Portugal and the Rush to Venture Capital

The securities market in Portugal is traditionally incipient. The PSI (Portuguese Stock Index), the main Portuguese capital market benchmark which aggregates the largest companies listed on Euronext Lisboa that have more than 1,000 million Euros of capitalization, comprised the shares of the twenty largest companies listed on the Lisbon stock exchange (the PSI-20). However, after years and years without reaching the threshold of twenty listed companies (currently, it is only 15), already in the course of 2022 it was decided to change the index from "PSI-20" to simply "PSI", no longer requiring the minimum number of twenty companies.

The lack of appetite from the Portuguese population in respect of the securities market is due to a series of factors such as low financial literacy, the short level of savings (where the household savings rate is only 7% of income while the EU average is around 12%) and the traditional aversion to risk (which justifies that 64% of the Portuguese population has never invested in financial products).

This standard has been challenged in recent years by the pronounced growth in the number of venture capital funds (VCFs) in Portugal, which resulted in CMVM’s decision to authorise 46 new VCFs in 2020 (representing a growth of almost 100% when compared to 2019, in which 28 were approved) and this trend continued in 2021, where CMVM recently disclosed in its Annual Bulletin on Asset Management that the administrative procedures for the authorisation/registration of entities and investment vehicles decided in 2021 increased compared to the previous year by 92% and 58%, each. This rush to venture capital results in a total of 226 FCRs currently active in the Portuguese!

What justifies and stimulates this "fever" for venture capital, almost in "contracycle" if we consider the context of global pandemic?

 We share some thoughts.

To begin with, Portugal has made a serious effort over the last few years to modernize, creating several incentives for investment in new technologies and innovation, and these areas are closely linked to venture capital. As a matter of example, we highlight the System of Tax Incentives in Research and Business Development (SIFIDE), provided for in the Investment Tax Code, which allows IRC (corporate tax) taxpayers a tax deduction of at least 32.5% and a maximum of 82.5% of the amounts allocated to "research expenses" intended for the acquisition of new scientific or technical knowledge or the "development expenses" carried out to explore the results of research work or other scientific or technical knowledge for the discovery or substantial improvement of raw materials, products, services or manufacturing processes.

Moreover, despite the size of the country, Portugal already has seven unicorns (start-ups valued at more than a billion dollars), as many as Spain, Greece and Italy together! These unicorns jointly represent more than €36 billion in market value, and the growth of these companies is essentially supported by venture capital investments.

Equally important is the tax regime associated with investment in venture capital. On the one hand, income of any nature obtained by VCFs is exempt from IRC. On the other hand, from the investors' point of view, the income generated by holding participation units in VCFs is taxed at 10% in the case of tax residents in Portugal and, in the case of non-residents, is typically exempt from withholding tax, which makes the investment particularly attractive from a tax perspective.

However, the reason that, in my view, more contributed to boost the spread of VCFs in Portugal is the golden visa regime. In fact, under Portuguese law, investing the minimum of € 500,000 in the acquisition of units in investment funds or venture capital funds entitles the foreign investor to apply for a residence permit for investment activity (golden visa) provided that such investment vehicles have a maturity of at least five years at the time of the investment and at least 60% of the value of the investments is allocated to capitalize Portuguese companies. This prerogative has led many management entities to adapt the VCFs in terms that make them eligible for golden visa purposes, thereby attracting foreign investment. In fact, according to official figures released by SEF (Portuguese Immigration Authority), investment in funds, including VCFs, accounted for a total of € 78,535,451.89 and 220 residence permits by April 2022 (the 4th most important in the investment scale). However, we are aware that the actual volume of investment is significantly above these values. In my view, this drive will tend to increase, mainly following the restrictions on the eligibility of residential real estate investments for golden visa purposes in force since January 1st of this year, being only natural that foreign investors redirect their investment to VCFs.

 This growth in the number of VCFs is not safe from risks. Given the large volume of VCFs on the market, translating into a lot of competition, there’s a serious risk of undercapitalisation of some VCFs. Without reaching the minimum capital subscription required to tackle their projects, undercapitalised VCFs may be forced to close prematurely, thus affecting the financial investment and, in the case of golden visa investors, the residence permit itself. Another risk, no less important, but completely opposite, is the overcapitalization of some VCFs which, having large millions in hands and pressured to invest, may end up investing "more" than ideal just not to have the money parked, affecting the profitability of the investments.

To mitigate these risks, some advice to investors. When deciding to invest, more than promised returns (which, given the nature of venture capital, are not guaranteed), consider:

(i) the track record of the Management Entity, looking to understand the historic performance of the VCFs they have under management;

(ii) the total capital raised for the VCF at the time investment is being contemplated; and

(iii) the pipeline of expected investments for the VCF, in order to assess whether the subscription of the VCF is aligned with the projected investments and, not least, whether they fit the risk profile of the investor (which can favor riskier investments but with higher potential returns or, to the contrary, more "safe" investments with lower risk of capital).

As one can see, there's plenty of options. Good luck with your investments!

Ricardo Falcão, Lawyer of Ana Bruno & Associados