Financing of Innovation

Financing of Innovation Presentation by Rumen Dobrinsky European Alliance for Innovation INNOVER-EAST: Training on Innovation Financing Tbilisi, 27 January 2016 1

Structure of the presentation Introduction: Why finance is key to innovation? Module 1. The Nature and Financing of Innovative Enterprises Module 2. Private Early-Stage Financing of Innovative Enterprises. Business Angel Financing Module 3. Private Early-Stage Financing of Innovative Enterprises. Venture Capital Financing Module 4. Public Policy Initiatives to Address the Early-Stage Financing Needs of Innovative Firms Module 5. The Experiences of Different Countries in the Financing of Innovative Enterprises 2

Why finance is key to innovation? The broader picture 3

What is innovation? Introduction to the market of: New products or services New business models that enhance the value of existing products or services Disrupts existing market processes Incremental (small-scale improvements) Radical new ways of doing business 4

Innovation in the modern economy Innovation is a complex phenomenon, requiring a combination of different types of knowledge and skills Involves the interactions of many actors (stakeholders): academic and R&D institutions, firms, public bodies, financiers, users, etc. Innovation is a process with highly uncertain outcomes: therefore there is a need to commit resources to reduce uncertainty 5

The innovation-finance cycle 6

How is innovation related to finance? Innovation performance and financial flows are closely interrelated and correlated Finance (relevant and adequate financial support) is a key factor driving innovation at all levels What follows illustrates these links and interrelations at the macro level 7

Measuring innovation performance (EU) The Innovation Union Scoreboard provides a comparative assessment of the innovation performance of the EU28 Member States IUS uses 25 indicators grouped in 3 categories: Enablers capture the main drivers of innovation performance external to the firm Firm activities capture the innovation efforts at firm level Outputs capture the effects of firms innovation activities Average performance is measured by a composite indicator, the Summary Innovation Index (SII) 8

Measuring innovation performance (EU) 9

Performance groups by SII Source: European Commission 10

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Regional innovation performance by SII Source: European Commission 12

Diferent innovation scoreboards Name Innovation Union Scoreboard Innovation Union Competitiveness Report OECD Science, Technology and Industry Scoreboard OECD Science, Technology and Industry Outlook Global Innovation Editing Institution European Commission European Commission INSEAD, Index WIPO Innovationsindikator Telekom Stiftung, BDI Global Competitiveness Report Knowledge Assessment Preparing Institution First Ed. Last Ed. Frequency Standard Target Number thereof structure countries of based on indicators innovation surveys MERIT 2001 2014 Annual Yes EU Member States European Commission 2011 2013 Biennial unknown EU Member States OECD OECD 1991 2013 Biennial No OECD countries OECD OECD 1998 2012 Biennial No OECD countries World Economic Forum World Bank Selection criteria 25 6 Reasoning, Correlation analysis Composite Indicator Yes 51 None No ~180 34 Reasoning No 22 (country fiches) None Not available INSEAD 2007 2014 Annual Yes World 84 None Yes Fraunhofer ISI, ZEW, MERIT Centre for Global Competitiveness and Performance World Bank 2005 2014 Annual Yes Germany and selected countries 1979 2013-2014 2001 2012 Regularly updated 38 None Model, Regression analysis No Yes Annual Yes World 116 None Yes Yes World 148 None Yes 13

Global Innovation Index 2014 (WIPO) Source: WIPO 14

Total R&D expenditure as % of GDP (2013) 15

R&D expenditure and innovation performance Source: European Commission (2013-2014) 16

R&D expenditure and innovation performance, 2013 Source: WIPO; UNESCO; OECD 17

Private equity investment - innovation performance Source: EVCA, European Commission (2013-2014) 18

SME access to finance and innovation performance Source: European Commission (2013-2014) 19

Innovation: the main financing instruments Financing instrument Grant, subsidy Business angel Venture capital Corporate venturing Key features in financing Seed funding for innovative start-ups and SMEs at the seed and early stage Financing source at early riskier stage and provides financing, advice and mentoring on business management. Invests at later, less risky growth stage. Referred to as patient capital owing to the lengthy time span (10-12 years) for investing, maturing and finally exiting. Used by large firms to invest in innovative start-ups with a view to improving corporate competitiveness with either strategic or financial objectives. Remarks Complements market failures, financing at seed and initial stage Financing at start-up and early stage Financing at later expansion stage Strategic motive Crowd funding A collective funding tool via the Internet which makes it easier for small businesses to raise capital at the seed and early stages. Still developing; potential for fraud Bank loans Needs collateral or guarantees in exchange for loans. Obligation to repay as debt Tax incentives A broad range of tax incentives for R&D and entrepreneurial investments in most countries. Indirect, non-discriminatory 20

