A lack of attractiveness of the French market

8Venture capital funds are habitually closed off, managed by professionals and funded from private (pension funds, insurance, banks, major companies, private individuals, etc.) or public sources (States, public financial institutions). The European Venture Capital Association (EVCA) assesses the amount of venture capital in the economy of each European country, either as a fund destination (whatever its geographical origin –activity financed), or as an investing country (whatever the geographical destination of the funds– financing activity). The difference between the two “market shares” can be read as an indicator of net attractiveness. A positive difference means that activity financed by venture capital represents a greater portion of the economy than the financing of venture capital: the country “imports” venture capital needed for financing innovative companies. This is the case in the United Kingdom and Germany (figure). France is in the opposite situation: the activity of its venture capital funds slightly exceeds the investment in innovative companies in France, so that “excess” venture capital is invested abroad. [2]

Amount of venture capital funds and businesses financed, 2015, as a ‰ of GDP

Amount of venture capital funds and businesses financed, 2015, as a ‰ of GDP

Read: Narrow definition of venture capital: investments made for the launch, and the early development of a business.

9The main reasons given by international investors for France’s lack of attractiveness as a place for establishing start-ups of significant potential are employment regulation, taxation, the perceived risk of public “anti-business” interference, exemplified by Dailymotion and Uber, or the lack of internationalisation of the Parisian marketplace. In the 2015 Compass ratings, Paris was ranked 11^th in the world’s innovation ecosystems, behind London (6th) and Berlin (9th). [3] In comparison with London, Berlin or the Silicon Valley, the Parisian “tech” start-ups employ few foreign talents and are overwhelmingly financed by local investors (table 1). According to a GP Bullhound [4] study, in 2015, France had only three “unicorns” [5] globally valued at 6.7 billion dollars, whereas Germany, Sweden and the United Kingdom had, respectively, 4, 6 and 17, valued at 18, 26.5 and 40.4 billion each.

10French venture capital is growing strongly, with 484 operations totalling 1.81 billion euros of investment in 2015, ie., twice the sum invested in 2014. [6] These performances place France second in Europe after the United Kingdom for the number of operations (21% of the total), but only third after Germany for the sums invested: French venture capital on average finances smaller operations. The comparison with the United States is even less flattering: a US start-up bene fits on average from 8.3 times more development capital than a European [7] start-up.

11Observation 1. French venture capital is dynamic, but it raises funds of more modest size than elwewhere in Europe. Its successes are fewer and more limited, and the French ecosystem suffers from a lack of internationalisation.

Weakness of the business angels ecosystem

12According to the EVCA, the majority of French investments in venture capital (in broad terms) is concentrated in the Takeoff phase. The financing of the R&D and start-up phases is more difficult, especially due to the lack of business angels (BAs). According to the EBAN, [8] BAs play a key role in the creation of innovating companies. They enable the difference between financing provided by the entrepreneurial team (including its personal networks) and financing by a venture capital fund to be made up. In 2014, they represented 73% of European Start-up phase investments, a sum of 5.5 billion euros. [9] However, the economic influence of BAs is relatively low in France: in 2013, their investments represented 1.7‰ of French GDP, as against 2‰ in Germany, 4.4 ‰ in the United Kingdom and 4.6 ‰ in Sweden. [10]

13According to FranceAngels, the French federation of BA networks, in 2015 France counted 10,000 BA (1 for 6,600 inhabitants) federated in 76 networks. [11] In the same year, BAs effected 386 operations for a total sum of 41.2 million euros. [12] France is noteworthy for the small sums invested: the average investment of a French BA is half that of an English BA and 2.5 times less than a German [13] BA. In the United States, the Center for Venture Research of the University of New Hampshire counted 265,400 BAs (1 per 1,200 habitants) for 2010, financing 61,900 new companies, for a total of 20.1 billion dollars. These tens of thousands of new companies constitute a pool in which venture capital can invest. Ultimately, France is noteworthy not only for its small number of BAs, but also for the small sums they invest in the projects they support.

14Observation 2. France suffers from too few business angels with limited financing capacity.

Difficulties in the Maturity & Sale Phase

15A study by France Digitale in 2013 shows that the environment for Maturity & Sale in Europe is considered as the most critical [14] point. Exit, which enables investors and entrepreneurs to acquire a full or partial return on their initial investment, can take three forms: Listing of a company (IPOs: Initial Public Offerings), sale of the business to a purchaser, or sale (in whole or in part) to a specialised private equity fund. A favourable exit market is fundamental, as it creates a positive feedback loop in the early stages of the financing chain. While there is no consolidated data on listing of companies and sales to private companies, the qualitative France Digitale study states that nine out of ten European start-ups are sold to US purchasers.

