Incentive Scheme at Management Development Institutes

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					Client: Enterprise Policy Directorate, Ministry of Economy and Energy, Bulgaria
ECORYS Research and Consulting

Dr. J.G. Djarova
Dr Jacob Dencik
Dr Marco Schwegler

Rotterdam/Sofia 2007




Creating Financial Incentives for Innovation in Bulgaria
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2
Table of contents
1 Executive Summary                                                  5

2 Introduction to the innovation financing measures in the EU        8
  2.1 Direct financial support to firms                             10
      2.1.1 Grants                                                  10
      2.1.2 Loans                                                   11
      2.1.3 Participation in the firm‟s share capital               11
      2.1.4 Subsidies                                               11
  2.2 Indirect financial support to firms                           12
      2.2.1 Loans guarantees                                        12
      2.2.2 Tax incentives                                          12
      2.2.3 Interest subsidies                                      13
  2.3 Enablers                                                      13
      2.3.1 Investor-aimed measures                                 13
      2.3.2 Measures aimed at financial environment improvement     14
      2.3.3 Intermediation                                          14

3 Main issues of financing for innovation                           15
  3.1 Introduction                                                  15
  3.2 Key obstacles and bottlenecks                                 16
  3.3 The situation in Bulgaria                                     18
      3.3.1 Bulgaria‟s innovative potential                         18
      3.3.2 Access to finance                                       19
      3.3.3 SWOT analysis of financing for innovation in Bulgaria   21

4 Potential schemes for addressing the obstacles and bottlenecks    24
  4.1 Voucher scheme                                                25
      4.1.1 Description of scheme                                   25
      4.1.2 Target groups of scheme                                 25
      4.1.3 Needs and political considerations                      25
      4.1.4 Impact of the scheme                                    26
      4.1.5 Governance structure                                    26
      4.1.6 Implementation                                          26
      4.1.7 Examples of scheme                                      26
      4.1.8 Conclusion                                              27
  4.2 Technostarters scheme and Entrepreneurship Centres            28
      4.2.1 Description of technostarters scheme                    28
      4.2.2 Target groups of scheme                                 28
      4.2.3 Needs and political objectives addressed                29
      4.2.4 Impact of scheme                                        30
      4.2.5 Governance structure of scheme                          30
      4.2.6 Implementation of scheme                                30
      4.2.7 Examples of scheme                                      32
      4.2.8 Conclusion                                              33



Creating Financial Incentives for Innovation in Bulgaria
                                                                     3
            4.2.9 Subsidy Entrepreneurship and Education – Centres of
                  Entrepreneurship                                        34
      4.3   Tax incentive scheme                                          35
            4.3.1 Description of scheme                                   35
            4.3.2 Target groups of scheme                                 36
            4.3.3 Needs and political considerations addressed            36
            4.3.4 Impact of scheme                                        36
            4.3.5 Governance structure of scheme                          37
            4.3.6 Implementation of scheme                                37
            4.3.7 Examples of scheme                                      38
            4.3.8 Conclusion                                              41
      4.4   Loan guarantee scheme                                         42
            4.4.1 Description of scheme                                   42
            4.4.2 Target groups of scheme                                 42
            4.4.3 Needs and political considerations addressed            43
            4.4.4 Impact of scheme                                        45
            4.4.5 Governance structure of scheme                          45
            4.4.6 Steps of implementation                                 45
            4.4.7 Examples of scheme                                      46
            4.4.8 Conclusion                                              47
      4.5   Venture capital scheme                                        47
            4.5.1 Description of scheme                                   48
            4.5.2 Target groups of scheme                                 48
            4.5.3 Needs and political considerations addressed            48
            4.5.4 Impact of scheme                                        49
            4.5.5 Implementation of scheme                                50
            4.5.6 Governance structure of scheme                          50
            4.5.7 Examples of scheme                                      51
            4.5.8 Conclusion                                              51
      4.6   TOP Technology Institutes                                     52
            4.6.1 Description                                             53
            4.6.2 Target groups                                           53
            4.6.3 Needs and political considerations addressed            53
            4.6.4 Impact                                                  54
            4.6.5 Implementation                                          54
            4.6.6 Governance structure                                    54
      4.7   Conclusions and recommendations                               56

    5 Annex 1: Selected schemes for innovation by stage of enterprising   59




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1 Executive Summary




  Bulgaria is faced with significant challenges and opportunities with respect to innovation.
  At the policy level, the response to these challenges and opportunities were set out in two
  strategic policy documents, The Innovation Strategy of the Republic of Bulgaria and The
  National Strategy for Research and Development of the Republic of Bulgaria.

  A central part of the Innovation Strategy was the emphasis placed on improving
  conditions for private enterprises in undertaking innovative activities. However, it was
  also recognised that these crucial actors in the innovation process are faced with a range
  of obstacles for successfully initiating and implementing innovative activities. In
  particular, the issue of lack of suitable access to finance has been raised as an area of
  serious concern.

  The difficulties with financing innovation raise a critical challenge for policy makers in
  Bulgaria: How can access to and use of different types of financing for innovation be
  improved?

  In this document, we outline a selection of different types of responses to the challenges
  facing the Bulgarian economy with respect to financing innovation, all intended to
  increase the incentive and opportunities for innovation among Bulgarian firms. We will
  discuss five schemes: a voucher scheme, a techno starter scheme, a tax incentive scheme,
  a loan guarantee scheme and a venture capital scheme. When considering these measures,
  we suggest adopting the following criteria that the schemes are evaluated against:
          The simplicity of how it works from the point of view of the enterprise.
          The target groups of the scheme.
          The needs and political considerations that it will address, with a particular
           emphasis on its strategic fit with Bulgaria‟s situation and the compatibility with
           EU rules and funding opportunities.
          Impact, with a particular emphasis on the leverage effect of the scheme.
          The governance and administrative requirements of the scheme.
          The ease of implementation.

  Based on our review and evaluation of the four schemes, we come to the following
  findings:
       Voucher scheme: Targets enterprises as well as know-how institutions. Good
          strategic fit and well suited to EU rules and funding opportunities. The impact is
          likely to be good if the scheme is complemented with other instruments and
          support mechanisms for innovation. The implementation of the scheme is,
          relative to other schemes, very easy. The scheme is also easy to work with for the
          target groups.

  Creating Financial Incentives for Innovation in Bulgaria
                                                                                               5
         Techno Starter Scheme: This scheme targets so-called technostarters (students,
          academics or others who intend to start their own, technology-based firm), young
          enterprises and know-how institutions, particularly universities and schools for
          higher professional education. Reasonably easy to implement, targeting the
          crucial link between universities and industry. As such, it addresses clear needs
          and political priorities. Long-term impact can be substantial, with limited
          administrative burden.
         Tax incentive scheme: Targets enterprises involved in R&D activities. Good
          strategic fit, and not in violation of EU rules. Impact needs to be carefully
          investigated, but likely to be significant, given the wide reach of the scheme.
          While there are some question marks with respect to implementation, these are
          not insurmountable. The same applies to the ease of use by the target group.
         Loan guarantee scheme: Targets innovative enterprises. Good strategic fit and
          excellently suited to EU rules and funding priorities. Impact is likely to be
          significant, although there are possible difficulties with respect to
          implementation.
         Venture capital scheme: Targets new and young enterprises. Excellent strategic
          fit and perfectly suited to EU rules and funding priorities. However, given the
          limitations of existing financial system and support structures for entrepreneurs
          and start-ups, the short-term impact is very unclear. Similarly, the
          implementation may also face difficulties. However, the long-term impact may
          be considerable.
         TOP Technology Institutes (TTIs): Targets R&D institutes and universities.
          Realises a national intend in developing high level knowledge and competence in
          strategic for the country fields. Requires public private cooperation. Needs
          substantial amount of investments, both public and private. Needs continues
          support for a number of years.

    In view of these findings, it is clear that some schemes may be of more strategic
    importance and/or have a greater immediate impact, whilst others may prove less
    beneficial or be more effective at a later stage. In the table below, we summarise our
    evaluation of the different schemes.

    Individual instrument should not be regarded as isolated interventions, but as belonging to
    a wider set of policies and instruments designed to encourage innovation. An instrument
    should thus not merely be evaluated on its own isolated merits, but also on how the
    instrument interacts with other policies and instruments.

    Based on these conclusions, our recommendation is to move ahead with a gradual process
    of wide stakeholder involvement in order to ensure that the most pressing needs are
    addressed. This should include extensive consultations with SME representatives and
    representatives from the financial sector and the research community. Without these key
    stakeholders on board, a financial instrument is unlikely to be appropriately tailored to the
    needs of Bulgaria, and will thus not succeed in achieving improved innovation outcomes.
    This process has already begun with the implementation of a techno starter scheme (e.g.
    entrepreneurship centres at technical universities) and could be taken further with the
    design and implementation of a pilot voucher scheme. The voucher scheme is very simple




6
to implement, and a pilot scheme administered under the auspices of the SME Agency
could be set up fairly quickly.

The pilot voucher scheme should be coupled with considerations of how the loan
guarantee scheme and tax incentive scheme can be best tailored for Bulgaria. Both of
these schemes are potentially attractive instruments, given the Bulgarian context, but need
to be designed such as best to address the needs of SMEs. We recommend that a design
process resulting in more concrete and detailed proposals is initiated. With respect to the
loan guarantee scheme, special consideration should also be given to the possibilities of
funding the scheme with Structural Funds.

As the venture capital scheme is of long-term interest it may currently be too early to
consider. However, with membership of the EU, the venture capital scheme should be
considered as a possible initiative to fund with Structural Funds.