1. The Nature and Financing of Innovative Enterprises 21

Issues covered in the module The nature and characteristics of innovative enterprises The financing needs of innovative enterprises The financing options for innovative enterprises 22

What are innovative enterprises? Innovation takes central stage in their activity Tend to be new or younger and small (startup, SME) Can grow substantially Account for over half of all innovations and almost all radical innovations Innovation opportunities: Market applications for new inventions or technological discoveries New applications for existing technologies Imitation (replication of business practices/ introducing products new to the local market) 23

Some key factors driving firm innovation Investment in education that is relevant to business. Support to investment in R&D by both government and business. Business investment in innovation strategies. Specific policy measures to create a conducive environment for firms to engage in the commercialization of innovative business opportunities. 24

What determines the prevalence of IE? Overall R&D environment R&D intensity Innovation leaders, followers, catching-up, trailing Attractiveness of entrepreneurship as a career Attitudes and aspirations towards risk and growth Workforce mobility Favorable environment of early stage financing and support (in particular for SME) 25

How innovative enterprises develop? It starts with an individual (group) and an idea Exploration of technical feasibility, market potential, and economic viability Product development Start-up of operations; market introduction Market and organizational expansion Growth 26

Financing needs in different stages Seed stage initial R&D, business concept refinement, feasibility analysis Start-up stage prototype development, market research and outreach, formal organization. Early-growth small-scale commercialization, platform for scalability Expansion substantial growth in scale and market impact. 27

Risks and roles on the journey to market 28

Risks sharing in financing innovation Risk Level Basic Research Discovery Invention Applied R&D Patenting and licensing Prototyping Public Support Public and private initiatives Grants, innovation vouchers, tax incentives Equity (BA, seed finance), convertible loans, guarantee schemes Industrialization Private Intervention VC, IPO 29

Challenges of attracting mainstream finance High uncertainty No track record, no collateral Limited evidence for feasibility and viability Possible high-rates of obsolescence Information asymmetry The entrepreneur s knowledge is tacit Hard to distinguish high- and low-quality opportunities Value is entirely based on the long-term growth potential This is why we need specialized financial institutions for early stage financing! 30

Cash Flow The dynamics of financing needs Public stock markets Debt / Bridge loans Feasibility grants Business angels Venture capital funds Founder, 3Fs Seed Start-up Early growth Expansion Valley of death Development stage 31

Innovation, risk and finance at different stages Turnover Innovation style Funding regime Early stage 0 to 500,000. Likely to pursue radical innovation. Possibly drawing on externally mobilised expertise Equity funding proof of concept / early stage fund Early development 500,000 to 20m 20m to 100m > 100m Likely to develop radical innovation. Possibly drawing on externally mobilised expertise Radical and incremental but at upper end of the turnover range. May suppress radical change if it damages an existing market Radical, incremental and open innovation, but may suppress radical change if it damages an existing market. May seek innovation from other sources such as universities, consultants or small radical innovation based companies. Equity funding angel or venture capital Self funding from revenue or floatation Self funding from mature markets 32

Types of finance in different stages Grants for assessing the commercial potential of the innovative idea/research Proof of concept (pre seed - FFF) Seed (Angel Groups; public funds) Start up (VC; public funds) Expansion (Private VC funds; Bank loans) 33

The financing sources of new firms 34

The financing sources by stages 35

Seed funding (the «valey of death») The stage of greatest uncertainty and risk Innovative enterprises ideally need financing that does not seek guaranteed repayment The 3F (Family, Friends, Fools) Merit-based awards (grants) Funding decisions are based on meeting pre-specified criteria Often provided by public agencies Substantial administrative and decision burden 36

Seed funding (contd.): external equity Match between risk profile and potential payoffs Investors have claims on the residual value of the enterprise (i.e. they share the upside) Investors also share the downside (i.e. they can lose their money entirely) Various mechanisms ensure that they get paid before the entrepreneurs do (e.g. convertible preferred stock) Examples: business angels, seed funds, incubators, venture capital funds 37

Framework conditions Capital Specialized intermediaries Entrepreneurs 38

2. Private Early-Stage Financing of IEs. Business Angel Financing 39

Issues covered in the module What is a "Business Angel What is the role of Business Angels and how do they operate? BAs and BA networks in Europe 40

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The 3F (Family, Friends and Fools) 42

