early stage financing is explained in more detail in section 2.2. Section 3.1 gives an overview of the main criteria that private investors use when investing in start-ups. This is mainly based upon the interviews conducted for this study. The next section provides a brief overview of the venture capital 5 6 See for instance the Lisbon agenda and European Commission. COM (2003) 713. Access to finance for SMEs. The full list of interviewees is given in Appendix A 1

markets in the US, Europe and the Netherlands. Section 3.3 focuses on venture capital backed seed and early stage investments in the Netherlands. Special attention is given to the role of informal investors and government schemes as providers of seed capital. This is chapter is concluded with a short summary (section 3.4) From chapter 4 the focus is on clean tech investments. Section 4.1 explains some of the drivers for clean tech investments and gives an overview of the venture capital markets for clean tech in the North America, Europe and the Netherlands. Section 4.2. presents some of the main challenges the clean tech area is facing. This is mainly based upon the interviews conducted for this study. Conclusions and recommendations regarding the role of government in supporting seed investments in the clean tech area and possible government interventions are given in chapter 5. This report is concluded with a section (section 5.2) on the role of government support after the initial seed phase financing round (i.e. early stage and expansion phase financing). 2

2 The equity gap and rationale for government funding of seed capital Section 2.1 briefly explains the equity gap which many technology-based starters face. The rationale for government support for seed and early stage financing, based on the existence of this equity gap, is explained in more detail in section 2.2. 2.1 Equity gap During their life cycle, starting from the development of an idea to market introduction and further company growth, companies (i.e. technology based SMEs) encounter different financing problems. The company life cycle is shown in Exhibit 1. Exhibit 1 Stages of equity financing Source: Graph adapted from Cardullo: Technological Entrepreneurism. New and innovative companies, especially technology-based companies, need to invest substantial amounts of money before they have a product or service on the market and start to generate (positive) cash flows. During this seed stage, with negative earnings, entrepreneurs use mainly family, friends and (other) fools and government funds or grants to develop their business idea. In this stage the external informal investors may also play a role by providing private capital. This difficult first phase is often referred to as the valley of death. At some stage all companies just run out of money and need to attract additional financing. Business angels and informal investors are usually reluctant to provide different rounds of financing and usually pull out when the company moves on from seed to early stage. Government funds are also not available anymore for this stage of 3

company development (or require very substantial amounts of co-financing by the entrepreneur). Banks require some short of collateral and company history (track-record) before they will provide a loan. This makes bank financing unobtainable for (technology-based) start-ups. Moreover, interest payments limit cash flow and flexibility of an expanding company. Venture capital funds are mainly interested to invest in relatively established companies that have survived the seed and early growth stages and are rapidly growing (expansion stage). This stage provides the best investments opportunities and return rates for professional investors. Investments in start-ups involves higher risks and these risks are much more difficult to assess fro financers when compared to established, conventional companies with long track record. Furthermore the costs for the VC (risk assessment, legal and administrative costs, supervision) of providing a small amount of finance are practically identical to providing a large amount. Therefore VC s are reluctant to provide funds in the start-up phase. As a result an equity gap occurs in early-stage financing (i.e. first and second financing rounds). This mismatch between venture capital supply and demand occurs particularly at the bottom end of the capital market. For instance, for high-tech startups in the Netherlands an equity gap has been noted between supply and demand that is roughly between 100.000 and 2.500.000 per financing round 7. Because of this lack of funding sources many young and innovative (technology-based) companies do not survive the equity gap and potential promising inventions do not make it to the market. Exhibit 2 Schematic representation of the equity gap 7 Policy letter Action for entrepreneurs Ministry of Economic Affairs. 2003 4

