Interest in investing has never been so high, but harnessing this boon for the benefit of innovative startups in Luxembourg requires a carrot. The Luxembourg Startups Association reckons it is time for a tax break solution.
Millionaire Mike Markkula was among the few to spot a great idea when, in 1976, he staked $92k of his own money in a personal computer project presented by two men called Steve.
In 2008, a little-known Munich venture-capital fund made a €13.5 million bet on a promising biotech company working on mRNA immunotherapies. These investments provided the financial foundations for the innovative firms we know today as Apple and BioNTech.
As managing director of the World Economic Forum Jeremy Jurgens states: “startups are crucial in bringing about societal change as well as driving economic recovery and responsible growth.”
But since many innovative startups require investment to hire talent and grow, few make it as far as Apple and BioNTech. Currently, early-stage startups are funded through a combination of bootstrapping, friends and family, angel investors, loans, and grants, with a small number backed by venture capital. Only one in ten startups are expected to make it to the five-year mark. And as inflation and interest rates grow, prompting VC investors to tighten their belts, many more innovative startups are expected to struggle and fold.
2023 wishlist
Before the Christmas break, the newly created Luxembourg Startups Association handed the Luxembourg government an urgent wishlist to foster the startups that will become the “national champions of 2030”. Top of the manifesto is a scheme to encourage private investment in entrepreneurship and new business start-ups: a tax break to incentivise investment in startups. It states: “As the capacity to remunerate investors is limited in the first years, a tax allowance on investment is an effective incentive.”
Leveraging the reform of the 1967 income tax law to boost investment in sustainable and digital entrepreneurship, the association wants the tax allowance investment ceiling, currently €5,000, to be raised significantly. It recommends that the percentage of deductible investment be around 45%-50%, so as to compete with neighbouring countries.
“The investor must be able to invest in several start-ups in the same tax year until the maximum allowance is reached,” it writes, adding all this should be applicable for 2023.
While ambitious compared to the current system, the proposal is grounded in practices observed in other European countries where the cap ranges from €50,000 per year in Spain to £1M in the UK’s Enterprise Investment Scheme (EIS).
In 2012, The UK also introduced a Seed Enterprise Investment Scheme (SEIS), a tax credit that was part of the country’s post-global recession recovery plan, aimed at early-stage companies with a €100K annual investment ceiling and 30% subsidy threshold. The schemes are working. According to HMRC figures, from 2020 to 2021, 2,065 companies raised £175M of funds under the SEIS scheme, up from £169M in 2020. While the EIS raised £1,658M for 3,755 companies in 2020-2021. Of Luxembourg’s neighbours, Belgium with its “Tax Shelter Pour Startups” has the most ambitious scheme, with a €100K investment ceiling, and benefits capped at 30% (for small companies) to 45% (for microcompanies) of the amount invested. According to the Luxembourg Startups Association, some €40m was raised for Belgian startups in 2018.
The investor of tomorrow
The pandemic and low-interest rates have given rise to a new generation of direct and indirect investors. According to broker Charles Schwab, in the US, 15% of current retail investors got started in 2020. Half of that cohort invested directly in companies via the stock exchange.
During the pandemic, savings in Luxembourg reached an all-time high, with an estimated €2B, a figure which is rapidly being whittled away by inflation. Retail investors could have a major impact on the Luxembourg startup ecosystem. According to the Luxembourg Startups Association, €52m was invested annually into the sector from 2016-2021. “Redirecting 2.5% of Luxembourg’s excess savings would double the amount invested in local startups,” states the manifesto.
Business Angels
Parliamentary discussions will require more than just agreeing on ceilings. Politicians and stakeholders must also consider how to convince a new generation of investors to support innovative startups in Luxembourg by envisioning the kinds of products required. One access point for direct investment could be through the Luxembourg Business Angels Network (LBAN), a federation of individuals who have invested more than €40M since 2015. “Add to that the fact that VCs join us and it makes startup investment much higher,” says LBAN board director Michel Rzonzef. Like most people in the startup ecosystem, Rzonzef supports methods that attract investment in startups. His network has done a lot. “But there’s a limit. We cannot finance all of the 600 startups in Luxembourg. And we are competing also with the other countries which also have ways to attract startups and attract investors.”
“We are competing also with the other countries which also have ways to attract startups and attract investors”
LBAN board director Michel Rzonzef
Crowdfunding
Crowdfunding offers another accessible option for direct investment in an innovative startup. Although less commonly used by Luxembourg startups, it has been proven to work. In 2021, Luxembourg regtech Governance raised €600K through the crowdfunding platform Crowdcube.
“We liked the idea of giving a wider audience the chance to participate, but the mechanics of doing that directly are complicated,” said CEO Bert Boerman, at the time. While there are perhaps fewer barriers to participation, investors still need to be thorough in their due diligence in order to make informed decisions. And the risk remains. As the government explains on myguichet: “In the event that the enterprise goes bankrupt, investors risk losing the totality of their investment.”
One way to de-risk investments in early-stage startups could be through the creation of a fully regulated crowdfunding platform for Luxembourg startups. Such a platform could draw inspiration from Belgium’s Spreds, an online digital investment portfolio connecting investors with innovative entrepreneurs raising from €50K to €1M. Since 2011, the platform has closed 260 successful campaigns. According to the Spreds website: “The crowd helps validate the business concept and consumer interest, while experienced investors help to examine the valuation of the company and the potential returns.” What is more, with tickets starting at €100, the barriers to entry remain low.
Funds
Investing indirectly in innovative startups through funds is an attractive approach because these vehicles diversify investments, lowering risk. Investors also have some reassurance knowing that a professional manager is researching the opportunities and making investment decisions on their behalf. A number of funds have emerged out of the UK’s EIS and SEIS schemes. However, unlike crowdfunding, the entry threshold is high, with minimum investments typically around €10,000.
As the home of the global funds industry, Luxembourg has all the skills and tools to create funds that would serve investors wishing to support the local startup ecosystem.
It already has two main funds which invest in early-stage startups: the Luxembourg Future Fund (LFF) and Digital Tech Fund (DTF). The LFF is a €150M fund aimed at diversifying the economy by attracting innovative businesses. It invests in VCs but has a sub fund that co-invests in innovative technology with business angels and VCs. The DTF manages a total of €20M in private-public investment for seed funding ICT startups in Luxembourg. Public participation provides a much-needed seal of confidence and trust to these kinds of investments. As such, more public-private funds with low tickets could offer an opportunity for more retail investors to join this momentum.
In the 2022 Silicon Luxembourg founder’s survey, founders cited access to capital as the second-biggest challenge facing startups. They have identified a clear need, which can be eased by introducing investment incentives. Whatever the shape or size of the scheme Luxembourg’s government settles on, for it to work it must be grounded in the overarching goal, as Rzonzef says: “The key is to look at the financing that will enable start-ups to develop and grow. How can we attract, in this higher risk asset class, more private capital from investors who otherwise will invest in other asset classes, in Luxembourg or abroad?”.
It may take time to implement a solution, but a source at the Luxembourg Startups Association has said they were fairly confident that a tax break for investors in startups is an achievable goal for 2023.