Creating Financial Incentives for Innovation in Bulgaria
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    2 Introduction to the innovation financing
      measures in the EU




      R&D and innovation financing measures in the European Union fall in one of three
      categories: direct financial support, indirect financial support, and enabling support.
      Despite a gradual shift, over the last decade, from the application of direct financial
      support to the growing use of enabling measures, direct support continues to constitute
      the overwhelming majority of all financing measures employed for R&D and innovation
      in the EU. Over the period, enabling support has gained popularity among Member States
      and is currently the second largest category of support measures. The use of indirect
      financial measures has remained relatively stagnant, in the EU, over the last decade.

      Direct financial support consists of grants, loans, equity taking in companies and
      subsidies. Grants are visibly the most applied of direct measures, accounting for over half
      of all support within the category. Loans and equity taking measures constitute
      approximately one-fifth and one sixth respectively of EU direct financial support.
      Subsidies make up a minor one-twentieth of the direct financial support measures.

      Indirect financial support measures consist of loan guarantees, tax incentives and interest
      rate subsidies. Within this category, loan guarantees account for three-quarters of all used
      measures. Tax incentives and interest rate subsidies divide the remaining share of indirect
      measures relatively equally between them.

      The enabling support category contains investor-aimed measures, measures aimed at
      financial environment improvements and intermediation. Intermediation measures
      account for the dominant proportion of enabling support. Measures aimed at investors
      also make up a considerable part of all enablers. Financial environment measures account
      for the smallest slice of enabling support.

      At present, there are numerous examples of R&D and innovation finance schemes in the
      EU. The more prominent of these are the „WBSO‟ scheme and the „Temporal
      Entrepreneurial Position‟ programme in the Netherlands, the „Research Technology and
      Innovation Competitive Grant‟ scheme in Ireland, the „Teaching Company‟ scheme in the
      UK and the Austrian „Profit Sharing Bonds‟ scheme.

      The direct financing support and the indirect financial support targets innovative firms;
      the support measures target enablers. EU surveys demonstrate that the provision of
      financial support, both direct and indirect, continues to be the principal means of
      financing R&D and investment throughout the EU accounting for more than half of all
      innovation finance measures instigated by the Member States. Nearly two-thirds of all


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financing measures during the period 1991 - 2001, or 50% percent of all innovation
finance measures, was in the form of direct financial support to firms. Indirect financial
support to firms accounted for 18% of all innovation finance measures and below one-
third of total financing support. Enabling measures constituted the remaining 32% percent
of innovation finance support in 2001.

Figure 2.1 Innovation finance measures




                                         50%
                                         Direct
                                      financing
                                        of firms




                                                                                  32%
                                                                                Enablers
                                      18%
                               Indirect financing
                                    of firms




Source: The European Trend Chart on Innovation, Thematic Report: “Innovation Financing”, May 2001-September
2001, Innovation/SMEs Programme, European Commission, Enterprise Directorate General


When looking at the trends in R&D and innovation finance support between 1991 and
2001, developments demonstrate a decline in the use of direct financing measures from
approximately 60% to roughly 50% of the total R&D and innovation finance measures.
Over the same period, the use of enablers has increased from under 20% to approximately
32%. The use of measures within the indirect financial support category has remained
relatively stagnant at roughly 20% over the ten-year period1. The above trends seem to be
maintained in the years to follow.

Counties apply different policies towards the distribution of budget among innovation
support instruments (see Table 2.1 below). The UK and the USA do distribute almost
equally the budget between fiscal incentives for innovation, subsidy measures and
integrated packages of support2. “It is important to acknowledge, however, that this
position is relatively new, with the increased emphasis being placed in recent years on
R&D tax credits. Previous periods would have seen the UK with an emphasis more like
that of the US with a greater emphasis on subsidy schemes”3. Finland‟s portfolio is
mainly focused on subsidies and loans. The Netherlands had a period emphasising on
fiscal incentives with a recent increase of grants.




1
    The European Trend Chart on Innovation, Thematic Report: “Innovation Financing”, May 2001-September 2001,
    Innovation/SMEs Programme, European Commission, Enterprise Directorate General, p. 8
2
    Promoting innovation - The role and efficacy of alternative policy instruments, www.abs.aston.ac.uk/newweb/research
3
     Idem.




Creating Financial Incentives for Innovation in Bulgaria
                                                                                                                          9
           Table 2.1 Innovation budgets for selected countries

              Percentage of innovation budgets by policy instrument (2003)

                                                           Finland      France   Netherlands                 UK         USA
                                                              %           %          %                       %           %
              Tax facilities                                      0           29           54                      35          24
              Subsidy schemes (grants)                           47           25           22                      29          42
              Credits and Loans                                  51           32           10                       2           1
              Others                                              2           14           14                      34          33

              Total                                              100          100               100               100         100
           Source: Promoting innovation - The role and efficacy of alternative policy instruments,
           www.abs.aston.ac.uk/newweb/research




     2.1   Direct financial support to firms

           Direct financial support covers four measures:

                     Grants
                     Loans
                     Participation in the firm‟s share capital
                     Subsidies

      2.1.1      Grants

           Grants prevail in the direct financial support provided by Member States and are by far
           the most used of direct financing measures in the EU.

           A grant covers a percentage of the costs of an innovation or R&D process or project.
           Throughout the EU, this percentage varies depending on a number of factors like the level
           of risk in the project, the nature of the expenses and geographical location. Evidence
           suggests that within the European Union the largest beneficiaries of grants are SMEs as
           well as public institutions, such as universities and research centres. 4

           In 2002, Finland was the only Member State not to have a grant scheme in place. Austria,
           Germany and Italy were at the forefront of grant schemes with twelve, seven and six
           schemes respectively. Belgium, Denmark, The Netherlands and Sweden each had a single
           grant scheme followed closely by UK, Luxembourg and France with two schemes each.
           Greece, Spain, Ireland and Portugal held the middle ground with five, five, four and three
           grant schemes respectively.5




           4
                  Ibid, p. 4
           5
                  The European Trend Chart on Innovation, Thematic Report: “Innovation Financing”, October
                  2002, Innovation/SMEs Programme, European Commission, Enterprise Directorate General,
                  Annex, Table 1




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2.1.2       Loans

    Loans are the second most popular direct financial support measure within the EU. A
    distinction can be made between loans aimed at the finance of newly established firms
    and those aimed at supporting established firms that are embarking on innovation projects
    with perceived high failure risk. A number of public or publicly supported institutions
    exist within the EU, providing loans, often together with equity, intended at supporting
    high-tech firms in the very early, start-up stages. Such loans are known as „soft loans‟ and
    are often accompanied with other support forms, such as management support to the
    young firms. Loans to established firms are generally made on the basis of subsidised
    interest rates or over an extended period, both favourable for a company, in return for a
    commitment from the loan recipient to exploit the innovated technology in the future, if
    the innovation project is successful. Furthermore, a mechanism exists whereby a loan is
    to be repaid only if the innovation project, for which the loan was granted, has been
    successful.

    In 2002, Ireland and Greece were the only two Member States not to have a loan system
    in place. The Netherlands, Spain and Austria had the majority, with six, four and four
    loan schemes respectively. Denmark, Belgium and the UK had established one loan
    scheme each while Italy, Sweden, Luxembourg, Finland and Portugal had established two
    each. Three loan systems were in present within Germany.6

2.1.3       Participation in the firm‟s share capital

    The third most important direct financial support scheme is equity participation. Through
    equity participation, governments or government-backed agencies provide capital to firms
    undertaking innovative activities. Generally, the shares are bought back after five to ten
    years. The government or the government backed agency that provides the capital plays
    the role of a „silent investor‟, not taking part in the management of the company in any
    way.
    Suggestions have been made throughout the EU that this form of state intervention
    generates unfair competition and distorts the working of the market. Others argue that
    such governmental support addresses an existing support failure at the high-risk end of
    the market, where financial assistance for companies can be difficult to find through
    private agents, unwilling to face substantial risk.

2.1.4       Subsidies

    Subsidies are not popular among direct support measures for innovation. Subsidy
    measures will continue to decline as a means for financing due to new regulations at EU
    and national levels. In addition, many of the indirect financial support schemes have an
    element of a subsidy.



        6
            The European Trend Chart on Innovation, Thematic Report: “Innovation Financing”, October
            2002, Innovation/SMEs Programme, European Commission, Enterprise Directorate General,
            Annex, Table 1




    Creating Financial Incentives for Innovation in Bulgaria
                                                                                                       11
     2.2   Indirect financial support to firms

           Indirect financial support covers three measures:

                    Loans and equity guarantees
                    Tax incentives
                    Interest rate subsidies

      2.2.1    Loans guarantees

           Loan and equity guarantees form almost two-thirds of all indirect financial support
           measures. The difference between direct and indirect financial support lies in the fact that
           with guarantees the state intervenes if an investment does not meet its targets and the
           R&D/innovation project fails commercially. Guarantees are provided with bank loans and
           on a more limited scale to guarantee investments by risk investors.

           In 2002 Sweden, Italy, Luxembourg, Ireland and Finland had no guarantee schemes. On
           the opposite side of the spectrum, Austria and Portugal had six and four schemes
           respectively. The remaining Member States held middle ground with one, two or three
           schemes in place.7

      2.2.2    Tax incentives

           Tax relief measures to stimulate corporate R&D and innovation are often used as
           substitutes for grants and to encourage high-risk investments.

           The arguments in favour of the use of tax incentives for R&D and investment stimulation
           are that such incentives are easy to administer by both governments and industries while
           they can be simply and accurately targeted at specific sizes of businesses if necessary.
           Arguments against the use of tax incentives are that such incentives tend to favour large
           firms, which may not need such assistance, over small firms, which do require support,
           and simply subsidise expenditures which would have been made anyway, therefore not
           encouraging much additional innovation.

