The Move Towards Supporting The Markets
Last week we covered how Finnish tax payers were forced to give publicly listed companies more than 40 million euros through Tekes. The argument from Tekes' side is that these larger companies are important drivers of innovation and projects. The President of Tekes Veli-Pekka Saarnivaara has stated that this year, growth companies were the focus of their financing. In 2010 Tekes approved more than 100 million euros in funding for younger companies, less than 6 years old. This is exactly the direction we should see the financing go - or even better, tie it completely to private funding.
Funding larger, publicly listed companies is just wrong
I have to disagree strongly with the fact that it is beneficial to fund large, publicly listed companies in their R&D efforts even though most of this money is trickled down to smaller, privately owned companies. I'll explain this in a bit, but first we need to understand the scale of this.
In the last three years, Tekes has funded companies employing over 500 people on average with 59 million euros annually. According to Tekes, 58 million of this money has been further channeled to smaller companies and research institutes. So the effectiveness metric here is that only 1 million has been used by the large companies to finance their own needs. This is all wrong.
The metric we should be looking at is, is with how little public support we are able to run our current growth company ecosystem. When 58 million euros of tax payer money is infused into the finances of growth companies - we really can't say this would be the case on the markets. We need to grow our growth companies with market support - ie. they must answer or create a demand that they cater to. Running as many companies as possible and in doing so employing as many people as possible on tax payer money simply can't be a metric of success.
What's my suggestion then?
While my answer is far from being academically researched and backed by huge sets of data, I'm willing to bet it would be a lot better than the current system. My suggestion is to do two larger changes to the current Finnish innovation ecosystem:
1. Put a cap on the age, companies must be under to receive financing.
2. Tie 80% of the funding Tekes gives out to private funding.
Let's look at these more closely. A cap on on the age of companies is pretty easy to argue. If you've been crunching away at the same business model unsuccessfully for over 10 years, constantly leveraging tax payer support to break even - it's unlikely you'll make it big next year either. Sorry, that's just the way it goes. Companies must grow independent and it's very much in the interest of tax payers to enforce this too.
Younger companies can be given funding on slighly looser terms as they need to build up their presence fast to be able to support their existence on market terms.
Secondly, I know this is something Tekes is already moving towards with their YIC (Young Innovative Companies) project. However, we should really make this more of a rule instead of an exception. Why? We need to create an environment where foreign investors and other early stage investors understand that Finnish tax payers are willing to share the risk they're taking if they decide to invest into Finnish registered companies.
There are two main reasons behind my second point. The first one is clearly the fact that markets are able to better decide on what terms and to which companies should money be flowing into. The incentives to invest are completely different for a government organisation compared to a private investor.
Also, this would dramatically be able to reduce the amount of bureaucracy Tekes needs to handle to keep its paperwork in order. Making the markets do the investment decisions enables Tekes to cut down on their overhead costs for handling all those investments. It would make the whole organisation a lot more efficient.
However, the second point regarding the tying of tax payer support to private money is more of a move towards the tax payers becoming investors and wanting a return on their investment. This is dramatically different from the current situation where the money is blindly supporting companies without returns (or at least those are very hard to put into figures). The way in which companies are forced use the money they receive from Tekes, should be relaxed. When there are private investors on board, they have an interest how the money is used and they'll be the guardians of tax payer money.
Furthermore, the support payed through Tekes should be considered more of an investment into the company. Tekes, and ultimately the tax payers, should become passive share holders through private investors into young growth companies. Once there's a positive liquidity event, the tax payers would be thanked financially for their support. Which is something completely opposite what we have in our current situation.
With this model in mind, Tekes would be able to calculate a more accurate return on investment instead of simply guessing the employment effects of this money. Would this compete with Finnvera's investment model? Yes. Would this mean that the two entities should be merged? Probably yes.
Supporting the markets is the only way to go
What I'm aiming here towards is that the Finnish innovation ecosystem with all its players and entities must move towards supporting the actions the market is willing to take. There's no point in trying to artificially support the ecosystem in a manner that the market won't. The only way to go about is to start leveraging the market actions with the tax payers money. All these moves would send a clear signal to investors - you're money is able to do a lot more in Finland than elsewhere as we're also willing to share the risk.
This would be one of the best ways to attract much needed foreign capital in the form of early stage investments into the future of Finland.
Thank you Antti for saying what we're all thinking about.
// Miki
If everyone's really thinking about this, then more people should speak out :)
But thanks, very much appreciated.
Problem with entrepreneurs: they've always got too much on their hands. True story.
// Miki
In essence, you are advocating TEKES to stop being a national technology development agency and change to become a passive non-leading early stage investor to startup companies. While Finnish ecosystem lacks early stage investment due to multiple reasons, high taxes being one of them, I am not sure if making Finnish government a shareholder of nearly all early stage startups really makes sense.
A better way to do such arrangement would be to have government funding agencies to invest in all venture capital funds that focus their investment operation to early stage startups in Finland. This is what the State of Israel does with their Technology Agency. The problem is, we already have government as the investor to all early stage companies through Finnish Industry Investment and other entities.
I would argue that the best result for everyone would be a Y-Combinator style approach with a twist, derived from current YIC/NIY program: Organize a startup funding review every two months and grant 20 most promising startups with €50k of initial funding in terms of €25k equity loan and €25k grant. That way the funding is in no way making government the owner of startups, but would offer 120 of the best startup ideas a money to kickstart the business every year. The cost of €6M a year from this would be well worth it for the government.
