Who says the French don’t have a word for entrepreneur? George W Bush does if you believe press reports. But that perception is slowly beginning to change, as recent regulatory and legal initiatives designed to boost entrepreneurship and VC commitment in France are now starting to have an effect. James Brandman reports.
True, French investors still lack the dynamism of investors in the UK, Germany and Scandinavia, despite strong declarations made last autumn by French LPs that they would commit more capital to the asset class. For them, it’s still a question of mindset more than anything else. “In France, there is a kind of superiority complex among LBO guys as they manage the largest funds and have had more to shout about than VCs until now,” says Jean-Marc Patouillaud, managing director at Partech International. “The notion of backing innovation, R&D, and start-up companies is considered minor league in Europe compared with the Champions League of the LBO world.”
However, the number of spin-offs and new ventures in search of capital is on the rise, while deal flow and quality compare favourably with other European countries. Experienced French entrepreneurs, who a few years ago fled to Silicon Valley to realise their dreams, are also coming back home to create new ventures and form management teams.
These trends, coupled with new legal initiatives are no doubt having an effect, although some VCs argue that imposing legal structures on LPs to invest in venture is not the way to change their mindset. “France is trying to promote innovation by forcing institutional investors to invest in private equity or imposing a structure on VC funds that they invest at least 25% of their capital in innovative projects in order to benefit from tax breaks,” says Stéphane Bacquaert, general partner at Atlas Venture.
France’s venture capital association, AFIC, recently created a Small Business Investment Company (SBIC) initiative mirroring the US structure in order to drive entrepreneurship in the country. More directly targeted at seed and VC companies and their investors is the Jeune Entreprises Innovantes (JEI), or young innovative companies scheme, implemented in January 2004. In effect this is a package of tax and social charge reductions for which close to 2,000 companies are now eligible.
“It’s very visible and easy to understand and has sent the right message to investors outside of France,” says Jean-Bernard Schmidt, managing partner at Sofinnova Partners. “Thanks to this scheme, France is now ranked among the top countries in Europe for young, innovative companies, whereas before it ranked among those at the bottom.”
Qualifying JEI companies are exempt from French minimum corporate tax, which is normally payable even in the absence of taxable profits. They also avoid French corporate tax during their first three profitable years and enjoy 50% tax relief in the following two years provided they continue to meet JEI criteria. “The new regime has one important limit,” says Ben Aller, partner in the Paris office of SJ Berwin. “Because of EU rules, the total tax benefit granted under the JEI tax regime may not exceed a €100,000 reduction in tax during any 36-month period.”
Alongside this, the French Government also plans to introduce ‘Jeunes Enterprises Quotés’, a scheme for newly quoted companies that will exempt them from capital gains, succession and wealth taxes in their first eight years of trading. Companies engaged in R&D will also enjoy the same exemption on social charges as young untraded companies. In the UK the London Stock Exchange’s Alternative Investment Market (AIM) allows for very similar tax exemptions, which have been a major driver in attracting companies to list there. Still, most early stage investments in France are committed to the development space.
Talk of VC in France revolves mostly around spin-offs, or at least young companies on the road to maturity. The funding gap can really only be bridged through government-owned vehicles, such as France’s Innovation Agency. “I’m pretty sceptical,” says Bacquaert. “I don’t think top-down initiatives are the ones that bear fruit. I much prefer the bottom-up approach: promoting innovation in laboratories and giving scientists the means to spin off companies. I hope the commission will go down to that level, introduce tax breaks for the founders when they create a company, and change the way stock options are issued in France. That is what is needed today.”
France’s Allègre law has gone some way to achieving this. Implemented around five years ago, it has been one of the building blocks of France’s recovering VC environment, according to Schmidt, providing the opportunity for scientists and researchers to get involved in start-ups, own stock, sit on boards of directors, and take a leave of absence to start a company. “It has really opened up the mindset of scientists, showing them that starting up companies is no bad thing,” he says.
The more R&D that results in the formation of new companies, the better, Schmidt says. In fact, Allègre has created more biotech entrepreneurs than ever before, according to Edgard Misrahi, partner at Apax Partners. “It allows people to take intellectual property with them out of the lab, and if they fail to commercialise it, to go back into the lab again, which was a major hurdle before,” he says. Bacquaert at Atlas is not so convinced, however: “In reality, it has not had a huge impact on university spin-outs. In fact, I’m not aware of any deal recently that owed its success to the Allègre law. Rather the scientists that returned from Silicon Valley to set up new businesses in France have had a much more obvious effect.”
VC fund structures in France fall under two banners, FCPR for high-risk investments and FCPI for investments in innovation. FCPI is more regulated, with sharp constraints on investment type and timeframe. FCPR is a little less onerous and has some key fiscal advantages for French LPs. One recent important initiative is the requirement insurance companies and other institutions in France now face to increase their asset allocation to private equity. However, constraints such as the way boards of French companies need to be structured and the legalities of sitting on a board of directors still act as a drag on new company formation.
