Detailed Scheme for Funding Innovation: Part II

From what it appears, a start-up scheme covering the whole of the European Union, seems to be a topic where many people have been considering, and hopefully many more will in the future. After the previous post where a detailed scheme for funding innovation was presented, and especially after Horatiu Ferchiu's excellent comments and Alex Ghita's significant contribution to this discussion, the time is here for a little more detail into what should constitute a Scheme that would be both beneficial and sustainable.

To quote Alex:
"Firstly, building the fund allocation system on national banking systems would mean that each member state would have different rules regarding allocation and especially regarding taxation (not of funds especially, but of the direct output). This could make some member states hot-spots for start-up building and innovation, while leaving others in the shadows. This would lead to further increase in disparities, not making the overall situation any different that it is now. Also, it would neglect start-ups and innovation based on international cooperation. Secondly, not all national bureaucratic/economic systems work the same, and with the same efficiency. Insuring an efficient system, for fund management that works in similar ways (national laws make it impossible to make it work in the same way) is key. The contrary would lead to the same polarization effect described above."

For better or for worse, Alex is right. Nevertheless, it was an omission from my side not to mention that when defining what the Sovereign Fund would do, I failed to mention that the particular Fund would only accept applications from that Member-State's nationals and the company would have to be based and registered in that Member State. This would essentially mean that the scheme would eliminate the tendency of having some countries benefit the most as start-up hotspots. Thus, by forcing the nationals to stay in their home nations, it would mean that we are trying to actually decrease disparities in the EU. Obviously we can never know whether an idea in Greece would be more or less successful than an idea in Netherlands, nevertheless this is a "risk" that we have to take.

An issue which will arise from the above explanation is what should happen when a national of e.g. Germany and a national of Malta decide to form a new company. Or what should happen when 3 or more people from different countries decide to apply for funding. In the case of 3 or more people the answer would be easy: apply and form the company in the Member-State where the most of the founders are from. In the case where all founders are from different nations then the answer would be that they would be free to select any country they see fit to apply to. This is not an easy selection, however. In our example of Germany and Malta, the former has more access to industrial goods and may provide a larger network of partners, nevertheless, Malta has a very lower tax rate for businesses, it makes it easier for a company to be set up and if the company is purely technological, access to industrial goods is not needed. If industrial goods are indeed needed though, then Germany would be a better choice.

Phenomena like just selecting a partner from another EU country, just to apply for funding there may arise (this already happens for many EU programs), but in the start-up context, very few people would be willing to share an idea with a stranger and give him/her access to potential millions just for an opportunity to register in a foreign nation. And besides, let us not forget that the funds would be distributed proportionately to the EU countries, which would make competition even harsher in either a small or a large county.

Bureaucracy is unfortunately not the same across the EU and Alex is right about that as well. Nevertheless, this is the reason why both the Sovereign Fund and the Investment Fund should not be considered as institutions of the particular country they are based, but as EU institutions. This would allow them to function irrespective of the bureaucratic system of each nation and reach decisions faster and more efficiently. When, however, they would be forced to work with the local authorities, country-specific bureaucracy might pose significant problems.

This is where an amendment to the previous article is needed: the Sovereign Fund should have priority to all other participants in any procedure that would require co-operation with local authorities. For example, when applicants are trying to register their new company, they should have priority over every other person applying for company registration. This is one of the reasons that I have not been very supportive of employing local banks as a way to promote innovation: the banking institutions would usually take longer than if an independent organization is used. Thus, in order to reduce bureaucracy, an independent institution should be created for this issue.

Again, Alex is right when stating that "Any fund, project, policy, or programme is useless if the targeted actors do not actively participate. This is why the governance model would also have to provide the necessary tools for the independent formation of supporting participatory structures, which could ensure the reaching of targeted of actors." It is my belief, or at least my hope, that with the introduction of such a project, many would choose to participate. On the wider circle, a surge in consultants and advisers is surely to emerge as many would seek assistance before or after obtaining the grants. I trust that although this wider circle may not emerge in the first year of the Scheme's application, it would arise after due time. For better or for worse, this is an issue we cannot rush and force.

