Report from the Commission and the European Investment Bank to the Council - EIF venture capital activity financed from own resources

1. Purpose

The Commission and the European Investment Bank (EIB) are hereby providing the Council with a report on the European Investment Fund's (EIF) own resources venture capital operations. In a declaration on the 21st of May 1996, the Council requested receipt of such a report before the Fund's own resources venture capital operations reached 20% of own funds (paid-in capital plus retained earnings).

2. Introduction

The EIF was created in 1994 as a Public Private Partnership, with a tripartite shareholding including the EIB, the European Community represented by the European Commission, and financial institutions representing all Member States of the European Union. The activities of the EIF were focused on two target areas of Community interest, namely trans-European networks (TENs) and small and medium-sized enterprises (SMEs). It provided loan guarantees for eligible projects in both areas of activity. In 1996, the Fund was also authorized to conduct venture capital operations on its own resources in favor of SMEs, up to a ceiling of 30% of own funds. Outside its balance sheet, the EIF manages funds on behalf of the Commission and the EIB on a trust basis. The present fiduciary mandates concern substantial venture capital and guarantee facilities supporting SMEs.

In 1996, in connection with giving its approval to equity participations by the Fund from its own resources, the Council adopted the following declaration : "Before giving its support to any participations beyond 20% of the EIF's own resources, the Commission and the Bank would draw up a joint report on the issue, at the earliest in 1998. The report would examine and assess whether equity participations has been a success up to that time, and would determine whether, and if so how, the equity participations of the Fund could be extended up to the 30% ceiling set by the EIF General Meeting. The report would be examined by the Council".

Following the conclusions of the March 2000 Lisbon Summit, which called for increased support for risk capital initiatives in favour of SMEs, the shareholders of the EIF approved in June 2000 a reform of the institution with a view to making the EIF a key financial instrument of Community policy directed to SMEs. The Fund now intervenes by means of risk capital and guarantee instruments, either drawn from its own funds or within the framework of mandates entrusted to it by the EIB or the European Community.

Subsequent to the Lisbon Summit, and following the reform of the EIF, endorsed by Ecofin on 5 June 2000, the Annual General Meeting of shareholders on 19 June 2000 approved the new Statutes and Rules of Procedure that no longer contain a reference to a ceiling on equity participations.

On 24 October 2000, the EIB and EIF Boards approved the transfer of all venture capital activities of the EIB in the Union (both the existing portfolio and additional funds to carry out new venture capital operations) to the EIF, thus creating a venture capital investment potential for the EIF in the medium term of in excess of EUR 3 billion. This will provide a significant push to the European venture capital sector and notably to those sub-sectors targeted by the EIF. At the same time, it was decided to transfer the EIF's TENs business to the EIB.

In fact, the EIF is well placed to become a significant player in the European venture capital market, complementing the market forces driving supply and demand. However, to properly fulfil this role EIF needs to be able to allocate more of its own resources to the venture capital activities.

3. Description of the EIF's mission and activities.

According to Art. 2 of its statutes, the European Investment Fund contributes to the pursuit of Community objectives; in particular it is committed to the development of a knowledge-based society, centred on innovation, growth and employment, the promotion of entrepreneurial spirit, the regional development and the cohesion of the Union.

The EIF acts independently and commercially under market conditions. According to Art. 24 of its statutes, it targets appropriate returns for its shareholders.

In its role as "the risk capital arm of the EIB Group", the EIF deploys the significant financial means at its disposal to support additional investments in the European venture capital market and to counteract potential market failures. In doing so, its action is fully integrated within the strategy, which aims to equip Europe with an increasingly innovative and competitive economy, generating high quality job creation.

The EIF plays a catalytic role to attract private sector finance. It optimises the impact and benefit of those operations in which it participates in close association with the financial sector. It contributes to the diffusion of best market practices in its business fields.

EIF Management

The EIF is managed on a day-to-day basis by a Chief Executive. He reports to a Board of Directors, which brings together individuals nominated by the three shareholder groups and which meets at least four times a year. Apart from its supervisory role, the Board of Directors is responsible for approving the executive decisions (project approvals). The shareholders themselves meet once a year in the General Meeting, in particular to approve the Annual Report and Accounts as audited by the Audit Board.

