Europe ventures forward: Getting the scaleup of cleantech right

Public interventions that help European startups to scale up their businesses have so far focused mainly on establishing a functioning market for venture capital (VC) and making it attractive to private investors. However, VC funding in Europe remains a fraction of what is required, still relies heavily on the public purse and fails to channel resources into strategic green sectors. Changing this requires three measures. First, the EU should enable institutional investors to invest independently in VC. Second, the European Investment Fund should strengthen the sustainability impact of its support for VCs. And third, the European Investment Bank should expand its direct investments in cleantech scaleups that are too risky for private investors.

The EU has a scaleup financing gap. Europe is not short of innovative companies, but those that want to grow face serious difficulties in accessing capital at home. Typically, venture capital (VC) firms provide capital to risky startups. But compared to other jurisdictions, Europe’s VC sector consists of fewer and smaller funds, because institutional investors in the EU rarely invest in VC or prefer established funds in the US. This constitutes a problem, especially for larger European scaleups that often relocate to the US where a vibrant and innovative finance ecosystem provides ample risk capital to new companies.

Public support for Europe’s VC industry has not closed the gap in private financing. While the US once kickstarted its now mostly privately-funded innovation financing ecosystem with direct state investment and China still uses government-controlled VC funds to support its industrial policy ambitions, the EU to date has mostly refrained from directly investing in startups, instead injecting public money into private VC funds that then take the investment decisions. As a result, the largest investor in European VC funds today is the European Investment Fund (EIF) – the investment arm of the European Investment Bank (EIB) Group. The EIF can point to significant successes in ramping up the European VC market. However, this cannot hide the reality that VC funding in Europe currently remains a fraction of what is required and still relies heavily on the public purse.

Providing innovative firms with capital at home is a priority for the new European Commission. In July, then President-elect Ursula von der Leyen proclaimed her intention to turbocharge tech investment in Europe. Further growing the European innovation finance ecosystem is indeed crucial to foster Europe’s competitiveness, productivity and sovereignty. But the EU firstly needs to spur investment in breakthrough technologies if it is to fulfil its climate ambitions. The International Energy Agency estimates that 35% of the technologies needed for reaching net zero in 2050 are not yet on the market. Boosting investment in green innovation – beyond enacting sufficiency-related policies that curb energy and resource demand – is therefore imperative.

Creating a European innovation finance ecosystem takes more than money. Instead of simply pouring more public money into Europe’s VC industry, the EU should rethink its approach to public innovation funding. First, the EIF should help institutional investors to build VC expertise. Second, the EIF should strengthen the conditions for its programmes targeting sustainable investments. Third, the EIB should gradually expand its direct investment in selected green companies that cannot receive funding on private markets.

1 Status quo of the European venture capital market, its problems and their drivers

1.1 Setting the scene: Innovation financing and the role of venture capital

As startups pass through their distinct stages of growth, their financing requirements change. At the nascent stage, founders often rely on self-funding, grants or loans from family and friends. As business ideas transform into companies, startups become more dependent on ‘seed’ capital to finance investment and then early-stage venture capital when they need to launch their products. Successful startups that have already established a product and have started to generate revenue but want to grow their production capacity and expand their business are called scaleups. They rely on venture capital and, at a later stage, on venture debt and bank loans (Figure 1).

Figure 1: Innovation financing ecosystem

^{Source: Author’s own illustration, based on IMF and EIB.}

Venture Capital (VC) sits at the heart of the ecosystem that finances innovative companies. VC is a high-risk, high-return form of private equity. VC funds are typically structured around a ten-year horizon and invest in a diversified portfolio of startups and scaleups. After raising a fund, the VC firm will allocate a portion of the capital to its portfolio of companies, and over subsequent years will winnow out underperformers and channel the unallocated portion to the success stories. VC funds raise their financing from a broad range of so-called limited partners. Investors range from wealthy individuals, family offices and endowments to institutional investors, including pension funds, investment funds and insurers. The larger these VC funds become, the more reliant they tend to be on financing from institutional investors. In Europe, however, institutional investor engagement is still rather low.

