How to get the investment machine up and running again?

This story is the third of a series of stories about what we are experiencing as a fundraising advisor being close to both startups and investors during the coronavirus outbreak. In the first two articles, we dug into the current situation from a macro perspective (click 👉 here if you want to catch up) and what was going to happen to the VC market while and after the lockdown (click 👉 here to access it). This new article focuses on how we could boost startups investments.

There are many uncertainties about the way out of the current crisis and the question that every investor is wondering about these days is the following :

Will economic expansion resume as soon as the epidemic is contained? Or will the recession be long-lasting?

Indeed, our economy already weakened by the debt crisis may not recover from this period of containment, which is reflected in a sharp slowdown in economic activity that could lead to the bankruptcy of the most fragile companies (especially early stage startups).

This situation translates in a noticeable slowdown of unlisted investments. On the one hand, the liquidity of angels investors is decreasing because of the stock exchange shakedown (-28% compared to mid-February) ; on the other hand, investment funds are sharply slowing down new investments to the benefit of their startups portfolio and also because they might have to face more hardships when raising money from LPs in the future.

Here is the million dollar question : are there any ways to get the machine running again faster?

First : Beat investments preconceptions in time of crise 🥊

It’s is quite human for an investor to start panicking when seeing its assets prices plummet. But economic crises do happen and fear can drive asset prices well below their fundamental value…thus creating opportunities for patient investors that have enough discipline and liquidity to take advantage. During the 2008 crisis, instead maintaining control, most of investors overreacted and made things worse selling their assets at low prices. However some investors saw the crisis as an opportunity and made opportunistic purchases because investing in crisis is certainly a High Risk but also a High Reward strategy.

Another investment strategy in times of crisis can be to take refuge in safe havens such as gold, real estate, artworks, certain currencies etc. That said, investors must put into perspective and keep in mind that these safe havens are not the most cost-effective in a long-term perspective. Indeed, from the following analysis of the magazine Le Revenu, it is clear that stocks are largely over performing gold, real estate and any other kind of investments…so it is fundamental to keep one’s cool and be patient!

Now, when it comes to startups funding, it is crucial that venture capitalist funds as well as individuals acting as Business Angels keep on playing the major role they are expected to play…Maybe even more Business Angels as the gap that lies between the start-up and venture capital stage might get wider.

What can the government do to accelerate the recovery ? 💡

The first thing the government had to do and did was to help the startups avoid bankruptcies. Rolling out a relief package of €4 billion to support French startups struggling during this difficult time and unblock credit was a very good starting point. Now, it is also important that the government gives as well a big push to investors to continue taking risks by investing in startups. Hereunder are a list of some ideas that could be implemented :

• Fully stimulate the PEA-PME (through tax and regulatory improvements), in particular by raising again the ceiling (already raised to 225K€ with ‘La loi Pacte’) ;
• Boost the IR-PME with a permanent increase in the tax reduction rate to 30% vs. 18% today and in the current ceiling (100K€ for married or civil union couples subject to joint taxation and 50K€ for others taxpayers today ). This ceiling should rather be 200K€ and 100K€ respectively ;
• Implement tax incentives to encourage the diversification of new retirement savings plans (RSPs) in SMEs ;
• Allow the access of private equity funds eligible for life insurance to non professional investors. Even though a decree implementing in “la Loi Pacte”, which came into force on last November, aims to broaden the range of private equity funds eligible for life insurance, their access is still more than limited, since these units of account are reserved only for professional investors ;
• Keep encouraging capital gains exemptions granted to entrepreneurs : Since 2019, a new version of Article 150–0 B ter of the General Tax Code also extends the capital gains exemptions granted to entrepreneurs selling their own company, provided that they reuse at least 60% of the proceeds of their sale in SMEs or certain funds of SMEs with an operating activity comparable to SME holding companies ;
• Encourage individuals to invest more by enhancing investments from life insurance in addition to the current PEA via crowd equity platforms ;
• Create a public fund that could complement the investment of private individuals : for each private euro invested, this fund could match with one public euro ;
• Recapitalize funds that are in the middle or at the end their investment period with public funding, which means an increase in the maximum fund holding threshold for a public player ;
• Enable public investors such as Bpifrance and the CDC to invest much more directly in startups — because they mostly have a funds-of-funds investment strategy ;
• Push banks to better manage unlisted securities with dematerialized solutions for record keeping and management in order to make operations cheaper, faster and more efficient.

Some inspiration from the UK 🇬🇧

When in a situation of crisis, it is interesting to look at how our European neighbors have been supporting their startups ecosystem because we might identify mechanisms that could speed up the exit from the crisis.

In that matter, the UK has been still far ahead of France in terms of venture capital funding. With $13.2 billion injected in 2019, the United Kingdom alone continued to surpass Germany ($7 billion) and France ($5.2 billion) combined. Why is that?

One of the reasons is that the UK has one of the most active business angel communities in the world and it is tax incentives that support this very dynamic community. To encourage innovation, the British Government has indeed implemented in 1994 the Enterprise Investment Scheme (EIS) and in 2012 the Seed Enterprise Investment Scheme (SEIS — 2 billion pounds) tax schemes. This schemes aim to facilitate early stage funding by offering tax reliefs to investors that would otherwise not back those projects because of their high risk profile.

The SEIS applies to investments in the seed phase, with small but early committed amounts (maximum amount is £150K invested) while the EIS allows the financing of start-ups in the growth phase, before the VCs intervention (limit of £12M per company).

The SEIS and EIS schemes offer respectively 50% and 30% tax reduction to the investor when he is a tax resident in the UK, a total absence of taxation on any capital gain on the capital outlay, and the carry forward of any loss as a deduction from taxable income in the opposite case. (Source SeedLegals)

To benefit from these schemes, startups must obtain a SEIS and/or EIS Advance Assurance label from the English tax authorities (HMRC). This label is the key to opening the doors to English business angels.

Maybe these schemes that notably include a deduction of the future capital losses from taxable income could be a great source of inspiration for the french government to boost early stage funding in the coming months?

Let’s not forget investors 💸

Unblocking the floodgates of credit was surely necessary but it needs to be complemented by other measures. This current crisis is different from the 2008 one and we must not forget that start-ups are mainly financed by capital increases : it is important to support investors in this context. The government has to strengthen its bailout package with strong action aimed at Business Angels and Venture Capital players. Tax measures must be strengthened to help the Business Angels framework to support startups. On the VC side, Bpifrance is a key LP but we are also awaiting the reaction of Europe and especially the European Investment Fund (EIF) that has a big role to play when it comes to the coming refinancing of European VC funds…

Sharpn is a fundraising advisor supporting ambitious entrepreneurs. We aim to support startups from late-Seed to Series A round.

So if you’re interested in our killer program please contact us at contact@sharpn.eu or visit our website https://www.sharpn.eu/