           Tax incentives fall into one of three categories: tax credits; tax allowances and tax relief
           on R&D staff employment costs. Most R&D stimulating tax incentives available in the
           EU fall within the first two categories. Tax credits are allocated for all sorts of R&D-
           related expenditure. Tax allowances are provided only where there are incremental
           increases in R&D expenditure. The final form of tax incentives essentially provides a
           firm with a subsidy that covers a proportion of the employment costs of staff engaged in
           R&D activities.




           7
               The European Trend Chart on Innovation, Thematic Report: “Innovation Financing”, October
               2002, Innovation/SMEs Programme, European Commission, Enterprise Directorate General,
               Annex, Table 1




12
      Regarding new technology-based firms (NTBFs), tax relief measures are seen as
      inappropriate as such firms very often trade at a loss, making tax relieves irrelevant. In
      such cases, Member States prefer the use of grants and subsidies.

      Many Member States (e.g. Austria, Belgium, France, Ireland, Italy, Luxembourg, the
      Netherlands, Portugal, Spain, UK) have a tax incentive scheme in place for quite some
      time.

 2.2.3   Interest subsidies

      Within the EU, regional development banks and agencies generally provide interest
      subsidies. Such measures reduce the levels of interest, which a firm must pay on a loan
      and therefore make borrowing cheaper. Interest subsidies are generally combined with
      other measures.


2.3   Enablers

      Enabling measures fall within three categories:

              Investor-aimed measures
              Measures aimed at financial environment improvement
              Intermediation

 2.3.1   Investor-aimed measures

      Two forms of investor-aimed measures exist. Tax relief for investors, the first investor-
      aimed measure, encourages non-professional investments (e.g. non-fixed assets) in
      innovative companies, either directly or indirectly through specialised funds, by private
      individuals and corporate investors.

      Equity investment in financial organisations, the second investor-aimed measure,
      involves government funding to venture capital funds and financial institutions which in
      turn provide finance to companies of a predefined profile, such as technology start-ups.

      There is a general agreement within Member States that in comparison to direct public
      investment into firms, equity investment in financial organisations nourishes the
      development of a private Venture Capital industry. Evidence suggests that the method is
      particularly suitable, together with guarantees to investors, when building a new Venture
      Capital industry in a setting where such an industry did not exist before. This has been
      evident in both Greece and Portugal where new Venture Capital industries were created
      using this enabling method. In addition, some of the larger member states, such as
      Germany, France and the UK, where a Venture Capital industry already exists, apply the
      method to build up a previously scarce regional seed funding capability.




      Creating Financial Incentives for Innovation in Bulgaria
                                                                                                   13
     2.3.2   Measures aimed at financial environment improvement

         Improvements to the financial environment of firms reduces the need for direct
         government intervention on a project to project basis while increasingly allowing the
         market to successfully evaluate, finance and oversee projects. EU decision makers have
         recently placed much attention on developing means for improvements of the financial
         environment within Member States. Such means include the creation of a professional
         infrastructure of investors through supply-side developments via direct financial support
         and guarantees. Additionally, regulatory changes to the fiscal and legal environment have
         been applied to push funds towards the financing of technology start-ups. Furthermore,
         stock markets specifically adapted to innovative, high technology projects have been
         developed. Such markets provide an exit route for investors, reducing risk and
         encouraging investment.

     2.3.3   Intermediation

         Intermediation measures are growing and account close to half of the enabling support.
         Intermediation is applicable in situations where there is ample money. This money is used
         to develop the structures and actions aimed at improving links and understanding between
         investors and entrepreneurs through training and the joint provision of information.

         The development of Business Angel Networks and Platforms where financiers meet
         enterprises is an example of intermediation. Such networks increase the level of
         information available to Business Angels regarding investment opportunities and allow
         entrepreneurs to have access to a large network of Business Angels.

         Intermediation is also an element in the support of incubators, which act as intermediate
         structures for start-ups, while assisting companies in identifying adequate sources of
         finance.

         The provision of consultancy services to potential entrepreneurs regarding the sources of
         R&D and innovation financing is also a possible element of intermediation.

         In 2002, a minor number of five Member States had intermediation schemes. These were
         Sweden with three, Ireland and Finland with two, and Austria, Belgium and Greece with
         one scheme each.8




         8
             The European Trend Chart on Innovation, Thematic Report: “Innovation Financing”, October
              2002, Innovation/SMEs Programme, European Commission, Enterprise Directorate General,
             Annex, Table 1




14
 3 Main issues of financing for innovation




3.1   Introduction

      The current challenges for Bulgaria with respect to innovation are two-fold. Firstly, the
      country must ensure its integration into the international (notably European) innovation
      system. This includes developing the absorption capacity of the Bulgarian economy for
      leading edge technologies and processes from abroad. Secondly, the Bulgarian economy
      and society must improve its domestic innovation capacity by developing a well-
      functioning innovation system.

      At the policy level, the response to these two main challenges were set out in two
      strategic policy documents, The Innovation Strategy of the Republic of Bulgaria and The
      National Strategy for Research and Development of the Republic of Bulgaria. Both
      documents emphasise the need for urgent action in order to improve the innovation
      capacity of the Bulgarian economy.

      A central part of the Innovation Strategy was the emphasis on improving conditions for
      private enterprises in undertaking innovative activities. It was recognised that these
      crucial actors in the innovation process are faced with a range of obstacles for
      successfully initiating and implementing innovative activities. In particular, the lack of
      suitable access to finance has been raised as an area of serious concern.

      Such concerns have been echoed in a range of documents on innovation emanating from
      Bulgaria and elsewhere. Notably, the recent report, Innovation.bg, notes: “Bulgarian
      innovative enterprises point out the lack of adequate public and private sources of
      innovation financing as the main challenge to their innovative activity”9. Accordingly,
      there is an urgent need for improved access to finance for innovative activities among
      firms in Bulgaria.

      The present document sets out a range of proposals for addressing this need. Firstly, it
      provides a brief analysis of the current obstacles and bottlenecks with respect to financing
      innovation among firms in Bulgaria. This is followed by analysis of five different types of
      schemes that could potentially address these obstacles and bottlenecks. This includes
      good practice examples of similar schemes from abroad, and an assessment of how
      lessons learned can be applied to the Bulgarian context. Finally, the paper draws


      9
          Innovation.bg, p.64




      Creating Financial Incentives for Innovation in Bulgaria
                                                                                                   15
           conclusions and makes recommendations on the possibilities for moving forward with
           implementing financial schemes for innovation in Bulgaria.


     3.2   Key obstacles and bottlenecks

           Finance for innovation remains a key barrier for developing the innovation potential in
           many countries. The difficulties associated with financing innovation exist because of a
           range of market and system failures in the process of developing new products and
           processes and bringing them successfully to market. These market failures result in a
           situation where firms and entrepreneurs meriting funds cannot get them, i.e. there is what
           is often referred to as a financing or equity gap.

           However, it is also recognised that actors at different stages in the innovation process face
           different types of problems. For example, most problems with respect to financing
           innovation are concentrated in the earlier stages of the innovation process, from when the
           entrepreneur wishes to translate the idea into a viable business plan to the stage where the
           innovation is beginning to yield profits. This is reflected in the scheme below, where the
           blue areas represent when in the innovation process different factors are important and
           potentially become problematic, requiring support from policy makers.




           Hence, the difficulties with obtaining finance are particularly prevalent for entrepreneurs,
           spin-offs, start-ups and SMEs, as these companies are subject to a number of risks and
           problems, rendering lenders or investors reluctant to provide the necessary funds. The
           European Mutual Guarantee Association (AECM) identified these risks and problems in a
           study in 2003 and their findings are:




16
        The risk associated with the high dependence on one single person or a small
         team
        Unforeseeable risk factors (illness, family conflicts etc.)
        Low level of capitalisation from manager-founders own funds
        Lack of clarity of ownership of assets between privately owned and those owned
         by the business
        Higher than average recourse to debt finance, which may jeopardise solvency and
         constrain availability of working finance
        Insufficient collateral to offer to lenders
        Incomplete or unclear financial statements information
        Insufficient management capacity to clearly communicate the aims and objectives
         of the business
        Business plans often based on opportunities or owner preferences rather than on
         the basis of strategic planning.

As entrepreneurs, spin-offs, start-ups and SMEs tend to play an important role in a
dynamic innovation based economy, the lack of finance for these actors is particularly
problematic for the objective of enhancing the innovation potential of an economy.

However, while problems of financing innovation persist across Europe, it is important to
emphasise that the financing problem is not a fixed or unchangeable problem. Rather, the
extent of the market and system failures shaping the financing problems is strongly
correlated with the overall development of the financial system and sector. The more
developed the financial system and sector, the easier it is for firms, entrepreneurs,
financiers and investors to address the market failures, minimising the financing problem.




Creating Financial Incentives for Innovation in Bulgaria
                                                                                         17
     3.3   The situation in Bulgaria

      3.3.1       Bulgaria‟s innovative potential




           As noted in the Innovation Strategy for the Republic of Bulgaria, the SME Report 2000-
           2002 makes it clear that the most important barrier to innovation in SMEs in Bulgaria is
           the lack of financing. This problem manifests itself in very low expenditure on R&D (less
           than 0.5% of GDP in 2001), with only approximately 20% of the R&D expenditure
           coming from the private sector. More worryingly, the level of private R&D expenditure
           as a percentage of GDP has been declining in recent years, from 0.31% in 1996 to 0.09%
           in 2002 and 0.1% in 2003. It does seem that Bulgaria does not have any chance to achieve
           the Barcelona goal of 3% R&D to GDP by about 2013. Exports of high technology
           products have increased from 1.7% in 1999 to 2.9% in 2003 which represents 16% of the
           EU average. IPR (Intellectual Property Rights) are incomparably low among all EU
           countries (in fact only Romania lags behind Bulgaria on this indicator)10.