16Observation 3. The market for listing of companies (IPOs) or sale is less dynamic in Europe than in the United States.

Performance below the European average

17According to the French association of investors for growth (AFIC), the net average venture capital internal rate of return (IRR) assessed over ten years was – 0.2% at the end of 2013, the average of the best 25% being 11.8%. [15] In Europe, the net average IRR for the same year was 1.68%, the best 25% being 15.5%. [16] This difference in performance may also contribute to the low appetite of foreign private capital for French venture capital. It does however merit closer attention, since a 2015 report of the Cour des comptes (French court of auditors) [17] on investment funds for innovation (FCPIs) and local investment funds (FIPs) showed a net average IRR based on a sample of tax funds of – 5.1% for 2014, much lower than the average AFIC, thus indicating a lower average. It would be useful to assess the net performance of French venture capital funds subscribed by institutional investors, without including FCPI/FIP tax funds to enable assessments on a comparable basis with other European funds. These poor rates of return figures suggest that there is not a main shortage of capital dedicated to start-ups in France.

18Observation 4. The return figures for French venture capital funds are below the European average.

The role of government intervention

19There are a number of arguments that justify government intervention in the financing chain for innovating companies:

• lack of long-term private investors. France lacks long-term funding. For regulatory reasons (capital ratios), banks and insurance companies can only invest limited sums in long-term risky projects. They also have management efficiency constraints (time spent/sum invested) and maximum investment ratios for subscribed funds, which naturally favours large funds. Above all, France has neither pension funds nor university endowments, which in other countries have long-term objectives and can therefore absorb risks. However, venture capital has an unforeseeable, historically low rate of return which takes 7-10 years to realize. Bpifrance’s investment policy for private funds of funds [18] is designed to encourage the emergence of benchmark long-term French investors. The France-Investissement programmes for their part aim at mobilising insurers towards venture capital;
• creation of an ecosystem. In the United States, successful entrepreneurs tend to re-invest their profits in other companies, creating a multiplier [19] effect. They contribute not only to the financing in the Start-up phase, but also to entrepreneurial competence. This channel is less present in France, especially due to successful entrepreneurs going abroad. This French difficulty of enhancing the role of private investors of this type can justify a policy of priming the pump (this is the raison d’être for the Fonds national d’amorçage, French national business creation fund), but such a policy is not built to last. Another solution would be to create the conditions (including tax incentives) encouraging entrepreneurs to stay in France;
• counter-cyclical policy. The capital-innovation market is pro-cyclical: provision of finance increases when the economy is in upswing and declines when during downswing. However, innovation needs stable financing. Government intervention is therefore justified for stabilising investment over time. Bpifrance’s investment in funds of funds during the financial crisis of 2008 therefore enabled French venture capital to survive, despite the departure of international investors. This argument makes sense: it is in that effective some gene rations of entrepreneurs have no access to favourable financing conditions. However, it leads to the political problem of reducing the influence of an institution such as Bpifrance at the spike of the cycle; [20]
• externalities and subsidies for R&D. Some investments produce significant profits for the community, but are insufficient for the private sector, which can lead to under-investment in innovation. However, government intervention in this case can use more direct (and transversal) subsidy systems rather than venture capital.

20In fact, the economic debate is not so much on the usefulness of government intervention as on its procedures, their calibration and above all their capacity to stimulate private initiative. It is useful to remember that venture capital in the US, systematically cited as an example, is in part constructed via sizeable public investment programmes and continues to rely on government intervention. The 1958 Small Business Investment Company programme (SBIC, an integral part of the Small Business Act, SBA) and even the Small Business Innovation Research (SBIR) programme of 1982 strongly supported the US [21] venture capital sector.

21However, France distinguishes itself by the significant government intervention in venture capital. In 2012-2015, the share of new funds raised by venture capital originating from public institutions [22] was much higher in France than in the United Kingdom and the Nordic countries (table 2).

22Bpifrance is a major player in direct investment in start-ups. According to tech.eu, it seems to have been the most active European investor in the 1^st quarter of 2016, with 15 operations, ahead of Index Ventures (10 operations), one of the first pan-European [23] funds. Bpifrance is also very active in indirect investment since it participates, via 262 partner funds in 2015, in half of the French capital-innovation [24] operations.