2.2 Rationale for government support for seed and early stage financing The equity gap and lack of funding for new and technology-based companies have growing attention among policy makers in Europe. Developing risk capital markets in Europe and improving access to risk capital for entrepreneurs and innovative, technology-based companies is one of the main policy challenges to stimulate innovation and competitiveness and achieve economic prosperity in Europe 8. A recently published study by a group of experts 9 commissioned by the European Commission analysed early stage finance in Europe and concluded that the cost of, and time needed for due diligence in seed and early-stage deals makes these investments often unattractive compared to later-stage deals and buyouts that provide more attractive risk-return profiles. The resulting market failure seems to be fairly permanent and the conclusion over the years has been that for the foreseeable future public incentives will be needed to correct it. The expert report argues that both at the supply side and at the demand side there are structural problems resulting in market inefficiency for (venture) capital and the equity gap for (technology-based) start-up companies. Because of these market inefficiencies government intervention is needed. The main problems are summarised below and can be categorised in supply and demand side problems. 2.2.1 Supply side problems Venture capital does not invest in seed and early-stage companies if they can achieve a better risk-return elsewhere. Currently risk-return profiles for expansion or buyout investments are much better then for seed investments resulting in under investments in early stages. The government can provide incentives for risk sharing and leverage investments through public-private investments and co-investments of business angels and venture capital funds. Venture capital needs successful exits to return funds to investors. Currently there are only a few IPOs (the ultimate exit) in Europe. The unavailability of exits and consequently the lack of success stories slow down venture capital activities. The European venture capital market is far from efficient. Cross border investment is hard or even impossible because of 25 different sets of regulation on establishment of venture funds and double taxation. This makes it impossible to achieve scale and liquidity in Europe. European venture capital funds are often small and regional focussed. Larger funds would not reduce the risks associated with seed or early stage deals, but they can better absorb the high due diligence costs, which is currently a main reason for 8 9 See for instance the Lisbon agenda and European Commission. COM (2003) 713. Access to finance for SMEs. European Commission. DG Enterprise and Industry. 2005. Best practises of public support for early-stage equity finance. Final report of the expert group. 5

investors to pull out of the seed and early stage market. Larger funds can also attract more professional fund managers, provide services, and ensure quality over time. 2.2.2 Demand side problems Entrepreneurs are often not aware of the different funding possibilities and are sometimes reluctant to share their ownership and control with equity investors. Instead, entrepreneurs try to borrow money or accept the limits of the firms growth. More effort is needed to bridge the gap in expectations between investors and entrepreneurs. The entrepreneurial spirit in Europe is limited, especially compared to the US and investment readiness of entrepreneurs remains a problem in Europe. Clarity concerning intellectual property rights is one of the key issues for investors. A solid and predictable contractual framework for technology transfer between universities and research institutes on the one hand, and enterprise and entrepreneurs on the other hand would facilitate birth of new companies. These issues described above, the main challenges and possible government actions are summarise in the table below (Exhibit 3). Exhibit 3 Government issues and actions with regard to seed capital Main issue Specific challenge Possible government action Lack of seed and start-up finance Scale and liquidity of European VC market Harmonise regulation on VC funds to make cross boarder investment possible and avoid double-taxation Risk-return profiles for seed and early stage investments Public-private investments fund (risk sharing and leverage) Better exit opportunities (show cases) - Business Angels as seed capital Facilitate business angel networks Investments in seed and early stage VC funds Entrepreneurial culture in Europe and Netherlands in particular is limited compared to US providers Institutional investors like pension funds are reluctant to invest in venture funds focussing on seed and start-up investments Tax incentives to encourage (institutional) investors to invest in start-ups Risk aversion Educational programme to stimulate creativity and entrepreneurship Fear of business failure - Investment readiness Communication gap between entrepreneurs and investors (mutual expectations) Stimulate coaching networks Facilitate networks and events where investors can meet entrepreneurs 6

