State aid — Invitation to submit comments pursuant to Article 88(2) of the EC Treaty, concerning aid C 56/2000 (ex N 334/2000) — Regional Venture Capital Funds (Text with EEA relevance)
Date: 2001-01-27
Institutions: European Commission
Subjects: State aid, United Kingdom, control of State aid, regional aid, small and medium-sized enterprises

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Official Journal of the European Communities

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Invitation to submit comments pursuant to Article 88(2) of the EC Treaty, concerning aid
C 56/2000 (ex N 334/2000) (cid:151) Regional Venture Capital Funds

STATE AID

(2001/C 27/04)

(Text with EEA relevance)

By means of the letter dated 7 November 2000, reproduced in the authentic language on the pages
following this summary, the Commission notified the United Kingdom of its decision to initiate the
procedure laid down in Article 88(2) of the EC Treaty concerning the abovementioned aid.

Interested parties may submit their comments on the aid in respect of which the Commission is initiating
the procedure within one month of the date of publication of this summary and the following letter, to

European Commission
Directorate-General for Competition
State aid Greffe
Rue Joseph II/Jozef II-straat 70
B-1000 Brussels
Fax (32-2) 296 12 42.

These comments will be communicated to the United Kingdom. Confidential treatment of the identity of
the interested party submitting the comments may be requested in writing, stating the reasons for the
request.

SUMMARY

not meet legal, moral or ethical standards, nor in SMEs that are
in difficulty (2)

DESCRIPTION

The (cid:145)Regional Venture Capital Funds(cid:146)
is a scheme providing
equity capital to small and medium-sized enterprises in each
of the English regions. The amount invested in each enterprise
is limited to GBP 100 000/500 000, since the UK authorities
have identified a reluctance on the part of British institutional
investors to invest such relatively small amounts. They have
also found that it is more difficult for SMEs outside London
to attract investors, which explains why the funds will operate
regionally.

The scheme as such will be administered by the Department
for Trade and Industry, based on the Industrial Development
Act 1982, Section 8. The budget is GBP 50 million over three
years. It is expected that private investors will contribute up to
five times that amount. The UK authorities intend to be a
minority investor in each fund.

A rough estimate is that about 300 SMEs will be able to
benefit from investment each year. A number of
identified
sectors considered relatively low-risk will not be eligible for
investment (1), but there is no particular focus on high-tech-
nology companies. The funds may not invest in SMEs that do

(1) Dealing in land, commodities, futures, shares, securities of financial
instruments; dealing in goods (other than in normal wholesale or
insurance, money lending, debt factoring,
retail trades); banking,
hire-purchase financing and other financial activities;
leasing or
letting assets on hire, except in the case of certain ship chartering
activities; providing legal or accountancy services; property devel-
opment, farming, forestry or market gardening.

seek a commercial

The managers of each fund will be selected through a
Community-wide tender. Experience of the fund manager in
the particular region may be an important, but not decisive,
criterion. The fund managers will invest on commercial terms.
return on its
The Government will
investment, although this return may be subordinated to that
of private investors at the minimum level required in order to
stimulate the creation of any fund. The extent of the subordi-
nation in each fund is determined through a public tender
limited to England.
It is expected that the internal rate of
return will be at least 12 %, which the UK authorities claim
would be in line with data currently available on investments
in this segment of the venture capital market.

1. ASSESSMENT

By notifying the scheme, the United Kingdom has complied
with its obligation under Article 88(3) of the EC Treaty.

1.1. Application of Article 87(1) of the EC Treaty

fund will

contain State

resources. The
Each regional
Commission finds that these State resources benefit operators
at two levels, namely at the level of (i) the private investors in
each regional fund; and (ii) the small medium-sized enterprises
in which the regional funds invest. Potentially, the scheme also
benefits the regional funds themselves, but this is conditional
on their status as undertakings.

(2) See Community guidelines on State aid for rescuing and restruc-

turing firms in difficulty (OJ C 288, 9.10.1999, p. 2).

