SUPPORTING START-UPS
Read Episode 1: How do business support structures facilitate value creation?
IN SUMMARY
If innovation is a strategic issue both on a ‘macro’ scale in terms of national economies and on a ‘micro’ scale in terms of the businesses involved, then so is its financing. This financing relies heavily on business support structures.
In France, the first support structures aimed to provide an outlet for public research, but the rise of private structures has come hand in hand with a growing awareness of the need for profitability. As a result, though the number of business support structures continues growing, it is no longer uncommon to see some placed under compulsory liquidation (Ekito, 33 Entrepreneurs) or required to change course (Numa, Usine JO).
A viable business model is difficult to achieve when providing services only aimed at start-ups. Fundraising has therefore become an entirely separate source of revenue for business support structures, in a context of heightened competition between them. Moreover, a structure’s ability to support fundraising – measured by the number rounds undertaken as well as by the amounts raised – has become an indicator of performance, sometimes somewhat reductively.
At the same time, the way in which traditional fundraising works is being called into question by the rise of new mechanisms, such as crowdfunding or the use of blockchain and, more generally, by significant societal developments. It is important to assess both the potential and the limits of these new tools and means of financing, as well as the perspectives that they open up to financing players, first among which are the business support structures.
A. Business support structures play an important part in the financing of innovation in France.
B. Different support structure models offer different approaches when supporting fundraising.
C. Although continuously growing, traditional fundraising measures come with a number of significant limitations for start-ups.
D. On a global scale, the Initial Coin Offering (ICO) phenomenon represents an attempt to reinvent fundraising, calling into question in particular the role of traditional players such as investment funds and business support structures.
E. However, taking advantage of the limitations of ICOs, new practices are already coming to the fore; they present new opportunities for innovation players in France.
1. INNOVATION FINANCING IN FRANCE: THE ROLE OF BUSINESS SUPPORT STRUCTURES
A. The substantial growth of venture capital activities in recent years has considerably strengthened the role of business support structures
Venture capital activities – the financing of risky companies with strong potential – have grown significantly in France since 2015 (almost 30% per annum on average for fundraising over the period 2015–2019). In 2019, over €5 billion was invested in these types of operation.
This phenomenon should be viewed against the backdrop of the growing number of start-ups over the past decade, which has brought with it the development of the business support structure market. These business support structures have also seen their number skyrocket, and over 700 communes in France have at least one.
Business support structures are generally the first to assist companies in their fundraising. Indeed, 74% of total venture capital investments in France are used to finance incubated start-ups1. Further, the incubation of a start-up by a business support structure maximises its chances of succeeding in its fundraising. This occurs because (i) the fact of being incubated sends a sign to potential investors and (ii) the business support structure makes it easier to connect young businesses with investors, in addition to providing them with the knowledge necessary to undertake such operations.
Start-up fundraising in France by year [€bn]
Sources: EY 2019 barometer of venture capital, Accuracy analyses
B. Essential support in advance of and throughout the fundraising process
Beyond purely belonging to an ecosystem – a source of value in itself for all stakeholders – there are three major benefits when an innovative project works with a business support structure: (i) administrative and financial support, (ii) human support necessary for the operational and strategic structuring of the company and (iii) the means to measure market response. This last benefit can help when reflecting on the business model, defining customer segments, undertaking targeted surveys or even developing a user-centred approach along the lines of design thinking. All these actions make it possible to gain traction commercially and to make progress towards a proof of concept. This is essential for the initial fundraising round to succeed and to open access to further private financing
at a later stage. The start-ups that succeed in their fundraising are, in a way, privileged, and the role of business support structures is fundamental well in advance of this stage. The diagram below, which displays the resources available for innovative businesses depending on their level of maturity, clearly shows the stakes surrounding support provided in advance. It shows in particular ‘Death Valley’, a tricky step where many startups fall and unfortunately do not get back up.
Whilst financing mechanisms for innovation are available in the technological and economic maturation phases, difficulties arise during the proof of concept phase and at the commercial launch. This is the moment when the start-up generally needs additional financial resources to boost its commercial traction but it also comes precisely when the start-up has used up all its equity funding. Not yet sufficiently desirable for private investors looking for commercial growth (and therefore waiting for proof that customers have validated the offer!), the start-up finds itself in danger of failing.
This state of affairs is all the more significant in non-metropolitan areas. Indeed, in such areas, private financial resources are less accessible, whilst the need is greater due to a lack of available technical skills (concentration of key profiles such as developers in large cities) and a smaller ecosystem (difficulty obtaining access to large customer accounts, industrial partners, financing specialists, etc.).
Detail of key steps in the creation and financing of a start-up
Therefore, the role of business support structures before fundraising is vital, particularly in non- metropolitan areas, to reduce the length of time spent in ‘Death Valley’ as much as possible. More precisely, this means delaying entry into this phase, all whilst anticipating coming out on the other side.
