State aid N 481/2008 Germany - Clusterfonds Innovation GmbH & Co. KG (Risikokapitalfonds)

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1 EUROPEAN COMMISSION Brussels, K(2009) 2047 PUBLIC VERSION WORKING LANGUAGE This document is made available for information purposes only. Subject: State aid N 481/2008 Germany - Clusterfonds Innovation GmbH & Co. KG (Risikokapitalfonds) Dear Sir, 1. PROCEDURE (1) By electronic notification of 30 September 2008, registered at the Commission on the same day, the German authorities notified to the Commission, according to Article 88 (3) of the EC Treaty, the above-mentioned measure. In its notification Germany pointed out that it considered the measure partly not to constitute State aid in the sense of the EC Treaty and notified insofar only for reasons of legal certainty. (2) As the information received was not sufficient, the Commission considered the notification to be incomplete. By letter of 17 October 2008, the Commission asked the German authorities for additional information. The German authorities responded by letter dated 20 November 2008, registered at the Commission on the same day. As the notification was still not complete, the Commission asked the German authorities for additional information by letter of 17 December. The German authorities responded by letter of 19 December, registered at the Commission the same day. Seine Exzellenz Herrn Frank-Walter STEINMEIER Bundesminister des Auswärtigen Werderscher Markt 1 D Berlin Commission européenne, B-1049 Bruxelles Belgique - Europese Commissie, B-1049 Brussel België Telefon: (0)

2 (3) By letter dated 16 January 2009, registered at the Commission on the same day, Germany declared that it planned to use the possibilities of the Temporary Community framework for State aid measures to support access to finance in the current financial and economic crisis 1 hereinafter referred to as Temporary Framework - with regard to the present notification. Germany further declared that this should be done in accordance with the Bundesrahmenregelung Risikokapital (German federal framework on risk capital), a federal framework scheme that introduced modifications of notified measures, such as the current notification. The German federal framework scheme has in the meantime been notified and approved by the Commission as N 39/2009 Germany Bundesrahmenregelung Risikokapital DESCRIPTION OF THE SCHEME 2.1. Objective and structure (4) The scheme intends to improve the availability of risk capital for small and medium-size enterprises (SMEs) in their early or expansion stage, seated or having an establishment in Bavaria, by establishing a public venture capital fund, the Clusterfonds Innovation GmbH & Co. KG hereinafter referred to as CFI. The CFI is to make risk capital investments on market terms into SMEs, together with leveraged private sector funding. (5) The Clusterfonds will start as 100 % public fund, legally set up as a Kommanditgesellschaft (partly limited private partnership under German private law). (6) One of the CFI's limited founding partners (Kommanditist) will be the Landesförderanstalt Förderbank Bayern - hereinafter referred to as LfA - a bank founded under German public law which is acting as a development agency for the Bavarian State. According to its founding statute, the LfA will fulfil tasks the Bavarian government entrusted it with, e.g. management of assets for the Bavarian State. The Bavarian government can entrust the LfA with additional tasks at any time and the LfA has to follow government's instructions. The Bavarian government also appoints the senior management of the LfA and the majority of its supervisory board. The LfA can only be liquidated by statute; in this case the Bavarian state will take over remaining assets and obligations. The capital invested by the CFI will be provided by the LfA. (7) The CFI's second limited founding partner will be the Bayern Kapital GmbH, hereinafter referred to as BKG, a 100% subsidiary of the LfA specialised in management of venture capital. The BKG will also act as the managing company of the CFI. The LfA is according to Germany entitled to decide upon the BKG's strategic goals and the LfA has a dominant impact on all essential decisions taken by the BKG. (8) The third founding partner will be the Clusterfonds Bayern Verwaltungs-GmbH (limited company under German private law) acting as the unlimited partner (Komplementärin) of the fund. 1 OJ C 16, 22 January 2009, p Approved by the Commission on 3 February 2009; not yet published in the OJ. 2

