Government venture capital in central and eastern Europe

Abstract

The venture capital (VC) sector in central and eastern Europe (CEE) is characterised by the dominance of public resources. This is mainly due to a new type of equity scheme introduced in the European Union’s 2007–2013 programming period. The paper examines how successful the CEE EU member states, with a relatively less developed VC industry, were in using government equity schemes based on market cooperation between public and private market actors. It provides a general overview of the VC programmes launched in the CEE region viewed through the lens of academic design theories. The paper concludes that government VC programmes in the region are characterised by short time frames, administrative requirements which restricted investors, small fund sizes preventing efficient operation and limited participation of institutional investors. Compared to developed countries agency problems were much more pronounced. The limited number of business angels and incubator organisations, the high number of underfinanced promising start-ups and the misuse of government connections meant that the use of predominantly hybrid funds’ forms of government VC programmes were more challenging in the CEE region compared to western Europe. However, the greatest risk of public equity schemes – the crowding out effect on private investors – is absent in the CEE region because of the lack of private investors.

Keywords:

• Venture capital
• government venture capital
• government equity schemes
• SME finance
• central and eastern Europe

Acknowledgements

I would like to thank Thomas Mayer and Gordon Murray for their invaluable comments and suggestions. Thanks also to the anonymous reviewers for their valuable contributions. The views of this article are solely those of the author.

Notes

1. This study considers the following EU member states as belonging into the CEE region (“the region”): Bulgaria, Croatia, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Slovakia and Slovenia.

2. It was very difficult to gain precise insight into the volume of funding involved in overall and the extent to which the funds had actually been disbursed to final beneficiaries largely owed to the absence of any obligation to EU member countries to provide such information before 2013.

3. Cf. Kitsing (2013) on Estonia; Simic (2015) on Croatia; Ptacek (2014) on the Czech Republic; Becsky-Nagy and Fazekas (2015); Fazekas (2014) and Karsai (2003, 2013) on Hungary; Avots, Strenga, and Paalzow (2013); Mannick (2007) and Prohorovs (2013, 2014) on Latvia; Venckuviene and Snieska (2014) and Stanckeviciene and Lakstutiene (2012) on Lithuania; Diaconu (2012, 2017) on Romania; Gadus (2012) on Slovakia; Klonowski (2010, 2011), Murray et al. (2012) and Rudnicka and Dietl (2013) on Poland.

4. Art 44 of Council Regulation (EC) No. 1083/2006 of 11 July 2006 states that as part of an Operational Programme, the Structural Funds may finance expenditure in respect of an operation comprising contributions to support financial engineering instruments for enterprises, such as VC funds, guarantee funds and loan funds.

5. The JEREMIE programme was basically a supplementary initiative to the CIP programme of the EU.

6. The UK’s regional VC funds were unsuccessful in part because of the negative influence of regional specificity on the deal flow (DAMVAD 2014). Combination of market pipeline being poorer in technologically lagging UK regions and regional investment restrictions, combined with agency failures attributed to the funding models’ causes of underperformance (Baldock and Mason 2015).

7. The size of individual venture capital funds financed by UK regional holding funds was typically between GBP15m and GBP25m (Regeneris Consulting 2013). These UK government’s regional funds were too small in scale and narrowly focused into English regions to generate a critical mass of investment and returns (NAO 2009). Rigos (2011) recommends an ideal UK fund size of GBP50m operating over a 10 year life cycle with global funds requiring at least GBP150m. Similarly, the Technopolis (2011) review of funding models for stimulating innovative new companies in Europe recommends that hybrid funds should be large (more than EUR50m), never regionally focused, as it constraints deal flow and benefits of specialisation and properly aligned to realistic commercial incentives.

8. Some previous schemes, such as the Regional Venture Capital Funds in the UK, offered downside protection to private investors to encourage them to invest. In case of the Enterprise Capital Funds, launched in the UK in 2006, the state is preferential investor receiving its investment back first. However, private investors are given greater opportunity to benefit from success (Aubrey, Thyllaye, and Reed 2015).

9. Theoretically, applications from foreign fund managers to the managed joint funds with the state were not excluded; however, in practice it was rather complicated in the absence of local knowledge. In the scheme launched by the Polish NCF, a foreign fund manager could win only on one occasion. The situation improved over time, since the Polish BRIdge VC scheme published by the National Centre for Research and Development (NCRD) in 2014 foreign fund managers had already won both published positions (NCBIR 2014). EIF also found a renowned regional fund manager as a winner in the Romanian JEREMIE programme.

10. In the management of public equity schemes in the CEE region, a further revealed problem was caused by changes occurring in the ownership and management of fund managers after winning the tender. Some of these were caused by the fact that the owner of the fund that won the position failed to make the committed contribution on the grounds of loss of interest and due to this the public funds already awarded to that fund had to be published again. It occurred that wealthy private individuals ran into trouble due to problems with their other businesses and thus they were forced to get rid of their investments in their VC funds and to transfer their funds to other private investors. The termination of the solvency of VC fund owners affected by the broker scandals which erupted in 2015 in the Hungarian market made the operation of some hybrid funds also impossible.

11. In the UK the creation of an arms’ length public body, the Capital for Enterprise Limited, staffed by both professional financial staff and ex-civil servants allowed commercial decision-making to take place without political interference while retaining government access to valuable knowledge (NESTA 2009).

12. This information "lacuna" largely owed to the absence of any obligation to member states to provide such information. Evaluation was also hampered by the quality of the available data, as in some cases the revolved sums were included in the sums invested in recipients, in other cases interest accruing to funds under management was also invested. The inclusion of these sums made it impossible to determine precisely to what extent the operative programmes payments to financial engineering institutions were invested.

13. Small early stage VC funds in less economically developed regions commonly do not survive beyond the exhaustion of the public subsidy and are rarely in receipt of genuine “matched” private financing. The very places that can use this funding least efficiently are often the places most likely to be in receipt of this form of financing (Murray and Lingelbach 2009).