EIF Investment Policy

In its venture capital activities, EIF:

* works through funds

EIF does not invest directly in companies but exclusively in specialised venture capital funds providing equity and other forms of risk capital to finance growth;

* concentrates on growing businesses

EIF gives priority to funds investing in smaller companies with high growth and job creation potential;

* operates throughout the European Union and in candidate countries or in countries adjacent to the Community insofar as cross-border projects are involved.

EIF targets funds throughout the EU focusing on European businesses;

* supports professional management teams

EIF recognizes that success demands a professional approach;

* plays a catalytic role

EIF takes minority positions which encourage commitments from a wide range of investors, especially from the private sector;

* seeks a commercial return

EIF is commercial in its approach and expects a return commensurate with the profile of the venture capital fund;

* participates on equal terms

EIF makes investments on a pari passu basis with the other investors;

* encourages best market practice

EIF expects funds in which it is involved to operate in line with best market practice.

4. Chronology of main events

* 27/3/1996 : The Supervisory Board approved the 30% ceiling for EIF's own venture capital activity, which was submitted to the General Meeting for inclusion in the Rules of Procedure.

* 21/5/1996 : The Council, in a declaration, introduced a 20% ceiling.

* 18/6/1996 : The General Meeting authorised the EIF to conduct equity operations amounting to up to 30% of own funds and noted that an interim review would be carried out once equity participation reached 20%.

* 25/9/1996 : The Supervisory Board endorsed that the EIF was bound by the 20% ceiling regarding a report to Council.

* 19/6/2000 : The new EIF statutes and Rules of Procedure introduced in the context of the reform of the EIF no longer mention any ceilings.

* 24/4/2001 : The Board decided to make a submission to the General Meeting for the removal of the 20% and 30% ceilings on EIF's equity participations. Furthermore, while not surpassing the level of own resources, it is proposed that the Board shall establish an operational limit on own resources venture capital investments taking into account existing and future own resources SME guarantees operations.

* 22/5/2001 : The General Meeting adopted the above Board proposal.

5. Present situation and first results

The EIF's main objective is the financing of innovative and job creating SMEs through its participation in venture capital funds, in the Union and in the candidate countries [1].

[1] According to Art.23 of the Statutes, "the Fund may conduct its activities (...)in countries that have applied to become a member of the Community and in respect of which the accession process has commenced, or in countries adjacent to the Community insofar as cross-border projects are involved".

Through its financing operations, the EIF acts as a catalyst, notably by backing funds, which, without it, would not have been able to get up and going so rapidly, on the same scale or with the same degree of success. As a European institution, the Fund will maintain a global overview of the venture capital market. Its interventions must generate private co-investments and contribute to the creation of a more dynamic and homogeneous market. The Fund also seeks to operate mainly in areas where market failures are hampering the establishment of an efficient and balanced European venture capital market. Such short comings may relate to a segment of the venture capital industry (i.e. seed, early stage), geographical scope (i.e. Mediterranean countries) or sectoral focus.

Its investments should focus mainly on "early stage" funds. Nevertheless, the EIF will also consider, in particular:

- capital development, notably in the case of "e-migration" investments, aimed at the dissemination of innovation among all SMEs;

- funds focused on specific industries or technologies (i.e. biotechnologies, agro business, nanotechnologies, "enabling technologies" etc.);

- regional funds ;

- funds financing the exploitation of research and development results;

- pan-European funds.

5.1. Venture capital participations on own resources

EIF signed its first own resources venture capital operation in 1997 and has committed up to year-end 2000 EUR 74.9 m to 27 venture capital funds, which have an aggregated size of EUR 1,688.2 m relating to investments in 474 companies, representing a gearing multiple of 22.

Total disbursements amount to EUR 59.5m and correspond to 79.4% of signed commitments.

Cumulative distributions (i.e. reimbursements received from funds) to date for EIF total EUR 23m or some 31% of capital invested. Of sixteen funds that have made distributions, four have already returned the capital invested by the EIF in these funds. Although it is too early to assess the overall prospective financial returns as many investments are still in the early stages and will take some years to mature, these substantial capital gains are encouraging.

EIF's own venture capital operations cover eleven Member States. Further operations may also include pan-European funds and funds in candidate countries.