3 (9) The German authorities informed the Commission that by means of public tender, Bavaria will try to attract additional private investors to become limited partners on the level of the CFI. These additional investors would have to provide a minimum investment of 2.5 million EUR up to a total private investment of currently 30 million EUR with a possibility to decide on additional investment if necessary. Deadline for application as a private investor on the fund level will be the 31 July (10) Regardless of intended private participation on the level of the CFI, the notified scheme foresees obligatory private co-investment on the project level whenever the CFI invests into a target enterprise Legal basis, granting authority, budget and duration (11) The national legal basis of the scheme will be the company agreement of the CFI, the rules of participation of the CFI and the rules of procedure of the investment committee of the CFI. (12) The granting authority will be the LfA Förderbank Bayern. (13) The total public funding will amount to 30 million EUR. The CFI will invest its resources until the end of 2014, only follow-on investments are allowed also after this date. (14) The CFI is designed as a non-revolving fund, resources can only be invested once and returns due to successful sales will be repaid proportionally to the shareholders of the fund The CFI's investment strategy and criteria (15) The CFI is not sector-specific but mainly focuses on young and innovative companies offering a high potential of development. (16) The CFI will undertake different kinds of investment measures, part of which are considered to be free of State aid whereas others shall fall within the scope of compatibility rules of the Community Guidelines on State aid to promote risk capital investments in small and medium-sized enterprises 3 - hereinafter Guidelines Co-investment together with private investors on pari-passu equal share conditions (17) In a number of cases, the CFI shall leverage at least 50% private co-funding (equal share) by a single investor on the level of each investment into target enterprises. The private co-investor will share exactly the same (pari-passu) conditions for his investment as does the CFI. This means notably that both, CFI and private co-investors will share the same up- and downscale risks with their investment. German authorities claim these cases to be free of State aid. In these cases, the following conditions also apply: (18) The private co-investor will participate in the administration of the investment together with the CFI. The co-investor also has to give technical and economical advice to the target company, he shall furthermore be willing and capable to provide additional investments if needed. 3 OJC p. 2 ff. 3

4 (19) The potential co-investors have to be economically independent from the target enterprises when they co-invest with the CFI. This will also apply for spouses, children and parents of the potential co-investor. (20) The co-investors will normally be addressed by the target enterprise that will then apply together with the target enterprise for additional investment by the CFI. The BKG as the fund manager will verify as part of the due diligence, if potential coinvestors meet the conditions stated above Co-investment together with private investors on conditions other than pari-passu (21) Under the notified scheme, the CFI will also invest together with private coinvestors providing at least 50 % of the capital but not sharing the same investment conditions. In this case the CFI would accept a ratio between investments into different financial instruments such as equity and subordinated loan that is more favourable for the private co-investor than for the CFI. Germany claims these investments to be compatible with State aid rules under chapter four of the Guidelines. For these cases, the following conditions apply: (22) German authorities affirmed that, notwithstanding temporary derogations in the context of the Temporary Framework, the size of the investment tranche including both, the public and the private part and including all sort of financial instruments - will be in line with what is stipulated in the Guidelines, not exceeding EUR 1.5 million per target SME over each period of twelve months. (23) As one of the CFI's financial instruments, the scheme foresees investments in equity (Offene Beteiligung, open participation). (24) Investments in equity can be combined with subordinated convertible loans (SCLs). SCLs will be granted until the end of 2014, with a maximum duration until 31 December The BKG will only grant SCLs in cases where it also invests in equity. Disbursement of an SCL is subject to a previous decision of the recipient company that it will accept possible subsequent conversion into equity. The interest rate will be fixed at 10 % p.a. and interests will only be due after a grace period of four years in cases of seed investments and two years in cases of start-up investments. Conversion of the loan including due interest is foreseen to prevent possible dilution of the participation because of subsequent investment rounds. SCLs will be subordinated, senior only to those loans granted by shareholders that are treated as equity in case of bankruptcy of the company (eigenkapitalersetzende Gesellschafterdarlehen). The SCLs are entirely unsecured and can be terminated only for good cause. (25) At least 70 % of the CFI's budget will be allocated in equity and SCLs. (26) The scheme also foresees the financial instrument of silent participation (Stille Beteiligung). In case of silent participation, the investor will receive a fixed interest rate which shall be in line with the Commission's reference rates. 400 basis points due to a complete lack of collateral will be added together with a risk surcharge of 5.5 % p.a. for start-up capital and 3.5 % p.a. for expansion capital. Companies in their seed phase will not benefit from silent participation in order to avoid a too strong drain of liquidity. (27) Apart from what has been stated above, the notified scheme does not foresee any additional loan instruments. 4

5 (28) Also for Co-investment together with private investors on conditions other than pari-passu, the CFI will normally require a single private co-investor providing at least the same amount of investment as does the fund. 5

