30.4.2009 EN Official Journal of the European Union C 100/15

Opinion of the European Economic and Social Committee on the Communication from the Commission to the Council, the European Parliament, the European Economic and Social Committee and the Committee of the Regions Removing obstacles to cross-border investments by funds COM(2007) 853 final (2009/C 100/03)

On 21 December 2007 the European Commission decided to consult the European Economic and Social Committee, under Article 262 of the Treaty establishing the European Community, on the

Communication from the Commission to the Council, the European Parliament, the European Economic and Social Committee and the Committee of the Regions Removing obstacles to cross-border investments by venture capital funds

The Section for the Single Market, Production and Consumption, which was responsible for preparing the Committee's work on the subject, adopted its opinion on 1 October 2008. The rapporteur was Mr MORGAN and the co-rapporteur was Mr DERRUINE.

At its 448th plenary session, held on 21, 22 and 23 October 2008 (meeting of 22 October), the European Economic and Social Committee adopted the following opinion unanimously.

1. Conclusions and recommendations via a stock market listing. Looking at the EU as a whole, it is a problem that there is not enough appetite for investing in small 1.1. The Communication from the Commission brings young companies. The EESC recommends that Member States together two important strands of the Lisbon Programme. use the taxation system to create incentives for private indi- One is the focus on the formation and growth of innovative viduals to invest in small companies. This will then encourage small companies. The other is the integration of EU capital the development of stock markets in which small company markets as a means of financing employment and productivity shares can be traded. For the time being the only such growth. The catalyst for the convergence of these two policies is markets in the EU are the Market the need to develop a pan EU venture capital industry. (AIM) in London and the Entry Standard of Deutsche Börse, although there is now an initiative from Euronext.

1.2. This Communication represents work in progress. Close cooperation will be needed between Member States, the European Commission and the VC industry to implement the 1.5. Because AIM provides the ideal transition from unquoted next steps detailed in paragraph 3.6. Following this work, the to quoted status, it makes venture capital investment in Commission will report again in 2009. unquoted companies very attractive. AIM provides the VC firms in the UK with the exits they need. Something like AIM in other Member States would provide an exchange in which to raise capital for SMEs and make a market in their shares. It could be an important factor for the development of Venture 1.3. The availability of venture capital is not a universal Capital in hitherto undeveloped EU markets. panacea. VCs are interested in big deals because a small deal can be as time consuming as a big deal. Accordingly they tend to be more interested in providing funds for the expansion of growing companies rather than providing seed money for start ups. Insofar as VCs deal with seed, start up and expansion capital, they are an important element of the Lisbon strategy 1.6. While Venture Capital is necessarily focussed on stock and the EESC supports this initiative from the Commission. It is market exits, it should not be assumed that a stock market important to improve access to venture capital in those Member flotation is the best exit for every small company. Public States where it is less developed. companies have the benefit of equity capital and their shares provide an acquisition currency, but in exchange they lose a certain freedom of action, particularly in the long term perspective, because of the demands of the market. Accordingly, Venture Capital does not provide a sensible way forward for 1.4. It is vital for the VCs that they be able to liquidate their every small company. Where an SME which is already investments. To do this they must find either a trade buyer, i.e. supported by a VC is not well adapted to an IPO, Replacement a larger company, or alternatively sell the company to Capital can provide an alternative. C 100/16 EN Official Journal of the European Union 30.4.2009

1.7. Venture capital will not meet all the demand for start-up — Seed capital is financing provided to study, assess and capital because VC firms will only invest selectively in early develop an initial concept. stage businesses. To help fill this gap, publicly funded venture capital providers can play their part but this, in turn, will still leave a gap to be filled by families and friends of the entre- preneur and by business angels. The requirement to encourage — Start-up capital is provided to companies for product devel- the provision of start up capital is a second reason why the opment and initial marketing. EESC commends to the Commission and to Member States the provision of tax incentives for private investment in start-up businesses. — Expansion capital provides the financing for the growth of a firm.