Then, for the more advanced companies, the funding model could simply be to invest 50% on top of any privately invested funding up to certain limit using convertible notes with the round valuation and entrepreneurs having the call whether to convert to shares or pay the loan back. The funding would be conditional to the company having a business model that is not based on charging man hours, and capable of enabling significant exports and international growth.
This would make the role of TEKES unique, would create an interesting PRIVATELY OWNED, internationally minded startup scene in Finland.
Mikko, I like your point about having TEKES couple investments with private VC funds / angels, as is the case is, for instance, with Chief Scientist's Office in Israel.
Building a YC type of program is tricky without a person like Paul Graham, and I seriously doubt that it would be at all good to have government officials "pick the most promising startups of the year".
Regarding the YC type program: Government does not have to pick the winners. They can just provide the funding. My concern is with the government being a direct shareholder of all early stage startups, or alternatively making TEKES into just another passive VC.
Coupling with smart money is of course the best choice. The Vigo program seems to be doing quite well in that sense, at least when looking at some startups in Lifeline Ventures' portfolio.
As I've understood, it's currently relatively easy to get some TEKES funding, if you also have an investment from private investors. At least if they are "proper" angels or investors outside of 3Fs: Friends, Family & Fools. Correct me with counterexamples, if I'm wrong on this.
Thus, there is no need to fix that, system is working on this aspect, although it can be made more efficient and less bureaucratic.
If we think about very early-stage investments by government, I think the problem that many startups in Finnish scene are complaining is that you can get say 15K€ from government to be paid for consultants, but it's much harder to get similar amounts and use it for something productive. 15K-30K€ can be a huge boost for team of 2-3 if they spend it wisely.
The current government model reflects the old, pre-internet thinking: building products cost a lot and you had to do viability studies via consultants. But in the internet age, capable team can use the same amount, build a minimal viable product and test the market need with a real offering.
Antti, you are forgetting that the Finnish tax payers are already a silent share holder of every startup. Otherwise, how can you explain they command a 28% share (capital gains tax) when there is a successful exit? Whatever support the government is providing for growth companies supports this goal.
The higher the exit valuation, the bigger the tax payer profit. Add to this the fact that every new startup generates tax revenue by employing people and consuming services even before they turn profit or generate sales. The motivation to support growth startups is obvious and it's hard to support any kind of model where it results in diluting the ownership further. We already have VeraVenture for that.
Thanks guys for the comments - sorry for not being able to comment earlier, but here are my thoughts.
Mikko Alasaarela, good comments and I'd rather use convertible notes to "invest" the money. Very lose terms and like you mentioned, have the founders make the calls to either pay it back or convert it.
Regarding the YC kind of approach; I think we are doing our share of that with the Vigo accelerators. The problem is though - only Vigo's get the fast track to the government money. Why not enable and extend this to all those investing into startups?
Teemu Kurppa: Like I mentioned in the post, I like the direction Tekes is going towards with the focus of young startups and I've too heard many cases where financing is easier to get when you have private money on the table.
The problem arises from all the bureaucracy though - why enforce the old ways, as you mentioned in your comment, to use the money into R&D only. Founders and private investors should be able to direct the money in the most effective way to grow the company. Commercialising on R&D is even more important, in my opinion, than simply researching and developing.
Jani Penttinen: I take back on the part of direct investments. Like I mentioned above, convertible notes would be a good way to go from the governments side. These wouldn't automatically take share of ownership away from the founder. Also, we have to remember that valuations would most likely go up in these cases as more money is invested into companies - thus a lower ownership of the company wouldn't automatically mean the founder is worse off.
However, I think it would be too naive to say the capital gains tax is enough, even though you're right on the concept.
Overall:
The Israeli model, that many people usually refer we should follow, is well documented in the book Start-up Nation by Dan Senor and Saul Singer. However, as I can't remember it exactly - I won't make any comments regarding it except that I don't think we'll be able to succeed by simply copying any model directly to Finland or any Nordic/Baltic country, be it Israeli or one from the Valley. We need to change it to work in our context.
Liked the original article, and really liked Mikko's comment.
The 10 year age limit is not that bad, though. There's plenty of "traditional Tekes" funding possibilities in my startup's first 10 years. After that - I agree with the author - the market and the company should be able to find the funds.
And 10+ year companies can always spin-off a baby, in order to regain Tekes funding. That might be better than nurturing the ideas within a BUG (sorry -meant to type big ;) company. It could bring the "3M" and "Gore" (not Al) dynamic thinking to Finland.
How many novel ideas has Finnish forest industry managed to make in the last 20 (or 40) years? Or am I just unaware of any? Please enlighten.
Teemu: you nailed it in the last paragraph.
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The current government model reflects the old, pre-internet thinking: building products cost a lot and you had to do viability studies via consultants. But in the internet age, capable team can use the same amount, build a minimal viable product and test the market need with a real offering.
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I guess many of us see this in our own experience.
Israelin malli ei ole kopioitavissa, koska siellä touhun perustana oleva asevelvollisuuskäytäntö on aivan toisenlainen.
Suurten yritysten potin voisi siirtää suoraan korkeakouluille. Nythän suurten yritysten pottia perusteella sillä, että rahoittavat korkeakoukujen tutkimusta. Ei se noin ole. Teettävät lyhytjännitteistä repputyötä ja testaavat potentiaalisia työntekijöitä yritykseen.
Yksi syy korkeakoulujen rappioon tietyillä aloilla on, että Nokia on syönyt siemenperunat...