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Through the subordination of its return on investments, the
State grants benefits to the private investors in the funds,
thereby strengthening their position compared to their
competitors in other Member States. Through the State inter-
vention, the SMEs in which the regional funds invest will have
access to equity capital that they would not have had access to
otherwise. Therefore, there is a benefit for them, which can
strengthen their position in relation to their competitors in
other Member States.
In both cases, the aid must therefore
be regarded as affecting trade and distorting or threatening
to distort competition.

TEXT OF THE LETTER

(cid:145)Sir,

The Commission wishes to inform the United Kingdom that,
having examined the information supplied by your authorities
on the measure referred to above, it has decided to initiate the
procedure laid down in Article 88(2) of the EC Treaty.

PROCEDURE

On the condition that the regional funds themeselves constitute
undertakings, the Commission does not exclude that there is
State aid to them as well. The fact that they will operate with
public participation could strengthen their position vis-(cid:224)-vis
private funds active in the same segment of
the venture
capital market.

By letter dated 26 May 2000, registered on 7 June 2000, the
UK authorities notified a new scheme called (cid:145)Regional Venture
Capital Funds(cid:146). The Commission requested further information
by letter dated 25 July 2000, which the UK authorities
submitted by letter dated 21 August 2000, registered on 24
August 2000.

1.2. Doubts regarding the compatibility under Article

DESCRIPTION

87(3)(c) of the EC Treaty

Firstly, the Commission would like to express a general doubt
concerning the incentive effect of the notified State aid scheme.
Among other things,
the British
Venture Capital Association has (cid:145)15 members in England who
invest under GPB 250 000 and have an average investment
size of GBP 500 000 or under
technology
specialists)(cid:146).

it can be mentioned that

(excluding

Rationale

The general purpose of the scheme is to address a lack of
equity funding at regional
level. An (cid:145)equity gap(cid:146) has been
identified in the range of GBP 100 000 to 500 000 for small
and medium-sized enterprises (SMEs) based outside the London
area, where most venture capital firms are located.

foresee a link between the aid
The notification does not
provided to the private co-investors and the SMEs and any
expenditure which can be considered to constitute eligible
costs under the Community guidelines on State aid to small
and medium-sized enterprises (3) or the guidelines for national
regional aid (4). This is true for the aid to the private investors
as well as for the aid to the SMEs, and for the potential aid to
the funds themselves. It cannot therefore be excluded that this
type of investments constitutes operating aid. Operating aid
can only be allowed in regions qualifying for an exemption
the aid is
under Article 87(3)(a) of
progressively reduced and limited in time. All of
these
conditions do not seem to be fulfilled in this case, as the
scheme is not limited to assisted areas, and it is not foreseen
to progressively reduce the aid.

the EC Treaty, and if

It

the present

development,

are Community

objectives,
scheme

is uncertain whether a call

Moreover, although the development of SMEs, as well as
the
regional
really
Commission doubts whether
the aid is the minimum necessary to achieve
ensures that
these objectives.
for tender
limited to England will be wide enough to ensure that the
subordination requested is the least necessary for a regional
fund to be set up. However, this has to be weighed against
the importance of local and regional knowledge for the success
of these funds perceived by the UK authorities. In addition, the
limitation might constitute an infringement of Article 43 of the
EC Treaty on the freedom of establishment and/or Article 56 of
the EC Treaty on the free movement of capital and if so, the
scheme cannot be approved.

to

larger

pursue

investments

According to the UK authorities, the existence of this equity
gap is due to the relatively high fixed costs for the remun-
eration of the investment executives. This cost and the direct
costs for due diligence and legal documentation do not fall
proportionately with smaller sizes of
investment and may
rise. Consequently, there is an incentive for venture capital
firms
in more mature
companies so that costs can be reduced relative to investment
value, enhancing returns and lowering management charges to
investors. Investors therefore seek to identify investments where
growth is likely to be so exceptional that the capital gain more
than compensates for the very high early costs. Consequently,
they demonstrate a reluctance to invest in businesses that need
equity-based investments in amounts below GBP 500 000, are
not in leading edge technology sectors and are located outside
London. At the same time, there is a widespread acceptance of
the potential benefits of venture
financing,
including the entrepreneurial drive and sound management
techniques which it can bring to an SME.

capital-type

The (cid:145)Regional Venture Capital Funds(cid:146)

fund in each of

The authorities are planning to establish at least one regional
the English regions and a
venture capital
maximum of 10 funds in total. The scheme is not limited to
assisted areas. The scheme as such will be administered at
central government level, although each regional fund will be
a separate legal entity governed by agreements between
investors. The funds are expected to take the form of limited
partnerships and have a 10-year life expectancy.