Who are the Business Angels Wealthy individuals, often cashed-out entrepreneurs Make equity investments of $25-50k (up to $1-2m for syndicated deals) in promising ventures Provide substantial portion of the seed and start-up capital of innovative enterprises Provide more than capital (expertise, support) Active & passive; novice & experienced 43

Added Value of Business Angels Business angels bring more than just capital: usually have extensive business and entrepreneurial experience provide strategic, operational, and market advice can offer insights on the specific industry can introduce the entrepreneur to major stakeholders such as customers and suppliers can offer much moral support to an entrepreneur BA s reputations may carry a lot of weight in attracting highquality deals 44

How business angel investment works? Atmosphere of trust between individuals Credible business plan in the eyes of the BA Good management team Fiscal incentives Market knowledge of the entrepreneur Availability of exit route Return on investment (capital gain) 45

How much they matter? (US example) 30 60'000 25 50'000 20 40'000 15 30'000 10 5 0 Business angels Early-stage Venture capital Later-stage 20'000 10'000 0 Business angels Venture capital Amount invested (Billion USD) Number of enterprises financed 46

Key decision criteria for BAs Is proposal unsolicited or through referral? Does the business have solid fundamentals? Potential market impact Sustainable competitive advantage Is the person qualified to run the business? Does the business operate in familiar area? Is it close enough for face to face interaction? 47

Business angel networks (BAN) Pool the financial, knowledge, and information resources of a group of angels Alleviate the inefficient flow of information between (individual) angels and entrepreneurs Attract bigger deal flow Allow individual angels to diversify their portfolios and participate in more deals 48

The operation of BANs Local, regional or national in scope Organized around interests in particular sectors Offer a number of key services Matchmaking Business plan coaching to entrepreneurs Training to both investors and entrepreneurs Syndication support Co-investment funds and opportunities 49

Factors affecting BA investing Potential for promising returns Availability of growth capital Lucrative exit routes Supply of high quality enterprises Tax conditions (tax relief, capital gains tax, dividend tax) Economic conditions (growth, interest rates, inflation) Stock market conditions 50

Number of BA networks in Europe Source: EBAN 51

European BA investment Source: EBAN 52

European BA investment by country, %GDP Source: EBAN 53

European BA investment by country Source: EBAN 54

Average Investment Amount by BANs (mn ) 55

Pros and cons of BAs vs. later stage investors Advantages Disadvantages Major source of funds Possible leverage effect on other investors Less visible on the market More limited investment experience Willing to provide small amounts of funding Less extensive networks Less restricted investment criteria More opportunistic less formal analysis Lower ROI expectations Cheaper in fees to obtain finance Provides know-how, advice and contacts More patient money less pressure to exit Invests in own locality Danger of extensive intrusion in business Less professional experience Less prestigious than VC investment May have hidden motives May become Business Devils 56

3. Private Early-Stage Financing of IEs. Venture Capital Financing 57

Issues covered in the module What is "Venture Capital" How VC investment works? The VC investment cycle VC in Europe and the US Crowdfunding: introducing the issue 58

What is Venture Capital? VC performs an intermediary function, channelling funds from institutional investors to high-potential enterprises VC provides specialized investment expertise Identify potential investments Monitor, provide financing in stages Add value through oversight and guidance Depend on smooth flow of funds from institutional investors and back (with returns) 59

Main functions of VC Provision of professionally managed equity capital to promising enterprises Anticipation of exit (liquidity event) in 5-7 years Patient capital illiquid before exit The bulk (70-80%) goes to early-growth or expansion-stage companies 60

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The levers of VC finance FUNDRAISING INVESTING Institutional investors VC firms Entrepreneurial firms RETURNS EXITING 62

Venture Capital and Private Equity Private equity - provision of equity capital to enterprises not quoted on a stock market. Often associated with buy-outs or buy-ins. Venture capital provision of equity capital for the launch, early development, or expansion of a business (i.e. a subset of private equity) 63

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VC investment process Provide incentives Capital infusion tied to achievement of milestones Entrepreneurs are vested in the residual value Provide expertise Discern opportunities and threats Operational and strategic guidance Professionalization of management Provide network and legitimacy Lend extensive network of relationships Ease the concerns of customers or suppliers 65

How do VC firms add value? Pre-investment Origination, prospecting Screening and due diligence Structuring Post-investment Monitoring and oversight Value adding Exiting 66

Investment decision considerations Detailed evaluation Potential market impact Strength of competitive position Management team quality Initial screening Does it meet the fund s basic investment criteria? Is there a personal referral? Quality of the business plan (executive summary) Due diligence Third-party opinions on underlying technology Corroboration of estimates and assumptions 67