6 Derogations under the Temporary Framework (29) Following Germany's request as stated above, until the end of 2010 the following modifications shall be applicable for co-investments together with private investors on conditions other than pari-passu claimed to be compatible: (30) The minimum level of private participation in investment is lowered to 30 %. (31) The maximum size of the investment tranche including both, the public and the private part - will be not exceeding EUR 2.5 million per target SME over each period of twelve months General provisions on investment strategy and criteria applicable (32) Regardless whether the notified measure foresees investments supposedly free of State aid or investments claimed to be compatible under chapter four of the Guidelines; the scheme stipulates a number of general provisions. (33) The CFI will exclusively invest in SMEs falling within the Community SMEdefinition 4, which are situated or have an establishment in Bavaria. Applying companies can be in their seed, start-up or expansion phase; however investments into medium-size companies in their expansion phase can only be entered in assisted areas. (34) Investments into companies in difficulties within the meaning of the Community Guidelines on State aid for rescuing and restructuring firms in difficulties 5 are excluded, so are investments into enterprises in the shipbuilding 6, coal 7 and steel industry 8 and investments linked with export related activities or contingent upon the use of domestic in preference to imported goods. (35) Investments into the defence sector, tobacco industry and trade, office building not used for industry purposes, garbage incineration and treatment of toxic waste and gambling are also excluded CFI management, its selection, remuneration and supervision (36) The CFI will be managed by the BKG which is 100% owned by the LfA. German authorities informed the Commission that BKG had not been selected by open tender procedure. (37) With reference to LfA's 100% ownership of BKG, the German authorities informed the Commission that the selection of BKG is to be considered as a socalled in-house transaction, as regards the commissioning of an affiliate which is by 100% owned by the contracting entity. Hence, according to Germany, public tender rules and provisions would not apply. Germany reasons that Council Directive 92/50/EEC of 18 June and its successor Directive 2004/18/EC of 31 March on the coordination of procedures for the award of public works 4 OJ L 124, , p OJ L 244, p As defined in the Framework on State aid to Shipbuilding, OJ C 317, p High, medium and low grade category A and B within the meaning of the internal codification system for coal laid down by the UN Economic Commission for Europe. 8 As defined in Annex I in the Guidelines on National Regional Aid for , OJ C 54, , p OJ L 209, , p OJ L 134, , p

7 contracts, public supply contracts and public service contracts are complied with. For its assessment of the selection procedure as in line with Community standards, Germany also refers to jurisprudence of the Court 11. (38) According to information provided by the German authorities, management of public risk capital is the only task of the BKG. The BKG has since 1995 gained broad expertise in managing investments in technology-oriented enterprises. (39) The remuneration of the BKG is stipulated in the company agreement. It consists of two components. As a first part there will be an annual fee of 2,5 % of the amount accounting for 50 % of the money invested by the CFI during the first two years and 2,5 % of the total amount of the money invested by the CFI starting from the third year. After five years, the management fee will be calculated on the basis of the money invested, deducting repayments and successful sales and completed insolvencies until the end of the previous year. VAT will be added to the management fee. As a performance fee, which is the second part of the remuneration, the BKG will be entitled to a percentage of 10 % of the profits due to successful exits if hurdle rate of 6 % p.a. of the investment of the other owners of the fund is achieved. (40) The remuneration of the managers working for the BKG will contain a flexible component that is depending on the economic success of the CFI. (41) German authorities provided the Commission with an analysis carried out by a German consulting agency active in the risk capital market. In this analysis, 13 new venture capital funds two of which are partly public, the other ones private have been assessed with regard to their remuneration system. The investigated funds represent 59 % of the funds started between the beginning of 2006 and the first half of 2008 and 90 % of the target volume of the market. For all 13 funds, the analysis reports that the management fee was 2.5 % of the committed capital for the time of the investment period. After this period, the management fee is reduced either by an annual decrease or by changing to the net invested capital as reference for the 2.5 %. (42) Furthermore the analysis states that all the investigated funds will foresee a profit linked remuneration of 20 % if a hurdle rate between 6 % and 8 % for the investors is achieved. (43) The analysis comes to the conclusion that the remuneration system for the BKG in the current case is in conformity with market standards. (44) The Bavarian Court of Auditors will be entitled to check the economic efficiency and the lawfulness of the management by the BKG Decision-making on economic reasons (45) In the CFI's company establishment agreement, together with the rules of participation, it is stipulated that the CFI management has to follow economic reasoning when making investment. (46) The CFI will have an investment committee, composed of four members. The LfA and the Bavarian ministry of economic affairs will be entitled to appoint one committee member each. Additional private shareholders of the CFI will have the right to appoint one or two members respectively, if their investment exceeds 11 Decision of C-107/98 Teckal and Decision of , C-458/03 Parking Brixen. 7

