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Report: financing innovation – earlystage investment in the EU

August 2023 • Capital marketsby William Wright & Christopher Breen

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Innovative growth companies are a vital part of rebuilding a more resilient, dynamic, and sustainable economy in the EU.  This report highlights the challenges faced in funding this important sector, analyses the rapid growth in early stage investment in the EU over the past five years, and outlines an ambitious but achievable growth opportunity that could unlock nearly €25bn a year in additional investment to support nearly 5,000 companies in reaching their potential.

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This report was prepared for and presented at the Informal Ecofin meeting of EU finance ministers and central bank governors in Stockholm in April.

Financing innovation: early stage investment in the EU

In the wake of the Covid crisis, the Russian invasion of Ukraine, and the recent turmoil in banking and financial markets, the EU needs all the help it can get to build a more resilient, more dynamic, and more sustainable economy. In particular, the EU needs to develop more financing of innovation at scale – an area where the EU has traditionally lagged behind other developed economies – to help support the sort of companies the EU needs to drive investment in jobs, growth, productivity, and prosperity.

This short paper was prepared for the Informal Ecofin meeting in Stockholm in April 2023 hosted by the Swedish Presidency of the Council of the EU. It frames early stage investment in the EU in the context of the state of wider capital markets, and compares early stage investment in the EU with comparable markets like the US, UK, and Canada. It highlights the welcome and rapid growth in activity over the past five years; analyses the wide range in the level of activity in different member states; and provides a directional indication of the potential growth opportunity at an EU and country level in concrete terms. It also presents some questions and suggestions for consideration at a member state and EU level as to how to achieve this growth.

Here is a summary of the key points from this paper:

1) The wider context: capital markets in the EU are under-developed and fragmented but they are heading in the right direction and have made steady progress since the launch of capital markets union. Activity has grown in absolute terms and relative to GDP in virtually every sector, and EU capital markets are deeper than ever before. But there is a wide range in development across the EU, and the EU’s share of global activity has halved in the past 15 years.

2) Financing innovation: the gap between early stage investment in the EU and other developed economies is stark. Over the past five years activity in the US has been more than six times larger than in the EU (€845bn compared with €131bn). The market is highly concentrated (with Germany, France, and Sweden accounting for 70% of activity) and investment is not evenly distributed across the EU. This suggests that many high potential companies in some markets may not have access to the capital they need.

3) Rapid growth: the good news about early stage investment in the EU is that it is growing rapidly. Over the past five years activity has increased fivefold, and after explosive growth in 2021 investment held up well in 2022 despite the wider market downturn. Last year, activity in the US was just four times larger than the EU, compared with 12 times larger as recently as 2018.

4) Growth opportunity: the wide range in development between member states and rapid recent growth suggests there is huge growth potential in early stage investment in the EU. Using a simple analysis to benchmark EU member states with each other, we estimate that early stage investment in the EU could realistically grow by nearly two-thirds. This would unlock an additional €24bn in investment in an extra 4,800 high potential companies across the EU every year.

5) Seizing the opportunity: there is no magic wand that the EU or individual member states can wave to achieve this growth potential, and early stage investment may struggle to adapt to rising interest rates. Enabling this growth will require a combination ‘top down’ initiatives at an EU-level to reduce barriers and ‘bottom up’ measures at a national level to drive capacity. Ultimately, innovative companies will thrive in markets with well-developed ecosystems that incentivise, attract, and retain the best talent.

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