1.2 Status quo: The European VC sector is underdeveloped

Europe’s VC ecosystem is less developed than in the US. European startups that are in their early business phases – that is, at the proof of concept or early commercialisation stage – have relatively good access to seed capital. However, when they reach the early growth and scaleup phases, many promising European startups struggle to raise the capital they need to expand. Over the last decade, the European VC market expanded steadily up until the ECB’s interest rate policy turnaround in 2022 (Figure 2). Over the same period, however, it has still been a mere fraction of the US market.

Figure 2: VC investments (% of GDP)

^{Source: Author’s own illustration, based on IMF data.}

The VC industry displays considerable intra-EU heterogeneity. VC funding in Europe is unevenly distributed across the EU (Figure 3). Member states where households invest a larger share of their savings in capital markets and that spend more on R&D relative to GDP tend to have higher VC investment ratios. But even scaleups located in those EU countries with the most developed capital markets raise less financing than those in the US. The size of the gap relative to San Francisco ranges from 71% in Germany to 40% in the Benelux area (Figure 4).

Figure 3: Venture capital invested in the EU, 2021-23 (% of GDP)

^{Source: Author’s own illustration, based on IMF data.}

Figure 4: Cumulative capital raised by scaleups after ten years (relative to San Francisco)

^{Notes: The financing gap is expressed as the percentage difference between the average cumulative capital raised in the first ten years since establishment by scaleups in a region and the average cumulative capital raised by firms located in San Francisco. The sample consists of a balanced panel of companies with at least one deal between 2013 and 2023 with a market valuation of between $500 million and $10 billion.}

^{Source: Author’s own illustration, based on EIB data.}

The gap is most pronounced in the large-scale VC segment. There are far fewer VC funds in Europe than in the US and even fewer of a size capable of financing individual scaleups’ later-stage financing needs while maintaining a diversification of risk exposures. The number of VC funds in the USD 500 million to over 1 billion range is twelve to 14 times greater in the US than in Europe (Figure 5). This lack of specialised and large-scale VC funds especially hinders the growth prospects of late-stage European scaleups whose financing needs can amount to hundreds of millions of euros.

Figure 5: Venture capital raised, by fund size, 2020-2023

^{Source: Author’s own illustration, based on IMF data.}

1.3 Problems arising from the current state of the European VC market

1.3.1 Negative consequences for the innovation ecosystem

The underserved VC market results in Europe losing innovative firms. Europe’s inability to provide later-stage scaleups with adequate domestic funding obliges many innovative firms to work with a foreign lead investor. Lead investors play a key role in financing deals and are responsible for coordinating the funding round and negotiating terms. The presence of a lead investor, often leveraging specialised industry knowledge, signals a company’s quality, catalysing additional investment from more generalist investors. As Europe’s VC ecosystem is less developed, 82% of scaleup deals in the EU involve a foreign lead investor. But that’s not all: given the need for repeated funding rounds and more profitable exit options in other financial centres with deeper capital markets, European scaleups face material incentives to relocate abroad and 12% actually do, most notably to the US where they can also more easily generate wide market reach than in the fragmented EU single market. Firms undergoing an IPO are likely to open headquarters in the country where they are listed: in 55% of cases the stock exchange and their new headquarters are in the same country.