The support provided will therefore follow two complementary and interdependent axes (illustrated in the diagram above):
• The acceleration of technological and commercial maturation: the aim here is to guide the start-ups and give them the technical means necessary to realise their idea and bring it to market. The technical improvement and economic development of the project feed into each other in an iterative process centred on the customer. Ultimately, we get to the minimum viable product and an initial
commercial proof of concept.
• The administrative and financial engineering aiming to maximise leverage effects: to obtain the proof of concept, financial resources need to be anticipated, mobilised and optimised to meet technical, human and commercial needs. However, sometimes start-ups do not sufficiently understand the innovation financing chain, particularly the mechanisms offered by structures like Bpifrance or regional authorities, which are increasingly at ease with their economic jurisdiction. Beyond pure knowledge of these mechanisms, business support structures help start-ups to use them at the right time and to benefit from substantial experience in administrative engineering.
These two axes help to secure the start-ups’ development path and make them desirable to investors, whilst giving them more time and therefore greater negotiating power.
“Our incubator’s knowledge of innovation financing is a key factor in our current growth. It has enabled us to obtain proof of the technical and commercial relevance of our solution and, therefore, prepare our recent fundraising round of €1.5 million with greater peace of mind.”
Pierre Naccache
co-founder of Asystom
C. Differentiated approaches based on the business support structures
Business support structures offer a wide variety of sizes and models, with varying profiles and therefore approaches.
Private structures, public structures, university structures
There are three main families of support structures that can be identified: those financed primarily by public subsidies, split into public subsidies and university funding, and those where private capital dominates. The structures financed publicly can concentrate on a wider range of topics and support a larger number of start-ups; for structures supported by universities or private capital, their economic equation requires them to take a more narrow and selective position in order to generate profits.
The public or private nature of the support structures also has an influence on how investors perceive the support.
We have analysed the top 20 support structures in terms of the average amount raised and the number of fundraising rounds supported. They represent 39% (i.e. a cumulative amount of approximately €1,750m) of the total amount of funds raised by incubated start-ups in France.
It is interesting to note that public support structures (excluding universities) represent 35% of this fundraising in number of rounds. Further, two of them hold the top two spots (Agoranov and Bpifrance Le Hub – see chart below). This success can be explained by the fact that their presence in a particular operation sends a very positive signal to investors: their engagement is a sign of stability, in that they do not necessarily favour short-term profitability, but take into account economic development, the strengthening of local ecosystems or support for strategic sectors.
Structures that have supported the most start-ups towards fundraising
Source: Study on the fundraising activities referenced by Capital Finance over the period 31 March 2017–8 April 2019
The top three support structures in France in terms of fundraising
Note: Four grandes écoles incubators place in the top 20 (Drahi -X Novation Center, ParisTech Entrepreneurs, Incubateur HEC and ESSEC Ventures). This can be explained by the fact that these structures aim to develop and apply scientific innovations, but also by their extensive networks of alumni, particularly among the main financing players (investment funds, banks, business angels, administration).
Venture capital structures, large group structures
For private structures, two main types of business plan stand out: one based on the integration of a venture capital activity, the other organised around strong links with a large group.
In the first case, the structures support a small group of high-potential startups, in which they also acquire shares.
Undertaking subsequent fundraising rounds is therefore a necessary condition of profitability for these players.
In the second case, the support structures have more of a technology-monitoring role for the group to which they are attached. Through them, the group takes a stake (often a minority interest), aiming to create new product and service lines that fit the core business of the group or to counter the risk of potential disruptions.
Generalist structures, specialised structures
Generalist structures generate 44% of fundraising; the remainder is generated by support structures with specific sectoral positioning. The information and communication technology, health and energy sectors are particularly well represented, covering 21%, 8% and 7% of the number of specialised structures respectively. As for the average amounts raised by sector, food, energy, telecoms and chemicals cover
the most significant amounts. Note that the average of the foodtech sector is inflated by the record level of funds raised by Wynd (€72 million), a start-up supported by ShakeUpFactory, an accelerator specialised in foodtech2.
Number of fundraising rounds by incubation sector
Source: Study on the fundraising activities referenced by Capital Finance over the period 31 March 2017–8 April 2019
More or less selective structures
A support structure’s ability to generate funds is not directly linked to the number of start-ups it supports – though the contrary could well be expected.
If we consider the 17 largest support structures in terms of number of fundraising rounds undertaken, they support on average 64 start-ups (49 excluding Wilco, which has supported over 300).
However, the three most ‘successful’ structures (Agoranov, Bpifrance le Hub and The Family) all support a smaller number (41, 55 and 17 respectively).