Some important criteria for VC investment Business plan credibility Business plan with patent technology Track record (over previous years) Ability to grow fast and deliver quick ROI Management team quality 68

Sample VC financing process Analysis Process Exclusivity Period (3 months) Deal Generation Pipeline Process Internal Due Diligence Non Binding Offer Due Diligence Process Final Process 2weeks-1month Mini Due Diligence Process NDA: Non Disclosure Agreement Information to the Investment Committee. DD+Legal Contracts If what you say is true, I will be able to pay you... $/. 69

Issues in fundraising Enticing institutional investors Education on VC nature and return profile Qualms about new funds, new managers Natural cycles of ebbs and flows Regulatory issues Existence of dedicated or suitable structure Exemption for cross-border fundraising Capital gain taxation Tax issues Third-party opinions on underlying technology Corroboration of estimates and assumptions 70

Issues in investing Availability of investment opportunities R&D environment Entrepreneurship as a career option; relevant education Availability of seed capital Recognition and selection of opportunities Support network for deal referrals and due diligence Industry specific skills and connections of VC managers Proper risk-return profile Effective contracts Tax treatments of convertible preferred stock Rule of law in enforcing contractual provisions 71

Issues in value adding Incentives to provide value added Stake in the upside Loss guarantees can be counter-productive Leveraging of lower-cost, public funds Ability to provide follow-on financing Small funds can be diluted in later rounds Possession of proper skills by the VC investors Career paths from high-technology settings Mobility of managers across firms and countries 72

Issues in exiting IPOs and trade sales are most lucrative routes Returns are sensitive to 1-2 big hits Successful IPOs require active stock markets, open to new securities IPO windows are sensitive to economic conditions (e.g. 2008-2009) 73

The fate of VC investments Source: Cochrane (2005) 74

Europe VC investment by stage ( mn) Source: EVCA 75

Europe private equity investment by stage ( mn) Source: EVCA 76

Sources of new VC in Europe (% new funds raised) Source: EVCA 77

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EU VC investment by country, %GDP Source: EVCA 79

VC vs. BA investment, %GDP Source: EVCA 80

VC investment in the United States Source: PwC/NVCA MoneyTree Report, Thomson Reuters 81

Crowdfunding: Introducing the issue 82

What is crowdfunding? Crowdfunding is a way of raising money to finance projects and businesses. It enables fundraisers to collect money from a large number of people via online platforms Crowdfunding is a broad concept that may apply to many different types of projects But it is also an approach to fund innovative entrepreneurial projects 83

Three main crowdfunding components 1. The project Initiator who proposes the idea and/or project to be funded 2. The Crowd/Community (individuals or groups who support the idea with money) 3. The online Platform that brings the parties together to fund and launch the idea 84

Crowdfunding vs. traditional funding 85

Types of crowdfunding Peer-to-peer lending the money will be repaid with interest. Equity crowdfunding Sale of a stake in a business to a number of investors Rewards-based crowdfunding expectations of receiving in return a non-financial reward Donation-based crowdfunding no financial or material return. Profit-sharing / revenue-sharing sharing future profits with the crowd in return for funding now Debt-securities crowdfunding Individuals invest in a debt security such as a bond. Hybrid models 86

The magnitude of crowdfunding 87

4. Public Policy Initiatives to Address the Early-Stage Financing Needs of Innovative Firms 88

Issues covered in the module The rationale for policy intervention: a systemic perspective Main types of policy interventions/instruments Public support programmes 89

Innovation in the modern economy Innovation is a highly complex phenomenon Involves the interactions/collaboration of many actors (stakeholders): academic and R&D institutions, firms, public bodies, financiers, users, etc. Innovation is a systemic process, where all components: actors/stakeholders; linkages among them and efficiency of their interactions matter 90

The National Innovation System (NIS) NIS: the network of institutions in the public and private sectors whose activities and interactions initiate and diffuse new technologies and products NIS agents: knowledge institutions (universities, research institutes, technology-providing firms), firms and government bodies The interactions and linkages between the elements of the NIS are also part of the system The flows of ideas and knowledge, as well as the ability to learn are also part of the NIS 91

The NIS of a small open economy Market demand: Domestic and international consumers, producers International business subsystem: firms; intermediaries Domestic business subsystem: Large firms, SMEs, Startups Innovation infrastructure/ intermedaries: High-tech, science and technoparks, technology transfer and innovation centres, venture capital, business angels, incubators, consultancy firms, others R&D/education subsystem: General education and training Higher Education R&D institutes Environment; Framework conditions: Financial and information systems, business infrastructure, standards, IPR rules, laws and regulations, taxation, strategies and policies 92