1.8. As is explained in Section 2 (Definitions), venture capital is technically a subset of . The EESC is insistent that the removal of obstacles to cross border activities of VCs — Replacement capital involves the purchase of shares in an should not facilitate without proper safeguards, other private existing company from another private equity or equity activities such as leveraged buy outs. shareholder.

— A buy-out involves the purchase of all or part of a firm from 1 1.9. In a previous opinion ( ) the EESC has already stated its existing shareholders. This may involve taking a company concern about the potential threat posed to employment from quoted to unquoted status, i.e. taking it private. In a (quality of jobs included) by private equity transactions. It is management buy-out the current managers are the buyers, essential that any such transactions are conducted within the usually with the support of private equity or venture capital. negotiating framework agreed with social partners in each Member State. Accordingly the EESC asks the Commission, in the context of this venture capital initiative, to ensure that social dialogue continues to prevail and that the Directive on infor- mation and consultation of workers applies in those cases. 2.3. Venture Capital describes investment in unquoted Further, the EESC urges again the Commission to submit a companies (i.e. companies not listed on a stock exchange) by proposal in order to update the ‘Acquired Rights’ Directive in venture capital firms which, acting as principals, manage indi- the way that transfers of undertakings resulting from operations vidual, institutional or in-house money. The main financing to transfer the shares are also covered ( 2). stages are early stage (covering seed capital and start-up), and expansion. Venture capital is thus professional equity co- invested with the entrepreneur to fund an early stage or expansion venture. Offsetting the high risk the investor takes 1.10. This concern is of paramount importance since ‘the most is the expectation of higher than average returns on investment. common exit route is trade sales to another corporation, accounting for 39 % of all exits. The second most common exit route is secondary (24 %), which have increased in importance over the last decade consistent with anecdotal 3 evidence’ ( ). 2.4. Strictly defined, venture capital is a subset of Private Equity. Private equity firms may engage in venture capital activities but their scope goes beyond the venture capital subset to include the provision of replacement capital and the 2. Definitions financing of buy-outs. The EESC is concerned about the potential social impact of these private equity activities. 2.1. The Communication from the Commission is supported by a Working Document. The Document contains an extensive glossary. The following are some of the key terms in the language of Venture Capital. 2.5. Business angels are wealthy private individuals who invest directly in new or growing unquoted businesses. Their capital can complement the venture capital industry by providing early 2.2. There are six generally recognised investment formats stage finance. used in the VC industry:

( 1 ) OJ C 10, of 15.1.2008, p. 96. ( 2 ) Directive 2001/23/EC of the Council of 12 March 2001 relating to the safeguarding of employees’ rights in the event of transfers of 2.6. Institutional investors are financial institutions such as undertakings, businesses or parts of undertakings or businesses, companies, pension funds, banks and investment OJ L 82, 22.3.2001, pp. 16-20. ( 3 ) Globalisation of Alternative Investment: the global economic impact companies which collect savings from (usually) private of private equity (p. viii), study published by the World Economic investors and then invest them in the financial markets. They Forum, 2008. have substantial assets and are experienced investors. 30.4.2009 EN Official Journal of the European Union C 100/17

2.7. Private placement is a sales method for financial 3.2. The potential of EU venture capital markets is not fully investments allowing the buyer and seller to conclude a trans- exploited and markets do not provide sufficient capital to inno- action subject to an exemption from many or all of the vative SMEs at early growth stages. The lack of an equity statutory requirements that would apply in the event of a investment culture, informational problems, fragmented public share offering. Private placement regimes generally market, high costs, untapped synergies between firms and the specify criteria for entities which are eligible to conclude trans- academic world are among the main reasons for this market actions under these conditions. This regime typically applies to failure. Divergent national policies create significant market investments made by institutional investors (which are, by defi- fragmentation which affects adversely both fundraising and nition, knowledgeable) into funds managed by venture capital investing in the EU. firms.