8 22.5 million EUR. The private shareholders will exercise their right of appointment jointly, following a majority decision among them whom to appoint. Additional shareholders e.g. those not joining the fund together with the initial private shareholders have to accept the members previously appointed by the private shareholders except for cases of legitimate interest or exceptional circumstances. (47) The final decisions on the purchase and sale of participations require previous approval by the investment committee that is deciding on purely economic reasons. (48) The committee's decisions are prepared by the CFI manager. (49) Investment suggestions to be approved by the investment-committee will require sufficient information about the potential target enterprise including a business plan, positive statements concerning future potential of the company, expected growth potential and the statement of a strong position against competitors trying to copy the innovation achieved by the management of the target enterprise. In addition, target enterprises have to be growth-oriented and have to have a management that possesses the required technological and in general also economic know-how. An exit strategy that is agreed upon with the private co-investor is also necessary to enter into an investment Cumulation with other aid (50) Given that Germany notified the measure partly for reasons of legal certainty, presuming that in so far no State aid is involved, cumulation rules only concern co-investments together with private investors on non pari-passu conditions claimed to be compatible with the Guidelines. For these cases, German authorities undertook to reduce the relevant aid ceilings or maximum eligible amounts by 20% in assisted areas or 50 % in non-assisted areas when the capital provided to a target enterprise under the risk capital measure is used to finance initial investment or other costs eligible for aid under the block exemption regulations, guidelines, frameworks, or other State aid documents other than the Community Framework for State aid for Research and Development 12 or any successor framework or block exemption regulation in this field. (51) Germany further undertook to comply with applicable cumulation rules of the Temporary Framework Reporting and monitoring (52) The German authorities undertook to comply with the reporting and monitoring provisions set out in point 7.1 of the Guidelines. They undertook to submit annual reports to the Commission containing a list of all the enterprise beneficiaries of risk capital measures as well as a brief description of the activity of investments funds with details of potential deals scrutinised and of the transactions actually undertaken as well as the performance of investment vehicles with aggregate information about the amount of capital raised through the vehicle. (53) The German authorities undertook to maintain for at least ten years detailed records regarding the granting of aid for the risk capital measure containing all in- 12 OJ C 45, , p. 5. 8

9 formation necessary to establish that the conditions laid down in the Guidelines have been observed, notably as regards the size of the tranche, the size of the company (small or medium-sized), the development stage of the company (seed, start-up or expansion), its sector of activity (preferably at 4 digit level of the NACE classification) as well as information on the management of the funds and on the other criteria mentioned in the Guidelines. (54) Germany further undertook to comply with applicable reporting and monitoring rules of the Temporary Framework Other commitments (55) Germany committed to provide the Commission with the final versions of all the documents that have been transmitted for notification. 3. ASSESSMENT (56) The Commission has assessed the measure under scrutiny in the light of Article 87(1) EC Treaty and in particular on the basis of the Guidelines, which specify the general provisions of the EC-Treaty in the field of risk capital measures targeting SMEs Existence of State aid (57) In order for a risk capital measure to fall within the scope of Article 87(1) EC Treaty, there must be an element of State aid. Therefore four cumulative criteria have to be met: 1) The measure must involve the use of State resources; 2) the measure must be conferring an advantage on certain undertakings, thus being selective; 3) the measure must distort competition and 4) the measure must be likely to affect trade between Member States. (58) Given that the CFI is investing resources provided by the State owned LfA, the notified measure involves State resources for all types of investments foreseen. (59) In line with point 3.2 of the Guidelines, the assessment of the presence of State aid within the meaning of the Treaty will consider the possibility that the measure may confer aid on three different levels: aid to investors; aid to an investment fund, investment vehicle and/or its manager; aid to the enterprises in which investment is made. (60) As for possible aid on the level of the investors and on the level of the companies invested in, the Commission has assessed the measure separately, depending on whether investments are foreseen on pari-passu or non-pari-passu conditions between the CFI and its private co-investors Existence of State aid in case of pari-passu investments Existence of State aid to private co-investors (61) In accordance with point 3.2 of the Guidelines, where private investors make investments on terms more favourable than public investors, or more favourable 9

10 than if investments had been made in the absence of the measure, then those private investors will be considered to receive an advantage. (62) The CFI will address private investors on a deal by deal basis, ensuring that private participation by a single investor will cover at least 50% of the investment and that private co-investors share exactly the same conditions, including upside and downside risks and opportunities on a pari-passu basis as does the CFI itself. Given the very significant share that the private investor will have to subscribe (at least 50%) it is in addition improbable that the measure reduces the private investor's risk exposure compared to the risk exposure of the CFI. Hence, the Commission can exclude that private investors receive an advantage of scale from this measure. (63) The Commission therefore considers that there is no State aid within the meaning of Article 87(1) EC Treaty at the level of the investors investing under the conditions described above alongside the CFI Existences of State aid to the CFI (64) At the level of the fund, the Commission in general tends to the view that a fund is a vehicle for the transfer of State aid to investors and/or enterprises in which the investment is made, rather than being an aid beneficiary itself pursuant to point 3.2 of the Guidelines. (65) The CFI will operate as separate partly limited private partnership (Kommanditgesellschaft) under German law with the sole purpose to work as a legal frame for the fund's financial resources in the context of the notified measure and carry out no other economic activities. No additional advantages for the fund are included in the scheme. The Commission therefore does not consider the CFI to be a separate aid beneficiary. The Commission concludes that there is no State aid within the meaning of Article 87(1) EC Treaty at the level of the CFI Existence of State aid to the CFI management (66) According to point 3.2. of the Guidelines, aid to the fund's managers or the management company will be considered to be present if their remuneration does not fully reflect the current market remuneration in comparable situations. On the other hand, there is a presumption of no aid if the management company is chosen through an open and transparent public tender procedure. (67) Given that BKG was not selected by public tender, the management remuneration has not been set in a negotiation process under market rules either. However German authorities provided, as stated above, an expertise carried out by an independent market expert confirming that remuneration for BKG is in line with common market conditions for fund management services. The Commission has assessed the expertise and concluded that it can follow its reasoning which is also in line with remuneration conditions notified in other risk capital measures 13. The Commission can therefore conclude that the fee paid to the fund managers will not contain an element of State aid to the CFI's management. The Commission therefore considers that at the level of the CFI's management there is no State aid within the meaning of Article 87(1) EC Treaty. 13 E.g. N 478/2008 Hannover Beteiligungsfonds, N 696/2007 EFRE-Risikokapitalfonds Brandenburg. 10