Policy targets and objectives in the NIS Traditional policy Systemic innovation policy Support R&D institutions Support specific R&D and innovation projects Target the concrete agents of R&D and innovation (R&D institutes and firms) Systemic coordination of the innovation process. Support linkages among innovation stakeholders. Policies to bridge sources and users of innovation. Promote collaborative models. Direct involvement in big science and large-scale technological project Catalyze/support the emergence of networks of stakeholders of large-scale innovation projects 93

The role of public policy Commercializing an innovation is a difficult process, especially for start-up entrepreneurs Entrepreneurs face a myriad of barriers in bringing their innovation to the market (finance, technology, management, regulatory, administrative, IPR protection) The main role of public policy is to establish a conducive environment for entrepreneurs to bring innovations to the market 94

Supportive framework conditions Capital Specialized intermediaries Entrepreneurs 95

The challenges of public policy Probabilistic nature of success Some enterprises will succeed But it is not clear which ones The ones that show promise need to be nurtured Balance between screening and nurturing Operating challenges Need for diverse, properly situated agents Coordination and incentives for these agents 96

Main types of policy interventions/instruments Mode of intervention Direct funding Indirect funding Credit enhancements Tax incentives Technical support Instrument Feasibility grants Public VC funds Business development grants / loans / equity Fund-of-fund programmes Debt/Credit guarantees Equity guarantees Tax rebates, loss deduction, exemption or deferral of capital gains Information dissemination Training and knowledge dissemination Business services (feasibility studies, business planning) Recipient(s) Potential entrepreneurs (Potential) entrepreneurs Incubators, technology transfer offices, micro-finance institutions (Private) VC funds SMEs Financial or micro-finance institutions Seed- or early-stage private investors Individual / corporate / institutional investors Potential entrepreneurs / investors Potential entrepreneurs /incubators / business angels Potential entrepreneurs 97

Direct funding Feasibility grants (innovation vouchers) Target potential entrepreneurs Aim to identify promising ideas Public VC funds Target potential or nascent entrepreneurs Feasibility study, start-up process 98

Indirect funding Business development grants, loans, equity Provided to incubators, technology transfer offices, micro-finance institutions Investment functions are outsourced Fund-of-fund programmes Target (private) VC funds Provide legitimacy, leverage, enhanced returns 99

Credit enhancements Debt/Credit guarantees Offered to SMEs; financial or microfinance institutions Eases up qualms about innovative enterprises Equity guarantees Offered to seed or early-stage private investors Improves economic viability and investment scale 100

Tax incentives Provided to individual, corporate or institutional investors Major forms Tax rebates for investments in certain companies Tax deduction for losses Exemption or deferral of capital gains 101

Principles of designing tax incentives General principles General versus selective measures Types of regime Incentives are transparent and accessible to many firms Incentives should not change too frequently General measures: apply to all firms and maximize the potential increase in R&D (no market distortions) Targeted measures: to reinforce technological leadership or build a critical mass (but risk creating distortions). Volume-based incentives: when market demand for R&D is stable Increment-based incentives: where there is a specific policy objective to support dynamic firms Types of relief Allowing up to the full cost of R&D expenditure to be capitalized and depreciated over a period of time Level of generosity The rate should be both attractive and sustainable in the long run Eligible R&D costs R&D current expenses Certain types of R&D-related capital expenditure (e.g. equipment), at least partly deductible. 102

Direct funding vs. tax incentives Criterion Effectiveness in boosting business R&D Ability to target industries/sectors Ability to influence business R&D Direct funding Varies depending on selection criteria, design, and capability of administrators Good Government can establish criteria Policy instrument Can affect collaboration, management of R&D Tax incentives Generates R&D in excess of lost revenue Limited. Some targeting of SMEs Limited. Can encourage increased R&D investment Selection of projects Administrative costs Government skills needed Scope of participating firms Summary Government selects among industry proposals High, need to establish bureaucracy Strong skills in selecting projects, managing programme Limited to selected firms Good for building R&D capacity in specific sectors, concentrating resources Incremental and radical innovation Industry decides without intervention Low, but hard to estimate. Enforcement costs vary Effective, efficient tax administration All R&D-performing firms, but special regimes may exist Good for providing basic financial incentive/reward to business; incremental innovation 103