Europe misses out on beneficial networking effects. Europe’s limited capacity to nurture innovative firms is a drag on its productivity, because venture capitalists not only provide funding but also knowledge, advice and networks that they bring to their chosen firms. First, the relocating of the most promising European startups shifts value creation to the US. Even if some operations stay in the EU, many of the growth and employment benefits accrue abroad. Second, it deprives Europe of the positive spillovers from innovation and R&D that such firms generate. Third, it prevents the creation of an entrepreneurial ecosystem in the EU: when companies move abroad, this weakens the ‘talent flywheel’ effect whereby new leaders support the next generation of startups, leading to entrepreneurial brain drain and missed opportunities for the local innovation ecosystem. Finally, if a lack of capital obliges founders and VC funds to sell a startup prematurely, they will be realising less of the ultimate value of the firm, reducing proceeds that could have been reinvested into the domestic startup ecosystem, as occurred for example after the successful exits of Skype and PayPal.

1.3.2 Negative consequences for clean and social investment

The lack of risk capital is especially pronounced in the cleantech sector. In absolute numbers, European cleantech obtained more money than any other tech sector in 2023. Nevertheless, green companies face more severe financing constraints than other innovative firms, because they are typically capital intensive and are associated with higher technological and regulatory risks, uncertain future demand, and longer time to market. Their ‘Death Valley’ is thus longer and deeper. Given VC firms’ focus on generating high returns within a fixed investment horizon, they may skew their portfolios toward sectors whose innovations are easier to commercialise or where uncertainty about demand is less pronounced, such as in the software development sector. What’s more, as almost none of the world’s largest VC funds consider human rights in their investment processes, venture capitalists may undermine social responsibility considerations. Lastly, cleantech manufacturers are generally required to produce a series of bank guarantees to mitigate a buyer’s risks in purchasing their newly developed equipment. Because of cleantech’s lower bankability compared to major industrial entities, banks ask for 100% cash collateral for the guarantees, tying up precious capital that could have been used for building up a cleantech firm’s manufacturing capacity.

1.4 The underlying reasons for Europe’s scaleup financing gap

Institutional investors in the EU aren’t investing enough in VC. Creating VC funds large enough to provide scaleups with later-stage growth financing requires the raising of greater amounts of capital, particularly from institutional investors such as pension funds, insurance firms and investment funds. In the EU, however, institutional investors provide only 30% of VC funds compared to 72% in the US (Figure 6). Public entities such as the European Investment Bank (EIB) Group and national promotional banks and institutions (NPBIs) together contribute 31% of VC funding but cannot compensate for the absence of private money.

Figure 6: Sources of VC funds by investor type (average % of total VC raised 2013-2023)

^{Source: Author’s own illustration, based on IMF data.}

Private pools of capital are heavily fragmented in Europe. The fact that the EU financial system is bank-based limits the aggregate size of Europe’s capital markets. Not only are capital markets in the EU smaller than in the US, the relative importance of pension funds and insurers is also reversed (Figure 7) as many EU countries rely more on public pensions. Insurance companies in the EU often stay clear of VC funds as their clients prefer life insurance products providing guaranteed returns which forces them to invest conservatively. On the other hand, pension funds do not reach a critical volume in any EU country. Most occupational pension systems do not offer pension products across borders because of differences in nationally stipulated social benefits and labour laws and the associated costs, complexity and operational risks. Sweden, Denmark and the Netherlands have retirement systems that are more market-oriented, but their pension funds are also not equipped to play in the same league as their US peers. The relatively small size of most EU countries and the limited pool of capital available from institutional investors in any one country would require raising funds across borders, but this is often difficult due to regulatory, legal and tax frictions that impede cross-border investing and trading. As a result, a far smaller share of VC funds’ capital in the EU comes from institutional investors compared to in the US.

Figure 7: Pension funds and insurers’ assets (% of GDP, 2022)

^{Source: Author’s own illustration, based on IMF data.}

EU pension funds lack familiarity with VC investments. European institutional investors are often unfamiliar with the VC asset class and thus their willingness to invest in VC or in the screening of promising VC funds is limited. This is because pension funds in many EU countries face quantitative limits on how much they can invest in private investment funds. Despite EU legislation such as IORPs (Institutions for Occupational Retirement Provision) in place, supervisory cultures and practices differ substantially among EU member states. For example, Poland restricts asset allocation shares and fees charged by alternative investment funds, effectively discouraging investment in VC. As a result of investment restrictions, supervisory incoherence and fragmented capital markets, many pension funds in the EU lack specialist teams able to research the European VC sector for promising investments. Instead, they prefer US-located VC funds that have a proven track record and offer bigger tickets which are easier to manage than many small engagements.