2.8. The prudent person rule allows pension funds to include private equity/venture capital funds in their portfolio of 3.3. While public authorities can go some way to support the investments, while respecting the risk profile of their clients. financing of innovation, the scale of the global challenge means In other words, the pension manager is obliged to invest for that only increased investment by private investors can provide his clients as he would do on his own behalf. This would a long term solution. For this, the Commission and the Member involve sensible portfolio diversification when venture capital States have to act to improve the framework conditions for is included. venture capital and one of these conditions involves removing unjustified barriers to cross border operations.

3. Gist of the Communication from the Commission

3.1. According to data of the European Venture Capital and Private Equity Association (EVCA), venture capital contributes 3.4. The strategy for improving cross border conditions significantly to job creation. Companies in the EU receiving involves free movement of capital, improved conditions for private equity and venture capital created one million new fund raising, improving the regulatory framework, reducing jobs between 2000 and 2004. Over 60 % of these jobs were tax discrepancies and progressing with mutual recognition. created by venture capital backed companies and employment in these companies grew by 30 % per annum. In addition, innovative and growth oriented firms backed by venture capital spend on average 45 % of their total expenses on R&D. (The EESC is concerned that the Commission has not been able to find independent data sources to verify this 3.5. The glossary and expert group report which accompanies analysis. We comment further in paragraphs 4.10 and 4.11 the Communication contains an analysis of the problems and below.) possible solutions (see Table I).

Table I

Problem Possible solution

Fund raising and distribution (between investors and VC funds)

Different national standards to determine qualified investors Common EU definition for a qualified investor (for institutional in private equity — VC (institutional versus private and private investors) investors)

Different national regimes concerning where institutional Using a prudent person rule (implementation of the investors can invest (country-specific restrictions) prudent person rule as defined by the Directive 2003/41/EC) C 100/18 EN Official Journal of the European Union 30.4.2009

Problem Possible solution

Difficulties in marketing private equity and VC funds in Common EU approach to ‘private placements’ different Member States due to different national approaches to private placement/exemptions from public offer rules

Tax neutrality (between VC funds and the country of investment)

Complex fund structures depending on investors’ home Taxation of capital gains in the home country of the investors; countries and investee company countries (aiming at equal treatment of direct investors and PE investors; equal avoiding double taxation) treatment of quoted and unquoted equity

Different rules and requirements for private equity funds to Tax transparency: list of mutually recognised PE fund structures benefit from tax treaties (or common criteria for Member States to determine tax trans- parency); Tax neutrality: PE funds established as limited companies (not transparent) should benefit from double taxation treaties; common requirements for benefiting from these treaties

Professional standards (for VC funds)

Different local rules for valuation and reporting (increased Encouraging use of industry self-imposed professional standards costs and a lack of comparability) (i.e. those of EVCA)

Problems in applying IFRS (International financial reporting standards) to PE funds: in particular the consolidation requirement

Permanent establishment (for the general partner or fund manager)

Risk of the general partner (VC management company) to — Mutual recognition of management companies; or passport have permanent establishment in the investee company for management companies; country (resulting in adverse tax consequences) — in the long term, a ‘passport’ for a management company

3.6. In response the Commission has put forward the lishing a European private placement regime will be issued following next steps and recommendations: in the first half of 2008 (now delayed to Q3 2008);

3.6.1. To improve fundraising and investing across borders, the Commission will: (b) identify, together with experts from Member States, cases of double taxation and other direct tax obstacles to cross- (a) analyse national approaches and barriers to cross border border venture capital investments; the expert group will private placement. A report on the possibilities for estab- report by the end of 2008; 30.4.2009 EN Official Journal of the European Union C 100/19

(c) analyse, based on these reports, the possibilities of defining 4.2. Because the venture capital industry depends on deli- common features in order to move towards an EU-wide vering good returns to its investors, the modus operandi is to framework for venture capital; raise a fund, invest the fund and then in due course liquidate the investments of the fund to deliver the expected return to the fund's investors. The life of each fund would typically be seven years.

