The design of the risk capital market in Slovakia ESTER meeting,Tel Aviv January 12, 2005

National Agency For Development of Small and Medium Enterprises 2 Outline Current situation Lisbon strategy Business environment The design of the risk capital market in Slovakia Critical factors Effective Policy Design

National Agency For Development of Small and Medium Enterprises 3 Supply side There is a very difficult access to finance for SMEs, particularly for innovative activities. Currently only one venture capital fund is active. It is based on public financial resources. There is no specific legislation concerning VC funds

National Agency For Development of Small and Medium Enterprises 4 Demand side Generally, the capacity and performance of R&D has decreased. There is no communication between R&D institutions and producing companies. Results of R&D are not transferred to firms. There is no system or market for knowledge products. Less then 5% of innovating companies use research results from the Academy or universities. firms are using for their innovation activities mainly their own financial resources the amount invested is for the majority of companies less then 10% of their turnover. Currently, there are no investors and financial resources willing to invest in this type of activities.

National Agency For Development of Small and Medium Enterprises 5 Lisbon strategy The Governments Lisbon Strategy focuses on enhancing capital market access for innovative SMEs –creating favourable conditions for the development of venture capital –to support venture capital for early-stage innovative companies –business environment and capital market reform integration of the Slovak market into larger regional capital markets, lifting of legislative and institutional barriers to commercial conditions and cross-border transactions promoting of investments by institutional investors, e.g., banks, pension funds and insurance companies

National Agency For Development of Small and Medium Enterprises 6 Business environment All tax rates are 19% including corporate and individual income tax rates. Transfers of tangible assets are tax-free. No fiscal incentives. Private limited company (s.r.o): –Minimum issued capital is Sk (5 000 ) –Registering in the business register lasts 5 working days and costs are about Sk (500 ). Public limited company (a.s.): –Minimum issued capital is Sk ( )

National Agency For Development of Small and Medium Enterprises 7 Business environment Bankruptcy and insolvency: –Slovakia provides mechanisms for the restructuring of companies facing financial difficulties. –Managers and directors of a bankrupt company will not face any limitations when getting involved in the management of another company. –It takes 2-4 years between the declaration of bankruptcy and the closure proceedings. Court cases last 1-2 years. Because of their long-term perspectives, pension funds and insurance companies should be free to invest in the asset class.

National Agency For Development of Small and Medium Enterprises 8 The design of the risk capital market in Slovakia institutional capacity building in Slovakia to introduce high quality services which supports Slovakian SMEs to access private funds to design and implement such a service so that it is embedded as an integrated part of Slovak SME support infrastructure the service simultaneously develops both the demand and the supply of private investment

National Agency For Development of Small and Medium Enterprises 9 Outputs Design of measures for creating risk capital market in Slovakia for supporting innovative firms, start-ups and fast growing companies by access to equity capital and related financial products. Measures should cover the supply side (i.e. design of private investment funds including incentives for private investors) as well as demand side (i.e. support measures for prospective companies). Needs Assessment of the training needs to enable private investment in SMEs. Design of tools and processes, which educates Slovakian SMEs to become investment ready. Highly trained and accredited advisers to enable local delivery of tools. A role out programme, which promotes and embeds this service in three sub regions of Slovakia. Strategic guidelines for nation wide development providing long-term sustainability of the SME Investment service into all sub regions.

National Agency For Development of Small and Medium Enterprises 10 Activities To research detailed framework conditions of business environment with the focus on private investments. Surveys of SMEs about their opportunities to innovate and financial needs including equity capital investments. Analysis of conditions for investors in Slovakia and expected deal flow. To initiate risk capital market and to support and prepare companies for accepting successfully equity investments. Consultations with an experienced partner institution about the best design and completeness of financial schemes and support measures.

National Agency For Development of Small and Medium Enterprises 11 Critical factors Private Management of Venture Capital Funds. Leveraging of Private Capital. Attention to Deal Flow Legislation

National Agency For Development of Small and Medium Enterprises 12 Private Management of Venture Capital Funds government should consider directly increasing the pool of venture capital, any government-supported venture capital should be managed by private fund managers, the funds should have appropriate governance structure and can be targeted toward specific types of investments, the private fund managers should be free from government influence with regards to specific investment decision-making and should have incentives to act on a purely commercial basis.

National Agency For Development of Small and Medium Enterprises 13 Leveraging of Private Capital A public instrument for venture capital should aim to encourage private capital, especially from local long-term investors, to support innovative companies. Having private capital involved will enhance the effectiveness of the governance structures, further encourage fund managers to act in commercial ways, and improve the sustainability of the venture capital industry. Therefore, the government should develop some sort of fund of funds structure with government capital leveraging private capital.

National Agency For Development of Small and Medium Enterprises 14 Attention to Deal Flow A public instrument supporting venture capital could be paired with specific technical assistance or grant funding to directly commercialise R&D projects from the Slovakian academic and research community. This approach could increase the attractiveness of early stage investments for the venture capital industry while also increasing the efficiency of the grants from assistance programs by getting the private sector involved in the grant selection process.

National Agency For Development of Small and Medium Enterprises 15 Legislation It is necessary to incorporate in legislation changes concerning establishing and functioning of risk capital funds. This can be made in analogy with share funds.

National Agency For Development of Small and Medium Enterprises 16 Effective Policy Design Policy Tools for Private R&D funding Direct Government Support for R&D Intervention in the Market for Risk Capital Finance

National Agency For Development of Small and Medium Enterprises 17 Sequencing policy intervention Innovative Capacity Increase Pool of Scientists and Engineers through Education Implement Science and Communication Infrastructure Fund pre-commercial basic research Intellectual Property Rights Establish incentives for private R&D through IPR framework Enhance capacity for enforcement of IPR through judiciary, patent office etc. Business Environment / Financial Framework Grants, Credit, Technical Assistance Increase Access to funding for ESTD entrepreneurs Incubators, Technology Centres, Investor–Scientists networks cdslkajdlksjd

National Agency For Development of Small and Medium Enterprises 18 Policy Tools for Private R&D funding direct government support for R&D investment by firms, typically at the early stage of the R&D cycle to determine commercial viability, through procurement preferences, tax incentives, direct grants or loans, intervention in the market for financing of innovative/ technology-oriented firms that are engaging in commercialisation of R&D through direct government funding or incentives for private venture capital funding.

National Agency For Development of Small and Medium Enterprises 19 Direct Government Support for R&D The low levels of private R&D funding and the lack of commercialisation of R&D from the academic and research institutions suggest the need for some form of direct government support for early stage R&D activity by firms. Matching grants that provide direct funding by government for R&D projects by firms are likely to be the most effective mechanisms to target directly the critical early-stage private R&D activity. Requirements for 50%+ matching of the grants by the firm, semi- independent selection committees, and requirements for partial reimbursement of the grants can all create incentives for the firm and the selection committee to emphasize projects with commercial potential. While the government should, in general, be dissuaded from picking winners at the industry level, R&D support could target particular weaknesses in the innovation system such as university-business collaborations.

National Agency For Development of Small and Medium Enterprises 20 Intervention in the Market for Risk Capital Finance Government Risk-Sharing in the Private VC Industry by participating in a privately managed VC fund, the government should remove itself from the investment decision- making but providing quality certification and encouraging other investors to participate in the industry, the government provides additional leverage for private investments by subordinating government capital and/or capping the return from the government investments in exchange for imposing certain requirements (e.g., that a portion of the fund be invested in early-stage technology companies), where a venture capital support program is appropriate this type of risk- sharing model is likely to be most effective because it depends on private sector decision-making and encourages private investment to balance government intervention.