11 Selection of the CFI management (68) The Commission has also assessed the selection of the CFI management. The Commission noted that the measure does not include a public tender procedure but instead it is part of the notified scheme to entrust the State owned BKG with the CFI's management. To justify this decision, Germany invokes the concept of in-house-contracting that under certain conditions, approved by the Court 14, allows for a Member State to contract with a legally distinct person without prior public tendering in accordance with relevant EC legislation. (69) In line with the Court's jurisprudence, the Commission had to decide, whether the lack of public tender prior to BKG's appointment is complying with the conditions for in-house-contracting. To do so the Commission has assessed, whether the relevant State authority " exercises over the person concerned a control which is similar to that which it exercises over its own departments and, at the same time, that person carries out the essential part of its activities with the controlling local authority or authorities. 15 " (70) As for the first condition, whether the control exercised is similar to the one over own departments, the Commission notes that the German Authorities exercise full control over the LfA that is founded by statute under German public law and subject to direct government orders. The LfA as a 100% shareholder of the BKG is then entitled to exercise full control over all relevant decisions of its subsidiary. The Commission finds that under this construction German authorities exercise a control over the BKG that is similar to the one exercised over Government departments. Therefore the first condition for in-house-contracting allowed for under EC provisions is met. (71) As for the second condition, whether the contracting person carries out the essential part of its activities with the relevant State authorities, the Commission notes that the BKG does not exercise economic activities other than managing State owned Bavarian risk capital. Therefore the Commission finds that also the second condition for compliance with EC provisions is met State aid to undertakings in which investment is made (72) According to point 3.2 of the Guidelines, where aid is present at the level of the investors or the investment fund, the Commission will normally consider that it is at least partially passed on to the target enterprises and thus that it is also present at their level. This is the case even where investment decisions are being taken by the managers of the fund with a purely commercial logic. (73) Under the provisions of the current scheme, given that for this part of the scheme there is no State aid present neither on the level of the private investors nor on the level of the fund and the management company, there is no such presumption that State aid is passed on and also present at the level of the undertakings in which investment is made. 14 Decision of 13 October 2005, Case C-458/03 Parking Brixen GmbH, recital L.c. 11

12 (74) The Guidelines envisage the possibility that under certain conditions risk capital investments into SMEs using State resources do not constitute State aid to the target enterprise, as stipulated in point 3.2. of the Guidelines: (75) "In cases where the investment is made on terms which would be acceptable to a private investor in a market economy in the absence of any State intervention the enterprises in which the investment is made will not be considered aid recipients. For this purpose, the Commission will consider whether such investment decisions are exclusively profit-driven and linked to a reasonable business plan and projections as well as to a clear and realistic exit strategy. Also important will be the choice and investment mandate of the fund's managers or the management company as well as the percentage and degree of private investors. " Profit-driven character of investment decisions, existence of business plan and exit strategy (76) Firstly, in line with point 3.2. of the Guidelines, the Commission has considered, whether investment decisions by the CFI are profit-driven. As pointed out above, the notified scheme requires in the part claimed to be free of State aid for coinvestments together with the CFI at least 50 % of investment of an independent private investor on a project basis alongside the CFI. This investor will be sharing exactly the same pari-passu conditions of investment. The existence of independent private co-investment is a strong sign of profit-driven decisions. In addition, the existence of an investment committee deciding on economic reasons should sufficiently ensure the profit-driven character of investment decisions. Therefore the Commission concludes that the first requirement stated under point 3.2. of the Guidelines is met. (77) Secondly, pursuant to point 3.2. of the Guidelines, the Commission has considered whether a business plan for each investment exists. Under the provisions of the measure as set out above, each investment has to be made on the basis of a business plan. Therefore, also the second requirement of point 3.2. is fulfilled. (78) Thirdly, according to point 3.2. of the Guidelines, the Commission has considered if a clear and realistic exit strategy is existing for each investment. As confirmed by the German authorities, there must be an exit strategy for each investment cofinanced by the CFI. Hence, the first three considerations of point 3.2., last paragraph of the Guidelines tend to indicate that the investment done by the CFI would be acceptable to a private investor in a market economy in the absence of any State intervention. Choice and investment mandate of the fund's managers or the management company and the percentage and degree of private investors (79) Considering the choice of the fund's manger, it has to be stated that the CFI manager is not chosen in an open tender procedure. Instead, management is entrusted to a specialised State owned agency, active in the management of State owned risk capital since As noted above the Commission has taken note that this entrustment complies with the requirements of EC law as specified by the Court jurisprudence. (80) To assess the quality of the investment mandate of the fund's managers, the Commission has applied the principles stipulated in point of the Guidelines, dealing with compatibility requirements for commercial management in a fund. The same requirements should also be met for a scenario where the absence of State aid is assessed under point 3.2. of the same Guidelines. 12