           The European Commission defines a number of challenges that Bulgaria faces in the field
           of innovation:

                   1. Extremely low level of business expenditure on R&D: it is at the level of 7% of
                      the EU average. At the sane time business funded university R&D is measured to
                      be five times the EU average. This perhaps compensates for a week pubic
                      funding of academic R&D and the low capacity of firms to perform R&D
           10
                Figures are taken from the European Innovation Progress Report 2006, EC Trend Chart




18
              themselves. The indicators show a very low rate of new to firm and new to
              market sales or that is low innovativeness in the economy. A report of ARC
              Fund11 states that Bulgarian enterprises are not innovative if compared to EU25;
              the share of innovative companies in Bulgaria is about four times lower.

         2. Good knowledge creation especially as far as education is concerned, but it does
            not reflect in more entrepreneurship and innovation. The share of science and
            engineering graduates reaches only 70% of the EU25 average. The training and
            education system does not provide continues updating of skills. Life long
            learning is only at the level of 13% of EU average. Both the labour market
            rigidity and nature of the academic education perhaps lead to Bulgaria being
            ranked low on innovation and entrepreneurship (third from the bottom of the rank
            list).

         3. Low pace of creation and growth of new technology based firms: Although
            attention has been paid on the topic of technostarters especially by the Enterprise
            Policy Directorate of the Ministry of Economy and Energy, the amount of funds
            dedicated to this are very limited; rather at a pilot level. New and growth
            innovative firms can only be supported by financial schemes such as venture
            capital, tax incentives, large and continues grants for start ups, R&D diffusion in
            firms, etc.

         4. Low level of employment in high-tech industries and in general: Compared to the
            EU average the employment in high tech services is very low (about 2.7 against
            84; 2003 level). The mid-hi and high tech manufacturing employment relative to
            EU is also quite low (about 5 compared to 71)12. R&D employment per 1000
            inhabitants in Bulgaria is below the level of the 10 new EU member states13.

3.3.2    Access to finance

    Part of the explanation for the inadequate financing of innovation in Bulgaria is to be
    found in the fairly underdeveloped and immature financial system. This is evident from
    the fact that the main source of funding for the innovation activity of the vast majority of
    Bulgarian enterprises is their own revenues. 78% of firms has their own revenue as the
    main source of funds for innovation, with little more than 8% reporting bank loans as the
    main source of funds for innovation and only little more than 1% having access to venture
    capital as a main source of funds14.

    However, it is also important to note that there have been significant developments in the
    provision of funds for firms in Bulgaria in recent years. Notably, the more stable macro-
    economic environment has enabled banks to become more open to SMEs and to
    increasingly offer more favourable credits to entrepreneurs and SMEs.


    11
       Innovation.BG, www.arcfund
    12
       European Innovation Progress Report 2006, EC Trend Chart
    13
       Idem.
    14
       Source: Vitosha Research (2004)




    Creating Financial Incentives for Innovation in Bulgaria
                                                                                              19
     Entrepreneurs‟ and SMEs‟ demand for such credits remains high thanks to the increased
     production and investment activities in the country. Almost all commercial banks in
     Bulgaria at present offer credit products targeted at SMEs as well as to free lancers. Most
     of the schemes are flexible and in principle there is an individual approach to each client.
     The total volume of credits has grown by € 2 billion during 2005, while corporate loans
     alone have increased by € 1 billion. According to data published by the economic
     department of Bank Austria Creditanstalt, credits in Bulgaria are forecast to grow on
     average 21% annually until 2008.

     Two leading banks in the field of lending to SMEs are the Promotional Bank and
     Procredit Bank. Both have been gradually decreasing interest rates and offer various
     lending schemes to SMEs. Procredit Bank is a leader in the sphere of SME financing.
     Since its establishment in 2001 until late 2005 it has disbursed loans for more than € 500
     million to SMEs alone. The bank also offers credits to start-ups under its “Sprint” scheme
     featuring lower interest rates, credit amounts of up to € 10,000 and 5 years repayment
     term.

     In addition, Raiffeisen Bank has been successfully operating on the Bulgarian SME credit
     market. The bank has doubled its maximum loan amounts to € 10,000, introduced an on-
     line application procedure for this type of loans and softer terms, thus definitely
     facilitating entrepreneurs and SMEs.

     A new tendency in the field of bank lending to SMEs is disbursement of credits without
     the requirement to submit a business plan. DSK Bank, which until recently specialised
     solely in the field of consumer credits, offers loans of up to € 40 000 for a 7-year term to
     micro-enterprises that do not have a business plan, if the funds are to be used for
     investment purposes. Unionbank and First Investment Bank, as well as Eurobank, also
     offer micro-credits of up to € 10,000. Credit lines, overdraft and other credit schemes are
     also offered.

     The banks‟ lending activity is facilitated by the credit lines of the European Bank for
     Reconstruction and Development (EBRD) as well as by other foreign financial
     institutions. Raiffeisen Bank uses such credit line by KFW amounting to € 10 million for
     lending to small and medium business. Raiffeisen Bank also succeeded in 2004 to realise
     two tranches of € 10 million each issued by the Development Bank at the Council of
     Europe for lending in Bulgaria. The interest rates on credits under such credit lines are
     lower because 20% of their amount is EU aid.

     Nevertheless, despite the above-mentioned wide variety of credit lines for SMEs, banks
     still refrain from financing start-up projects. Rather, entrepreneurs use alternative sources
     of finance, such as the credit cooperatives, credit unions and self-help funds. These are
     micro finance organisations for whose operation there is still no clear legislative
     framework and whose services are used by small family firms. There are some 110 such
     institutions in Bulgaria. Some operate under the Law for obligations and contracts, others
     under the Commercial Law and few with temporary regulations. However, there are
     legislative contradictions that hinder these micro-institutions‟ development and
     functioning.




20
    Furthermore, alternative sources of funding, such as venture capital funds, are barely
    present in Bulgaria. With the exception of a few foreign venture capital funds, which are
    involved in comparatively larger projects, there is no venture capital financing at present
    in Bulgaria.

    Hence, notwithstanding significant improvements in the lending and provision of credit
    (e.g. over the past eight years, the outstanding credit stock supplied to Bulgarian private
    non-financial enterprises by the bank system increased ten times and reached four billion
    Euros in 2005), access to finance remains a significant, if not the most significant, barrier
    for innovation among Bulgarian firms. These problems encompass access to bank loans,
    but in particular venture capital. As noted in the Annual Innovation Policy Trends and
    Appraisal Report for Bulgaria, 2004-2005, from the European Trend Chart on Innovation,
    “However booming the financial sector in Bulgaria may seem it is still lacking one of the
    crucial elements for a fast development of innovative activities – the venture capital
    funds”15.

    Two major sources have come to open up new opportunities for financing innovation in
    companies (mainly SMEs) in Bulgaria: the Innovation Fund (operational as of 2005) and
    the measures under Priority Axes 1 of the Operational Programme (OP) Competitiveness
    “Development of knowledge based economy and innovation activities”. The first has
    gained positive results in about 3 years of operation, while the execution of measure
    under the OP are about to start. Although an important financial means, the Innovation
    Fund offered limited resources and for only one type of grant, the one that stimulates
    commercialisation of R&D by companies. Funds for start ups, R&D employment in
    companies, and growth of innovative companies have not been there years to follow the
    endorsement of the National Innovation Strategy in 2004. Another element that is often
    forgotten is the broad public awareness in the need of innovation in the country. About
    28% of the Bulgarian population perceives innovations with reluctance and 20% deny
    it16. Funds and therefore measures aimed at increased awareness are more than needed.
    Even in Finland where the experience in innovation has convinced the population in the
    benefits of being more innovative as a country, measures aiming at awareness raising are
    part of the policy mix.

3.3.3      SWOT analysis of financing for innovation in Bulgaria

    In view of the above, we can summarise the current situation with respect to financing
    innovation in Bulgaria in a SWOT analysis as follows:




    15
         Published by the European Commission
    16
      Perceptions of living conditions in an enlarged Europe, European Foundation for the Improvement of Living and Working
    Conditions and European Commission Directorate-General for Employment and Social Affairs, Luxembourg, 2004




    Creating Financial Incentives for Innovation in Bulgaria
                                                                                                                         21
      Strengths                                                      Weaknesses
      Bulgaria has a burgeoning credit market, with growing          Lack of bank lending for entrepreneurs, spin-offs, start-ups
      availability of finance from banks. This suggests that there   and SMEs in general, and for innovation in particular.
      should be increasing opportunities for innovative SMEs to
      gain access to finance from banks.                             None, or very limited, venture capital funding available.


      The National Innovation Strategy provides a coherent           Lack of long-term thinking and planning among SMEs.
      framework for improved innovation policy and point out at
      measures that reflect the main challenges.                     Low level of business expenditure in R&D.


      As part of the implementation of the National Innovation       Low pace of creation and growth of new technology based
      Strategy, the National Innovation Fund has been                firms.
      introduced, aimed specifically at improving the financing of
      innovation activities of firms.                                Low level of employment in high-tech industries and in
                                                                     general.
      The Operational Programme Competitiveness is placing a
      special attention to development of knowledge based            Low (or rather negative) awareness of the population in
      economy and innovation activities.                             innovation.


      High level of business investing in academic research via      Low public spending on academic R&D.
      universities.
      Opportunities                                                  Threats
      Structural Funds offer an opportunity to address key           Keeping the status quo may result in low innovation
      financing problems, including bank lending and venture         expenditure and a weaker innovation system with
      capital.                                                       concomitant loss of economic competitiveness.