(d) study possible ways of assisting Member States in the process of Mutual recognition.

4.3. It is vital for the VCs that they be able to liquidate their investments. To do this they must find either a trade buyer, i.e. 3.6.2. To reduce market fragmentation and improve conditions a larger company, or alternatively sell the company to investors for venture capital fundraising and investing, the Commission via a stock market listing. Looking at the EU as a whole, it is a invites Member States to: problem that there is not enough appetite for investing in small young companies. The EESC recommends that Member States use the taxation system to create incentives for private indi- (a) extend, where it is not yet the case, the ‘prudent person rule’ viduals to invest in small companies. This will then encourage to other types of institutional investors, including pension the development of stock markets in which small company funds; shares could be traded. For the time being the only such markets in the EU are the Alternative Investment Market (AIM) in London and the Entry Standard of Deutsche Börse, although there is now an initiative from Euronext.

(b) create a common understanding of the features of venture capital funds and qualified investors and consider a mutual recognition of the national frameworks;

4.4. The availability of venture capital is not a universal panacea. VCs are interested in big deals because a small deal can be as time consuming as a big deal. Accordingly they tend (c) overcome regulatory and tax obstacles by reviewing existing to be more interested in providing funds for the expansion of legislation or by adopting new laws; growing companies rather than providing seed money for startups. A case in point is , the long established UK venture capital firm. It announced at the end of March 2008 that it was pulling out of early stage investments — its worst performing sector since the collapse of the dotcom bubble in (d) enable cooperation and mutually acceptable levels of super- 2000. Its exposure to venture capital assets had already reduced vision and transparency; significantly with start-up investments representing only a tenth of its portfolio — down from half in 2000. 3I stated that there was more value in later-stage financing and that the group will focus on buy-outs, and infrastructure.

(e) encourage development of competitive clusters (along the lines of science parks);

4.5. Venture capital will not meet all the need for start-up capital because VC firms will only invest selectively in early (f) promote liquid exit markets. stage businesses. To help fill this gap, publicly funded venture capital providers can play their part but this in turn will still leave a gap to be filled by families and friends of the entre- preneur and by business angels. The requirement to encourage the provision of start-up capital is a second reason why the 4. General remarks EESC commends to the Commission and to Member States the provision of tax incentives for private investment in start- 4.1. Outside observers of the venture capital industry tend to up businesses such as those provided by the UK Enterprise focus is on VCs as providers of investment capital whereas the Investment Scheme. In this scheme, capital invested attracts VCs themselves are as much concerned about raising funds as income tax relief while capital gains from the venture are free they are about investing them. Accordingly the integration of of tax. These tax incentives make the risk reward ratio rather venture capital financing across the EU must facilitate favourable for private individuals who invest in early stage investments into VC funds as well as disbursements from them. companies. C 100/20 EN Official Journal of the European Union 30.4.2009

4.6. In the UK scheme, similar incentives apply to investments partners in each Member State. Accordingly the EESC asks the by private individuals into collective investment funds which Commission, in the context of this venture capital initiative, to take stakes in small new companies quoted on the AIM ensure that social dialogue continues to prevail and that the market. These funds are known as Venture Capital Trusts. Directive on information and consultation of workers applies Investments attract income tax relief and the capital invested in those cases. Further, the EESC urges again the Commission to is free of both gains tax and inheritance tax. submit a proposal in order to update the ‘Acquired Rights’ Directive in the way that transfers of undertakings resulting from operations to transfer the shares are also covered ( 4).