13 (81) The commercial management criterion is considered to be present where all the following conditions of point of the Guidelines are fulfilled, ensuring that the management of the measure is effected on a commercial basis. (82) Firstly, according to section (a) of the Guidelines, there should be an agreement between the CFI's management and the fund participants, providing that the manager's remuneration is linked to performance and setting out the objectives of the fund and proposed timing of investments. As pointed out above, the CFI's manager's is required by the CFI's company agreement together with the rules of participation to make investments on a commercial basis. (83) As for the performance based remuneration it has to be noted that the BKG's remuneration will depend on the number of investments made and the return on investments. The Commission further notes that also the remuneration of the persons acting for the fund management company is partly performance based. Hence, the conditions laid down in point (a) of the Guidelines are met. (84) Secondly, pursuant to point (b) of the Guidelines, private market investors must be represented in decision-making of the fund, such as through an investors' or advisory committee. In the case of the CFI, there will be an independent investment committee. In addition to this, the CFI will proceed with an investment only if the private co-investor agrees to invest alongside the CFI. Therefore the Commission finds that private co-investors are also represented in decisionmaking. Hence the requirement laid down in point (b) of the Guidelines is met. (85) Thirdly, section (c) of the Guidelines stipulates that best practices and regulatory supervision apply to the fund. The BKG will be subject to supervision by the 100% shareholder LfA and the Bavarian Court of Auditors. (86) Although there is no direct reference to best practices in the notification, the Commission finds that given the relatively long professional record of the BKG since 1995 and the supervision by the Court of Auditors, the provision of point (c) of the Guidelines is met in a way that the management mandate is in line with the mandate, a private operator operating in a market economy would have granted in the absence of any state intervention. (87) As concerns the very last condition of point 3.2. of the Guidelines, the percentage and degree of involvement of private investors, the Commission has already assessed this involvement above, stating that both, CFI and the independent private co-investor share exactly the same conditions of investment, the private coinvestor provides at least 50 % of the investment and that this level of participation of the private investor is very significant. (88) The Commission therefore finds that in the light of point 3.2 in principle the investments by the CFI should be made on terms which would be acceptable to a private investor in a market economy in the absence of any State intervention. (89) As for the part of the measure that foresees pari-passu investments under the conditions described above, the Commission concludes that the measure does not qualify as State aid as set out in Article 87 (1) of the EC Treaty and in the Community Guidelines on State aid to promote risk capital investments in small and medium-sized enterprises. 13

14 Existence of State aid in cases of non-pari-passu investments Existence of State aid to private co-investors (90) Where the CFI grants investment conditions to private co-investors providing at least 50 % of the capital - or at least 30 % under the Temporary Framework - on conditions which can be more favourable than the conditions for the fund itself, the requirements for the absence of State aid to the co-investors as described under point 3.2. of the guidelines are not met. The use of State resources to provide these more favourable conditions for co-investors constitutes an advantage in the sense of Article 87 (1) of the Treaty on the level of investors. Given that only a number of co-investors will be selected, the measure is also selective. (91) It furthermore can not be excluded that private co-investors of the CFI insofar as they exercise an economic activity compete with undertakings in other Member States and the measure therefore distorts competition and is likely to affect trade between Member States. (92) The Commission therefore concludes that there is State aid at the level of the private co-investors in cases where these co-investors can enjoy investment conditions more favourable than those for the CFI Existence of State aid to the CFI and its management (93) As for the question of possible State aid in the sense of Article 87 (1) on the level of the CFI and it management agency BKG, the Commission has already assessed the issue in recitals (66)to (67) for the part of the measure claimed to be free of aid and found that no State aid is present. This finding is not depending on whether investments are agreed on pari-passu conditions for the CFI and its private co-investors. Therefore for non-pari-passu investments the finding of the absence of State aid to the CFI and its management does not change Existence of State aid to undertakings in which investment is made (94) As mentioned above, according to point 3.2 of the Guidelines, where aid is present at the level of the investors or the investment fund, the Commission will normally consider that it is at least partially passed on to the target enterprises and thus that it is also present at their level. This is the case even where investment decisions are being taken by the managers of the fund with a purely commercial logic. The Commission therefore finds that in cases of non-pari-passu investments, State aid is also present on the level of the undertakings in which investment is made NOTIFICATION OF THE AID (95) By notifying the measure before its implementation, Germany respected the obligations under Article 88(3) of the EC Treaty COMPATIBILITY ASSESSMENT Applicable legislation (96) As a part of the measure constitutes State aid at the level of the private coinvestors and the target SMEs, the Commission has to examine whether this State aid is compatible with the common market according to the relevant provisions of the Guidelines. 14

