In France we’re now entering what I think of as the “easy money period” for startups. The easy money period begins roughly around April 15 (perhaps coincidentally, the U.S. tax deadline) and runs until June 15 (the French wealth tax filing deadline, and that’s no coincidence).
To be fair, fundraising in a startup is never easy. The fundraising process represents a substantial effort in time and distraction for the entrepreneur, even during the frothiest of times.
But stimulated by recent fiscal measures in France, the 2-month stretch between April 15 and June 15 has become a period in which a wave of investment vehicles come out of the woodwork in a rush to invest in French startups.
The genesis of this wave began in August 2007 in the form of a French law enacted to stimulate work (travail), employment (emploi), and purchasing power (pouvoir d’achat), abbreviated as the “Loi TEPA”. While this law encompasses a basket of tax incentives, the most impactful for the venture capital industry has in my opinion been the component that treats the French wealth tax.
The French wealth tax (ISF) represents a progressive tax on households possessing net assets exceeding a certain threshhold, currently 800k€. The annual filing deadline for the ISF tax return is June 15.
Specifically, under the Loi TEPA, French taxpayers liable to the ISF can receive an immediate tax deduction on investments they make in French SME’s that are not publicly-quoted. This tax deduction reached as high as 75% last year, though now has been trimmed back to 50% in 2011. In other words, a taxpayer that invests 90k€ in a French startup before June 15 will receive an immediate deduction of 45k€ on his ISF tax. Of course, certain boundaries apply, for example, the total deductible amount is capped at 45k€, and the SME must meet certain criteria, notably a number of employees below 2,000 and a business activity that is considered “innovative.” While SMEs in other EU countries and even non-tech industries may qualify in theory, the upshot is that this ISF tax deduction is easiest to justify for investments in French high-tech startups.
The French seem to be even more passionate about tax deductions than about foie gras or fine wine. And the amount of ISF tax receipts in France is significant (3.8m€ in 2008). So, investment vehicles which offer ISF tax deductions are popular among the French upper middle-class. Moreover, private bankers love these ISF Funds; they represent another investment product they can push out to their wealthy clients which is an easy sell and hence fast fee generator.
As a result, ISF Funds are numerous. And they target investments in the very same companies that traditional VC funds would target.
However, the nature of these ISF Funds leads to one key distinction: since the investors in these vehicles have already received a significant tax deduction, their ROI requirements on the performance of the funds’ underlying investments is less important. In fact, a general perception among ISF Fund investors, rightly or wrongly, is to be satisfied with a money-back situation. If the ISF Fund returns exactly the original investment, say 5 years later, one could argue that the performance of the Fund is unacceptable. Yet the individual investor will be delighted with his blended return, thanks to the significant tax deduction at entry.
This key distinction creates a mismatch in the market relative to a traditional VC fund. On the one hand, an ISF Fund does not require the same rigor and high-calibre team necessary in a traditional VC fund. Traditional VC’s must keep their institutional investors happy; and it is largely on the basis of their track record that they succeed or fail in raising future funds. Raising an ISF Fund does not require a road show, merely the right distribution network to reach the individual taxpayers with a no-brainer product.
Additionally, thanks to the existence of the “tax shield,” the ISF Fund can thus afford to invest at higher valuations than a traditional VC whose investors’ IRR will be based solely on the capital gains.
So the existence of these vehicles is a double-edged sword. For entrepreneurs seeking to raise money at higher-than-market valuations, the ISF Funds can be a relative easier source of funding. Decision cycles with these vehicles tend to be fast too, as they must invest before June 15 to qualify for the tax deduction.
On the flip side, the entrepreneur may in return forfeit the longer-term benefits of partnering with a VC firm who will be laser-focused in adding value in whatever way they can (network, recruiting, m&a, international expansion, etc.) with the sole objective of maximizing capital appreciation of the company.
Accordingly, at Truffle we tend to not make many investments during this easy money period (with, for full disclosure, the sole exception being via our holdings incubatrices, which are indeed ISF vehicles).
Flush with cash | satisfy my soul wrote:
[…] funds is one of the main reasons that we curtail our investing during the “Easy-Money Period” each […]
Link | August 1st, 2011 at 15:52
Taxing times in French asset management | Satisfy my soul wrote:
[…] written in the past on the perverse effects that these taxpayer-funded structures can have on the venture capital sector. And for full […]
Link | February 20th, 2012 at 22:50