With regard to targeted stages the investee funds are focused for 75% on early stage, for 22% on the expansion and 3% on the pre-IPO stage.

A detailed list of the EIF's own resources venture capital operations is annexed.

5.2. Beneficiary SMEs

The venture capital funds in which the EIF has invested on own resources have shareholdings in presently 474 SMEs for a total of EUR 764.1m. The shareholding in 19 SMEs has been divested and 10 investments have been written off.

As indicated in the annex, portfolio investments are located in 14 Member States and also outside the EU. Within the EU, the countries attracting the largest number of investments are France (23%), United Kingdom (21%) and Germany (18%).

The annex sets out that 95% of the investments can be considered to be in high technology areas, with 52% in IT and some 15% in biotech and related areas.

These investments focusing on high technology and high-growth companies, as they play a crucial role in business start-ups and their further development, have consequently an impact on job creation within the European Union. The overall impact in terms of job creation can only be judged properly at a later stage but figures known from investee companies are encouraging.

With regard to leverage effect, it is interesting to compare the EIF aggregate paid-in investments of EUR 59.5m with the total investments made by the venture capital funds, which stand at EUR 764.1m, being a multiple of 12.8.

6. Utilisation of resources

During the first years of its venture capital activity the 20% ceiling translated into a limit of roughly EUR 80m for the EIF. Against this, at end 1997, venture capital commitments amounted to EUR 25.7m and at end 1998 to EUR 58.4m. In 1999 following the rapid increase in activity in the previous two years, new commitments decreased as total commitments standing at EUR 70.9m started reaching the 20% limit.

The year 2000 saw the reform and restructuring of the EIF leading on the one hand to an increase in shareholder equity; as a result the resources available for own resources venture capital operations amounted to some EUR 91m following the increase. On the other hand, during the period of restructuring, the operational activity obviously stagnated somewhat. Following reorganisation, reorientation and relaunch, EIF looks at a strong pipeline of deal flow, with a significant number of operations already approved, foreseeing the possibility of joint EIF/EIB investments. This would require a considerable extension of EIF available resources.

7. Outlook

As risk capital specialist, EIF endeavours to position itself at the very early stage of investment where it can play a "catalytic role". It also seeks to nurture pan-European funds and to finance sectors shunned by risk capital markets, which in high technology can sometimes be driven by fashion.

To this end, in order to have a meaningful impact, the EIF, besides applying the funds, which have been made available by the EIB and the European Community, needs to utilize its own resources also to underline its commitment and highlight credibility. Indeed, a certain level of co-investment is required from the EIF in the context of the risk capital mandate managed for the EIB.

Given the increased pace and the larger amounts per investment required, the resources available under the 20% ceiling have now virtually been exhausted and therefore no new commitments would be possible. Even the 30% ceiling would only allow limited growth and would not leave sufficient room for the EIF to carry out the ambitious role entrusted to it by its shareholders. During its reform it has been acknowledged that EIF has an important role to play as European risk capital institution. The EIF's business plan for 2001 and its projections for subsequent years clearly seek to implement this mission.

To ensure that the EIF can properly fulfil this role, and the requirement under the EIB risk capital mandate to maintain a certain level of co-investment, it is necessary that its own venture capital activity be not undermined by a lack of resources. Notwithstanding this, there is a need to retain both liquid and capital reserves to support the obligations of EIF, in particular in regard to existing and future own resources SME Guarantees.

Therefore, in future, after confirmation by the General Meeting of the removal of the existing ceilings and while not surpassing the level of own resources, the Board of Directors shall establish an operational limit on own resources venture capital investments.

Annex

Key Figures

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Table 1 - Breakdown of committed capital by country

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EIF committed capital by country

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Table 2 - Breakdown of committed capital by currency

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EIF committed capital by currency

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Table 3 - Breakdown of capital drawdowns by currency

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EIF capital draw down by currency

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Table 4 - EIF Principal Figures

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Table 5 - Equity Vehicle Characteristics

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Table 6 - Equity Vehicle Onward Investments

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Chart 1 - Targeted Stage

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Chart 2 - Management Location

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Chart 3 - Investee Sectorial Breakdown

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Chart 4 - Investee Location Breakdown

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