This reflects the varying degree of selectivity between support structures. In particular, an investment-fund-type structure like The Family will choose projects primarily based on their future ability to raise funds. Public structures like Agoranov and Bpi have selection criteria that include short-term fundraising prospects but also wider objectives, such as offering a commercial outlet for technologies developed in public research laboratories.
Number of start-ups supported and fundraising rounds undertaken by structure
Source: Study on the fundraising activities referenced by Capital Finance over the period 31 March 2017–8 April 2019
D. The limits of business support structures
The growth of the amounts invested in venture capital and the multiplication of business support structures hide an uneven situation in France, as well as the numerous inefficiencies that startups face.
First of all, though business support structures have certainly spread out across the country in recent years (particularly via the FrenchTech label), fundraising remains concentrated in Île-de-France. Start-ups in this area in 2019 represented 75%3 of the amounts collected in France and 97 in 10 of the most significant amounts raised. This can be explained by the fact that the majority of investment funds and business angels are based in Paris.
Further, as well-intentioned as the support provided may be, fundraising can be seen as a risk by entrepreneurs looking to retain control of the management of their company.
Finally, undertaking fundraising rounds remains a difficult task for start-ups: they have to invest significant human and financial resources in processes where the outcomes are unknown; they
often have to repeat the processes for each potential investor with no possible economies of scale; and they are often limited to a national target so as to reduce the number of physical meetings.
In this context, alternative modes of financing have started to emerge little by little, namely crowdfunding mechanisms (crowdfunding, crowdlending, crowdequity) and blockchain mechanisms
(Initial Coin Offering, Security Token Offering).
Number and value of fundraising rounds by region in France in 2019
Source: Accuracy and Eldorado analyses
2. THE INITIAL COIN OFFERING (ICO) PHENOMENON – THE WRONG ANSWER TO REAL PROBLEMS
A. The beginning of ICOs
The years 2017–2018 saw the rise of a new way of fundraising for start-ups: Initial Coin Offerings or ICOs, a play on the term IPO for Initial Public Offering. An ICO corresponds to the issue on the primary market of an asset (a token), of which the ownership and transactions are recorded on a blockchain4 ICOs quickly became an innovative means of raising funds for tech entrepreneurs.
In this process, tokens represent the future right of use of a service, with the token issue guaranteeing the financing. They almost equate to a voucher that can be resold on the secondary market. ICOs can therefore resemble crowdfunding, as the issue aims to finance a service that usually only exists at the fundraising stage of the project.
As soon as the tokens are issued, they can be exchanged directly on the secondary market. Their value is determined by the demand for the service that requires or results from their use. Investors therefore bet on the growing adoption of the service to maximise their return on investment. In addition, it is not rare for project owners to reserve a portion of the tokens issued for themselves in order to benefit from the success of their service.
How an ICO works
B. After seemingly replacing traditional financing means, ICOs are in great decline
After the very first ICO in July 2013 by the Omni project, these operations multiplied in parallel with a significant increase in the market capitalisation of cryptocurrencies, the primary investment vehicle for these operations.
Between September 2017 and November 2019, more than $29 billion was raised in the world by this type of operation, primarily at the end of 2017 and in the first half of 2018 (between September 2017 and December 2017, the capitalisation of this market quadrupled). It should be noted that in France, the number of these operations over the same period was more limited, with only 48 ICOs and $153.6 million raised5. However, this is not representative of the situation in the country, insofar as numerous entrepreneurs chose to organise their ICOs elsewhere6.
Whilst the success of this method of financing can be explained initially by a certain number of specific circumstances, such as the strong increase in the capitalisation of cryptocurrencies, other structural factors need to be considered in order to take the full measure of this phenomenon.
First, the relative efficiency of this fundraising, that is, the ratio between resources (both human and financial) mobilised by a start-up and the amounts collected is significant. For a small company, issuing tokens on the primary market is in theory less expensive than classic fundraising and makes it possible to access a greater number of investors. As for larger companies, an ICO is also less expensive than issuing regulated financial securities.
Breakdown of funds raised in France and across the world
in 2018 and 2019 by fundraising process
This mechanism also has the advantage of security, with the blockchain by its very nature unable to be hacked. Finally, it offers better liquidity because the securities can be easily exchanged, in contrast to a direct investment in a start-up, something that is far from liquid.
The strong growth of the amounts collected during ICOs could give the impression that they would become the indispensable fundraising tool for innovation. However, since the second half of 2018, the amounts collected, as well as the number of ICOs, are in net decline: $2bn per month on average between September 2017 and August 2018, against $0.36bn (i.e. five times less) between September 2018 and November 2019.
Such a slowdown can be explained in particular by the fall in the market capitalisation of cryptocurrencies. Indeed, the loss of value of cryptocurrencies has reduced investors’ available funds and has weakened the cash positions of companies that retained amounts raised in the form of cryptocurrencies. The inordinate exposure of some projects to price fluctuations has led to numerous bankruptcies, which has also highlighted the complete lack of protection for token-holders. The fall in the number of ICOs can also be explained by the numerous fraud schemes and scams that plague this type of operation, of which some have featured heavily in the media.
