unquote” research shows VC reliance on public funding bodies

Since the bursting of the dotcom bubble, LPs have exercised caution when committing to European venture capital – and the statistics reflect that. In 2000, continental venture funds raised in excess of €34bn, according to unquote" data. Four years later, that number had plummeted to around €2.4bn.

Public funding bodies have played a large part in plugging the gap left by the institutional exodus from venture capital and now account for a large proportion of the commitments to European venture capitalists. But the relationship has not been entirely straightforward.

Fund managers bemoan bureaucracy, strategy restriction and an impact on terms. Yet, without public funding body support, the industry would have suffered an even more dramatic decline with far more depleted coffers.

It is within this context that unquote" conducted an exclusive study on the role of public funding bodies in European venture capital, consulting public and private LPs with more than 600 commitments between them, and fund managers holding more than 2,500 companies in their portfolio with upwards of 147 funds under their belts.

The largest such funding body is the European Investment Fund (EIF). Two-thirds of participants in the study had received a commitment from EIF. Its role in European venture is unparalleled. According to one UK-based VC: "If you took the EIF out of the equation in the European venture industry, you would have a major problem."

Though the relationship between public funding bodies and private fund managers may not be entirely harmonious, it is essential. Only 10% of participants in the study said they do not target public sources when fundraising, with almost 50% of GPs revealing they target them heavily.

Public endorsement
The appeal is more than purely financial. According to VCs across the board, a key benefit of securing a commitment from public funding bodies is the scale it allows them to achieve by attracting other sources of capital, such as high-net-worth individuals and family investors. Said one UK-based GP: "In terms of attracting private money, the reassurance of public money is very important. It is incredibly attractive to the private investors to have government money for them to invest alongside." A Spanish counterpart concurs, highlighting the role of public funding bodies in kick-starting the fundraising process: "It's much harder to start fundraising from private investors with 0% of the fund raised than with 30% already raised. That's what government bodies really change."

But perhaps most relevant in today's climate, which has seen the LP base for venture shrink, is the reassurance that public funding bodies provide to untapped sources of capital further afield. Given the strict due diligence processes VCs are required to pass – lamented by fund managers themselves – securing a commitment is often perceived by new investors as an endorsement of the VC's strategy and is an important accelerant in the sometimes arduous fundraising process.

Another player highlighted the EIF's warranties division and its unique convertible note initiative as a positive move to sustain the venture industry. "Under this scheme, EIF supports GPs through a warranty system that partially covers some of the write-offs a fund is bound to have in the first year of its life," the VC explained. "This helps to decrease the J-curve effect that funds often have in the first few years of their life, leading to negative IRRs. By using these warranties to return part of the write-off back to the LPs, the EIF is helping to improve the profitability of the fund."

Outside of financial support, the benefits of public funding commitments are clear. But are such bodies making full use of their influence? No, according to one VC: "Public funding bodies are the biggest investors in European venture and, as such, I think they should foster more synergies between the funds they back to encourage co-investment opportunities, sales, dealflow, and so on. They have an immense relationship network but they don't leverage it enough." Power could be better harnessed to support the ecosystem in ways that are more than merely financial.

From increased scale to reassuring private LPs, the benefits of public money are varied for both the single fund manager and the wider ecosystem. And this crucial component of the European industry is here to stay; more than 40% of venture players surveyed expect the proportion of money contributed by public funding bodies to increase in the next five years, with less than 20% anticipating a decline in commitments. The relationship is certainly long-term, but it comes at a cost.

Check back tomorrow to read the second part of our analysis, which will focus on the downsides of public commitments.

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