Rude VC: Pour une France Compétitive


Over the weekend I had the pleasure of perusing France Digitale’s whitepaper “Pour une France compétitive et créatrice d’emplois.”

I say pleasure, because I really did enjoy reading the organization’s pragmatic proposal of four concrete measures to include in the upcoming Loi des Finances 2013. For those who are not familiar, France Digitale is a new French lobbying association for the digital economy comprised of some of the best VCs and entrepreneurs that France has to offer. Given the talented leadership of France Digitale, and the fact that the whitepaper reinforced many of the points I advocated two weeks ago in my letter to President Hollande (which I’m sure is coincidence), FD’s “4 Measures” did not disappoint.

First the facts: As many of us in the venture industry have long argued, small, high-growth technology companies are the engine of France’s future economic development. France Digitale cites two recent studies — from McKinsey and Ernst & Young — that reiterate this point. French startups of the digital economy post average annual revenue growth of 33%, increase headcount an average of 24% each year, employ personnel with an average age of only 32 (compared to 41 in large firms), and offer permanent contracts to 87% of new hires. No other sector of the French economy comes close to matching this potential. Yet alarmingly, France’s internet economy contributed to only 3.2% of GDP in 2009 with hopes to climb to only 5.5% in 2015. Contrast this with UK, where it was 7.2% in 2009 and expected to reach 15% of GDP in 2015. It’s no coincidence the UK considers the internet sector to be an economic priority.

So concretely, what can be done to rev up this engine ?

As I have argued in the past, venture capital represents the premium fuel that can improve performance and keep this motor running smoothly in a sustainable way. Similarly, France Digitale proposes the new government a badly-needed tune-up in the form of four pragmatic measures:

  1. Refine and reinforce the ‘young innovative entreprise’ status.
  2. Channel assurance-vie monies toward innovative SMEs by forcing them to invest in VC.
  3. Improve the R&D tax credit to strengthen links between large companies and innovative SMEs.
  4. Maintain the tax incentives that preserve the retail VC model.

Overall, I believe these are excellent suggestions, evoking reactions ranging from “It’s ridiculous that France hasn’t fixed this earlier,” to “That’s a truly original idea that just might work.”

For example, FD underscores a legitimate problem of how France’s narrow definition of innovation hinders economic success stories like Facebook, LinkedIn, and Netflix. Are these companies innovative ? Most of the world would argue resoundingly that they are. But by France’s current definition of what constitutes an innovative company, which requires a minimum 15% op.ex spend on R&D, these companies do not qualify. Idem for Instagram, Pinterest, Etsy, and even Twitter.

Maintaining policy that over-emphasizes the importance of R&D to the detriment of web service ventures is not only embarrassing, it can be dangerous. The fact of the matter is that the world has changed. With the accessibility of open source components, APIs, and cloud services, it’s cheaper than ever before to start a software or digital media company. The real innovation, and ultimately, capital requirements, come from identifying new markets and designing solutions for them.

Restricting subsidies to engineering effort implicitly undervalues notions like product conception, design, user experience, and marketing — qualities which distinguish the winners in the new paradigm. Even worse, it perpetuates the errant yet pervasive view that innovation is “technology-driven” rather than market-driven. By subsidizing the process of over-engineering a product until it’s perfect and only later seeking a market for it will all but ensure the absence of innovation. Redefining innovation more accurately, as per FD’s first suggestion, with the corresponding re-alignment of subsidies, is thus a no-brainer.

On the truly original end of the spectrum, FD’s suggestion to require large enterprises to invest 20% of their R&D tax credit subsidies (CIR) into venture capital funds (measure #3) could kill several birds with one stone. First, with the right parameters, it would ensure these subsidies are subsequently directed toward the most innovative opportunities in the market (far more efficiently than happens currently). Secondly, it would address the challenge facing French VCs in raising new funds from institutions that are hampered by Bâle 3 and Solvency II regulations. And perhaps most politically palatable of all, it wouldn’t cost anything extra to the government budget.

But the free market should still play a role

The other two of FD’s proposed measures (#2 and 4) reflect a premise on which my viewpoint diverges, though I do endorse their conclusions.

Take measure 4, for example, where FD sounds the alarm about the government’s rumored plans to both reduce and cap the tax breaks individual taxpayers receive when they invest in retail VC funds (i.e. FCPIs and FIPs). I agree that taking drastic action like this would send deadly shockwaves to the hundreds of SMEs currently financed by such fund vehicles. However, as I’ve contended (again, here) the long-term goal should be to transform the investment case for retail VC funds into one that is based on performance rather than based on tax deductions.

The same logic applies to the second proposed measure, which would require Assurance-Vie companies to invest at least 0.2% of their float into venture capital funds that promise to invest in “innovative” opportunities (the same restrictions governing retail VC funds). {An assurance-vie is a life insurance policy that essentially behaves almost like an open investment account offering favorable tax treatment if the investments inside are not withdrawn until after 8 years}. My contention is that if such VC funds demonstrate strong investment performance over time, eventually Assurance-Vie holders will want to allocate a portion of their portfolios to such VCs.

In fact, there is a precedent for this in the U.S. In 1978, the U.S. government revised certain parts of the ERISA law (regulations governing employee pension funds), under a “prudent man rule,” thus allowing (though not obliging) corporate pension funds to invest up to 5% of their allocations to private equity. Pension funds were not required to invest in VC, but they increasingly clamored to do so as the asset class demonstrated high return potential.

In France, the government could help advance the VC industry’s migration toward performance by defining consistent standards for calculating investment returns and then requiring disclosure for each fund that seeks tax money. Ultimately, this will force VC practitioners to deliver superior value creation and hence economic growth.

That being said, conventional wisdom needs to be shaken up during a time of crisis, and in that spirit, I find the four measures recommended by France Digitale as an excellent place to start.