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Simulating investment in French start-ups

A number of legislative changes, designed to stimulate investment in start-ups, have recently taken place in France. SJ Berwin gives an overview of the reform package including a series of tax breaks for young innovative companies.

In recent months a variety of measures aimed at stimulating investment in innovative start-ups have taken effect in France. These eagerly awaited changes bring much needed relief to a sector that has suffered badly since the technology bubble burst more than three years ago, and could help to kick-start the struggling French venture capital industry.

The centrepiece of the reform is a package of generous tax breaks for "young innovative enterprises" (jeunes entreprises innovantes, or JEIs) that will apply from 2004 onwards. To qualify for these, companies must meet various conditions. First, the new rules only apply to SMEs: for these purposes, that means businesses with less than 250 employees and turnover below Euro40 million or net assets of less than Euro27 million. They only apply to independent companies: at least 50 per cent of the company's share capital must be held at all times, directly or indirectly, by individuals or certain eligible institutional investors (including most French venture capital funds). And (not surprisingly) the company has to be "young" - its activity must have been created within the last eight years - and "innovative" - its research and development (R&D) expenses must account for at least 15 per cent of its total annual costs.

Qualifying companies will enjoy a number of significant new tax benefits. First, a JEI is exempt from French minimum corporate tax (which is normally payable even in the absence of taxable profits). It will also escape French corporate tax during its first three profitable tax years. And during the following two profitable tax years, the company will enjoy 50 per cent tax relief, provided it continues to comply with the criteria set out above. But the new regime has one important limit: because of EU rules, the total tax benefit granted under the JEI tax regime may not exceed a Euro100,000 reduction in tax during any 36-month period.

A decree to be published later this year should allow JEIs to avoid payment of employer social charges on salaries paid to certain research personnel.

An individual investor in a JEI may elect to be exempt from tax on the capital gains resulting from the disposal of his shares in the company if that investor has never held more than 25 per cent of financial and voting rights in the company, and has held the shares for at least three years. The exemption from capital gains tax applies so long as the company qualifies as a JEI and for a period of five years afterwards. A ruling process is available to investors so that they will know in advance whether a potential investment will qualify.

Two other measures have further enhanced the attraction of investing in innovative French SME's. First, the Finance Act for 2004 significantly expanded the types of R&D expenses giving rise to a credit for corporate tax purposes. Beginning in 2004, French companies will be entitled to a tax credit equal to 5 per cent of all R&D expenses up to Euro8 million per year (instead of Euro6.1 million in 2003). And in July 2003, the Economic Initiative Act also increased the income tax credit available to individual investors who subscribe shares in French SME's (that is, companies meeting the turnover and ownership criteria mentioned above for JEIs). Under French tax rules, individuals are entitled to a tax credit equal to 25 per cent of the amount subscribed. The tax credit is now capped at Euro20,000 per year (Euro40,000 for married couples), instead of Euro6,000.

All of these measures are good news for the French venture capital industry. With the right fiscal incentives, more innovative French start-ups should see the light of day. Improving deal flow should renew investors' interest after years of hesitation and disappointment.

SJ Berwin is a pan-European law firm, with a focus on all aspects of private equity.  For more information on these recent changes to French law, or any other aspect of private equity in France, please contact Ben Aller (benjamin.aller@sjberwin.com) or Sylvie Vansteenkiste (sylvie.vansteenkiste@sjberwin.com), both of whom are based in the firm's Paris office.  For any other enquiries please email simon.witney@sjberwin.com.