      Other EU initiatives, such as the Competitiveness and          Legislative barriers to delay introduction of new
      Innovation Programme, offer new opportunities for funding instruments for improved financing of innovation.
      innovation.
                                                                     Coordination for innovation stays segmental with the
      EU membership offers opportunities to integrate more with      Ministry of Economy and Energy playing the leading role.
      EU financial sector, encouraging foreign banks and venture     Decision making tends to take long.
      capital funds to invest in Bulgaria.
                                                                     Brain drain of R&D people and talented young people
      Nationally funded initiatives to finance innovation and        leaving the country to pursue higher education abroad.
      encourage more long-term planning by firms, such as
      vouchers and tax incentives, can be used to improve the        If not closed down, the gap between science and business
      innovation capacity of Bulgaria.                               will damage further the innovation and entrepreneurship



     The difficulties with financing innovation, as summarised above raise a critical challenge
     for policy makers in Bulgaria: How can access to and use of different types of financing
     for innovation be improved?

     In what follows, we outline a selection of different types of responses to the challenges
     facing the Bulgarian economy with respect to financing innovation, all intended to
     increase the incentive and opportunities for innovation among Bulgarian firms.




22
In view of the above outlined challenges for the innovation in Bulgaria, one can only
conclude that there is a lot to catch up with if Bulgaria is to contribute to the fulfilment of
the Lisbon agenda and Barcelona‟s goals.




Creating Financial Incentives for Innovation in Bulgaria
                                                                                             23
     4 Potential schemes for addressing the obstacles
       and bottlenecks




       In addressing the challenge of improving financing opportunities for innovation in
       Bulgaria, a number of different schemes can be used. When considering these, it is
       necessary to keep in mind the particular circumstances in which Bulgaria finds itself.
       Hence, a financial scheme for innovation should operate in a fairly simple manner, whilst
       target the relevant firms, entrepreneurs and organisations. Moreover, it must support the
       objectives set out in the Innovation Strategy for the Republic of Bulgaria and, in view of
       Bulgaria‟s recent accession to the EU, a scheme should comply with the State Aid rules
       of the EC Treaty, and be deigned such as to make the most use of complementary EU
       funding. In addition, given the limited public financial resources available, the scheme
       must ensure that it creates the greatest possible impact. This entails ensuring that the
       public funding is leveraged with private funding to the greatest extent possible. Finally,
       since the administrative capacity of the relevant implementing institutions and firms
       (notably SMEs) is limited, the governance and implementation of the scheme should only
       place a limited administrative burden on the implementing body and final beneficiaries.
       Accordingly, there are the following criteria that possible schemes need to assess against:

              The simplicity of how it works from the point of view of the enterprise.
              The target groups of the scheme.
              The needs and political considerations that it will address, with a particular
               emphasis on its strategic fit with Bulgaria‟s situation and the compatibility with
               EU rules and funding opportunities.
              Impact, with a particular emphasis on the leverage effect of the scheme.
              The governance and administrative requirements of the scheme.
              The ease of implementation.


24
      Below, we provide an outline, analysis and preliminary assessment of how different
      schemes could work in the Bulgarian context, with an emphasis on the criteria outlined
      above.


4.1   Voucher scheme

 4.1.1   Description of scheme

      The voucher scheme is an instrument where SMEs are given a voucher worth a limited
      amount to purchase innovation services from research institutes and universities. It is a
      form of direct financial support, both to the firm and the know-how institution.
      Hence, once an SME has been awarded the voucher, the firm can at its discretion use the
      innovation vouchers to acquire knowledge from all scientific institutes and organisations,
      universities or SME, implementing R&D units, included on the list attached to the
      subsidy scheme and to present to them their needs of research on particular problem,
      specified in the application. Usually, the following knowledge objectives can be
      supported with a voucher:

              Considerably improved/upgraded production or organisational technology;
              Design and development/elaboration of technological documentation for the new
               product implementation.

 4.1.2   Target groups of scheme

      The target groups for the voucher schemes are SMEs lacking the capacity to undertake
      the required R&D activities in house. These companies can make use of the voucher to
      purchase „R&D‟ from universities and R&D institutes. As such, the scheme will also help
      universities and research institutes entering into collaboration with industry and
      commercialise the outcomes of their scientific and technical research.

 4.1.3   Needs and political considerations

      A great volume of knowledge is accumulated in universities, R&D institutes and units, a
      considerable part of which could bring real value to SMEs. Regretfully this knowledge
      very often remains under-utilised because of lack of interactions between the firms and
      the know-how institutions.

      The innovation voucher scheme enables SME entrepreneurs to present their needs for
      knowledge to the knowledge providers and to receive from them the respective
      knowledge or technology. The innovation vouchers shorten the road of knowledge‟s
      “time to the market”.

      Strategic fit
      Innovation vouchers can be an effective instrument for allowing SMEs to access the
      research and knowledge development in research institutions and universities.



      Creating Financial Incentives for Innovation in Bulgaria
                                                                                               25
         In view of the simplicity of the scheme, vouchers represent an attractive instrument for
         achieving the Bulgarian Innovation Strategy objectives.

         EU rules and funding
         Voucher schemes for SMEs do not violate State Aid rules. Moreover, ERDF funds can be
         made available for funding such a scheme, as has been the case in e.g. Lombardy and
         Murcia.

     4.1.4   Impact of the scheme

         Existing voucher schemes across Europe have proven successful in getting SMEs to
         undertake research and development projects that would otherwise not have taken place.
         An evaluation of the Dutch scheme showed that vouchers had enabled many of the
         participating SMEs to undertake key knowledge development activities.

         In view of its simplicity for beneficiaries and the implementing body, the voucher scheme
         could prove a cost-effective way to improve the access of SMEs to research and
         knowledge creation.

         However, whether such research and development will be translated into more innovation
         and improved economic performance depends on the existence of wider support
         structures for SMEs, and opportunities for funding the development of new knowledge
         into new and improved products, services and processes.

     4.1.5   Governance structure

         The implementing body of the Ministry of Economic Affairs (e.g. in the case of the
         Netherlands) manages this scheme and distributes the vouchers and arranges payments
         for returned vouchers from universities. Financial checks are kept to a minimum; only a
         small number of applicants are visited and examined. The administration of all
         knowledge providers is audited. The administrative burden is kept purposely low; there
         are only financial transactions between the knowledge institutes and the implementing
         body.

     4.1.6   Implementation

         The voucher scheme is one of the simplest financial instruments to implement. Simply
         put, a voucher with a given value is made available to SMEs that can then use it to
         purchase services of research institutes and universities. The vouchers can then be
         exchanged for the subsidy by the knowledge provider (research institute and universities).

     4.1.7   Examples of scheme

         Innovation voucher scheme – The Netherlands
         A pilot scheme in the Netherlands has proven that there is a desire for innovation among
         SMEs and that it need not cost a fortune. Innovation vouchers worth €7,500 (equivalent
         to approximately 2 salary of a junior researcher in the Netherlands) have helped small




26
    firms pay for research on everything from better software to new vehicle-flooring
    systems.

    In 2004 and 2005, a total of 1,100 vouchers, each worth €7,500, were made available to
    small firms by SenterNovem, the innovation agency of the Dutch Ministry of Economic
    Affairs. The money helped them fund research into new ways of doing things, carried out
    by public „knowledge‟ institutes or research-oriented larger firms. Former Minister of
    Economic Affairs, Mr Laurens Jan Brinkhors, said that due to the “gigantic success” of
    the scheme, it is being extended for the next three years with €60 million in funding being
    made available.

    In the latest phase, SenterNovem has widened the scope of the scheme – now extended to
    cover 2006- 2008, to allow SMEs to use the vouchers to pay public knowledge institutes
    in neighbouring North Rhine-Westphalia and Flanders as well as the Netherlands.

4.1.8     Conclusion

    In the table below, we summarise the analysis and evaluation of a voucher scheme in
    Bulgaria.

        Scheme       How it works         Target       Needs and           Impact         Governance         Implementation
                                          Groups       political                          structure and
                                                       considerations                     administration
        Voucher      ++++                 +++          ++++                ++             +++                ++++
        scheme
                     Simple               Only         Strategic fit, EU   Limited        Relatively         Easily within the
                     implementation, SME,              acceptance,         number and simple to              capabilities of the
                     low                  without      local conditions    size of        administer,        Bulgarian
                     administrative       access to    all positive        projects,      limited cost of    structures
                     requirements         university                       starting       execution
                                          R&D                              point for
                                                                           continuing
                                                                           R&D
    Legend (applies to all tables of this kind):
    +++++ = most applicable and positively evaluated; lesser the number of (+), lesser applicability and level of positive
    evaluation
    Any (-) indicates non-applicability; as many (-) as worst.




    Creating Financial Incentives for Innovation in Bulgaria
                                                                                                                             27
     4.2   Technostarters scheme and Entrepreneurship Centres




           Science Quiz
           Source: Photo Gallery University of Technology Delft, the Netherlands


      4.2.1    Description of technostarters scheme

           Technostarters schemes are designed to encourage and assist students and staff members
           at universities to establish their own technology-based firm, so-called technostarters.
           The scheme consists of a centre located within the university campus, providing a range
           of support services to the technostarters, including advice on strategy, marketing,
           intellectual property rights, legal issues, accounting and financial issues and incubator
           services. The services are provided by professionals to the start-ups free of charge or for
           limited cost in the case of incubators. In addition, financial support for networking
           activities, such as informal meetings, can be provided. In some cases, seed funding for
           new enterprises may also be made available as part of the scheme.