Non-financial policy instruments Instruments that do not involve direct public financial support to actions implemented by non-public bodies Rely on the coordinating and convening power of the state and its capacity to stimulate linkages among stakeholders Among the most efficient such instruments are those that promote connectivity among stakeholders Others efficient instrument are those that promote risk sharing among stakeholders through knowledge sharing among them Examples: information brokerage (technology forums, fairs, exhibitions); innovation intermediaries ; knowledge services These are relatively cheap policies in terms of the claims on public resources 104

Technical and knowledge support Information dissemination Support the diffusion of information and knowledge to potential entrepreneurs and investors Close information gaps and fragmentation Training/managerial skills To boost the capabilities of potential entrepreneurs and investors Increases the rigor in the investment cycle Business services Feasibility studies, business planning Professionalization of potential entrepreneurs 105

Issues to address in public support programmes Synergies and complementarities among programmes High-level coordination of programmes Ad hoc vs. coordinated approaches Learning mechanisms in policy making Learn for others experiences Understanding of goals and results Proper and effective measurement and evaluation 106

Issues (contd.): Public vs. private funding Would financing be possible without the public programme? If yes, programme is redundant and inefficient But getting the answer is not easy Does the programme attract enterprises of marginal or poor quality? Would a private investor invest in these? Expertise and selection criteria of decision maker 107

Issues (contd.): Targeting the right recipients Is this an innovative enterprise? Carefully derived and tested operational definitions Novelty can apply to a wide range of domains product, market, process, location What is a seed-stage enterprise? What is an early-stage enterprise? Age Number of employees Assets and revenues 108

Measuring programme success Success is an elusive concept Survival, growth, profitability, social impact, etc. Common metrics are necessary for comparisons But focus on single metrics can ignore other, less tangible aspects of the enterprise Pressure to show tangible results Could lead to too much focus on short-term metrics But exclusive long-term focus begs the delicate question of whether further funding is necessary Need for set milestones and staged funding 109

Programme evaluation Key questions Have the immediate objectives been achieved? What has the programme s impact been? Careful design to balance effectiveness and efficiency Incudes the duration of public intervention/support (the right exit moment - avoid a lock-in effect ) Key design and implementation issues Displacement of private funding Targeting the right recipients Measuring success 110

5. The Experiences of Different Countries in the Financing of Innovative Enterprises 111

Issues covered in the module Types of policy programmes: an overview Leading international experiences (US, Israel) European experiences (France, UK, Finland, Sweden) 112

The objectives of public support programmes The overarching objective is to facilitate the journey from innovative ideas to the market Specific objectives may include: Closing the equity gap for startups and SMEs, Facilitating SMEs access to finance (both equity and debt) Support to the commercialization of research Encouraging linkages and connectivity among NIS stakeholders Enhanced provision of innovation support services. 113

Summary of programmes operated by country Type of measure CA US EU AT BE DK FI FR DE GR IE IT NL PT ES SE UK BG CZ EE HU LT LV PL RO SK SI IL NO CH BL KZ RU Direct funding Investments through government VC funds Investments through other government agencies Feasibility studies and other seed-stage activities Innovative SMEs Co-investments with private investors in innovative SMEs Indirect funding Investments in privately managed VC funds Financing of incubators and other early-stage intermediaries Guarantees and incentives Debt guarantees for investments in innovative SMEs Equity guarantees for investments in innovative SMEs Tax incentives for financing innovative SMEs Tax incentives for investments 114 in VC funds

Types of early stage support programs Type of programme Public fund Public/private equity fund US (SBIC)-type of refinance schemes Guarantee schemes Fiscal incentives Description 100% publicly owned funds focused on pre-seed and/or seed stages Fund in which government and private sector co-invest with same focus as previous Schemes which leverage the deals made by adding public money to the private investment Insurance schemes in which the government guarantees part of the VC money in case of bankruptcy Tax reduction schemes on value added or income tax deduction Example Twinning Growth Fund and Biopartner (The Netherlands) University Challenge Funds (UK); Technologiebeteilungesellschaft (Germany) Arkimedes (Belgium); SBIC (USA); Kreditanstalt für Wiederaufbau (Germany) Various, in each country Aunt Agaath Scheme (Nl); Banque de Développement des PMEs (France); Trust Capital Funds (UK) Incubation scheme Scheme which pays salaries of coaches, offers facilities and/or which offers network opportunities National Incubator Programme (Sweden); DIILI Programme (Finland); Innovationsmiljoer (Denmark); Exist (Germany); Les Incubateurs Publiques (France) 115

Leading international experiences: USA The SBIC (Small Business Investment Companies) Programme Small Business Act (late 1950s) The lunch of The Small Business Investment Company programme (1958) Establishment of Small Business Investment Companies (SBIC), designed to increase the availability of funds to new ventures Still in existence, after several reorganizations 116