3 The role of Venture Capitalists in seed and early stage financing Section 3.1 gives an overview of the main criteria that private investors use when investing in start-ups. This is mainly based upon the interviews conducted for this study. The following section provides a brief overview of the venture capital markets in the US, Europe and the Netherlands. Section 3.3 focuses specifically on venture backed seed and early stage investments in the Netherlands and special attention is given to the role of informal investors and government schemes as providers of seed capital. This is section is concluded with a short summary (3.4) 3.1 Investment criteria Venture capitalists (VC) invest in companies with high profit potential. Because of this high profit potential they are prepared to take the risk to invest in technology based start-up companies that have no or limited positive cash-flows (yet). Traditionally VCs prefer to invest in new technology based companies that operate at emerging or fast growing markets, because this offers the highest growth potential (20-30% per year) and returns (15-20% per year). Traditional capital providers (banks, etc) take less risk and only invest in already established company with a strong track-record und and therefore ask lower returns (i.e. interest payments). Not all initiatives are suitable for venture capital investments. VCs do not invest in (development) projects, only in companies (or investment funds). VCs invest in a certain company or investment fund because they expect to achieve significant returns in the future, given a certain risk profile 10. The time scope is different for every sector: in the ICT sector a return time of 1-2 year is normal, while in the biotech this is 8 years or longer. Once an investment has been made VC companies normally participate actively in the board of directors and provide coaching, management experience, access to networks of investors and clients, etc. to the entrepreneur. They help the company to grow significantly in a relatively short period of time. Normally a VC receives shares in the company to ensure profits after an exit. The most important investment criterion for a VC company is trust in the management team of the company. The management team must have an excellent track record (preferably in the same technology sector) and besides technological knowledge also have knowledge about the market they operate in (who are my clients and why do they want to pay for my product or process) and general management experience. Other important investment criteria are market opportunities (strategy) and technology position (IP). 10 Risk-return ratio; risky investment have higher expected returns 7

In general VCs invest in 1 out of 80 or 100 propositions. Main reason not to invest is lack of market perspective: many engineers that want to start a company are often too focused on developing the technology without thinking whether there is a market potential for this new technology. A VC will never make a big investment alone, because risk of failure is too high. Seed or early stage investment deals are limited (0.2-0.5 mln Euro) and investors often make such an investment alone, but follow-up investments usually require large amounts of money. Therefore multiple VC s invest together in big deals to share risk and costs of due diligence. Moreover, co-investors can act as a second opinion and can provide the necessary funds to later stage investments. 3.2 Overview of venture capital markets in the US and Europe This section provides a brief overview of venture capital markets in the US, Europe and the Netherlands to get an idea about the market size and investment deals. In 3.2.2 more details about seed and early-stage investments are presented. 3.2.1 Global overview of venture capital investments The total amount of US venture capital investments (excluding buy-outs) in 2004 was $20.8 billion. In total 2873 deals were performed and the average deal size was $7.3 million 11. Since the peak in 2000 private venture capital investments are declining each year in the US. In 2000 US venture capital investments reached over $100 billion and more than 7800 deals. European venture capital is much smaller compared to the US, but investments have risen annually after the drop in 2000 and have reached 11 billion in 2004, excluding buyout investments ( 36 billion if you include buyout investments) 12. Investments in expansion stage represent 7.9 billion. The average deal size in this stage was 1.7 million (see Exhibit 4). The Dutch venture capital market follows more or less the European developments. In 2004 468 companies attracted Dutch venture capital investments which accounted for 1.7 billion. Buyouts investments accounted for over 70% of this. The total amount invested excluding attractive buy-outs deals was approximately 500 mln. 3.2.2 Seed and early stage venture investments After the peak in 2000 investments in early stage companies have been declining over the past couple of years, both in the US and in Europe. In 2004 the share of seed investments was only 1.65% of total US venture capital investment (excluding 11 12 National Venture Capital Association, 2004 figures. See www.nvca.com European Venture Capital Association, 2004 figures. See www.evca.com 8