      4.2.2    Target groups of scheme

           The techno starter scheme is open to both staff and students of selected technical
           universities and institutions of higher education. The main criteria for consideration are



28
    that the firm they wish to establish has to be technology-based, i.e. it has to draw on or
    apply technology developed at the university.

4.2.3   Needs and political objectives addressed

    The rationale for setting up technostarters schemes arises from three main trends. Firstly,
    growing international competition places a premium on high value-added and quality
    employment from new technology-based firms. In promoting the development of new
    technology-based firms, technostarters schemes can play an important role in creating
    such jobs.

    Secondly, there is a growing trend towards greater individualism, with workers taking
    responsibility for their own careers and striving for a „life without bosses‟. Technostarters
    represent an interesting opportunity for people to set up their own enterprises, with more
    attractive career prospects as a result.

    Finally, universities and institutions of higher education are themselves subject to
    significant changes in their activities and raison d’etre. The responsibilities of
    universities and higher education have traditionally been confined to education and
    research. Increasingly, however, globalisation means that universities are working across
    frontiers. As they do so, they are liable to face competition from other universities on an
    international scale, with the best students and researchers looking for the best
    opportunities within a global „market‟ for education and research. In order to position
    themselves within this new global market for education and research, universities and
    institutions of higher education need to identify their strengths and enter into new
    partnerships such as to attract funding. The winners in this new market will be able to
    extract significant rewards from both public and private funding sources, with
    concomitant improvements in their offers to students and researchers, whilst the losers
    will face increasing difficulties in attracting students and researchers. Hence, the survival
    and further improvement of universities requires them to be entrepreneurial and exploit
    their teaching and research activities for commercial gains. In other words, the outcomes
    of teaching (students) and research (scientific advances) will have to be commercialised.

    In response to this challenge, universities are faced with the need to implement structures
    and mechanisms that allow for the effective commercialisation of their research and
    student results. However, in addressing this need, universities often lack the financial
    incentives and know-how to support the commercialisation of scientific and engineering
    outcomes. The technostarters scheme is intended to address this issue. More specifically,
    the techno starter scheme supports staff and students in their efforts to establish and
    develop new enterprises based on their education and research activities, by providing
    support and seed funding.

    Strategic fit
    As a mechanism for better commercial exploitation of scientific and education outcomes
    of universities and institutes of higher education, a technostarter scheme can play an
    important role in the realisation of Bulgaria‟s innovation strategy.




    Creating Financial Incentives for Innovation in Bulgaria
                                                                                                 29
         EU rules and funding
         The technostarters scheme does not conflict with existing EU rules on state aid and
         support to enterprises. Moreover, Structural Funds can be used for setting up seed funds
         and courses on entrepreneurship and innovation, as has, for example, been done with the
         IKUBA (Innovative Communications Network for Companies) project in Vienna,
         Austria, in 2002-2003.

     4.2.4      Impact of scheme

         The economic impacts of a technostarters scheme are most likely to materialise in the
         longer term. The enhanced commercialisation of research and education activities will
         require time before significant economic and employment impacts are realised. Rather,
         the more immediate impacts of the scheme are likely to be enhanced entrepreneurship
         among academics and students, and greater application of scientific results in the
         development of new technologies (e.g. patents). These immediate impacts are likely to
         contribute to the innovation and dynamism of the Bulgarian economy, which in turn
         should lead to improved economic growth and employment.

         In view of the untapped potential in Bulgaria with respect to the application and
         commercial exploitation of scientific results, a technostarters scheme may act as a catalyst
         for improved innovation performance. Moreover, the technostarters scheme can have
         additional induced impacts on the links between higher education and industry, with
         improved entrepreneurial activity within a university attracting other firms to the
         institution. Moreover, it may make the researchers and students more open to
         collaboration with industry.

     4.2.5      Governance structure of scheme

         The technostarters scheme is often administered centrally within the auspices of the
         implementing body of the Ministry of Economic Affairs. However, the role of the
         Ministry is primarily a coordinating one, with the actual implementation taking place
         within individual universities and institutes of higher education.

     4.2.6      Implementation of scheme17

         The scheme is implemented at the level of individual universities. Hence, the selected
         universities are awarded a sum of money to set up a technostarters „factory‟ that will
         support staff and students who are interested in setting up their own business. This can be
         further elaborated to include a seed fund for the individual companies emerging from the
         „factory‟.
         In order for the „factory‟ to operate effectively, four types of flows are required:
             1. Flow of potential starters (students and staff)
             2. Flow of new technologies (from the faculties)
             3. Flow of support
             4. Flow of finance

         17
              Following the 4-flow model of Prof. H. Wissema published among others in a book translated into Bulgarian: Techno starters:
                Why and How?, Sofia, 2006




30
These flows need to be coordinated and integrated such as to yield the best possible
outcome. Moreover, the „factory‟ requires publicity and awareness raising, such that
industry and government are willing to support and fund it. Greater awareness will also
help strengthen the individual flows.

Below, we explain the role and nature of the different flows in greater detail.

Flow of starters
Students and staff need to be aware of the opportunities for becoming an entrepreneur, in
order to provide them with the option of establishing a techno starter. In order to raise
awareness and prestige of the technostartera, the faculty and/or the university can
organise events for successful technostarters (such as Silver Medal, presentations during
university ceremonies, speakers from the faculty, creation of laureates for technostarters
etc.), to which students and staff can be invited. All these events should be supported by
publicity. Moreover, the awareness of the possibility to become an entrepreneur should be
monitored regularly by, for example, conducting surveys among students and staff. This
will allow the university to gauge the need for further and improved awareness raising
activities.

Once awareness of the possibility to become an entrepreneur has been achieved, there
need to be opportunities for interested students to learn about the processes of setting up a
techno starter. Such opportunities can take the form of a set of courses, where the students
and staff will be introduced to the steps required for setting up a techno starter. These
courses should cover issues such as patenting, the development of business plans etc. It is
important to stress however, that these courses will be delivered in parallel with the
development of the technostarters. Hence, when the „starters‟ attend the initial course on
patenting, they will be given a patent for their particular technology. If the application of
the developed technology appears feasible, the students will develop a business plan as
part of the courses on different aspects of the business plan. For example, professionals
will provide courses on financing, financial projections, strategic management etc. such
as to enable the students to develop their own business plan.

In due course, the university may decide to formalise the provision of courses and offer
an MSc course in Entrepreneurship (this should ideally be done as a joint offer from two
faculties, technical and management).

Flow of technologies
The flow of technologies from faculties for commercialisation is not a given, but needs to
be stimulated and encouraged. A key barrier is often a culture within the university that
does not place a great value on the commercialisation of scientific results. Rather, the
emphasis is on publication of articles in academic journals or books by academic
publishers. Accordingly, there are few incentives for professors and other faculty staff to
set up a technostarter.

By changing the financial rewards to faculty staff for the commercialisation of their
scientific results, it is possible to make it more attractive for the faculty to provide the
technological input for the technostarters. This can, for example, be done by giving the
faculty/university a share of the established company.

Creating Financial Incentives for Innovation in Bulgaria
                                                                                               31
         Flow of support
         The staff and students wishing to set up a company require professional support and
         advice with respect to the different aspects of establishing the business. In addition, they
         may require a physical location, which can be provided through „shared accommodation‟
         within a business incubator. The business incubator provides rooms and facilities
         (reception, secretariat, administration and other overheads) in halls for reduced rents for a
         limited period of time (e.g. maximum 4 years, with the rent discount diminishing every
         year). Within the business incubator, coaching can also be provided by university alumni.

         Flow of finance
         As previously noted in this report, the availability of finance is critical for entrepreneurial
         activity. Within the context of the techno starter scheme, additional funding for the
         enterprise can be raised from the university or business angels. The techno starter scheme
         can thus include funding for the individual enterprises in addition to the funding for the
         techno starter „factory‟ itself. This will take the form of seed financing to the new
         companies.

     4.2.7   Examples of scheme

         The Netherlands – Technosprint (TU Delft)
         The aim of Technosprint is to identify (new) knowledge within TU Delft, to estimate its
         commercial value and to pass it on to the business sector. The emphasis is on the transfer
         of knowledge to (pre-) technostarters. If this knowledge is to be put to optimum
         commercial use, a dynamic and sustainable interaction will have to be generated between
         institutes of knowledge, intermediary organisations and the business sector. All parties
         will have to make an active contribution in identifying, patenting and transferring
         commercially useful knowledge. The knowledge acquired in this way will then be
         conveyed to those market parties in a position to put it to good use. The aim is that all
         partners in the consortium will act together to bring about more alignment between
         demand and supply on the knowledge market.

         In this way, the knowledge operation project will create an environment in which (pre-)
         technostarters can rely on guidance and support to develop their ideas into commercially
         successful businesses. The businesses will receive both scientific and operational
         guidance (coaching) and financial backing ((pre-) seed capital).
         Technosprint is part of a wider knowledge valorisation programme and links in with other
         current initiatives such as YES!Delft (Young Entrepreneurs‟ Society) and Slachtkracht in
         Innovatie ((Power in innovation) of 3TU, the association of the three technical
         universities in the Netherlands.

         Target group
         The project offers support to (pre-) technostarters from both within and outside TU Delft.
         Although there is no focus on specific areas of technology, there must be a technological
         link that offers added value to TU Delft. Alongside the aspect of innovation, potential to
         develop business capacity and potential for a sound business case are also taken into
         account.




32
    Intended results
    Technosprint aims to double the number of technostarters in the Delft region from 15 to
    35 per year and to increase the number of inventions/patents from an average of 18
    inventions per year to approximately 25. In concrete terms, this means that the target of
    more than 100 new entrepreneurs (technostarters), 25 new patents and some 30 patent
    transfers per year will have been realised by the year 2010.