23Another French particularity is the small contribution of universities to innovation financing. Apart from the funding issue, the close links between the universities and innovation ecosystems are now well-known, due to examples such as the Silicon Valley in the US and the Wadi Valley in Israel. Historically, the US Bayh-Dole Act, adopted in 1980, has played a fundamental role. This mechanism, which gives universities and SMEs the intellectual property in inventions resulting from research conducted with funds from the Federal Government, facilitates technological transfers between universities and companies. The programme also enables the diffusion of entrepreneurial culture, using courses on the creation of companies and/or the participation of students in the analysis of capital-investment projects conducted by the university. More and more US universities have their own incubators and significant resources through their foundations, which they partly invest in venture capital. [25] The links between universities and companies are more complicated in France, despite the efforts made. A scientist who has obtained results which may be diffused through services, products or software, must declare the invention at his university’s commercialization service, which will then be taken charge of by a transfer subsidiary (for example, a technology transfer accelerator, SATT). If the inventor wants to participate in the start-up creation, appearance in front of the Commission nationale de déontologie (French national ethics commission) is mandatory.

24Observation 5. Government intention in the financing of venture capital is greater in France, but universities participate less in the innovation ecosystem compared to other countries.

Reasons for and dangers of government intervention

26The reasons for government intervention in financing young innovating companies have been set out above. They aim at compensating “market failures”, such as the existence of positive externalities linked to innovation, the pro-cyclic nature of private financing and the private sector’s difficulty of financing certain particularly risky and/or long-term segments, or creating a dynamic ecosystem. In addition, there is the lack of pension funds and private financing in the start-up phase in France. Government intervention, however well-intentioned, has certain drawbacks:

• The State, in general, has no special skills in detecting promising sectors and companies; it does not better at “choosing winners” than the private sector;
• Government intervention can oust certain private entities as it de facto has not the same profit and capital requirements;
• Pressure groups can, via the political process, obtain other options than those chosen by independent experts; [26]
• Politicians can be tempted to use government intervention for electoral purposes, whether to obtain the votes of targeted groups or to position themselves on strong and influential public opinion themes;
• Similarly, it is very difficult to end public initiatives, whether or not the initial project seems to be justified. These factors demonstrate that industrial policies are not always fruitful in the long-term and that institutions multiply them over time;
• The significant influence of the public sector can be regarded negatively by foreign investors, which might consider Bpifrance as the “strong arm” of a French State with a “protectionist” reputation (especially after the conflicts with Uber and prevention of the Daily motion sale), or fear geographical quotas for French market exposure.

Bpifrance: A fragile success

27Created in 2012 by fusion of Oséo, CDC-Entreprises, the FSI and FSI-Régions, the French public investment bank (Bpifrance) is 50% State-owned and 50% owned by the Caisse des dépôts et consignations (French deposit and consignment office). Its Managing Director (MD) is appointed by the Minister of Economy. Its Board of Directors has 15 members: 8 shareholder representatives, 2 regional representatives, 2 staff representatives and 3 qualified personalities (including the MD). Bpifrance was created to finance companies from the Start-up to the Maturity & Sale phases, by transmission of loans, sureties and shareholder equity. In partnership with Business France and Coface, it also accompanies exporters and helps with their innovation projects. Only part of its business is concerned with venture capital. This is divided between funds of funds and direct funding (box 2).

2. Business of Bpifrance in 2015 (current)

Notes: ^a Including private financing; ^b Including Telethon financing; ^c 2014 and non-current flows.

28According to the Grandguillaume report, Bpifrance has a fixed objective of a positive overall return, around 3 to 4% per year on shareholder equity, for the whole institution. [27] Performance should be assessed over time: the rationality of recent decisions can only be assessed over several years. Mid-2014, the result shown by the capital-investment branch, as from 1998, was an overall return on investment of 1.10 euros for 1 euro invested (with 0.46 euros in latent capital gain). [28] This type of “return” on investment does not take into account the duration of capital mobilisation, which renders interpretation difficult; it is clearly less than 3% p.a. It is also a financial return, whereas ideally, one should assess the social profitability of the investment. [29]

29Many actors interviewed by us emphasised the competence and independence of Bpifrance’s current teams, while questioning the durability of a virtuous balance, which seems strongly dependent on the current Board and not on the institutions themselves. The institution seems susceptible to future political pressure.