buyouts) and accounted for a total of $346 million. Start-up and other early stage investments accounted for another 18.5% or $3.9 billion 11. In Europe seed and start-up investments in companies accounted for only 6.4% or 2.35 billion of total investments in Europe (including buy-outs). Seed financings were only 0.4% or 150 million. This is shown in Exhibit 4. If you exclude buyout investments, which make a comparison with US figures possible, seed investments account for 1.4% of total investments in 2004. Other start-up investments were and additional 20% (or 2.2 billion). The average deal size for start-ups was 733,871 in 2004 12. Exhibit 4 Stage distribution of amount investment (European average, 2004) Seed 0,4% Start-up 6,0% Expansion 21,4% Buyout 69,7% Replacement capital 2,5% Source: EVCA, 2004 In both the US and Europe the share of seed capital investments is low and continues to decline since the 2000 peak. This is clearly shown in Exhibit 5, which provides figures for Europe. Furthermore, this exhibit shows that early-stage investment is declining both in absolute figures and relatively to expansion investments since 2000. Between 2003 and 2004 total early-stage investments have increased a bit, but relatively to expansion investments decreased further. 9

Exhibit 5 Early stage (seed and start-up) and expansion investments in Europe (1995-2004) Source: EVCA and Expert report on Best practises of public support for early-stage finance 3.3 Seed and early-stage investments in the Netherlands In line with global trends seed and start-up financings by venture capitalist in the Netherlands have been trending downward over the last five years since the peak of more than 300 million in 1999 to only 37 million in 2004. In 1999 20% of all venture investments were done in early-stage companies (seed and start-up) while in 2004 this share has dropped to only 2.2% of total investments (including buyout). This share is much lower than in Europe and the US. Based on figures of the NVP 13 only a few companies attracted seed-capital in 2004 (for 2.2 million) from venture capitalist while in previous years 10-15 companies received seed financing annually. At the same time the amount of companies that attracted start-up financing reduced with 50 percent to 44 companies in 2004 and accounts for 35 million. The average deal size in start-up companies is 0,8 million 14. The recent growth in VC investments is due to expansion investments and buyouts. Private equity investments in technology based companies like ICT and biotech have decreased with more than 20% to 130 million in 2004. The investment climate for technology-based companies is expected to remain difficult in the coming years, according to the NVP. 13 14 NVP statistics cover approximately 80% all venture capital investments in the Netherlands, but with regard to seed and early-stage investments NVP covers a much smaller share of all deals in the Netherlands. NVP. 2005. Ondernemend Vermogen de nederlandse private equity markt in 2004. 10

3.3.1 Informal investors The lack of interest among venture capital providers to invest in seed and early stage companies means that new and innovative (technology-based) companies need to find other sources of funding to finance their business development. It is highly probable that informal investors are the most important source of capital for seed and start-up investments in new, and often technology-based, companies. Informal investors act as the natural providers of seed capital. Informal investors participate more active in a company than VCs do, and provide management support and advice to the entrepreneur on a very personal basis ( hands-on ). They usually have experience as entrepreneur themselves and act as a coach to the entrepreneur. There are no statistics available on (the amount of) seed investments by informal investors, but it is likely (as was also mentioned in the interviews) that this is significant more than the amount of seed investments by VCs. Informal investors focus on the very early phases of company development. Once a company has achieved some mass, informal investors normally exit the company and scout for new business ideas. Often financial and personal capacities to provide active management support of informal investors are limited so they provide only a few rounds of financing. These seed investments are only picked up by limited number of venture capital providers limiting company growth (equity gap, see section 2.1). 3.3.2 Public initiatives to support availability of seed capital Another important source of seed-capital for entrepreneurs are government funds and grants. There are currently three government schemes (not including regional initiatives) aimed at supporting (innovative) starters. These are TechnoPartner, the Venture Capital Scheme, and BBMKB SMEs Credit Guarantee scheme. Furthermore there are project-oriented subsidies, which provide subsidies for R&D activities (usually a percentage (50%or less) of actual costs). These traditional R&D subsidies are not discussed in this report. An elaborated study on VC/seed capital support initiatives outside the Netherlands was also not part of this study, but a list of interesting schemes abroad is provided for information in Appendix C. 3.3.2.1 TechnoPartner With the start of TechnoPartner in 2004 the Dutch government has created an integrated support forum for new business development. The aim of TechnoPartner 15 is to promote more and better technology-based start-ups ("technostarters"). It is a generic and flexible programme, designed with the intention to streamline technostarter policy in the Netherlands. The TechnoPartner programme is a result of the re-design of the current and recent technostarter initiatives of the ministry of Economic Affairs (EZ) into one programme - including Twinning, BioPartner and Dreamstart. 15 http://ww.technopartner.nl 11