    Project organisation
    The Programme Manager of the TU Delft Valorisation Centre is responsible for the day-
    to-day running of the projects. The programme supervisor for Knowledge Valorisation
    (appointed by the Executive Board) has final responsibility for the programme.
    Coordinators have been appointed for each separate programme component, and an
    Advisory Body will make recommendations to the programme supervisor with regard to
    the strategy and the approach to the SKE project.

    UK – University Challenge Seed Fund
    The aim of the Scheme is to fill the funding gap in the UK in the provision of finance for
    bringing university research discoveries to a point where their commercial usefulness can
    be demonstrated and the first steps taken to ensure their utility. The Scheme‟s primary
    focus is the exploitation of science and engineering research outcomes. The government
    suggested that the availability of seed funds could help the commercialisation process in a
    number of general ways – financing access to managerial skills; by securing or enhancing
    intellectual property; by supporting additional R&D; construction of prototype;
    preparation of business plan; covering legal costs; etc. The contributors to the Scheme
    were charities (Welcome Trust and Gatsby Charitable Foundation) and the government.
    These central contributors have committed a nationwide total of £40 million. These funds
    were divided into 15 University Challenge Seed Funds that were donated to individual
    universities or consortia. Each recipient university of a University Challenge Seed Fund
    had to provide 25% of the total fund from its own resources.

4.2.8     Conclusion

    In the table below, we provide a summary of the analysis and evaluation of the techno
    starter scheme.

        Scheme    How it works     Target         Needs and          Impact        Governance         Implementation
                                   Groups         political                        structure and
                                                  considerations                   administration
        Techno    +++              +++            +++                ++            ++                 ++
        starter
        scheme
                  Simple           Universities Strategic fit, EU    Limited       Relatively         Need of
                  implementation and start        acceptance,        number        simple to          strengthen
                  , low            ups from       local conditions   and size of   administer, but    capacity of
                  administrative   universities   all positive       projects,     needs a            Bulgarian
                  requirements                                       Limited       collaboration of   universities to
                                                                     commercial    universities and   implement the




    Creating Financial Incentives for Innovation in Bulgaria
                                                                                                                        33
                                                              capacities      other parties   scheme
                                                              of                              successfully
                                                              universities;
                                                              future
                                                              success
                                                              dependent
                                                              on
                                                              schemes
                                                              for start ups




     4.2.9   Subsidy Entrepreneurship and Education – Centres of Entrepreneurship

         A Centres of Entrepreneurship scheme was introduced in the Netherlands in 2007.
         SenterNovem, an agency of the Ministry of Economic affairs, implements it. The main
         points of this scheme are:

                It is a combined initiative by the Ministry of Education and the Ministry of the
                 Economic Affairs.
                It provides a funding scheme for two distinct and separate initiatives,
                 Entrepreneurship Centres (EC; at institutes of higher education) and
                 entrepreneurial education (at all levels of professional education).
                The stated aim of the EC initiative is to provide a central point in the structure of
                 the institute where all initiatives on entrepreneurship are coordinated,
                 strengthened and combined.

         An EC is not so much a new institute or legal entity but rather a focal point in which all
         activities in entrepreneurship merge. The universities/colleges should continue the
         activities of the EC after a one-time subsidy. EC are directed towards the students,
         lecturers, researchers, PhD students and entrepreneurs linked to a university but they can
         also be directed to people outside the university.

         The scheme sponsors 50% of salary costs, labour costs of hired services and materials
         costs, with restrictions on overheads and project costs and with a maximum of € 3
         million. The total budget available is € 12 million. The selection is based on the following
         information and criteria:

             1) A short description of the project (max 6 pages).
             2) A condition for allocating the subsidy is that enterprises should be involved,
                financially or by giving lectures, visits, internships, etc.
             3) All students should have access to the EC activities.
             4) The Evaluation Committee then decides within 8 weeks after submission
                deadline whether they consider the proposal “eligible”.
             5) If so, the applicant is invited to submit an extended request within 20 weeks.
             6) The decision is 13 weeks after the second submission.
             7) There is no restriction on the legal form of the EC or the collaboration.




34
      The creation of the EC should start within 12 months after the submission of the first
      proposal; it can last for maximum of 4 years.


4.3   Tax incentive scheme


 4.3.1   Description of scheme

      The general trend across OECD countries is to
      make increasing use of the tax-system as a
      means for promoting investment in R&D. This
      involves structuring the tax system in a manner
      that makes it more attractive to firms to invest
      in R&D and other innovation related activities.

      The tax incentive schemes currently operating
      across the OECD countries are often tailored to
      the specific context of each individual country.
      Moreover, most countries do not operate with
      one scheme in isolation, but often work with a
      combination of schemes. Notwithstanding such
      diversity in schemes, it is possible to group them within a typology of three different tax
      incentives:

          1. Deductions, which mean that the cost of R&D is subtracted from the revenues
             and therefore reduces the profit which is taxed
          2. Tax credits, which have a direct effect on the amount of tax paid by the
             company. While the benefits of deductions depend on the taxation of profits, a
             tax credit reduces the overall tax payment directly.
          3. Targeted tax incentives, which are mainly used to support small and medium
             sized enterprises (SMEs). Developing tax incentives for this group of companies
             requires particular solutions, as they rarely have any profits to be taxed. One way
             is to reduce the amount of tax the company has to pay on salaries to employees,
             thereby reducing overall labour costs for the company.

      The general trend has been to introduce more schemes and make existing schemes
      increasingly generous. However, there are still significant differences between countries
      in the overall levels of tax-incentives granted to innovative firms. Furthermore, it is not
      only the overall level of tax incentives that differ between countries, but also the nature
      and portfolio of schemes. While deductions are still prevalent among many OECD
      countries, several countries have in recent years paid particular attention to encouraging
      more R&D investment and innovation among SMEs. Accordingly, several countries have
      introduced tax credits and/or tax incentives targeted specifically at the needs of SMEs.




      Creating Financial Incentives for Innovation in Bulgaria
                                                                                                35
     4.3.2   Target groups of scheme

         The tax incentive scheme can be designed to target different groups of firms. Some
         schemes cover all firms that conduct R&D activity, whilst others are specifically targeted
         at innovative SMEs. The benefits can also be differentiated according to the applicants‟
         size or status, e.g. a higher percentage tax deduction for SME‟s.

     4.3.3   Needs and political considerations addressed

         Using the tax system to stimulate innovation serves three main purposes:

                To encourage established firms to invest more in innovation;
                To make it easier for new innovative firms to grow;
                To attract innovation intensive firms to the country, or encourage existing firms
                 to stay.

         Strategic fit
         The introduction of a tax scheme targeting labour costs for R&D could potentially assist
         SMEs in Bulgaria with their innovation efforts. Accordingly, such a tax scheme could
         address the challenge of lowering the costs of R&D for firms generally and SMEs in
         particular. This may be of considerable importance in Bulgaria, where current
         expenditure on R&D (95% of total R&D expenditure) is largely made up of payroll costs
         (albeit mainly for employees in the public sector).

         However, it is important to note that labour costs have not been mentioned as a
         significant barrier for innovation among firms. This needs to be kept in mind when
         considering the appropriateness of such a scheme for Bulgaria.

         EU rules and funding
         As is evident from the large number of EU countries using tax incentives to support
         innovation, such schemes do not violate State Aid rules, as long as they are applied
         horizontally and not focused on individual sectors or firms.

     4.3.4   Impact of scheme

         Tax incentive schemes for innovation have generally proven to be successful in
         stimulating innovative activity. Targeted tax schemes, in particular, have been useful
         instruments for assisting SMEs with the innovation efforts.

         In the Bulgarian context, a targeted tax incentive scheme may well be successful in
         stimulating innovation among SMEs. However, a cause for concern is the fact that labour
         costs do not appear to be considered a significant barrier for innovation among SMEs in
         Bulgaria. This suggests that the scheme may only have limited impact. Nevertheless,
         reducing the labour costs of key innovation personnel should create an added incentive to
         innovate.

         At the same time, Bulgaria appears to have a problem retaining its highly educated
         science and technology graduates due to limited R&D opportunities. If exemption from


36
    social security and income tax can raise the net incomes of R&D personnel, the scheme
    may encourage highly educated people to stay in Bulgaria rather than look for work
    abroad, in which case the scheme may prove to have a significant impact.

4.3.5   Governance structure of scheme

    Tax incentive schemes are usually managed under the auspices of the implementing body
    of the Ministry of Economic Affairs. The general experience of countries that have used
    tax incentive schemes is that the governance and implementation is relatively easy (when
    considering the number of firms reached). Notably, the schemes tend to place only a
    limited administrative burden on the beneficiaries. Indeed, if the scheme is designed in
    such a way as to make a number of employees exempt from social insurance and tax
    payments, the scheme may actually reduce the overall administrative burden on
    beneficiaries.

    However, it is important to stress that the implementation of a tax incentive scheme must
    take account of the fact that a large proportion of SMEs in Bulgaria operate in the „grey‟
    economy, and may be out of reach for the scheme.

    Furthermore, the limited administrative capacity of the potential implementing body, the
    SME Agency, is a cause for concern. However, this problem could potentially be
    addressed by sharing the administrative burden between the SME Agency and the
    National Revenue Agency. A good cooperative relationship is essential.

    In addition, ensuring simplicity in the administration and application process can reduce
    the administrative burden. Both the UK tax credit scheme and the Dutch experiences with
    the WBSO (see more below) highlight the importance of simple and predictable designs
    of tax incentive schemes.