US pension funds have a more pronounced risk-taking culture. The importance of investment restrictions is underlined by the consequences of a 1979 reform that enabled US pension funds to invest into risky assets, including VC. In the following eight years the share of US pension funds in VC capital increased from 15% to over 50%. What’s more, the reform encouraged pension funds that were lacking the expertise and institutional capacity to manage complex and risky investments to hire specialised asset managers. This reform thus sowed the seeds of the risk-taking culture for which the US economy is today renowned and which is still rather absent in the EU. As a result, EU pension funds on average invest a mere 0.018% of their total assets in venture capital, whereas US pension funds allocate 1.9%. This more than a hundredfold difference represents a huge gap when it comes to the funding of innovative companies in Europe.

2 Public sector intervention to address Europe’s scaleup gap

Public initiatives for narrowing the transatlantic gap in VC funding go back to the early 1990s. While they can point to notable successes, they are not without flaws.

2.1 Development of the public support for European scaleups

Public money today has a substantial footprint on the European VC market. Over time the financial resources available at EU level increased. Alongside its role in providing SMEs with guarantees and credit enhancement through securitisation, the EIF has become the largest investor in European VC funds and supports almost 50% of VC-backed startups in Europe in a typical year. With mandates from the European Commission, EU member states and private investors, the EIF acts as a public investment manager. In 2023, the EIF invested €2.8 billion in VC, approximately half of all EIF equity commitments. At EU level, the scaleup activities of the EIF are complemented by the EIB and the European Investment Council (EIC) Fund (Table 1).

Table 1: Overview of EU activities targeting the scaleup gap

2.2 Current EIF activities targeting scaleups

Financial intermediaries play a central role in the activities of the EIF. The EIF in general does not directly provide startups and scaleups with equity but invests in private VC funds which serve as financial intermediaries and select the ultimate beneficiaries. To identify suitable VCs, the EIF conducts a selection process and then negotiates with the VC fund manager any contract terms, including investment strategy, reporting requirements and financial compensation. Typically, the compensation model of venture capital consists of an annual management fee and the carried interest – that is, a share in the capital gains resulting from the successful exit of an investment or the overall portfolio. To receive the full carried interest, the VC firm must fulfil pre-defined key performance indicators (KPIs). There are three programmes through which the EIF strives to promote investment in European scaleups and to partner with institutional investors.

First, the EIF manages capital on behalf of private investors and shares VC market information with them. Under the Asset Management Umbrella Fund-of-Funds (AMUF) initiated in 2017, the EIF fundraises among institutional investors and family offices with a minimum investment of €80 million and invests on behalf of its private participants. In addition, the EIF provides AMUF investors with access to the EIF’s Knowledge Hub, which offers insights and best-practice examples relating to the private equity market, and EIF information portals such as the Virtual Data Room and the Investment Café, which share private equity market insights and act as communication platforms for investors.

Second, the EIF manages public-private co-investment in VC. Under the InvestEU programme, the EIF injects public capital into VC funds and invites private investors to do the same. Investors can choose to invest at equal terms (‘pari passu’) or with an asymmetric risk–return structure as provided through the European Scaleup Action for Risk capital (ESCALAR) programme. This initiative is a fund-of-funds with individual engagements of up to €100 million, whereby the EIF invests into VC funds by creating a new, less risky share class that is investible also for private investors. Where a fund underperforms, the ESCALAR shareholders, including the EIF, have their capital repaid first. With this mechanism, the EIF reduces risk for itself and for other investors, an outcome intended to attract risk-averse investors such as insurance companies.