Beside three operational action lines, the programme has an "institutional pillar" which is focussed on the improvement of the environment in which starters operate. The programme action lines are: TechnoPartner Seed facility. This aims to promote and mobilise the Dutch venture capital market to the benefit of technostarters; TechnoPartner Knowledge Exploitation Subsidy Arrangement (SKE). This includes a Pre-Seed facility for potential technostarters and a Patent facility for knowledge institutes to professionalize their patent policies; TechnoPartner platform. This provides information and expertise to technostarters. The TechnoPartner Seed Facility participates in seed funds financed by, and managed by the private sector. The total size of the investment funds financed in the first financing round of this action line is 33.2 million (including 16.2 million government participation). These funds are: Aglaia Oncology Seed Fund, Business Angels Technostarters, Seed Fund III, Solid Capital Technostarters Fund Prime Technology Technostartersfonds HENQ Innovative Fonds TechFund These funds have recently been launched (October 2005) and the first investments in techno-starters have taken place. All funds focus specifically on seed capital for technology based starters. Specific support for informal investors is not included in TechnoPartner, although informal investors are allowed to set up a seed fund in the Seed Facility. At the moment there are no facilities for support after the seed phase within TechnoPartner. They are however expected to be operational later this year (TechnoPartner Growth facility). 3.3.2.2 Venture Capital Scheme The Venture Capital Scheme (Durfkapitaal regeling) aims at private investors who are willing to provide a loan to start-up companies. This scheme consists of three fiscal instruments: A (maximised) tax exemption (wealth tax, box 3 ) for direct and indirect investments in venture capital Tax deductions for losses on direct investments in venture capital Negative levies (Heffingskorting) for direct investments in venture capital A recent evaluation of this scheme 16 showed that the scheme was mainly used by relatives (9 out of 10 investments was done by a relative) to finance cross generation take-overs and real estate in the farmer sector. It was not very successful in attracting 16 Bureau Bartels. 2005. Evaluatie van de durfkapitaal regeling. In opdracht van het Ministerie van Economische Zaken. 12

