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State action in favour of startups? Yes, if well balanced

NewsFromThePlatform | December 13th, 2018

In the US, jobs come from start-ups. This was stated, among others, in a recent report by the Kauffman Foundation. It’s a trend that the OECD has been monitoring for about 20 years: big corporates are firing employees, while innovative SMEs and start-ups are hiring. This makes the need for a start-ups policy extremely clear.

In Italy, in this sense, we have the Startup Act, the Italian law that supports innovative startups since 2012 (we have previously talked about it here, imagining its possible developments as an update is being discussed in Parliament). This update contains many elements of regulatory innovation and goes in a different direction than that of mere public funding. Government funds, indeed, have proven to be a poor flywheel for the growth of VC and sometimes, when used in the wrong way, it has even had a restraining effect. At least, we at P101 think so, together with OECD, which has expressed its view in its evaluation study of the Startup Act.

Before explaining in detail why, let’s see how the new budget law deals with this issue. The 2019 Italian Budget Law allocates a certain amount of funds to start-ups. All the news are in Article 19.

The first news is the establishment of a “Fund to support Venture Capital” (which can itself invest in VC funds) at MISE, 30 million euros each year from 2019 to 2021 and of 5 million euros each year from 2022 to 2025.

A small fund that could be the driver of the Italian market’s growth, which is still underdeveloped compared to other European countries. Article 19 also provides for the closing of the Balkan fund that was established in 2001 and has been scarcely used by Triveneto entrepreneurs. And the closing of the Startup Fund established in 2009, which was also not widely used. The two old funds had a budget of 2.5 million each, which will be allocated to the State.

Paragraph 20 establishes the creation of fund for Artificial Intelligence, Blockchain and the Internet of Things, with a budget of 15 million euros each year from 2019 to 2021: the stated objective is to support economic competitiveness and productivity. Meanwhile, at the end of October, CIPE assigned 100 million euros to the development of these very enabling technologies.

Will the funds be useful? It depends on how they will be used. Of course, the emphasis on an industrial policy for VC and start-ups is important.

According to the OECD, the effects of the Startup Act have been positive, considering the relatively low cost of the policy. This policy has allowed many startups to increase their sales by 10-15%, as well as to gain higher added value and assets than the startups that have not resorted to the Act. “Access to credit also significantly improves the magnitude of the effects” especially for “those that benefit from the bank public guarantee fund for bank loans to SMEs (Fondo di Garanzia); and, on the other hand, those that benefit from other policies, supposedly those that favour equity financing” writes the OECD.

Then the OECD names some additional descriptive evidence, which should not be interpreted as causal but are significant nonetheless. As the one highlighting that “the policy is associated with a higher number of venture capital (VC) deals and with a higher probability of receiving VC within the first three years of life at the company-level. However, there is no evidence of an increase in the total amount of VC funding.

So, there’s still space for improvement. State intervention in the world of startups should be well-balanced, since it can be useful in the early development phase of the market, but later it might also have a boomerang effect.

More investments in government VC funds are also advocated as a possible solution to the persistent and striking underdevelopment of the VC market in Italy, also in light of positive experiences in other countries” writes Ocse. Government intervention in the VC market is also justifiedby the existence of market failures of the private VC market and by the lack of a critical mass.” However, there are also some important risks associated with government VC investments, “for example the possibility of saturating the market and crowding out of private investments.”  For this reason, “such a strategy should be accompanied by complementary and synergic polices aimed at facilitating the access to the market and at removing the growth barriers for the high-potential start-ups.

Therefore, besides using government funds, Italy should develop a different cultural attitude, as today it seems to be “refractory” to innovation, as well as filling its ” lack of advocacy in the public debate. While in countries like the United States and France advocacy groups for innovative entrepreneurship are becoming increasingly influential, in Italy the policy debate seems to be much more responsive to the needs of established incumbents that go through temporary – or sometimes even chronic – distress, rather than to the instances of young companies.” A cultural change is therefore strongly needed, starting from the institutions.

Besides culture, the OECD stressed the need to balance the use of debt financing with equity financing. “While the large majority of start-ups in the policy appear to benefit substantially from the public guarantee fund for bank loans, the economic literature suggests that equity financing is more suited to high-growth and high-risk innovative start-ups.” Debt guarantees should therefore be carefully monitored and assessed: first of all, because they employ a considerable amount of public resources, and then, in order to avoid that an easier access to debt than equity could induce high-potential startups to opt for a slower growth path. Academic studies also show that, once startups access secured credit, they then have more trouble attracting venture capital funding.

However, an effective and complete policy for startups is not enough to create a positive environment for innovative businesses. Horizontal reforms are proportionally more helpful. “The inefficiency of the judicial system is a very illustrative example of an Italian weakness that, if properly addressed by effective reforms, would significantly unleash the growth potential of innovative start-ups”, concludes Ocse. And there are no doubts: without a favourable habitat and without a cultural change – the two major weaknesses of the Italian ecosystem – making new businesses and doing VC will always be complex.