Third, the EIF manages public capital. In February 2023, the EIB Group and a handful of EU member states launched the European Tech Champions Initiative (ETCI). With EIB Group resources alongside contributions from Germany, France, Spain, Italy, Belgium, and more recently the Netherlands, the total capital of the fund-of-funds is now €3.85 billion. By investing in VC funds with a target fund size of at least 1 billion euros, its aim is to support the emergence of large-scale VC funds. To satisfy the financing needs of Europe’s biggest scaleups, EIB Group President Nadia Calviño recently proposed opening up the ETCI for private investors. By pooling capital from public and private purses across the EU, the ETCI could improve cross-border integration and offer big-ticket engagements for institutional investors seeking to diversify their investment portfolios.

The EIF also cooperates with national promotional banks. Since 2016, the EIF-NPI Equity Platform has promoted knowledge sharing and best practices between the EIF and NPBIs. Its goal is to enhance access to equity funding in particular for SMEs and midcaps, support the defragmentation of equity markets, and to match national, EU and private funding sources.

2.3 Support to scaleups from the EIB

The EIB engages in direct equity investments, but only to a limited extent. Regarding scaleups, the EIB is a prominent provider of venture debt and recently announced that it would make available €5 billion in counter-guarantees to strengthen the provision of commercial bank guarantees for wind energy manufacturers. On a more limited scale, the EIB is also directly co-investing into selected startups and scaleups alongside some of the funds that are already backed by the EIF. Eligible companies can be operating both in their early stages and in their expansion and internationalisation phase and are typically active in the life sciences, information and communications technology (ICT), infrastructure and renewable energy, and industrial technology sectors. The EIB’s co-investment activity differs from the EIF’s model in that the latter does not determine what companies to target. By making direct co-investments in core EU priorities like climate-change mitigation and ‘deep tech’, the EIB has begun to shift public support towards a more explicit technological competition with the US and China, although at a limited scale.

2.4 Support for scaleups from the European Commission

The European Innovation Council (EIC) Fund provides startups directly with equity, but only until their early-growth phase. The EIC Fund with a budget of €3.5 billion is a European Commission funding instrument supporting innovation in deep tech, providing long-term equity to companies selected under the EIC Accelerator scheme. To attract private investors, the Commission recently launched a Trusted Investors Network bringing together investors willing to co-invest together with the EIC Fund. However, the EIC Fund’s equity investments are limited to early-growth scaleups and capped at €15 million. The EIC is run by an advisory board and EIC programme managers who identify emerging and disruptive technologies of potential strategic importance. The EIC Fund’s investment decisions are taken by a private fund manager and the EIB holds the European Commission’s equity stakes. But, as Mario Draghihas argued, the EIC’s achievements are undermined by the fact that “it is mostly led by EU officials rather than top scientists and innovation experts”.

3 Strengths and weaknesses of EU activities in the VC market

On the positive side, the EIF has successfully expanded the European VC market. First, the EIF is attracting private investment into VC companies. As the initial ‘anchor’ investor in new funds, the EIF assumes a systemic roleby taking on the risk that the fund will start operations with less capital than would be ideal. Its competitive advantagein identifying promising investment opportunities leads other, more generalist investors like pension funds. Second, by diffusing international best practices and providing advisory services, the EIF has helped the European VC fund industry to catch up with other jurisdictions and become more attractive to investors worldwide. By providing long-term support, the EIF has protected Europe’s relatively young and fragile VC market in economic downturns. Third, the EIF’s efforts benefit entrepreneurs. Examples like the Baltic Innovation Funds and the Portuguese Venture Capital Initiative show how the EIF has not only sparked the growth of local VC ecosystems but has encouraged a sense of optimism among first-time founders.

