French venture: Retail funds under threat

The FCPI and FIP structures were introduced in 1997 and 2003 respectively, to encourage investments from individuals in French small and medium enterprises (SMEs). FCPIs focus on innovative companies, while FIPs are dedicated to local businesses (located in the four regions surrounding the fund's base). Both structures reward investors with a tax rebate equating to 25% of the sum committed, with a €3,000 cap, while capital gains tax on the proceeds is waived. These funds have therefore proven popular and contribute a large part of French venture and growth capital financing.

Legislators were set to review the scheme this year, and examine whether it should be maintained. The Loi de Finances 2011 - equivalent to the Budget announcement in the UK - is currently being debated in parliament, and should leave venture firms happy as it will renew FCPI and FIP structures for the next two years. However, European competition rules and a general tax rebates review have led to proposed changes in the scheme's terms and conditions that do not bode well for French venture.

Of primary concern for GPs is a proposed cap on investments coming from these funds. As the new regulation stands, an eligible company will not be able to receive more than €1.5m from FIPs and FCPIs per year. Antoine Colboc, head of venture investments at Crédit Agricole Private Equity, highlights the evident shortcomings of this measure: "If you run a company in the Internet, software, electronics, or above all life sciences sector, you won't get far with €1.5m per year." He points to the inadequacy of such a cap in an environment where larger round tables are common: "This would eliminate 80% of venture funding invested over the past two years."

The move has apparently been prompted by EU competition regulation, which views the schemes as giving an unfair advantage to French fund managers over their European counterparts. Knowing the industry's lack of appetite for small cross-border venture deals, it is unlikely that such a low limit will entice European players to fund French SMEs.

Another proposed change could also threaten the scheme's attractiveness for private investors: the 25% tax rebate would be brought down to 22%, and management fees would be excluded from the calculation base. These new measures come on top of one already in effect since November 2009: the investment period for FCPIs and FIPs was shortened from 30 to 16 months, with the aim to speed up the French economic recovery. In practice, the change was seen as counterproductive by venture firms, leading to hasty due diligence processes and an incentive to invest recklessly at a time where caution is paramount.

Finally, the new legislation will effectively be back-dated, and could infuriate investors and discourage them from committing further money to the scheme. The rules would indeed apply to all FCPIs and FIPs, regardless of whether they have already received commitments. "The retroactive nature of the regulation changes is terrible: investors commit to a fund based on specific conditions, and these are being changed before their money is put to work," explains Colboc.

As it stands, the Loi de Finances leaves French venture players wary of a lacklustre FCPI/FIP fundraising environment in the future - and of the impact this could have on recovering SMEs. "Too many constraints will impact fundraising in a negative way. Today, these funds make up for about 75% of venture investments in French SMEs. The price will ultimately be paid by small businesses, which will not have access to these resources to fund their development," Colboc concludes.

The new regulation will now begin its back-and-forth trip between the two French legislative chambers. Before the hammer finally drops at the end of the year, venture firms will need to highlight the potential threats it poses to SMEs, many of which have already been hit hard by the downturn.

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