The venture capital investment environment in Switzerland

Switzerland is the source of some of the world's most advanced technology, particularly in the areas of biotechnology, microelectronics, and information technology. Swiss banks, pension funds and asset managers have more than ample capital to invest. Nevertheless, Switzerland is not known for being for being a centre of entrepreneurship or of venture capital activity. A few years ago, a Swiss bank that was considering establishing a venture capital finance division concluded that there were not enough promising technology companies in Switzerland to make the project worth pursuing.

One of the reasons cited for this is a cultural aversion to risk and a fear of failure. Another reason is that the Swiss financial environment has been dominated by banks, whose lending practices are ill suited to financing companies in the new economy. One Swiss bank, when making a presentation at a seminar on entrepreneurship, cited profitability, a strong balance sheet, and the absence of a previous business failure as its lending criteria.

However, the fiscal and legal environment in Switzerland also contributed to the lack of entrepreneurship and venture capital investment. Several fiscal and legal obstacles have hindered both the creation of new technology businesses as well as the creation of venture capital investment funds that might provide financing to such businesses. The difficult legal and fiscal environment fuelled a vicious circle: the limited number of entrepreneurs failed to attract venture capitalists, while the lack of available financing failed to attract entrepreneurs.

Fiscal and legal obstacles
Some of the obstacles that have impeded entrepreneurship and venture capital investment are the following:

From the entrepreneur's stand-point:

• Creation of a Swiss corporation requires a minimum of CHF100,000 of equity capital, of which CHF50,000 must be paid in on the date of incorporation.
  
  
• A minimum value per share of CHF10 made financing difficult. As share values of successful start-ups multiplied in subsequent rounds of financing, prices per share quickly became too high. Some companies faced the prospect of going public at prices of CHF1,000 per share or more. The transfer of share premium to share capital to create more shares with a lower price is subject to withholding tax at prohibitive rates.
  
  
• Taxation of stock options - vital for attracting and retaining key employees - is extremely unfavourable for start-up companies. Stock options generally are taxed when granted, based on values determined using the Black-Scholes option pricing model, which is ill-suited to start-up companies. The Black-Scholes model is applied differently from canton to canton. In some cantons, the taxable values of stock options computed using the Black-Scholes model effectively prohibit the issuance of employee stock options. Employees of start-ups have been known to refuse stock options rather than pay taxes on options that may never be exercised.
  
  
• There is a lack of qualified personnel available in many fields and a limited number of permits available for foreign workers.

From the venture capitalist's stand-point:

• Switzerland has no capital gains tax for individual taxpayers. However, a tax-transparent investment vehicle, such as a limited partnership, is not practical for investment funds in Switzerland. Thus investors in venture capital funds domiciled in Switzerland have difficulty taking advantage of the absence of a capital gains tax. The only Swiss legal entity available for venture capital investment funds is a corporation. Capital gains are thus subject to double (rather than no) taxation - once at the fund level and again on distribution as dividends to shareholders.
  
  
• Provisions in the investment regulations governing Swiss pension funds permitted investment in non-Swiss private equity only on an exception basis, strongly discouraging Swiss pension fund managers from investing in venture capital funds, most of which invest in non-Swiss companies. Thus venture capitalists had great difficulty raising money from Swiss pension funds, which might have constituted their most important source of investors.
  
  
• There was no government support for venture capital investment funds - matching government investment, guarantees or tax advantages - such as exists in several other countries.

Nevertheless, Switzerland did feel the passion prevalent elsewhere for high-technology entrepreneurship and venture capital investment in the late 1990s. Entrepreneurship and venture capital investment increased, despite the unfavourable fiscal and legal environment for investment. Industry and lobbying groups put pressure on the government to eliminate some of the obstacles cited above. In the meantime, Swiss entrepreneurs and venture capitalists attempted to find ways of dealing with the remaining obstacles.

The current situation in Switzerland is as follows:

Venture capital fund structure
Some Swiss venture capital funds are corporations that qualify as holding companies for cantonal and communal tax purposes. (Cantonal and communal tax represents from two-thirds to three-quarters of a corporation's total tax burden.) Holding companies are exempt from capital gains tax at the cantonal and communal level. At the federal level, gains on the sale of investments that represent at least 20 per cent of the investee are exempt from tax, if they have been held for at least one year. Not all venture capital fund gains will qualify for this exemption. Furthermore, this structure does not solve the problem of taxation at the investor level.