Institutional investors have low incentives to build their own expertise in the VC segment. Currently, the programmes administered by the EIF pursue the goal of creating scale by attracting institutional investors onto Europe’s VC landscape. However, with the EIF managing due diligence procedures on the selected funds, private investors rarely engage with the funds’ management and so are less incentivised to build their own expertise. As a result, these patterns perpetuate the reliance on public support and the dominance of more established US capital providers in Europe’s VC market. On the plus side, the EIF shares information regarding the VC segment with the private investors of its funds-of-funds, which helps investors to develop expertise in-house. Investors that do not engage with the EIF, however, are left out because the EIF does not report on the performance of the funds it supports and thus withholds information that could attract investor interest in VC.

Public money has been supporting high-growth firms, but not necessarily the ones that serve the climate. In the past, the primary goal of the EIF was to build a European VC market and not to foster the growth of specific technologies. As a result, most of the EIF’s capital is currently invested in a technology-agnostic way, with most supported VC funds focusing on sectors other than green (Figure 8). In reality, the funds’ investment in green technologies is presumably higher than the 5% derived from the official statistics because funds covering a non-green sector may also invest to some extent in clean technologies. However, it was not until 2021 that the EIF introduced in its Corporate Operational Plan a 10% target for annual commitments regarding climate action and environmental sustainability. This has been increased every year, with the 2024 target now standing at 30%.

Figure 8: Sector focus of all active VC funds benefitting from EIF support (as of 31 December 2023)

^{Note: ‘Green’ includes Cleantech/Manufacturing, Energy and Environment, Energy Efficiency, Renewable Energy, and Resource Efficiency. ‘Other’ includes Financial Services, Consumer Products, Services and Retail, Business and Industrial Products and Services, Agricultural, Chemicals and Materials.}

^{Source: Author’s own illustration; calculation based on EIB data.}

There are two reasons for the limited climate footprint of publicly supported VC investments in Europe. First, conditions for sustainability investments benefitting from public money are rather weak and poorly enforced. The relevant EIF term sheets for green investments foresee that the contracts agreed between the venture capitalists and the EIF include KPIs that are linked to environmental features. Only when VCs fulfil these KPIs do they receive their full compensation. However, in practice the KPIs negotiated between the VCs and the EIF do not always follow the strictest environmental criteria and focus instead on financial results. Additionally, the responsibility for assessing these criteria lies with financial intermediaries that self-report on the sustainability of their investments. As stated in the EIF’s applicable guidelines, green indicators “shall be estimated and reported where indicated on a best effort basis”. Finally, the VCs’ sustainability reporting is voluntary and failure to report does not lead to penalties or the withdrawing of investments. Taken together, the conditions for sustainable investments are rather weak and the absence of sanctions is an invitation for VCs to ignore these conditions yet still receive full compensation.

Second, the current model of indirect funding means that clean technologies with large capital needs and uncertain demand tend to be inadequately funded. By delegating the selection of ultimate beneficiaries to the VC firms that operate as financial intermediaries, the activities of the EIF are tied to the inherent logic of VC – one of hyper-growth and maximum returns. However, whereas private investors favour well-known technologies and digital applications that are easily scalable, cleantech scaleups with high capital needs and uncertain future demand end up empty-handed. This is problematic because to achieve climate neutrality by 2050, the European economy relies also on new technologies that may not generate high returns within an investment horizon of just a few years. Fixing this would require direct equity investments. However, the EIB’s direct investments target only a very limited set of companies, while the EIC equity injections in breakthrough technology firms have been capped at €15 million. The EU thus lacks the suitable instrument to scale up all clean technologies required to reach net zero.

4 Recommendations

To narrow its scaleup gap, the EU must shift gears and rethink its approach to public funding. The first-best option would be to build a Savings and Investments Union as called for by Enrico Letta. Since overcoming the frictions in European capital markets is no low-hanging fruit, the European Commission intends to maximise the leveraging of private investment with public money. However, more of the same will not close the EU scaleup gap. Spurring cleantech investment at home and not losing out in the competition with the US and China, requires three measures (Table 2). First, institutional investors should be supported to invest independently in VC. Second, the EIF should strengthen the green credentials underpinning its support for VCs. And third, the EU should expand direct investments in cleantech scaleups that are (still) too risky for private investors.