15 General requirements (97) Section 2.1 of the Guidelines requires the exclusion of aid to enterprises in difficulty and to enterprises in the shipbuilding, coal and steel industry. Furthermore, the Guidelines do not apply to aid to export-related activities, namely aid directly linked to the quantities exported, to the establishment and operation of a distribution network or to other current expenditure linked to the export activity, as well as aid contingent upon the use of domestic in preference to imported goods. (98) The measure complies with section 2.1. of the Guidelines. It excludes the aid to enterprises in difficulty and in the shipbuilding, coal and steel industry. The requirements for eligible investments do exclude that the aid would be conditioned upon export activities of the targeted SMEs or their use of domestic in preference to imported goods Maximum level of investment tranches (99) According to section of the Guidelines, the risk capital measure must provide for tranches of finance, whether wholly or partly financed through state aid, not exceeding 1.5 million EUR per target SME over each period of twelve months. As pointed out above, the CFI will normally operate in accordance with the overall investment limit of 1.5 million EUR annually. Hence, section of the Guidelines is met. (100) The temporary raise of the maximum level of investment tranches to 2.5 million EUR is in line with what has been approved in N 39/2009 as part of the German federal framework on risk capital Restriction to seed, start-up and expansion financing (101) In line with section of the Guidelines, the risk capital measure must be restricted to provide financing up to the expansion stage for small enterprises, or for medium-sized enterprises located in assisted areas. As pointed out above, the measure provides seed, start-up and expansion financing, in line with the definitions of section 2.2. of the Guidelines, for SMEs located in Bavaria, expansion financing to medium-size enterprises however only in assisted areas. Therefore the measure complies with section of the Guidelines Prevalence of equity and quasi-equity investment instruments (102) Section of the Guidelines requires that the risk capital measure must provide at least 70% of its total budget in the form of equity and quasi-equity investment instruments into target SMEs. (103) As pointed out above, the scheme foresees investment into open participation with or without annexed subordinated convertible loans (SCLs), making up for a minimum of 70 % of the investment, as well as investments into silent participation, making up for the remaining up to 30 %. (104) While pure investment into open participation, i.e. shares of the target company, easily qualifies as investment into equity in the sense of point of the Guidelines, the economic classification of SCLs under the scheme deserves further assessment The economic classification of subordinated convertible loans (105) To classify the CFI's SCLs- as economic debt instrument or economic quasiequity instrument, the Commission assessed the instruments under the Guidelines. 15

16 Point 2.2 of the Guidelines provides the following definitions of quasi-equity and debt investment instruments: Quasi-equity investment instruments means instruments whose return for the holder (investor/lender) is predominantly based on the profits or losses of the underlying target company, and which are unsecured in the event of default. This definition is based on a substance over form approach. Debt investment instruments means loans and other funding instruments which provide the lender/investor with a predominant component of fixed minimum remuneration and are at least partly secured. This definition is based on a substance over form approach. (106) Furthermore, point of the Guidelines stipulates that " the Commission will have regard to the economic substance of the instrument rather than to its name and the qualification attributed to it by the investors... [taking] into account the degree of risk in the target company's venture borne by the investor, the potential losses borne by the investor, the predominance of profit-dependent remuneration versus fixed remuneration, and the level of subordination of the investor in the event of the company's bankruptcy [ ], the treatment applicable to the investment instrument under the prevalent domestic legal, regulatory, financial, and accounting rules, if these are consistent and relevant for the qualification." (107) Having assessed the information from the German authorities, the Commission has come to the following findings: (a) Investor risks and potential losses (108) In line with the Guidelines, the Commission assessed the degree of risks and potential losses borne by the CFI. On the one hand, the Commission took into account that the SCLs do not bear the full exit risk, as it would be the case with pure equity investors. In case of losses of the target enterprise, only the openparticipation investment into shares of the target company will suffer from a loss whereas the SCL has to be paid back entirely. (109) On the other hand, the Commission notes that the SCL will only be paid back after a relatively long period of time, with repayment starting in after a grace period of two to four years and a maximum duration until the end of Moreover, termination of the contract is only possible for good cause. Thus, in the frequent event of a substantial worsening of the target company's financial situation or a failure to reach certain milestones in development of a product, the SCL contract can not be terminated. Such unconditional long-term commitment makes an SCL similar to equity rather than debt-based instruments. (110) Furthermore, the investor risk is shifted towards a situation typical for equity investments by factors such as subordination and collateralisation that will be assessed below. Considering investor risk, the Commission therefore finds that the SCLs contain some elements that are typical for loans while at the same time there are also significant factors present that are typical for quasi-equity. (b) Degree of collateralisation (111) The Guidelines require under point 2.2 (d) that a debt instrument, in order to qualify as such, must be at least partly secured. The Commission took into consideration that the SCLs are completely unsecured. The Commission can therefore con- 16