additional investments in new and innovative companies. Informal investors do not widely use this scheme, because they normally do not provide loans to companies, but participate actively in a company. To conclude, the scheme was not successful in attracting investments in new technology based starters. 3.3.2.3 BBMKB SMEs Credit Guarantee scheme (Besluit Borgstelling MKB Kredieten) Purpose of this scheme is to stimulate the provision of credit for small and medium enterprises (SMEs). The Ministry of Economic Affairs (EZ) provides security for a part of the credit that is given by the bank to an SME. For banks, such a guarantee is an important element in the decision to provide credit (or not). A security of EZ can compensate a shortage of securities. The amount EZ provides is based on the credit need, the shortage of security, and the credit amount that the bank will give. There is a specific facility for technostarters. If they apply for a TechnoPartner label (an official statement by TechnoPartner that they are a high-tech start-up) the banks get additional security, and are therefore able to provide more credit to these technostarters. 3.4 Summary To summarize, the venture capital markets in the US, Europe and in particular the Netherlands are clearly not focused on seed and early-stage investments. This is shown in Exhibit 6. Exhibit 6 Overview of VC markets in US, Europe and the Netherlands Total VC Total other Seed Start-up investments Total Seed start-up investments as investments as excl. buy-outs (mln ) investments (mln ) investments (mln ) share of total excl. buy-outs share of total excl. buy-outs US 20.800 346 3900 1,6 % 18,6% EU 11.000 150 2200 1,4 % 20,0% NL 1.700 2,2 35 0,1 % 2,1% Source: NVCA, EVCA, NVP There is a tendency among VCs to invest in less risky expansion stage deals or profitable buyouts. This trend is expected to continue in the coming years. The seed and early stage venture capital market, in particular in the Netherlands, is very small in terms of deals and amounts invested. The high risks of failure and the cost of and time needed for due diligence makes these investments unattractive compared to later stage investments and buyouts. The figures show that there is a problem with availability of seed capital in the Netherlands, but some interviewees stress that the top really good business ideas always get funded. The natural providers of seed capital are informal investors. Informal investors and government grants seem more important providers of seed and early stage capital for new and innovative (technology based) starters than Venture Capitalist. 13

4 Venture capital investments in clean technology companies In this chapter more information is given about clean tech investments, which are taken as a proxy for eco-efficient technologies. Section 4.1 explains some of the drivers for clean tech investments and gives an overview of the venture capital markets for clean tech in the North America, Europe and the Netherlands. Section 4.2. presents some of the main challenges the clean tech area is facing. This is mainly based upon the interviews conducted for this study. 4.1 Drivers for clean technology investments Various reports and all interviewees predict a significant market growth for clean technologies. They see the following drivers for the clean tech market: Energy supply is a key problem for the coming years (if you solve energy problem all other problems are solved as well), High expected returns and making the world a better place is an extra incentive for investors to invest in clean tech, Energy and environment related investments (clean tech) are an emerging investment market with high growth potentials. The market for ICT and biotech investments is not expected to grow significantly anymore (but is still very important). Political awareness for clean technologies is high due to high oil price and security of energy (oil), Big multinational companies (Shell, BP, GE, Daimler-Chrysler, Sharp, etc) invest large amounts of money in clean tech and see clean tech as promising multi billion market in the near future (within 5-10 years) As a result clean tech investments are expected to grow at an exceptional tempo both in North America and Europe. Gathering information about VC investments in eco-efficient technologies (ecoinnovations) is however not straightforward, because detailed VC investment data are not publicly available and clean technology investments are not categorised as such in industry and sector statistics. Therefore the figures in the sections below must be handled with some care. 4.1.1 Clean technology investments in North America The most reliable and detailed information source on clean tech investments is Cleantech Venture Network 17 that monitors VC investments in clean technologies, mainly in North America. Clean technologies are not specific to a particular 17 Cleantech Venture Network LLC is an organization that connects private equity, corporate and institutional investors with "clean technology" entrepreneurs. See www.cleantech.com 14

