Can governments really be venture capitalists?

A flood of funding

European early-stage startups are flooded with government funding. It might be the stuff of nightmares to a fervent laissez faire capitalist, but European taxpayers fund startups through a variety of means. It is more prevalent than most taxpayers think, and certainly a lot more than most VCs and entrepreneurs will let you think.

It is more prevalent than most taxpayers think, and certainly a lot more than most VCs and entrepreneurs will let you think.

Cash injections into startups at both EU and state level are BIG and on the rise with no signs of slowing down. 

There are four layers to state investment into startups:

1. Tax relief

This is the most indirect and the more accepted method of state investment. Schemes such as EIS and SEIS in the UK offer tax breaks to investors in innovative and early-stage companies.

Essentially, it's free leverage backed by the Queen with no capital gains tax on exit.

Some have criticised these tax breaks on two foundations: Taxpayers are subsiding investments that HNWI would have made anyway and it mainly just increases the early stages valuation.

In short, both argue that rather than impacting the number of new innovative companies created, it just provides better returns to investors and founders.

The truth is probably somewhere in between. This kind of tax break did have undoubtedly a significant impact on the rise of European tech but they certainly brought with them their share of toxicity.  

2. Investing in VC funds

Fund of funds. Without the carry incentive, state investment bank workers might have neither the risk appetite nor the dealflow to find the most promising companies. 

The solution? 

Delegate that task to a seasoned GP with access to the best deals.

The French Tech Acceleration fund (200mil EUR) does this by investing in VC funds, accelerators and startup bootcamps. There is also the Digital Fund of Funds (140mil EUR) which invests in digital VC funds, although the website categorises this as a form of private equity.

The British Business Bank invests in early-stage companies through two underlying fund-of-funds: the UK Future Technology Fund (which has now ceased investing) and the Hermes Environmental Innovation Fund, with £159mil invested overall, mostly in scaleups. 

One subsidiary is British Patient Capital, a £2.5bil fund (of which £1.5bil is yet to be deployed), investing in venture and venture growth funds. 

For VC funds BPC has invested in between 2013-2017, the pooled DPI multiple generated to date is 0.18, which is slightly higher than the wider UK VC market (0.17).

The European Union has created 6 Venture EU funds-of-funds raising up to 2.1bil EUR of public and private investment aiming to invest at around 25% of the target size of smaller VC funds. Each fund will aim to invest across 4 countries, expecting to reach 1500 startups. 

3. Co-investing (crowding in)

This is another approach that tries to strike a balance with market forces. It seeks to invest alongside VCs or angel investors.

BPI France’s 1bil EUR Large Venture fund co-invests a minimum of 10mil EUR alongside private investors. It has had 5 exits and cites Devialet and Doctolib as its greatest success stories. 

The French 400mil EUR Seed Fund provides up to 250,000 EUR per startup in the form of convertible bonds (quasi-equity.)

The BBB’s Enterprise Capital Fund, invests in and alongside VC funds having committed £1.6bil so far. 

It also has the Angel Co-fund, which has invested £280mil alongside angel syndicates as of December 2018. 

The most recent government announcement was the £375mil Future Fund co-investing in R&D-intensive companies in a minimum round-size of £30mil

The EU does this through the European Investment Bank, co-investing alongside funds backed by the European Investment Fund, focusing on life sciences, cybersecurity and renewable energy. 

4. Direct investments

This is the most controversial method because it involves systematic direct state intervention into private companies.

It is extremely prevalent in France, for example, where BPI is deploying 40% of investment value at an early stage. This is without counting that BPI is also a main LP in all of the other funds below, that some regional / thematic incentives might join via method 3 and 4, and that co-investors probably benefit from some kind of tax breaks.

Top venture funds in France

More recently, the pressing need for the energy transition has seen a new dawn of direct investment going into areas where rapacious VCs won’t dare to tread. 

The UK Government announced the £40mil Clean Growth Fund, with every £20mil of invested matched by the CCLA, the UK’s largest asset manager for charities, public and religious organisations. This could have gone in the above section but given the nature of the CCLA and the absence of VCs, it belongs here. 

Then there’s the departed Dominic Cummings’ vague pet-project (ARIA) seeking to emulate the US ARPA agency that invested in seminal technology that laid the foundations for the internet. 

The EU announced 178mil EUR of direct equity investments fused with grants through the European Innovation Council Fund. 

So, how should governments invest in venture?

I was at a dinner party recently where someone working for the British Business Bank mentioned the IRR of a fund of VC fund program of the BBB.

It was good. The room was then divided between people praising it and those arguing that IRR shouldn’t be an objective for the BBB (Do enterprise B2B SaaS need public money?)

Whether or not governments should invest in startups depends on convictions. How they should do it depends on convictions too, but also on the aims.

Is it:

A. To generate national champions and develop the ecosystem

B. To create a high IRR for the taxpayer

C. To fund technologies that are critical for our future but hard to finance for the private sector because of their long-term timeframe and capital requirements.

Or might it be all of above at the same time?

State roots

Regarding the latter, the economist Maria Mazzucato argues that governments are inherently involved in the value creation process, so in turn, taxpayers should retain equity in the startups a nation produces. She cites the state-funded origins of Silicon Valley and Arm in the UK as examples of value expropriation from the taxpayer.

But under her line of thought, investing in fund-of-funds would represent value extraction by the GP in the form of carried interest.

Still, if investing in startups through fund-of-funds can help increase tax receipts amid record pandemic borrowing, that can’t be such a bad thing. 

Direct investments, however, could represent a case of crowding out the private sector, or dragging along zombie companies unable to raise private capital.

Indeed, it was generally accepted until recently that technocrats should not be picking winners and that the duty must be passed onto a market actor taking a risk, such as VCs through fund of funds investment, or onto angel investors through tax breaks.

Yet to advance the goal of decarbonisation, directly investing in green technologies missed by the market may well advance the welfare of the entire planet.

What do you think?

Should governments invest in startups - and if yes, how so?


For the purpose of this article, when we refer to the ‘state’ or ‘governments’ that includes the EU despite its status as a political and economic union of 27 member states. We also exclude debt financing and R&D tax credits since they are well documented. 

Rémy Astié