Thursday, 14 February 2013

VIGO FUNDING – Should Entrepreneurs Be Warned?

Approximately two years ago I was requested to write a column for the Finnish Tekniikka & Talous magazine on the cleantech sector in Finland. In the story, I highlighted some problematic aspects of public funding that are different in this business field compared, e.g., to the game or high-tech industries. Several developments have taken place since. For example, Finnish start-ups have received approximately €100M of funding from the so-called Vigo Accelerator Programme. In this blog, I wanted to share a lawyer’s experiences of deals with Vigo accelerators and why entrepreneurs should be careful with these deals despite the very high-level political support and popularity enjoyed by this programme.

The Vigo accelerator programme was launched in 2009 to address perceived gaps in the high-growth venturing ecosystem. According to a recent report published by the Ministry of Employment and the Economy (TEM), the programme "…has created a new channel that makes world-class competence and private funding available to growth companies, enabling the start-up of high potential growth companies and their entry into the international markets" (read publication from here). Vigo seeks to connect innovative business ideas that have international potential with internationally experienced business professional and private and public growth finance (TEM, 2012). According to TEM’s study, it has been “…designed to provide contributions to the Finnish entrepreneurship ecosystem:
  • Accelerate growth and internationalization of new firm
  • Help high-potential new firms attract equity funding, both from Finland and abroad
  • Strengthen high-growth capability (both managerial and governance) in Finland
  • Strengthen the links between the Finnish high-growth venturing community and its foreign equivalents
  • Create a network of business accelerators in Finland to address growth bottlenecks in the post-incubator phase”
Thus, the programme has many objectives but what is unclear is whether it actually promotes more the interests of the accelerators or those of the entrepreneur. In many cases, start-ups are in need of funding and, naturally, in such case they may have to content with even very strict provisions from venture capital investors to ensure the ability to continue their business as there are limited funding possibilities available. Should Vigo be any different? To my view it should, because accelerators are working as instruments in public financing and what I consider problematic is that public funding seems to praise venture capital activity and fund formation while the core focus should be on the growth and internationalization of new firms. And if these companies are successful, they will certainly attract venture capital investments.

In several cases where we have been involved with Vigo accelerators, the term sheet proposals received by the entrepreneurs have systematically failed to reflect the public-funding rationale behind the program.When a promising, in our opinion at least, start-up commented on an accelerator's term sheet, the feedback was, "we know it [that our proposal is completely unreasonable] but we’ll give to you access to public funding". I wanted to give six real-life points that at least should be recognized and considered by entrepreneurs:

First, if the entrepreneur has not done "everything possible" to secure the subsequent funding, the accelerator will get additional X % ownership of the entrepreneur's company – we will all know what to think about this kind of requirement;

Second, the entrepreneur must commit to a monthly management fee that varies from one to several hundreds of thousands of euros depending on the contract term (How much services from different top-level experts from different sectors could one buy with this amount of money as opposed to support from one VC? Just a thought and personally I am pleased to see that restrictions are recommended...);

Third, in addition to the management fee (and ignoring that it is already very significant), there have been cases of free-of-charge "sweat equity", typically 10% or higher or in tranches;

Fourth, anti-dilution protection has systematically been full ratchet (e.g., an investor who pays €2 per share for a 10% stake would get more shares (or conversion rate would be adjusted) in order to maintain that stake if a subsequent round of financing were to pass at 1€ per share and, as a result, the early round investor's price is actually reduced to the price of the new issuance).

Fifth, existing owners are required to work in the company if they wish to retain their share ownership;

Sixth, owners give accelerators normal reps and warranties without limitations or up to the investment amount.

I do not say that all Vigo accelerators have the same principles, but I call for discussion on whether the personal role of the accelerators in these companies should significantly be more restricted or controlled, as otherwise there seems to be conflicting interests between their personal benefits on the one hand and the interests of the entrepreneurs on the other. If we want to support the Finnish venture capital industry, then there should, in my opinion, be a direct public support mechanism available and not one that facilitates the venture capital industry at the expense of the entrepreneurs. As one solution, I would also continue to support an idea that we introduce a mandatory standard agreement model for accelerator-entrepreneur relationships that would equally take into account the interests of both sides.