The State of European Venture Capital

The State of European Venture Capital

          
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The State of European Venture Capital

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    How to Develop a Universe of Privately Managed Funds of Funds

    In a nutshell, we see two ways to reshape the GP landscape by attracting a diverse mix of large, private LPs and restoring private fund-raising levels. The timely and efficient option is to ease the regulatory restrictions for pension funds, insurers, and other private investors. Tax incentives for private investors offer an effective and timely mechanism for encouraging the supply of funds.

    A second alternative will take more time. As a potential interim step, market players should consider setting up a funds-of-funds layer that could attract both private and public money. Such a structure could leverage public capital as a catalyst to scale up quickly. And it could help make the European VC market more accessible to private investors—not just by offering larger investment opportunities but also by increasing data transparency by, for example, encouraging the sharing of VC-fund performance data.

    A successful example of this approach has been implemented in Canada as part of its Venture Capital Action Plan. (See Exhibit 5.) The initiative’s objective is to increase private-sector investment in innovative businesses. The Venture Capital Action Plan has made available as much as C$350 million to establish up to four large-scale private-sector-led funds of funds in partnership with institutional and corpo-rate investors. The role of the government consisted in defining the structure of the action plan and providing financial support to the funds of funds in the form of loans. These funds of funds are active investors in VC funds as well as innovative, high-growth companies, and they are managed by leading private-investment firms.

    exhibit

    Europe could follow this example. Five to ten such sector-focused funds of funds would be sufficient to cover the most important high-growth sectors, such as software, Internet and mobile communications, life sciences and health care, energy and clean technology, hardware, electronics and robotics, and business-to-consumer and business-to-business commerce. VC funds focused on these sectors could be selected on the basis of their track records or future performance expectations, because of the management team’s expertise and experience. Fund strategies should privilege and encourage cross-border investment. The funds of funds could be equipped with a mandate to invest in both pan-European VC funds and to make direct investments (for greater and faster generation of scale and returns) in attractive startups across the entire deal-size spectrum. Such funds-of-funds investments could be supplemented by other asset classes, such as private equity, to scale up capital faster, gain diversity, and reduce risk.

    To overcome the hurdle of additional fees for the funds of funds and their lack of performance history, the funds of funds could use a distribution model with asymmetric return structures. Public investors would receive a return equivalent to speculative-grade bond returns (currently around 5 percent). All remaining surpluses and losses would fall to the private investors. Risk levels should remain unchanged to avoid distortions in resource allocation. Private investors could also have the option of buying out public funds-of-funds positions. Such a funds-of-funds structure should be outlined and initiated by public bodies such as the European Commission, but management should be in private hands. Other barriers, such as regulations—including Basel III, Solvency II, and Alternative Investment Fund Managers Directive—that historically have discouraged equity investment, should also be adapted.