Despite this mixed balance sheet linked to a passing trend for cryptocurrencies, ICOs remain important for three reasons: (i) they represent an expression of mistrust towards historical players in fundraising (advisory services, traditional investors, and business support structures), (ii) they serve as a means of obtaining financing for those that could not obtain it elsewhere and (iii) they are attractive to those with a pronounced desire for innovation. It is based on these elements that a new generation of financing models is now being built.
Amounts collected by ICO, number of ICOs and market capitalisation of cryptocurrencies
Source: CoinSchedule, ICO Bench, Accuracy analyses
3. TOWARDS NEW HYBRID MODELS?
A. Initial Exchange Offering: a return to trusted third parties?
An Initial Exchange Offering (IEO) is an ICO undertaken directly on a cryptocurrency exchange platform (an exchange). In this process, the exchange plays the role of the trusted third party. By sorting through the projects and undertaking sufficient due diligence on them, the exchange guarantees investors that the project is serious and, in particular, that it has potential. Indeed, the exchanges7 have the skills necessary to value the projects and put their reputation on the line by accepting to list them – thus providing the projects with the liquidity that investors seek.
The IEO practice has been growing since the end of 2018: whilst the number of ICOs has been consistently falling since March 2018, the number of IEOs has been consistently rising since January of the same year.
This recentralisation is somewhat paradoxical in light of the decentralisation aims of blockchain, but it makes it possible to assuage the concerns of investors. By repurposing the principle of the ICOs, IEOs show that this innovative process can still be relevant for certain projects, whilst conserving the far from negligible advantages it has over traditional fundraising, provided that asymmetry of information between start-ups and investors is remedied. It highlights that only a thorough analysis of the business model, the addressable market and the benefit of blockchain technology can guarantee a project’s reasonable chances of success.
In this sense, the ICO experiment makes the case for the increasing involvement of trusted third parties such as advisory firms, support structures and, in the case of IEOs, exchanges.
Amounts collected by ICO / IEO and market capitalisation of cryptocurrencies
ICO vs IEO: development of amounts collected
Source: CoinSchedule, ICO Bench, Accuracy analyses
B. Security Token Offering: a hybrid model
A Security Token Offering (STO) corresponds to an issue on the financial securities primary market, represented by a token on a blockchain. Far from a simple voucher like in the context of ICOs or IEOs, a token here gives rise to the right to future revenues, either fixed or variable depending on their configuration. As the financial securities are subject to strict regulations, investors have potential recourse against ill-intentioned start-up entrepreneurs.
Blockchain here represents only the technological infrastructure on which the transactions are registered. However, it opens up wider perspectives in terms of the digitalisation of financial securities and beyond. The acquisition of a €5 million stake in Tokeny Solutions8, a Luxembourg start-up specialised in the “tokenisation”9 of financial assets, by stock market operator Euronext, follows this dynamic.
Indeed, blockchain characteristics make it possible to consider the lowcost securitisation of any type of asset, whether works of art, financial securities or real estate. The liquidity of these securities on the secondary market is not yet guaranteed due to the lack of exchange platforms with the necessary licences and sufficient volumes, but dozens of projects across the world are under development in this area.
Examples of STO projects in progress around the world
Blockchain also represents an opportunity to develop innovative financial securities, which for example allocate to investors a percentage of certain elements determined in advance, such as operating profit or profit before tax. Whilst this type of instrument was already possible before blockchain, the automation made possible by smart contracts10 changes the cost/benefit equation. This would mean generating wider interest among investors, in exchange for less involvement in governance.
Though the ICO phenomenon is losing momentum, business support structures can learn a great deal from it, despite first perceiving it as a threat. It has revealed the complexities and the excesses of ‘traditional’ fundraising and is an opportunity for the innovation financing ecosystem to reinvent itself with new hybrid mechanisms.
And it is not the only driving force. Indeed, the digitalisation of operations is growing with more and more services being performed remotely: support, events, conferences, fundraising, etc. This revolution in our way of working is leading to a greater number of structures with no physical locations and off-site support programmes.
In addition to adapting to this innovative way of working, business support structures will have to adapt to new market requirements: improve their ability to operate in non-metropolitan areas by mobilising relevant investors outside major cities or develop their mastery of cutting-edge technologies such as blockchain, which makes it possible to digitalise complex operations without jeopardising data security.
Between the search for profitability, new start-up needs (mobility, flexibility, transparency), developments in utility (crowdfunding) and technology (blockchain), and changes in their ecosystem (digitalisation, globalisation, decentralisation), business support structures need to be as innovative as their innovative clients!