What Horatiu was mostly worried about during our discussions (you can have a look at them here and here) was that the technocrats controlling the Sovereign and Investment Fund would have tremendous power over what the businesses and that embezzlement or misuse of funds might arise. After considering this issue, Horatiu proposed that a simultaneous audit on both the Fund and funded company would be of more use than just on the former. In addition, I would also comment that the audit should occur bi-annually, at random intervals and on all funded companies simultaneously, so that the possibility for fraud is reduced. Severe penalties should also be imposed, to both the people responsible in the Fund as well as the funded company, when irregularities are discovered.

As for the technocrat power, this is unfortunately unavoidable. What the Scheme should account for though, is for aligning their interests with the Fund's interests. By this I mean that the participants in both the Investment and Sovereign Fund should receive remuneration at about the average salary of the country they are being employed and additional bonuses when funded companies do well. This would create an incentive for them to fund the companies which would appear to have the most growth potential, something which would help themselves, the funded companies, the Member-State and the Union as a whole.

I would like to end this article with another quote from Alex's contribution to this subject:
"The opportunity given by this type of fund is, I believe, a currently non existent way of sponsoring a type of work-economy that is specific to this day of age. Sponsoring location independent businesses and creating the infrastructure for them to function from anywhere, is one of the ways in which the EU can step ahead of its competitors."

We should not forget that although companies need a specific space and place to function, its people do not.

Let us know if you have any contributions, suggestions or comments on the subject.

Start-ups, Democracy and Growth

While the economic climate is deteriorating rapidly in South Europe what seems to raise our expectations about the future is the fact that in Spain, with unemployment reaching 25% and youth unemployment more than 50%, young people have began creating start-up businesses as a response to the economic crisis in the country. (for more information concerning start-ups in Spain read this).

Europe, especially in the South, does not have the same mentality or maybe not even the same resources when it comes to start-ups and establishing new businesses, as countries like the US or Israel do. The only nation in the EU that comes near this mentality is the technology-oriented Estonia which in 2005 it became the first country to offer Internet voting nationally in local elections. The feature itself is very impressive and something I would love to see in all countries. This will bring a new era in democracy, allowing citizens to have a direct opinion on many aspects of national affairs through courses of action like referendums. For those who love numbers 1.9% of the Estonians (approximately 9,300 people) voted online in 2005 whilst the percentage rose to an impressive 15.4% (150,800 persons) in the 2011 parliamentary elections.

Returning on the start-up discussion, with a simple visit to the EU grants website the reader may observe how many grants are targeted in  start-ups. Exactly none. Entrepreneurship is left to be promoted by individual countries and not at the EU level. Nevertheless, whilst in the UK (and to a much lesser degree in Germany), entrepreneurship attracts a rather significant amount of young talent, the South European mentality states that a job at a large corporation or in the government sector is a much more prestigious one. This is rooted in genes of all South European people, maybe a fact which derives from the instability in governments over the last century and has resulted in a need for a stable job, salary and life. (remember that Italy, Spain, Portugal and Greece suffered through dictatorship regimes over the last century, with all of them experiencing terrorist attacks over time and Cyprus had been prone to rough civil disputes and a Turkish invasion in 1974). These experiences lead to a risk-averse society, with the specific mentality passing on to the next generations.

However, when talking to today's youth, this mentality seems to be changing. This might be the result of the economic catastrophe the aforementioned countries are facing, where the most stable of organizations of the past, the banking institutions, are proposing layoffs and shrinking of business activities to survive. It seems that the most prestigious employers have lost their reputations.

My hope for the future is that EU governments understand the importance of start-ups in the economy and provide financial assistance, in the form of subsidies or state-owned Venture Capital (VC) firms to aid individuals get the funding needed to start their business. This need only be done for a short period of time, since after the initial phase, more and more privately held VC firms and angel investors will emerge. The cost of funding a start-up is also very low as most of them require less than 100,000 euros to function. Given the amounts each country spends on foolish expenses each year sparing 10 million a year for start-up funding is infinitesimal. On the contrary, the outcome of such policies will be extremely beneficial as the now deteriorating economies will be able to bounce back, create thousands of jobs and restore confidence in the nation as a whole.