From university research to industrial innovation

43As opposed to the United States, the university system in France plays a secondary role in the emergence of start-ups. Certainly, the world success stories are not all based on cutting-edge innovations in IT or biotechnology (cf., for example, Facebook, Airbnb or Uber). But while the quality of French engineers and scientific results is highly regarded abroad, France has relatively few international successes in the hightech domain, despite its scientific prowesses.

44Our enquiries reveal certain weaknesses in the process (some of which are already clearly identified in the Berger report, 2016, op. cit):

• Lack of streamlining. The accumulation of the resources of universities and public scientific and technological establishments and other public bodies (which are often partners of laboratories) implies a major loss of returns to scale. The same applies to accumulation of structures within university centres: SATT (technology transfer accelerators), IRT (technological research institutes), Carnot (a French technological institute), competitivity centres, etc. [36] Another cause of a major loss of returns to scale is geographical dispersion. One example: Commercialization, which is a SATT’s competency, is a real occupation requiring international experience for deciding which patents are worth developing and at what price, whether the rule of exclusiveness for licences can be circumvented, which partners to look for, etc. It also requires specialisation; an IT engineer is hardly well-placed for negotiating a licence for a pharmaceutical patent. It is undoubtedly better to have these skills –necessarily rare and costly– at the national level, even if it means maintaining local contacts;
• Selection of and incentives for commercialization staff. In connection with the above, our academic research contacts pointed out the difficulty in finding the skills required for commercialization in France. They also referred to inappropriate performance figures, such as the
  number of patent filings, patents or start-ups created, quantitative data which is hardly relevant if most of these patents and start-ups are of no value;
• Commercial valuation. Too much attention is paid to the sale of patents. The profits of valuation are only one component of the equation, as the example of US universities shows. The economic benefits in terms of start-ups (in commercial value, not in number) and employment are significant.

45Recommendation 4. Encourage the involvement of the scientific community in the entrepreneurial momentum in France.

46This objective could be pursued by simplifying the procedures enabling researchers to exploit their inventions/innovations commercially, by implementing specific systems for exchanges between start-ups and universities (start-up work experience for science students integrated into the course, establishment of CIFRE [37]-SME theses, etc.) and in encouraging the reciprocal presence of scientists on governing bodies (Bpifrance’s Board of Directors, CGI, etc.) and entrepreneurs on university governing bodies (University Boards, etc.).

Taxation of institutional investors: The need for international visibility

48French venture capital funds for institutional investors (professional capital investment funds, FPCIs, and free partnership companies, SLPs) are exempt from capital gains tax on exit. The French subscribers are therefore only taxable (at 15.5%) with payment of the CSG-CRDS (general social contribution/contribution to repayment of State indebtedness) and with the exceptional Fillon contribution for high incomes (3 then 4%). This puts taxation under the French “exempt” scheme virtually at the English maximum capital gains rate (20%).

49French investment funds are not a common structure in Anglo-Saxon law. Indeed, taxation of FPCIs and SLPs is litttle known by foreign investors, including Anglo-Saxons, which are used to fully transparent structures. Foreign investors are therefore disorientated by this type of structure, which differs from partnerships, with which they are familiar, and they understandably question the taxation of their investments. To reassure international investors, including Anglo-Saxons, regarding taxation and in default of harmonising European or international taxation, it would be useful for the French tax authorities to issue clear instructions on the taxation of foreign tax residents investing in funds such as FPCIs or SLPs. Otherwise, the commercialisation of these funds in other European or foreign countries will continue to be difficult and expensive. It would be useful to facilitate the formalities for obtaining the EuVECA passport from the Financial Markets Authority and to simplify the procedures for subscribing to these funds (electronic signature, digitisation of legal documents, etc.).

50Recommendation 5. Clarify taxation for foreign, private or institutional investors subscribing to French venture capital funds and simplify their access.

Review the taxation of entrepreneurs for creating virtuous “recycling”

51A common point of acknowledged entrepreneurial ecosystems is that successful entrepreneurs or their employees contribute both financially and operationally to the creation or training of the following generation of entrepreneurs. [40] A key area in this regard, for projects and financiers, is taxation.

52Two fiscal mechanisms will affect the capacity and desire of a successful entrepreneur to become a business angel for start-ups of the next generation: capital gains taxation and reinvestment in start-ups.

Encourage investment by French savers in venture capital