4.7. Similar incentives apply to private individuals who make direct investments into any companies listed on the AIM market. The existence of the AIM market and the tax reliefs associated with it have provided a significant impetus to 5. Specific comments on the proposals of the company formation in the UK. Commission 5.1. It is important to develop statistical instruments that will give a better picture of the hedge fund and private equity industries and to develop indicators for corporate governance, all of which are subject to harmonisation, at least at European 4.8. AIM specialises in initial public offerings (IPOs) of shares 5 in small new companies. This makes venture capital investment level ( ). in unquoted companies very attractive in the UK because by such IPOs AIM provides the VC firms with the exits they need. Development of facilities like AIM in other Member States, serving either single or multi-country markets, would provide Commission proposals to improve fund raising and investing across exchanges in which to raise capital for SMEs and make a market borders in their shares. It could be an important factor for the devel- opment of Venture Capital in hitherto undeveloped EU markets.

5.2. The establishment of a European Private Placement regime is fully supported by the EESC. It is a fundamental 4.9. The EESC is very aware that demand for venture capital requirement of cross border venture capital. needs to be created to provide the opportunity for the VC industry to flourish. This, in turn means that company formation must increase across the EU, with a commensurate increase in enterprise and innovation. The EESC simply registers this concern. It is not the purpose of this opinion to discuss 5.3. The barrier of double taxation must be removed. aspects of enterprise and innovation except to repeat the point Otherwise, cross border venture capital will not be sufficiently that if tax incentives are made available, there will be an profitable for VC firms to get involved. The EESC awaits with upsurge in small company formation. interest the report from the working party set up by the Commission to consider the taxation issues.

4.10. While the EESC is supportive of the proposals to facilitate VC activities across borders, it regrets that there is no reliable and impartial data available as the basis for its assessment. 5.4. The concept of a European wide framework for venture Indeed, independent studies suggest caution in this context capital is attractive if it results in Member States accepting VC given the ‘failure to distinguish cleanly between employment firms regulated by other states. This will help mutual recog- changes at firms backed by venture capital and firms backed nition and facilitate cross border activities by VCs without excessive bureaucracy. However, recalling the importance of by other forms of private equity’ ( 1 ). coordinating fiscal policy more closely, the Committee deems it necessary to set minimum requirements concerning the taxation of the funds’ managers in order to avoid fiscal dumping and economic inefficiency.

4.11. In a previous opinion ( 2 ) the EESC has already stated its concern about the potential threat posed to employment (quality of jobs included) by private equity transactions. Private-equity backed companies create about 10 % less jobs Proposals for Member State actions to reduce market fragmentation than similar companies in the wake of the buy out (5 and improve conditions for venture capital fundraising and investment years) ( 3 ). Further, it is essential that any such transactions are conducted within the negotiating framework agreed with social ( 4 ) Directive 2001/23/EC of the Council of 12 March 2001 relating to the safeguarding of employees’ rights in the event of transfers of ( 1 ) WEF, p. 43. undertakings, businesses or parts of undertakings or businesses, ( 2 ) OJ C 10, of 15.1.2008, p. 96. OJ L 8, 22.3.2001, pp. 16-20. ( 3 ) WEF, p. 54. ( 5 ) OJ C 10 of 15.1.2008, p. 96. 30.4.2009 EN Official Journal of the European Union C 100/21

5.5. Extending the Prudent Person rule is a fundamental 5.7. The idea of competitive clusters relates to policies in requirement for fund raising because the investing institutions support of enterprise and innovation. The idea is that clusters are the primary source of funds. It is important that Member of innovative firms would be spun out of and co-located with States create regulatory frameworks which will facilitate prudent universities. Such developments are very attractive to VCs. participation in venture capital funds by investing institutions, especially pension funds.

5.6. Member State cooperation in work on regulation and mutual recognition is needed for the Commission's initiatives 5.8. The issues relating to liquid exit markets are discussed in to proceed. Section 4 above.

Brussels, 22 October 2008.

The President of the European Economic and Social Committee Mario SEPI