Battle Of The Hubs

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Rumors are swirling on Twitter and other social media channels that entrepreneurs are planning to move out of France in reaction to the government’s new capital gains tax rules. “I know a lot of them but they are not to be disclosed,” whispers a veteran French venture capitalist. “No one wants to say publically that they are leaving and risk a contrôle fiscal (tax audit).”

At issue: an initiative by the new government to tax capital gains as salary. Entrepreneurs and investors quickly formed a group called “Les Pigeons,” slang for suckers, to express their opposition. The group gathered more than 34,000 supporters in less than six days on Facebook and generated thousands of posts on Twitter, with the founders of vente-privee.com and Meetic throwing in their support.

“The government thinks France’s entrepreneurs are pigeons,” the movement’s initiators wrote on a dedicated Facebook page. “Anti-economic policies are crushing the entrepreneurial spirit and exposing France to a big risk.” The government realized it went too far and tried to mitigate its initial proposal by adding a set of restrictions that end up creating misalignment at the founder and shareholder level. For example, two founders of the same company, one owning 15% and the other 9%, would end up paying very different tax rates.

“The ideal scenario is that by year’s end we will be rid of the bad portions of these proposed capital gain tax measures; otherwise angel investment will become something not worthwhile because the tax rate is so high and the risk so high that nobody would ever invest,” says venture capitalist Jean-David Chamboredon, (pictured on Informilo’s home page) who is widely credited with kicking off the Les Pigeons protest movement. A vote is expected in the French Parliament in December. “The irony of the situation is that when you look at France’s policies toward young innovative companies what is in place is quite favorable,” says Chamboredon, CEO of ISAI, a micro-VC fund seeded by successful French web entrepreneurs.” But this capital gains tax scheme is basically dissuading angel investing and pushing entrepreneurs to try and escape France when they get liquidity.”

The capital gains tax policies are being implemented at a time when other European governments — which see the tech sector as key to stimulating their economies — are bending over backwards to attract start-ups to move to their countries.

Faced with a choice of paying up to 60.5% capital gains tax in France and navigating a byzantine set of rules that promise to mainly enrich tax advisors and lawyers, or paying 10% of the first £10 million in London or 0% in Belgium, it would not be surprising if some French tech industry stars pulled up stakes. (See the pull-out flowchart comparing capital gains tax rules on pages 10 and 11.)

“France has built the best early stage ecossystem in Europe in the last 15 years and now this ecosystem is clearly at risk from all angles: this will impact business angels, venture capitalists and entrepreneurs,” says Philippe Collombel, a partner at Partech International and a founding member of France Digitale, a French lobbying group that is composed of both venture capitalists and entrepreneurs.

France Digitale stresses that France’s digital economy is important not just to investors but to the country’s future growth. A 2011 study conducted with Ernst & Young looked at 108 French tech start-ups, and found these companies’ revenues were growing 33% per year; 39% of revenues were generated internationally; and the companies created 24% more jobs in 2011 than in 2010. Collectively these companies generate €1 billion annually. The Internet sector in France is expected to contribute 5.5% of the GDP in France in 2015, up from 3.2% in 2009, according to a 2011 McKinsey study.

While mid-sized French companies with full-time employees are stuck, others can vote with their feet, says Chamboredon. “Two kinds of people are thinking about leaving the country: those that work at very young companies, with a small team who are unfunded — they are going to move to London, New York or San Francisco or wherever they can find some funding. The other kind of companies that could move are the very large ones. They know when they sell their business that they will probably pay much less capital gains tax because the French scheme is a really bad one.”

“A country that is incapable of offering its elite a future is doomed,” says Tariq Krim, the high-profile French founder of NetVibes and JoliCloud, a Paris-based cloud computing company which has attracted funding from Atomico. He complains that in addition to government policies local VCs are not taking enough risks. “Entrepreneurship and disruptive start-ups are the future of this country. We love Dior or Saint Laurent savoir faire but who is building the new global brands, who has the new French savior faire? I see our company crafting quality designed products like haute couture. Start-ups are the only way for French talent to express themselves at a global level. Shut down start-ups and you shut down the expression of that talent.”