17 clude that the SCLs under the scheme do not meet this condition for debt instruments as stipulated in the Guidelines. (c) Predomination of profit-dependent vs. fixed remuneration (112) Similar to debt instruments, the contractual obligations of the SCL require the repayment of the principal at the end of the loan term and the interests of 10 % annually starting two respectively four years after granting. The Commission can therefore conclude that there is no clear predomination of profit-dependent remuneration and therefore this condition for quasi-equity instruments as stipulated in the Guidelines is not met. (d) Subordination (113) In accordance with the Guidelines, the Commission took into account the level of subordination of the SCLs in the event of bankruptcy. As stated above, the SCLs are subordinated to all other debt, senior only to those shareholder-loans that are according to German jurisprudence treated as equity in case of bankruptcy of the target company. Due to its subordinated nature, the SCL is therefore available to cover losses in the case of insolvency or liquidation. The Commission therefore finds that the substantial subordination of the SCLs is an element economically similar to equity rather than debt. (e) Annexe-nature (114) For an assessment of the economic character of the SCL, the Commission also had to take into account that the SCL must always be invested alongside the fullrisk equity in the target company. Thus, any investor into SCLs has to bear an equity investor risk linked to an uncertain profit at time of exit as well. The Commission finds that this annexe-nature to an investment into shares is a characteristic that is typical for quasi-equity rather than debt. (f) Conversion clause (115) The Commission also considered the SCL's conversion clause. Due to this clause, whoever grants an SCL to a target company is legally entitled to convert the loan to shares. The disbursement of the SCL is in addition subject to a previous decision of the recipient, i.e. the target company and its shareholders, to accept possible subsequent conversion. The Commission finds that the conversion-clause of the SCL underlines the economic character of a transitory instrument and the conversion into real equity appears to be likely when entering into this sort of investment. Therefore the conversion clause is a typical feature for a quasi-equity instrument. 17

18 (g) Conclusion (116) Having examined the economic nature of the SCLs, the Commission notes that the fixed interest rate of 10 % p.a. as well as the obligation to fully repay the loan is a typical factor for a debt instrument, predominantly based on a fixed interest rate and the obligation to repay. At the same time, the long duration of the investment, the restrictive conditions for termination of the SCL, namely only for good cause, the complete absence of collateralisation, the strong degree of subordination, the annexe-nature of the SCL and the provisions for subsequent conversion into shares are factors typical for a quasi-equity instrument linked with the economic performance of the target company. Balancing these factors, the Commission comes to the conclusion that typical quasi-equity factors prevail. Hence, the SCLs under the scheme can be economically classified as quasi-equity instruments The economic classification of silent participation (117) Given that silent participation under the scheme will not make up for more than 30 % of the CFI's investment, the Commission did not have to further assess the economic nature of this instrument. (118) As to the prevalence of equity and quasi-equity investment instruments the Commission concludes that the conditions, as stipulated by point of the Guidelines, are met Participation by private investors (119) Section of the Guidelines requires at least 50% of the funding of the investments under the risk capital measure to be provided by private investors, or at least 30% in the case of measures targeting SMEs located in assisted areas. As pointed out above, under the notified measure normally at least 50% of the invested capital shall be provided by private investors. Therefore, the measure complies with section of the Guidelines. (120) The temporary allowance for private co-investments constituting only 30 % of the capital invested is in line with what has been approved in N 39/2009 as part of the German federal framework on risk capital Profit-driven character of investment decision (121) The profit-driven criterion is considered to be met if the cumulative conditions under section of the Guidelines are fulfilled. (122) Firstly, according to section (a) of the Guidelines, a significant involvement of private investors as described in section of the Guidelines, providing investments on a commercial basis, directly or indirectly, into the equity of the target enterprises, must be present. As pointed out above, the measure involves normally at least 50% of private investment together with the CFI's investment on a commercial basis. The Commission finds that a minimum of 50 % private coinvestment is a very significant private involvement. Therefore the requirement laid down in section (a) of the Guidelines is met. (123) As for the temporary allowance for private co-investments providing only 30 % of the capital invested, the Commission had to assess, whether this amount of private investment would still qualify as significant in the sense of (a) of the Guidelines. Given that under the Guidelines, in cases of investments in assisted areas according to point , 30% of private co-investments qualify for sufficient private participation; this percentage then also has to qualify as significant 18