(3) OJ C 213, 23.7.1996, p. 4.
(4) OJ C 74, 26.3.1998, p. 9, as amended by OJ C 258, 9.9.2000, p. 5.

The legal basis
Section 8.

is

the Industrial Development Act 1982,

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The budget foreseen is GBP 50 million over three years. It is
expected that private investors will contribute up to five times
that amount. The Government
to be a minority
investor in each fund.

intends

The selection of a fund manager and the establishment of
a fund

A person who wants to set up a fund in a particular region is
called a (cid:145)sponsor(cid:146). It can be a natural or legal person including
a regional development agency. The sponsor will appoint a
manager for the fund based on a Community-wide public
tender (5). All of
those entering the competition will be
expected to have authorisation from the financial services
authority and to operate according to British Venture Capital
Association guidelines. The main criterion for appointment will
be experience of, and success in,
fund management in the
(cid:145)equity gap(cid:146) part of the market. A track record in the particular
region may be one of the criteria that prospective sponsors
may wish to take into account but lack of experience in a
particular region will not, on its own, prevent a prospective
fund manager from entering a competition in that region. The
UK authorities believe that to insist on a proven track record in
the open
any region prior to appointment would restrict
competition for
fund
managers. However, prospective fund managers will have to
demonstrate that they have strategies in place to ensure that
their expertise could be transferred and utilised in the region.

the process of

appointment of

region that have not

The selected fund manager will proceed to select private
the fund. The focus will be on institutions
investors for
within the particular
traditionally
invested in this market, e.g.
local authority pension funds.
However,
fund managers are not prevented from accepting
investment from any other potential investor in England. The
UK authorities see it as a possibility that some institutions may
wish to invest in all the English regions in order to widen the
geographical portfolio of their investment. Once the sponsor
has found a manager and the manager has found investors, the
investors agree on the terms on which they will be prepared to
invest in a regional fund. The next step is a public tender, in
which the perspective sponsors in England submit the bids they
have agreed with their investors. One of the selection criteria
in the tender procedure will be the extent of the subordination
of State returns that potential co-investors request. Sponsors
have to explain in their bids why they believe that
the
degree and type of subordination is the minimum necessary
to attract private investors.

The selection is carried out by an independent appraisal board,
which is a sub-committee of the newly created small business
investment taskforce (SBIT). It will consist of members from
investors,
venture capital academics, experienced institutional
financial
institutions, the regional development agencies and
venture capitalists. The final decision to make a commitment
to invest Government money in any fund will remain with the
to invest will
State.
generally follow the advice of the board.

the decision to commit,

In practice,

(5) Those prospective sponsors for the creation of a fund that are
required to

already authorised fund managers will not be
undertake a competitive process to appoint themselves.

The investments

The regional funds may only invest in small and medium-sized
enterprises that fulfil the Community definition (6) and are not
in difficulty. Furthermore, the funds may not invest in SMEs
that do not meet legal, moral or ethical standards, nor in
companies active in the production, processing or marketing
of products listed in Annex I of the Treaty. A rough estimate is
that about 300 SMEs will be able to benefit from investment
each year. The only form of investment is equity shareholdings,
for an amount of GBP 100 000 to 500 000. The funds may
not invest in the following sectors, considered to be low-risk
and not requesting public stimulation:

(cid:151) dealing in land, commodities futures, shares, securities or

other financial instruments,

(cid:151) dealing in goods (other than in normal wholesale or retail

trades (7)),

(cid:151) banking,

insurance, money lending, debt factoring, hire-

purchase financing and other financial activities,

(cid:151) leasing or letting assets on hire, except

in the case of

certain ship chartering activities,

(cid:151) providing legal or accountancy services,

(cid:151) property development,

(cid:151) farming, forestry of market gardening,

(cid:151) operating or managing hotels or nursing or residential care

homes.