If French start-ups do decide to leave, other European countries are ready to welcome them. IDA Ireland (Industrial Development Agency) has a dedicated team both at home and internationally in its Emerging Businesses Division which aims to attract foreign companies to set up their operations in Ireland, says IDA head Barry O’Dowd. The Irish government considers that these companies don’t just bring foreign investment – they help seed the ecosystem.

“Ireland has been punching above its weight in winning investment from early-stage tech companies over the last two years,” says O’Dowd. He says that in 2012 the country attracted, on average, two start-ups a month to move to Ireland, exceeding its own targets. “The key to Ireland’s offering is access to skills and a thriving entrepreneurial culture,” he says.

It also helps that Ireland has a zero percent corporation tax on profits for start-ups during the first three years of operation and 12.5% thereafter.

U.S. start-ups that have set up operations in Ireland this year include Engine Yard, Zendesk, Dita, Riot Games, Marketo, Indeed.com, HubSpot, Aasonn, KeyedIn, Otter, Ancestry.com, ExtenSys, and Van Tibolli. European start-ups such as SumUp from Berlin, CULTURETRANSLATE from Frankfurt, and Diaceutics from the UK have also opened offices. “Ireland is now firmly positioned as the location of choice for smaller business in Europe,” says O’Dowd.” This nicely complements the successes Ireland has had in attracting larger players like Facebook, Twitter, Google, SAP and LinkedIn.

The UK Government, as part of its Business Plan 2012–2015, is doing more than ever to make entrepreneurs welcome. It too has attracted its share of high-profile entrepreneurs, such as Germany’s Stefan Glaenzer, the founder of lastfm and Passion Capital, and Romania’s Emi Gal, the founder of Brainient. And the government has made no secret of the fact that it is happy to welcome entrepreneurs from France. The UK Trade & Investment’s Global Entrepreneur Program (GEP) hopes to attract the world’s best early-stage companies and entrepreneurs to set up their global HQs in the UK, by offering them a bespoke service to help companies that move there accelerate into global markets.

The UK’s new investors’ and entrepreneurs’ visas will make it easier for high-value investors and entrepreneurs in future. Like Ireland, the UK has one of the lowest main corporate tax rates in the EU, generous tax allowances and competitive personal rates. The standard rate of corporation tax in the UK is 24% and the plan is to reduce it to 22% from April 2014. The UK also has an extensive range of capital allowances that allow the costs of capital assets to be written off against taxable profits.

Furthermore, the lifetime limit for entrepreneurs’ relief for serial investors has been doubled and the relief available under the Enterprise Investment Scheme (EIS) and Venture Capital Trusts has been enhanced.

Berlin is also attracting both start-ups and venture capitalists. Soundcloud, which was founded by Swedish entrepreneurs, famously moved to Berlin to build its company. Earlybird closed down its Hamburg office to open shop in Berlin and make Berlin its hub. And international VCs are becoming increasingly active with some, such as Macquarie, opening offices.

The German legislator is supportive of lowering entry barriers for entrepreneurs, says Albrecht von Breitenbuch, a counsel in the Berlin offices of Orrick, a global law firm that focuses on the tech sector. “Modifications of corporate law were introduced some years ago to make it more simple and less expensive to incorporate a limited liability company,” he says.

What’s more, “public and private funding has improved substantially over the past years. In particular for seed capital there are a lot of public-funded programs on the market which make it easy for entrepreneurs to develop their ideas and to extend bootstrapping over a long period of time,” says von Breitenbuch. “And you can see investors competing for investment opportunities in the hot start-ups.”

That said, in a recent study Paris ranked well ahead of Berlin as a good place to be an entrepreneur. Research conducted by the Startup Genome and Telefonica Digital identifies the ecosystem factors that have contributed to the success of Silicon Valley and uses those as a baseline to compare how well-suited other cities are to fostering entrepreneurs. Silicon Valley was number one, Tel Aviv two, London seven, Paris 11, and Berlin 15.

Even if it is ranked lower, Berlin is crafting a reputation for itself as a great place for entrepreneurs and getting a lot more buzz internationally than Paris. If the French government is not careful Berlin and other European hubs could attract more than just buzz; they could also end up snaring more of its entrepreneurs.

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