Table 2: Overview of recommendations for addressing the EU scaleup gap

4.1 Enable institutional investors to invest independently in VC

4.1.1 EIF to help investors build their own expertise in VC

Institutional investors need to develop the skills to distinguish good from bad VC investments. After successfully creating a European VC market attractive to private investors, the EIF should now step up its efforts in building institutional investors’ VC expertise. This is the basis for an ecosystem that does not require constant public support but can stand on its own feet. To more effectively support capacity building at institutional investors, the promising model of information provision under AMUF should be extended to all EIF programmes. Furthermore, the EIF should open its Institutional Investor forums to all interested parties, while also offering training sessions and access to its knowledge base to potential investors. Lastly, to counter the lack of transparency on the performance of European VCs, the EIF should publish – in an anonymised way – detailed data on returns and key statistics pertaining to individual funds that receive EIF support. This way, the EIF would complement aggregated private market dataindicating that over the past 15 years, European VCs have outperformed their US counterparts.  

4.1.2 European Commission to harmonise rules for pension funds

National policies restricting investment in VC should be harmonised across the EU. In the medium term, it would be helpful to eliminate unnecessary barriers enshrined in EU financial markets regulation. The latest revision of the Solvency II Directive that regulates the EU (re)insurance industry has already eased the capital requirements on insurers’ long-term investments in equity. To also increase pension funds’ engagement, the European Commission should replace the existing IORPs Directive with a directly applicable EU Regulation and therein include harmonised limits for VC funds domiciled in the EU and a lower cap for investment in non-EU VC funds. A legislative window might open soon as the review of the IORPs Directive has been overdue since January 2023 and the European Commission is set to issue its legislative proposal during its 2024-2029 term. An EU Regulation would also tackle the broader fragmentation in the single market for capital. It would converge member states’ differing supervisory practices and offer the possibility to subject the biggest pension funds to direct oversight by the European Insurance and Occupational Pensions Authority (EIOPA) at a later stage.

4.2 Strengthen the sustainability impact of EIF support for VC

4.2.1 EIF to skew its support to VCs financing cleantech

To shift its focus towards impact, the EIF should increase the green proportion of its VC investments. The EIF’s ambition so far does not reflect the reality that Europe is in a state of climate emergency. To speed up Europe’s transformation to a clean economy, the EIF should align its target for new green investments with the EIB Group's commitment to devote more than 50% of its financing to climate action and environmental sustainability by 2025. In addition, the EIF should put pressure on its financial intermediaries to gradually shift the capital allocation of existing funds towards more sustainable technologies if they want to benefit from future support programmes.

4.2.2 EIF to apply and enforce strict sustainability conditions

Public money promoting the Green Deal must be truly sustainable. There is a need to strike the right balance between entrepreneurship and accountability. It is unrealistic to compete with Silicon Valley by trying to micro-manage financial intermediaries and overburdening them with excessive bureaucracy. However, the current ways of operating – with vaguely formulated sustainability-related KPIs and greenwashed or inexistent sustainability reporting – are unacceptable when public money is involved. This is why a substantial positive impact on the environment as stipulated in the EU Green Taxonomy should become a non-negotiable requirement for all financial intermediaries receiving money from green EIF programmes. Furthermore, financial intermediaries should be required to report on the sustainability-related impacts of the companies in their portfolios and subject their self-reporting to an independent audit by a publicly registered third party. Irrespective of the specific programme, the EIF as a public actor should lead by example and require all its financial intermediaries to establish robust risk management systems for reviewing their human rights due diligence obligations in line with the European Directive for sustainable supply chains (CSDDD), even though it currently applies only to very large companies and not to the financial sector.

