The downside of public commitments to VC

To read part 1, click here.

Perhaps unsurprisingly given public funding bodies' ties to nation states, bureaucracy emerged as a major downside of securing the support of such backers. Around 30% of venture capital fund managers complain of the limitation on operational abilities; they find their investment targets limited or the bureaucratic requirements of investment committees, reporting or auditing leaving precious little time for sourcing and backing companies – their very raison d'etre.

But perhaps the most potentially pernicious element is the regional demands of certain public funding bodies. In several European countries, venture capital fund managers are only able to secure commitments from regional public funding bodies if they agree to commit a certain amount to the region in question. Spain is a particularly good example, with one such body in most of the country's 17 regions.

Said one Spanish VC: "I don't mind getting money from the Catalan or Madrid body, because I invest there normally. But if you give me money from a region where not much is happening, I'll be investing in something I don't want to invest in, so I wouldn't accept that kind of money. Regional funds are fine, but don't accept money when it doesn't make sense because you won't raise the private contributions and it will be a disaster. Or you'll be selling half-truths to investors, which is a disaster too." Given the asset class's need to pursue improved returns if it is to entice more private LPs, accepting a commitment from a regional body that requires a substantial commitment to the region could be problematic.

Losing control
For private LPs, the loss of influence and control over LPA terms and the advisory board remained a sticking point. Qualitative interviews revealed this to be a particular problem when discussing the role of European Investment Fund (EIF). One German VC with commitments from public and private sources said: "The most important thing is the rigidity of their charter and their rules of operation. You either comply or you're out – not just at the beginning, but also further down the road. And other LPs don't like that, because it is not purely just about economic drivers."

The slow decision-making process also proved problematic for private investors. Said one UK-based LP: "The problem is the lack of decision-making power some of the public funding body representatives have. Whether it's the investment terms or fund extensions, they have to go back to an investment committee and this makes for a more inefficient process. And sometimes you get quite junior people in the process. That can be a big negative. Anything to do with advisory board decisions involves a time lag and that can impact the GPs' ability to operate quickly." However, with public funding bodies such as the EIF managing the money of the European taxpayer, the fine-tooth-comb approach seems a lesser evil than rash decision-making.

Despite some thorny issues, private LPs neither saw the presence of a public funding body as a reason not to invest in a venture fund, nor as likely to lead to lesser returns. Though the multi-tiered approval process in place at the largest public bodies – with lead times of up to 12 months from initial engagement to cash in the coffers – may have an impact on the negotiation of terms, the benefits appear to outweigh these disadvantages.

For many VCs, particularly those operating in less developed venture ecosystems, the severe shortage of institutional investors in local venture funds leads to a serious reliance on public funding. "When it comes to venture capital in Spain, many investors don't understand why they should have venture capital in their portfolio. We don't have Axa Private Equity in Spain, for example, but if we did, I couldn't fundraise with them because my fund is too small. That's a catch-22 situation."

Though the relationship between public sources of capital and venture managers may be challenging at times, it provides an essential crutch as the European venture ecosystem evolves in the shadow of its Silicon Valley counterpart.

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