Brexit, and That Huge Investment Fund You’ve Never Heard Ofby
European Investment Fund has 9 billion euros in regional VCs
U.K. venture capital may lose anchor investor in an EU divorce
It is an open secret among British venture capitalists that many of their funds would have never gotten off the ground without a hefty check from the European Investment Fund -- the EU institution that pools billions in financing from European governments, the EU itself and a number of private banks, to fund investments.
After the U.K.’s vote to leave the European Union, the community faces concern that this important source of funding could be in jeopardy.
Between 2011 and 2015, the EIF committed 2.3 billion euros ($2.5 billion) to some 144 U.K.-based venture firms. That amounts to about 37 percent of all venture funding raised in the U.K. during those years, according to data from Invest Europe, the trade association for European VC firms.
By the end of 2015, the EIF had 9.9 billion euros committed to venture capital and private equity in Europe. As of the end of 2014, the fund directly contributed about 12 percent of all venture money raised in Europe and funds that had the EIF as a key limited partner were responsible for about 45 percent of all European venture money raised, according to a report the fund published in June.
Joe Steer, research director of the British Venture Capital Association, said in a guide to Brexit published this week that, "any loss of this funding could prove damaging to the industry."
The EIF issued a statement the day after the referendum noting the result "with regret". It said the fund’s future activity in the U.K. would be decided as "part of the broader discussions to determine the future relationship of the U.K. with Europe and European bodies."
Hussein Kanji, a partner at London-based Hoxton Ventures, which is not backed by the fund, said the loss of EIF funding was one of the most important "non-obvious risks" facing Britain’s tech ecosystem in the wake of the referendum.
"They were a very influential player," Kanji said, noting that many private European investors would not commit to a new fund unless it had secured EIF backing. "They are often the biggest and first and most concrete investor, and their confidence usually unlocks other capital from the Continent."
Among the well-known venture firms in London that have the EIF as a limited partner in at least one of their funds are Atomico, Balderton Capital, DN Capital, Draper Esprit and Seedcamp. Several of these firms did not respond to requests for comment. Balderton said it could not comment on its limited partners. Seedcamp partner Carlos Espinal also said he was not permitted to say much about the fund’s backers, but confirmed that EIF was "a key investor."
Saul Klein, a partner at London-based venture firm LocalGlobe, which has not taken EIF money, said he was not concerned that the EIF would withdraw support from U.K. venture firms. Many of the U.K.-based venture firms are major investors not just in Britain but across Europe, so the EIF would have a compelling rationale to continue funding them even post-Brexit.
Additionally, Klein said, the EIF had a mandate to generate returns as well as to support the EU’s tech ecosystem. As a result the fund had been increasingly backing ventures in non-EU countries, such as Israel, where those firms might make portfolio investments into European startups. By the same logic, the EIF could continue support U.K. venture firms even after a Brexit.
European Investment Bank, which controls 58 percent of the EIF’s shares, said in an e-mailed statement following the Brexit vote its "engagement to support investment in the U.K. will not change unless and until a decision to change lending activity is taken by EIB’s shareholders." A spokesman for the bank, David Yormesor, also confirmed separately in an email that it would continue to commit money to U.K. venture funds while the nation’s relationship with the EU is being negotiated.
The EIF is majority-owned by the European Investment Bank, an institution which is in turn controlled by the governments of the 28 countries currently part of the European Union. A further 11.7 percent is owned by 30 private banks, including Barclays Bank Plc and Banco Santander.
The fund was created in 1994 to foster innovation and the growth of small and medium-sized businesses in the EU, which had long lagged the U.S. in its ability to foster entrepreneurship, particularly in the tech sector.
"There was a recognition that the venture capital industry didn’t exist in Europe the way it existed in the U.S.," Thomas Hellmann, a professor of entrepreneurship and innovation at the Said Business School at the University of Oxford, said in a telephone interview.
The plan, Hellmann said, was that once government seeded some venture funds, private investors would gradually step up their commitments, and, over time, government support for venture capital would become less necessary and ultimately decline to nothing. It hasn’t worked out that way. Institutional investors started to pour into the venture capital industry in the late 1990s during the dot com bubble only to get burned in the subsequent crash. They haven’t really come back.
"The dot com bubble created a 10-year hangover in venture capital," Hellmann said. "Institutional investors were not forward looking and simplistically shunned the whole asset class." Private fundraising by venture firms had just started to accelerate again when the 2008 financial crisis hit.
The EIF has been particularly important in seeding new venture funds with unproven track records, Hellmann said. New funds have minimum amounts they must raise in order for them to close, and the EIF has helped boost these nascent finances over the initial threshold.
The EIF’s average annual return on equity since 2011 has been 3.74 percent. This compares to a five-year average annual return of 14.92 percent for the Cambridge Associates LLC U.S. Venture Capital Index, a key benchmark for the largely-privately backed U.S. venture industry.
Oxford’s Hellmann said that he did not think the EIF’s returns were terrible. European venture returns have generally been lower than their contemporaries in the U.S. Between 1980 and 2013, the average five-year internal rate of return for all European venture firms was just 1.32 percent, according to a report from Invest Europe. Given the EIF’s mandate is to seed the European venture capital industry, not just make profits, some underperformance is expected, Hellmann said.
With returns like that, the EIF might not able to afford to stop backing U.K.-based funds. "I would be shocked if the EIF stopped supporting funds in the U.K., with which it has a long-term relationship," LocalGlobe’s Klein said.