The key advantage France’s venture market can take heart from is the wide availability of public research. There is clearly a real public research strategy in France and the conditions in which researchers can spin out teams and transform them into private entities are improving all the time. The level of support public researchers now have enables them to take initiatives into the private arena more easily. “Most of the deals we do come out of those resource centres in both IT and life sciences. They come right from the lab,” says Sofinnova’s Schmidt. “But those labs could be much more productive if the way they operated were to be updated. We need to introduce such concepts as product evaluation before it gets funded and to reward scientists in a much more efficient way if they are successful.”
Schmidt is confident it’s just a matter of time before such initiatives come into force. But research labs in France need to become more commercially aware, according to Bacquaert, and become aware of the ways in which they can transform technologies into products. There’s still no structured way in which technology can be spun out from research labs and made into start-up businesses, he argues. “Just to get the patents from a public lab is a complicated process,” he says. “A public lab reacts like a government, asking for tonnes of paperwork and often a commitment to remain in France. I must confess, it’s always a headache trying to spin off companies from these groups as there is no standardisation for shareholders or IP transfer agreements in place yet.”
Nevertheless, there’s no getting around the fact that there is a wind of change sweeping through the French venture market. In February, Sofinnova Partners held a final closing on its largest ever VC fund, the €385m Sofinnova Capital V vehicle, which is also one of the largest VC funds Europe has ever seen. On the life sciences side, the fund is targeting investments in new drug development for cancer and cardiovascular disease, as well as in therapeutic medical devices. In IT, it will identify opportunities in microelectronics (including nanotechnology), semiconductors and wireless. “The fact it is larger will give us the resources to fund ambitious projects in Europe,” says Schmidt. “We can invest from €500,000 at the seed stage up to €25m in later rounds. And if we form syndicates, we can participate in capital funding up to €100m.”
But the huge size of this fund is raising more than a few eyebrows across Europe’s VC landscape. Some critics are sceptical about VC funds that are more akin to mid-cap buyout vehicles and doubt whether funds of such a size can meet the expectations of investors. “There were clearly a lot of question marks after the fund raising with people questioning whether one could reasonably expect to return big multiples on such a fund with a European positioning,” says Partech’s Patouillaud. “These are the comments you hear at cocktail parties when chatting with other VC players. People are seriously asking this question. Returning multiples of between 2.5 and 3.5 times the size of the fund would mean having to return around €1.1bn. Looking at history, it seems pretty ambitious to hope to return over a billion euros on a single European VC fund over four to five years.” Banexi Ventures Partners could draw similar criticism if it comes to market soon with a large VC fund, as rumour suggests.
Another factor that is holding back France’s venture market is the lack of any real pan-European stock market for venture-backed companies looking to go public. This has contributed to the general difficulty in making exits across Europe, with the only listing options for companies being AIM in the UK or NASDAQ in the US.
However, Euronext has begun marketing Alternext, which if successful, may provide a much needed exit avenue for French and European venture-backed companies. Over the next few months, it could become the equivalent of what the Nouveau Marché was a few years ago, but with less stringent requirements, such as a need not to be cash flow positive.
Examples of French venture-backed companies that have launched IPOs recently include BioMérieux, a firm specialising in vitro diagnostics for medical and industrial applications, which listed on Euronext in July last year. The issue was five times oversubscribed and raised more than €400m, raising hopes that the long slump in new issues had come to an end, particularly given that just three weeks previously another French biotech company, IDM, failed to raise the €100m it was seeking from its IPO to finance its expansion plans.
However, there are several successful early stage companies that have grown enough over the past few years to now be knocking at the door of the stock market. “In the next six to nine months, there is likely to be a reopening of the IPO market,” says Apax’s Misrahi. “Mid-cap stocks look to be fully valued, which will lead investors to look for opportunities among newly-listed companies.”
Clearly, the future for France’s venture market looks a lot better than it did five years ago. Together with other European markets, the French market is developing to rival Silicon Valley, particularly in the wireless field where Europe is more dominant. “Even in life sciences, Europe is at least on a par or ahead of the US in certain segments. In the last decade, the future of any technology company in Europe was to go to the US. That’s no longer true today, as those companies can, from within Europe, grow into Asia or the US,” says Schmidt.
Recent success stories in mobile data applications and service-related companies have mostly come from within Europe. Mobile gaming, for instance, boasts at least three European companies among the top six in the world, two of which are French. Admittedly, as far as enterprise and infrastructure software are concerned, a sizable presence in the US is a prerequisite. But in terms of vertical application technology, such a presence is by no means necessary. “Of course, you need a US strategy, but it’s not needed as much as in the enterprise software business,” says Partech’s Patouillaud.
Despite the positive signals VCs can take from comments made recently by French finance minister Thierry Breton and minister of the interior, Nicolas Sarkozy, namely that entrepreneurs create wealth for France, the market still has a lot to prove. “VC in Europe has not yet demonstrated that it is an asset class worth investing in,” says Misrahi. “The only time it did was in the late 1990s, a period of activity which is unlikely to be repeated in the short or medium term, and since which time, many companies of that vintage have disappeared completely. VC in France and across Europe still has to prove itself as an asset class, as very few funds have a real track record.”