industry and can be broadly applied to a range of industries. Examples of clean technologies include advanced energy storage, bio-based materials, filtration membranes, high-temperature superconductors, industrial process controls, etc. These clean technologies are taken as a proxy for eco-efficient technologies. Total investment into clean technologies in North America is increasing according to Cleantech Venture Network. In 2004 $1.209 billion was invested, virtually unchanged from the $1.216 billion recorded in 2003 and up 11.4% from the 2002 total of $1.085 billion. Before 2000, clean tech venture investments averaged approximately $350 million per year, while from 2000 to 2004 this is increased to more than $1 billion per year. This accounts for approximately 5-6% of all VC investments in North America 18. The average deal size in the last few years is between $6.2 and $7.2 million, in line with the average investment deals in equity across all industries and sectors in North America 19. The latest figures available from Cleantech Venture Network (Quarter 2, 2005) show that (in this quarter) 7 companies received seed capital investments in North America, which accounted for 1.4% of total clean tech venture investments. The average deal size was just about $1 million. This is in line with the share of seed capital investments across all industries in North America 20. Seed capital investments in clean tech have been decreasing over the past few years, just as seed capital investments in other sectors and industries. Another 11 companies received first round financing in Q2 2005 accounting for 10.3% of total clean tech investments. Latter stage deals receive the bulk of the investment capital capturing 88% of total clean tech Q2 2005. Energy related invested capture around 50% of total clean tech investments (approx $0.5 billion). This share has been stable for the last couple of years. According to the Deloitte and NVP Global Venture Capital survey 21, venture capitalists worldwide are planning to increase their investments in companies operating in the energy/environment sector. Twelve percent of all VCs surveyed said they are currently focusing on investments energy/environment, with that figure jumping to 21 percent over the next five years. The increased interest in energy/environment reflects the opportunities the VC industry sees in developing costeffective energy sources, Jensen, partner and national director of Deloitte & Touche LLP s Venture Capital Services Group, said. 18 19 20 21 Total venture investments in North America (US and Canada) are approx. $21 billion ($20.8 billion in the US and $1.3 billion in Canada) Cleantech Venture Monitor Q4 2004 See section 0. Seed capital investments in the US accounts for 1.68% of total VC investments The Deloitte and NVCA 2005 Global Venture Capital Survey was conducted jointly by Deloitte & Touche LLP and the National Venture Capital Association. It was administered to venture capitalists in the Americas, Europe and the Middle East (EMEA) and Asia Pacific (APAC). Deloitte received 545 responses from general partners with assets under management ranging from less than $100 million to greater than $1 billion. The survey was conducted between February and April 2005. Of the total number of respondents, 257 were based in the Americas, 141 in EMEA and 147 in APAC. 15

The Cleantech Venture Capital Network also reports an increasing interest among VC fund managers to invest in clean and environmental technologies. 4.1.2 Clean tech investments in Europe For Europe no specific figures on venture investments in environmental or clean technology are available. EVCA does provide a sectoral distribution of investments, but environmental or clean technologies are no separate category so these investments are typically categorised under energy, chemical, transportation or agriculture. If we apply the US percentages for clean tech investments to Europe, we estimate the annual clean tech venture investments in Europe at approximately 660 million per year. Seed capital investments in clean tech should the 9 million in Europe (2004). Clean tech is also an emerging sector in Europe. For example, the 2005 EVCA conference EVCA (European Venture Capitalist Association) in Barcelona had a specific session on clean tech and a Clean Tech Venture Network is launched in Europe. The interviews conducted for this study confirm this growing interest in clean tech in Europe as well. All interviewees state that there is a lot of interest to invest in clean tech among venture capitalist, business angels, and institutional investors, but actual investments are still low in Europe (excluding UK), especially in the Netherlands and Belgium. Germany, Denmark, and Spain are interesting markets for VC investments in renewable energy, because of attractive long-term policy to promote this sector. UK and US based venture capitalist focus mainly on their home-markets because expected rates of return are higher there than in continental Europe. 4.1.3 Clean tech investments in the Netherlands Specific figures about clean tech investments in the Netherlands are missing. A rough estimate can be made by applying the US percentages for venture capital investments in clean tech (clean tech investments as share of total investments) to the Netherlands. This reveals that annual clean tech venture capital investments in the Netherlands accounts for approximately 100 million. Seed and start-up capital in the Netherlands represents 2.2% of total venture investments (see section 3.3). By applying the same shares to clean tech investments we estimate the average annual seed and start-up investments by VCs in this sector at 2.2 million. Because the low share of seed venture capital in the Netherlands translation of the percentage for seed capital in clean tech in the Netherlands is not possible. There are in the Netherlands approximately 10-15 venture capital organisations that focus explicitly on sustainability and/or clean tech. This does however not mean that other venture capitalist in the Netherlands do not invest in clean tech as well, but this 16