USA: the SBIC Programme Regulation Definition SBICs must only invest in Small Businesses Small Businesses are defined as businesses with tangible net worth of less than $18 million AND an average of $6 million in net income over the previous two years at the time of investment. SBICs must invest 25% of their capital in Smaller Businesses Smaller Businesses are defined as businesses with tangible net worth of less than $6 million AND an average of $2 million in net income over the previous two years at the time of investment. 117

USA: the SBIC Pgm (contd.) Small Business Loans: General Small Business Loans Microloan Program Real Estate & Equipment Loans others The Small Business Technology Transfer (STTR) Supports public/private research partnerships for the commercialization of new technologies Grants Small Business Innovation Research (SBIR), launched in 1982 (The Small Business Innovation Development Act) 118

USA: Small Business Innovation Research (SBIR) The SBIR Program enables SMEs to explore their technological potential and provides incentive to profit from its commercialization. The most significant public support programme in the US: accounts for some 60% of the public funds in support of SME The most successful US public support programme: evaluations consistently confirm that the survival and growth rates of SBIR recipients exceed those of non-recipients. 119

The SBIR Programme is structured in three phases Phase I. To establish the technical merit, feasibility, and commercial potential of the proposed R&D efforts. Phase I awards grants $150,000 for 6 months. Phase II. To continue the R&D efforts initiated in Phase I. Funding is based on the results achieved in Phase I, the S&T merit and commercial potential of the project. Phase II awards grants $1,000,000 for 2 years. (Phase III. Where appropriate, to pursue commercialization objectives resulting from the Phase I/II R&D activities. Not funded by SBIR but success in Phase I/II give good chances to raise funding from other sources) 120

Other US policy initiatives The Advanced Technology Programme (ATP): established in 1988 to support the development of earlystage, innovative technologies by funding high-risk R&D performed by public-private partnerships California Technology Investment Partnership (CalTIP) provides grants of up to $250,000 to technology companies that receive competitive federal grants The Massachusetts Technology Development Corporation (MTDC) The oldest state managed VC fund (1978) targets early-stage and mezzanine investments, typically in the $250,000 - $500,000 range funds provided by MTDC are matched by private funds 121

Leading international experiences: Israel The YOZMA programme: Launched in 1992 with the objective of creating a competitive VC industry A $100 mn government VC fund, which were invested a) in private VC funds ($80 mn in Yozma funds) and b) directly in high-tech companies ($20 mn) Established ten drop-down funds, each capitalized with more than $20 mn Each Yozma fund had to engage one international financial institution and one domestic institution ($100 mn of government capital matched with $150 mn of private capital) Continuous growth of the programme itself: a second wave of funds attracted pension funds and other institutional investors. 122

Israel (contd.) The YOZMA programme (contd.): The $250 mn was invested in over 200 start-up companies The drop down funds had a call (buy-out) option on the government shares for up to five years could continue to be engaged in the growth phase of these companies Made direct investments in about 50 portfolio companies. Helped a number of its portfolio companies go public on stock exchanges in the US and Europe. Was instrumental in positioning its portfolio companies for acquisition or an investment by leading corporations (incl. America On Line, Cisco, General Instruments, Johnson & Johnson, Microsoft, etc.) 123

Israel (contd.) The MAGNET programme: Sponsors innovative industry-oriented technologies to strengthen the country's technological expertise and enhance competitiveness Funding is conditional on industry-science collaboration: partners must form a consortium including partner(s) from industry and academia The industrial partners enjoy a grant amounting up to 2/3 of the approved R&D costs; the academic partner can receive a grant of up to 90% of such costs 124

Israel (contd.) The Global Enterprise R&D Cooperation Framework: Objective: to encourage industrial R&D cooperation between Israeli firms and MNCs Joint projects between MNCs and Israeli companies are entitled to financial assistance of up to 50 per cent of the Israeli company s approved R&D expenses Direct investment made by MNCs in R&D projects of Israeli companies can be credited (for tax purposes in Israel), with 150% of the value of such investment 125

European experiences: France The OSEO-Garantie Programme The oldest loan guarantee scheme for SMEs Provides a guarantee to entrepreneurs who do not have easy access to the banking system Also provides guarantees to VC funds investing in innovative SMEs in exchange for a share of the fund profits Since 1982 has provided 4.2 bn in guarantees The Mutual Funds for Innovation (FCPI) programme Provide tax incentives (income tax reduction of 25% of the invested amount) to individual investors investing in funds targeting innovative private SMEs 126