The return on investments

It

terms.

invest on commercial

The fund managers will
is
expected that the internal rate of return will be at least 12 %,
which the UK authorities claim would be in line with data
currently available on investments in this area. However, they
also note that indicative rates of return for the venture capital
market are based on historic data, and that many of those
operating towards the equity gap end of the market do not
rates of return. The State will also seek a
disclose their
commercial return on its investment, although this return
may be subordinated to that of private investors at
the
minimum level required in order to stimulate the creation of
any fund. The type of subordination will depend on the indi-
vidual bids brought forward in the tender, and may include
State guarantees to other investors.

(6) Commission recommendation of 3 April 1996 concerning the defi-
nition of small and medium-sized enterprises (OJ L 107, 30.4.1996,
p. 4).

(7) The UK authorities have chosen to include normal wholesale and
retail trades as an eligible sector, since it contains many small busi-
nesses seeking small-scale finance in order to grow. It is in keeping
with the provision of loan finance as provided by the small firms
loan guarantee scheme.

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limited partnerships.

The UK authorities do not prescribe anything concerning
incentives for the fund managers to maximise the performance
of the funds. Apparently, the funds are likely to be established
as
Limited partnership agreements
normally contain a clause concerning carried interest, setting
a profitability (cid:145)hurdle(cid:146), which the manager has to exceed in
order to get an extra bonus.
the
hurdle rate is attainable yet stretching, thus incentivising the
fund managers to reach and exceed their hurdles.

It should be set so that

Specific commitments

The UK authorities undertake to apply the Commission notice
on the application of Articles 87 and 88 on State aid in the
form of guarantees, should a regional
fund choose a State
guarantee as a form of subordination of the State return.

The UK authorities are prepared to set a formal limit of 50 %
Government investment in each regional venture capital fund.

The UK authorities have undertaken to ensure that the regional
venture capital funds will not invest in companies active in
sensitive
rules
governing State aid have been laid down.

special Community

for which

sectors

ASSESSMENT

By notifying the scheme, the United Kingdom has complied
with its obligation under Article 88(3) of the EC Treaty.

Presence of aid within the meaning of Article 87(1) of the
EC Treaty

Under Article 87(1),
(cid:145)any aid granted by a Member State or
through State resources in any form whatsoever which distorts
or threatens to distort competition by favouring certain under-
takings or the production of certain goods shall, in so far as it
affects trade between Member States, be incompatible with the
common market(cid:146).

in each regional

Each regional fund will contain State resources up to a limit of
50 %. The Commission finds that these State resources benefit
operators at two levels, namely at the level of (i) the private
investors
the small and
medium-sized enterprises in which the regional funds invest.
The Commission is also considering whether the funds theme-
selves, which are the vehicle for the funds’ operations, should
also be considered to constitute undertakings which are bene-
ficiaries of the aid.

fund; and (ii)

Presence of aid to private investors in each regional fund

The private investors are only covered by Article 87(1) to the
extent that they constitute undertakings.

The State expects
to have to subordinate its returns on
investment in one way or another. These are not terms that
are present in a purely commercial investment situation, so the

State cannot be said to be acting as a private investor in a
market economy.

The notified scheme will benefit the private investors in the
funds, strengthening their position compared to competitors in
other Member States. It must be assumed that these private
investors have the potential to participate in the international
financial markets. The scheme must therefore be regarded as
affecting trade and distorting competition at this level.

Presence of aid to the SMEs in which the regional funds
invest

The SMEs in which the funds invest will receive equity capital
that they would not have had access to otherwise, at least not
if there is a true equity gap. In any case, the presence of the
funds will greatly improve their access to capital. The resources
have partly been invested by the State, and the private capital
of each fund has been raised thanks to the State aid provided
to the private investors. This could also imply that the capital
might be provided on terms which would not be acceptable to
a private investor, and that fund managers would not invest on
commercial terms.

Recipient SMEs will be able to strengthen their position in
relation to their competitors in other Member States, which
can have an effect on intra-Community trade and distort
competition.

The Commission concludes that at these two levels, scheme is
covered by Article 87(1) of the EC Treaty.