In order to permit Swiss investors to take advantage of the absence of capital gains tax for individuals, holding company funds generally commit to their investors that the company will become listed, so that investors will be able realise the return on their investment by selling their shares and recognising a capital gain, rather than receiving taxable dividends. One fund, New Venturetec AG, was created through an initial public offering in 1997. Non-quoted holding company funds include ETF Group, HPI Ltd, MiniCap AG and Ventis Ltd. Holding company funds may encounter difficulties in listing their shares, particularly under current market conditions.

The most common structure currently used for venture capital funds is the offshore limited partnership, generally domiciled in the Channel Islands, with perhaps a parallel fund domiciled in the US for US investors. Even a Swiss cantonal bank, when considering establishing a venture capital fund, intended to use a Jersey limited partnership. Offshore limited partnerships include Index Ventures I and II, Vision Capital, Invision funds, and Absolute Ventures. Offshore partnerships are not taxable, and it is hoped that Swiss tax authorities will respect the nature of capital gains distributions and not impose tax on such distributions to individual Swiss investors.

In 2000, Switzerland created a special vehicle for venture capital investment called the Venture Capital Company (VCC). The VCC can benefit from lower thresholds for exemption from capital gains tax at the federal level, as long as it meets certain conditions - principally that it invest 50 per cent of its capital in Swiss companies under five years' old, that the investment sold must be at least five per cent of the investee company and have a value of at least CHF250,000.

Swiss taxpayers who make subordinated loans to companies similar to those in which VCCs invest are able to deduct 50 per cent of the loans from their taxable income (subject to a maximum lifetime deduction of CHF500,000), provided that a VCC makes an investment in the same company within one year of the loan. However, this deduction must be added back to taxable income to the extent that the loan is repaid. If the loan is not repaid, the investor may deduct 50 per cent of the losses in excess of the amount originally deducted, up to a maximum of CHF250,000. Accordingly, the maximum deduction for a loss of CHF1,000,000 or more is CHF750,000.

The incentives provided by VCC vehicle are meagre at best, and so far have had little effect on venture capital investment. However, some existing holding company funds such as MiniCap and Ventis have chosen to become VCCs in order to benefit from the limited advantages of this investment vehicle.

Minimum value per share
Swiss company law has been changed to permit a minimum nominal of CHF0.01 per share. Several companies - large multinationals as well as start-ups - have already taken advantage of the new law.

Pension fund investment
In 2000, the regulations governing Swiss pension fund investment policy were modified effectively to permit investment in venture capital funds. Even before the regulations changed, pension fund investment in venture capital was not unknown in Switzerland. Certain well funded Swiss pension funds have historically invested in venture capital. In addition, a special venture capital fund, Renaissance PME, was created in 1998 especially for Swiss pension funds. In return for accepting restrictions on investments, notably that 90 per cent of its capital be invested in Switzerland, Renaissance was granted tax exempt status by Swiss authorities.

It remains to be seen whether the change in the regulations and the initial success of Renaissance PME will encourage Swiss pension funds to invest in venture capital on a more widespread basis.

Stock option taxation
Unfavourable taxation of stock options granted by start-up companies remains an obstacle to hiring and retaining qualified employees. In December 2000, the cantonal tax authorities rejected a proposal intended to reduce taxation of stock options granted by companies that are under five years' old. However, the proposal was not a significant improvement on the current situation. The Swiss tax administration is currently studying the issue with a view to making a new proposal by the end of the year.

Work permits
Efforts to increase the quotas of work permits for highly qualified individuals have so far not met with success.

Summary
Although obstacles to venture capital investment in Switzerland still exist, the venture capital industry has made great progress. Five years ago, there were virtually no active venture capital investment funds in Switzerland. Today there are many, of various structures and investment objectives. Some fiscal and legal obstacles to venture capital investment have been removed, and efforts to remove others are unabated.

The venture capital industry in Switzerland has probably been less affected by the bursting of the high-tech investment bubble than other countries where venture capital activity is greater. New funds have been raised and others are being planned. One explanation of the resilience of Swiss venture capital is that, with a lower level of venture capital activity, Switzerland had less far to fall. Another explanation is that only the savviest venture capitalists had what it takes to operate in the Swiss fiscal, legal and (yes) cultural environment.

Frederick (Bud) Heerde is a partner with PricewaterhouseCoopers in Geneva who specialises in the venture capital industry. His clients include several Swiss venture capitalists, as well as high technology companies financed by venture capital. He has also been active in encouraging the growth of venture capital in Switzerland and has written several articles and made several presentations on this topic. He is a representative of PricewaterhouseCoopers to Le Réseau, a group of multinational companies and venture capitalists whose purpose is to promote the creation of new high technology companies and the development of the venture capital industry in Switzerland. You can contact him at This e-mail address is being protected from spambots. You need JavaScript enabled to view it Tel: +41 (22) 748 5111