France (contd.) The Regional Incubator Structures programme Supports cooperation between public research bodies and enterprises to encourage creation of technology-based firms Selected incubators have to include partnerships between universities and/or public research organizations Public grants cover 50% of the incubation expenses, linked to the number of supported projects The Seed Capital Funds measure Assists funds that invest in innovating companies The support constitutes an advance of capital to the funds reimbursable in a time span of 12 years 8 national seed-capital funds and 10 regional seed-capital funds manage some 300 mn, supporting >200 companies 127

France (contd.) The Fund for the Promotion of Venture Capital (FPCR-2000): fund of funds Takes minority shares in private venture capital funds investing in innovating companies <7 years old These funds must invest >50% of their capital in French companies and >75% in European countries The Co-Investment Funds for Young Enterprises Takes minority participations in the young technological enterprises (<7 years old) together with other investment funds established in EU countries 128

European experiences: United Kingdom Guarantee and tax schemes Small Firms Loan Guarantee Scheme: A guarantee covering 75% of the loan amount; the borrower pays a 2% premium on the outstanding balance of the loan. Guarantees loans of up to 250,000 up to ten years maturity Available to businesses that are up to five years old and with an annual turnover of up to 5.6 million. Enterprise Investment Scheme (EIS): income and capital gain tax reliefs for early stage investors Income tax rebate equal to 20% of investments up to 400,000. Exemption from capital gains tax on angel investments Income tax relief of 40% on failed investments Deferral of tax on capital gains if reinvested in EIS companies 129

United Kingdom (contd.) Direct VC funding University Challenge Seed Funds Objective: to provide access to seed funding and facilitate the transformation of research ideas The Enterprise Fund initiative Objective: to stimulate the availability of finance for small firms as well as foster regional development via 2 pgms: UK High Technology Fund: fund of funds which invests in VC funds targeting the early stage high technology SME sector The Regional Venture Capital Funds programme: a network a of regional VC funds, raising additional private investment The Community Development Venture Fund Objective: to increase private investment in enterprises in disadvantaged communities and many others 130

European experiences: Finland Overall coordination by the Finnish Funding Agency for Innovation (TEKES) Provides innovation funding for: companies, research organisations public sector service providers The main target group consists of SMEs seeking growth in internationalisation. 131

Finland: select current TEKES programmes 5th Gear 2014 2019 (wireless data communications) BEAM Business with impact 2015 2019 (dev-ping countries) EVE Electric Vehicle Systems 2011 2015 Feelings Intangible value creation and experienced value 2012 2018 (social innovation) Green Growth Towards a Sustainable Future 2011 2015 (energy efficiency, green growth). Industrial Internet Business Revolution 2014 2019 Innovations in Social and Healthcare Services 2008 2015 Innovative Cities 2014 2020 Liideri Business, Productivity and Joy at Work 2012 2018 132

Finland: other public support institutions Tekes Venture Capital Invests in venture capital funds, which invest in the early stages of development of Finnish companies Partner in 17 domestic and 27 international venture capital funds SITRA (Finnish Innovation Fund): runs a PreSeed Finance Pgm Invests in domestic early stage companies mainly through venture capital funds. Partner in 17 domestic and 27 international venture capital funds Finnvera (specialised financing company): Direct investments in early-stage enterprises through Seed Fund Vera Ltd 133

European experiences: Sweden Overall coordination by the VINNOVA, Sweden's innovation agency Mission: to promote sustainable growth by improving the conditions for innovation, as well as to fund needs-driven research. Manages programmes for strengthening Sweden s innovativeness 134

Sweden: VINNOVA programmes Programmes in strategically important knowledge areas : Health and Healthcare Transportation and Environment Services and ICT Manufacturing and Working Life Programmes fostering innovativeness of specific target groups: Innovation Capacity in the Public Sector Innovative Small and Medium-sized Enterprises The Knowledge Triangle Individuals and Innovation Milieus 135

FURTHER READING ON FINANCING INNOVATION Financing Innovative Development: Comparative Review of the Experiences of UNECE Countries in Early-Stage Financing (available at www.unece.org) Policy Options and Instruments for Financing Innovation: A Practical Guide to Early Stage Financing (available at www.unece.org) A Guide to Financing Innovation (available at www.biochemproject.eu) European Private Equity Activity, various years (available at www.evca.eu) Evaluation of EU Member State Business Angel Markets and Policies (available ate ec.europa.eu) 136

THANK YOU! Thank you! Rumen Dobrinsky E-mail: rumen.dobrinsky@eai.eu rumen.dobrinsky@gmail.com 137