Conditionalities should be rigorously enforced. To allow for necessary financial control and policy steering, financial intermediaries should face sanctions in case of non-compliance with green and social conditionalities. First, failure to report on the sustainability impact of investments should lead to the withdrawing of investments and the excluding of the VC firm from public support programmes for a pre-defined blocking period. Second, where the audited sustainability report reveals that conditions have not been met and the VC fund’s estimations of the actual environmental impact were overly optimistic, the fund managers should not receive full remuneration or could even be obliged to pay back public monies they originally received.

4.3 Expand direct investments in selected cleantech scaleups

4.3.1 EIB to directly support selected cleantech scaleups

The EIB should ramp up its direct investment in targeted cleantech companies that cannot obtain funding from the private sector. To achieve the emissions reduction targets set out in the EU Green Deal, long-term transition projects that may not (yet) be attractive to private investors must also receive funding. Against this backdrop, the EU should expand its direct investments in selected later-stage scaleups. This would not constitute a break with the status quo but would build on the activities of the EIB and the EIC Fund that are already providing startups directly with equity and venture debt. As the EIB is managing its own equity holdings and the ones held by the EIC Fund on behalf of the European Commission, it would be straightforward to make the EIB the central investor in underserved cleantech scaleups across the EU. Alongside supporting selected scaleups with equity and venture debt, the EIB should broaden its counter-guarantee programme for wind energy to other sectors, as suggested by the cleantech community.

4.3.2 European Commission to strengthen coordination role of EIC

The coordination of public support for scaleups at EU and national level should be improved. Just as the VC industry in the US is concentrated in only a few cities, not every EU member state has to develop a full-scale VC ecosystem nationally. However, as in the US, startups in all EU member states should have access to funding opportunities. A strong coordinating role for the EIC which is already at the forefront in identifying promising breakthrough technologies could help to exploit the benefits of geographical concentration in the internal market and amplify efforts made at EU level. It could take the existing EIF-NPI Platform on a higher level and form a network of national and EU investments. However, to ensure that public support is focused on those areas where the EU brings most added value and which are most clearly oriented towards public goals, the representation of scientists, innovation experts and civil society stakeholders in the EIC should be strengthened.

4.3.3 EU member states to increase EIB’s financial firepower

Member states should increase the financial firepower of the EIB. To provide sufficient funding for selected cleantech scaleups, EU member states should consider boosting the EIB Group’s budget beyond the latest increase in the gearing ratio and perhaps also inject fresh capital. What’s more, all EU member states should use the flexibility introduced under STEP to allocate unused Recovery and Resiliency Facility (RRF) funds to InvestEU programmes with a focus on innovative cleantech projects. This would help level out any cliff effects resulting from the drop in InvestEU deployment from 2025 onwards.

5 Conclusion

Providing scaleups with growth capital at home is a must for Europe’s future prosperity. The EIF has been crucial for kick-starting a European VC ecosystem. Now that there is a functioning VC market in the EU, the EIFshould strengthen the sustainability impact of its support and work towards a system that can stand on its own feet. The European Commission can ease this shift by enacting changes to the relevant financial legislation. Following in the footsteps of the US and China in nurturing innovative companies, the EU should boost direct equity investment into selected cleantech scaleups that are hamstrung by high capital needs and uncertain demand.

The EU should not lose sight of the long-term agenda. This paper suggests some short-term fixes to the EU scaleup gap. However, overcoming the limited presence of pension funds and insurance companies in the VC market will eventually require tackling the national mishmash of insolvency law, securities regulation and tax policies that currently hinders cross-border investment. Pushing ahead with the Savings and Investments Union should therefore become a priority for the new European Commission. For the same reason of incentivising private innovation financing, the EU Green Deal should remain high on the European agenda. Investors will only mobilise their capital if they are convinced that a profitable market for the green transition will emerge in the near future.

Photo: CC Pat Whelen, Source: Unsplash