Presence of aid to the regional funds

The UK authorities have stated that the British Venture Capital
Association has 15 members in England who invest under
an average
GPB 250 000 and have
size of
GBP 500 000 or under
(excluding technology specialists).
These venture capitalists are active in the same segment as
the regional funds, as are other venture capitalists established
in other Member States. Therefore, if the regional funds are to
be seen as undertakings, the fact that they operate with the aid
of public resources could distort competition on the venture
capital market.

investment

Compatibility of the aid with the EC Treaty

The Commission has assessed the compatibility of the notified
scheme under Article 87(3)(a) and (c) of the EC Treaty.

First, the Commission would like to express a general doubt
concerning the incentive effect of the notified State aid scheme.
Among other things,
the British
Venture Capital Association has (cid:145)15 members in England who
invest under GPB 250 000 and have an average investment
size of GBP 500 000 or under
technology
specialists)(cid:146).

it can be mentioned that

(excluding

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Doubts with regard to the aid to the private investors

The notification does not
foresee a link between the aid
provided to private co-investors and any expenditure which
can be considered to constitute eligible costs. Moreover,
although the development of SMEs, as well as regional devel-
opment, are Community objectives, the Commission doubts
whether the present scheme really ensures that the aid is the
minimum necessary to achieve these objectives. Normally,
the subordination requested from the
when the extent of
State is determined through an open call for tender,
it may
be assumed that the bid selected will be the one in which the
therefore the aid
least subordination is requested, and that
granted is
is
case,
uncertain whether a call for tender limited to England will be
wide enough to ensure that the subordination requested is the
least necessary for a regional fund to be set up. However, this
has to be weighed against the importance of local and regional
knowledge for the success of these funds perceived by the UK
authorities. In addition, the fact that the tender is limited to
England might constitute an infringement of Article 43 of the
EC Treaty on the freedom of establishment and/or of Article 56
of the EC Treaty on the free movement of capital. If so, the
Commission could not approve the scheme, as it would be
contrary to a provision of the Treaty.

the minimum necessary.

In this

it

Doubts with regard to the aid to the SMEs

in particular, aid for the devel-
The Commission authorises,
opment of SMEs. One of the principal reasons for doing so,
as noted in the guidelines on State aid for SMEs (8)
is that
(cid:145)SMEs suffer from a number of handicaps that can slow
down their development. One of the main such handicaps is
the difficulty in obtaining capital and credit, the chief causes of
which are imperfect information, the risky nature of financial
markets and the limited guarantees that SMEs are in the
position to offer(cid:146).

Nevertheless,
commitment

the notification does not
to link the investment

foresee an explicit
to initial
in SMEs

investments by the beneficiary companies in the sense of either
and
the Community guidelines on State
medium-sized enterprises or
for national
regional aid (9).

the guidelines

aid to small

It cannot therefore be excluded that the aid granted to the
private investors as well as to the SMEs constitutes operating
aid. Operating aid can only be allowed in regions qualifying for
an exemption under Article 87(3)(a) of the EC Treaty, and if the
aid is progressively reduced and limited in time. All of these
conditions do not seem to be fulfilled in this case, as the
scheme is not limited to assisted areas, and it is not foreseen
to progressively reduce the aid.

Doubts with regard to the aid to the regional funds

the Commission should find that

If
funds
constitute undertakings in receipt of aid, the question of the
compatibility of operating aid arises in the same way as for the
other aid recipients.

the regional

Conclusion

requests

the United Kingdom to submit

In the light of the foregoing considerations, the Commission,
acting under the procedure laid down in Article 88(2) of the
its
EC Treaty,
comments and to provide all such information as may help
to evaluate the measure within one month of
the date of
receipt of this letter. It requests your authorities to forward a
copy of
the aid
immediately.

to the potential recipients of

this letter

The Commission wishes to remind the United Kingdom that
Article 88(3) of the EC Treaty has suspensory effect, and would
draw your attention to Article 14 of Council Regulation (EC)
No 659/1999, which provides that all unlawful aid may be
recovered from the recipient.(cid:146)

(8) OJ C 213, 23.7.1996, p. 4.

(9) OJ C 74, 10.3.1998, p. 9, as amended by OJ C 258, 9.9.2000, p. 5.