    Finally, the tax scheme, as operated in the Netherlands, is based on a high degree of trust,
    with only limited monitoring of the firms. There is thus a clear trade-off between reaching
    as many firms as possible (in particular smaller firms with limited administrative
    capacity), and the degree of monitoring that can be imposed. Average payments to single
    SME‟s are usually low.

4.3.6   Implementation of scheme

    The practical implementation of a tax incentive scheme can differ widely depending on a
    number of fundamental choices, to be made at an early stage.
    First one has to select the appropriate tax to base the incentive on, a corporate profit tax,
    wage/income tax, or other possibilities. The basis for this choice must be found in the tax
    structure of the country and the major hurdle to be overcome by the scheme. Lack of
    money for investment in R&D apparatus for instance would need a different incentive
    than a high labour cost for R&D personnel.

    The existence of a proper tax base and information system is a prerequisite of such a
    scheme. The advantage of a tax-based incentive is that there is no need for a separate flow


    Creating Financial Incentives for Innovation in Bulgaria
                                                                                               37
         of money requiring separate administration and associated costs but a reduction or
         rearrangement of an existing money flow with a minor additional amount of information.
         Practically the revenue service could implement such a scheme within their own
         administrative process, if the determination of eligible costs is essentially a
         straightforward administrative process. For instance, investment costs for well-defined
         R&D activities, buying equipment, building a lab etc could be administered by the
         revenue agency. A less straightforward definition of eligible activities, for instance “non-
         standard development” would need a more specialized evaluation, not easily done by tax-
         oriented personnel. When there is a clear decision about the activities that are eligible, a
         good communication and clear agreements between such an agency and the revenue
         office is very important.

         The administrative capacity of the agency responsible must be secure before such a
         scheme is started, as the number of applications may be very high. In the Dutch situation
         around 100 staff handles more than 30 000 applications annually. A well-organized
         process and a good IT-infrastructure are essential to handle these numbers of applications.

     4.3.7   Examples of scheme

         The Netherlands, WBSO
         The WBSO (Eng. Research and Development Promotion Act) was set up to support
         firms, notably SMEs and self-employed, in their efforts to invest in R&D. Having run for
         more than 10 years, the scheme targets the labour costs involved in R&D activities. This
         is mainly due to the fact that time/labour costs often constitute the most significant
         investment for R&D efforts of smaller enterprises and self-employed professionals. In
         addition, there are other schemes to support capital costs for R&D that are project based,
         so the WBSO is only one scheme in a wider set of efforts to promote R&D investment
         among firms. As background information, we need to note that the Netherlands is
         characterised by a high income-tax level and high labour costs. The scheme helps to
         offset certain negative aspects of the general business-climate for knowledge intensive
         industries.

         The main principles underpinning the scheme are:
               The importance of low administrative costs on the recipient, such as to enhance
                accessibility and take-up. The application procedures are therefore very simple,
                allowing for approximately 30 000 applications from 10 000-15 000 companies
                every year. These applications are processed at a special office of SenterNovem
                with approximately 150-200 employees.
               Projects receive support if they are likely to add to the technological capacity of
                the firm. Wider socio-economic impacts are not considered. This is a deliberately
                very low threshold, intended to ensure that small firms and self-employed also
                are eligible. Consequently, approximately 90% of applications are successful.
               The scheme does not provide a subsidy as such, but reduces the amount of labour
                cost by targeted reductions of income tax (which in the Dutch situation is directly
                withheld by the employer) and social insurance costs for R&D staff.

         The proportions of R&D wage costs to be exempt from taxation are as follows:
         For start-ups (less than 5 years old)


38
        60 percent off first Euro 110 000
        14 percent off remaining R&D wages


For established organisations
       42 percent off first Euro 90 756
       14 percent off remaining R&D wages


Self-employed persons engaged in R&D activities are eligible to receive a reduction of
Euro 11 154 per annum in their taxable level of income.
Self-employed persons, with a start-up firm, engaged in R&D activities are eligible to
receive a reduction of Euro 16 731 per annum in their taxable level of income.
The main vehicle for delivery is SenterNovem, which administers the scheme. Staff at
SenterNovem receive and process the applications. If the applicant is successful,
SenterNovem informs the tax office of the need to reduce the amount of which income
tax and social insurance is paid. However, the process is currently being reformed, so that
more and more of the administration and implementation is being run by SenterNovem
and less by the tax office. This should lead to a more efficient and quicker processing of
applications.

The process of application starts at the beginning of every tax year (calendar year in the
Netherlands), when firms and self-employed apply for WBSO. At this stage, firms/self-
employed people are required to write a brief description of what they attempt to do,
including a concrete activity plan and an outline of the estimated number of man-hours,
and equivalent labour costs, required for the R&D project. If the project is found eligible
for WBSO support, SenterNovem will report to the tax office, that the amount of labour
costs for which the firm is required to pay income tax and social insurance should be
reduced.

Throughout the year, the employees involved in the R&D activity will have to keep a
timesheet in which the actual number of hours used on the activity is filled in. The time
sheet will have to be sent to SenterNovem at the end of the year, to confirm that the
number of hours actually used match the number of hours in the application. In addition,
the beneficiaries are monitored by means of random visits by inspectors at the firm
premises. However, far from all beneficiaries are visited, and it is the threat of monitoring
rather than the actual monitoring in itself that works as a regulating mechanism.

While it is difficult to assess the exact impact of the scheme on R&D investment, one
possible indicator of its success is the fact that the scheme is still running as one of the
major initiatives to promote R&D investment in the Netherlands.

The critical success factors and lessons learned from the Dutch experiences with the
WBSO are as follows:
       Because the scheme does not operate as a subsidy, but targets the amount of tax
        paid on R&D efforts, there has to be a good working relationship between the
        authorities and ministries responsible for collecting and administering taxes
        (Ministry of Finance) on the one hand, and the authorities responsible for

Creating Financial Incentives for Innovation in Bulgaria
                                                                                               39
               implementing the scheme on the other (SenterNovem, Ministry of Economic
               Affairs). Without a good working relationship and sufficient backing for the
               scheme from both of these Ministries, the scheme is unable to succeed.
              At a more practical level, there needs to be a very good administrative system in
               place that can quickly process the large number of applications and beneficiaries.
               In particular, the availability of a solid ICT infrastructure among the
               administering authorities and beneficiary firms has been critical for the efficient
               working of the scheme.
              Finally, a central lesson to learn from the success of the WSBO is that schemes
               aimed at facilitating R&D investment among mainly small firms and self-
               employed require a very low level of administrative burden. Moreover, there has
               to be a very low threshold of requirements for becoming eligible for support. If
               the likelihood of receiving support is low, or the administrative burden too high,
               the costs and risks associated with applying for support is too high to attract small
               firms and self-employed to the scheme.

     UK R&D tax credit
     One of the best examples of a tax credit scheme designed to encourage greater R&D
     investment is the UK R&D tax credit. Introduced in 2000, the R&D tax credit is a tax
     relief that can either reduce a company‟s tax bill or, for some SMEs, provide a cash sum.
     Between April 2000 and April 2005, approximately 17 000 claims for R&D tax credits
     were made with around GBP 1.3 billion of support claimed.

     There are two R&D tax credit schemes, one for SMEs (less than 250 employees and
     either annual turnover not exceeding Euro 50 million or a balance sheet totalling Euro 43
     million) and one for larger companies. The R&D tax credit for SMEs works by allowing
     companies to deduct up to 150% of qualifying expenditure on R&D activities when
     calculating their profit for tax purposes (similar to a traditional deduction scheme).
     Furthermore, SMEs can in certain circumstances surrender this tax relief to claim payable
     tax credits in cash, equivalent to GBP 24 for every GBP 100 of qualifying expenditure on
     R&D.

     Broadly speaking, the differences between the SME scheme and large company scheme
     are as follows:
      SME scheme                                              Large company scheme


      150% rate of enhanced deduction                         125% rate of enhanced deduction
      Payable credit at GBP 24 for every GBP 100 of           No payable credit
      qualifying expenditure on R&D
      Company can claim for expenditures on R&D is sub-       Company can only claim for expenditure on R&D it
      contracts to others                                     carries out itself, unless it sub-contracts R&D in
                                                              certain limited circumstances to certain entities
      Company cannot claim for contributions to               Company can claim for contributions to independent
      independent research                                    research
      Claim can be reduced if the R&D project is subsidised   No reduction for grant or subsidy
      or a grant is received in respect of it
      Company must own the intellectual property arising      Company need not own the intellectual property
      out of the R&D                                          arising out of the R&D




40
    The scheme defines R&D as efforts to:
          Extend overall knowledge or capability in a field of science or technology; or
          Create a process, material, device, product or service which incorporates or
           represents an increase in overall knowledge or capability in a field of science or
           technology; or
          Make an appreciable improvement to an existing process, material, device,
           product or service through scientific or technological changes; or
          Use science or technology to duplicate the effect of an existing process, material,
           device, product or service in a new or appreciably improved way (e.g. a product
           which has exactly the same performance characteristics as existing models, but us
           built in a fundamentally different manner)

    Moreover, these efforts only qualify as R&D if the project seeks to achieve an advance in
    overall knowledge or capability in a field of science and technology, not a company‟s
    own state of knowledge or capability alone. As such, the threshold for benefiting from
    UK tax credits is higher than tax incentive schemes in many other countries, notably the
    Netherlands.
    The UK tax credit has, above all, been designed to be as simple and predictable as
    possible, by limiting the administrative burden on firms, and keeping to simple flat rates
    of relief. The UK system also stands out for a number of other features, not least, the
    „payable‟ credit for SMEs not in profit and the availability of the credit for large
    companies funding „independent research‟ in universities and for SMEs‟ subcontracted
    R&D. As such, the UK tax credit compares favourably with other tax incentive schemes,
    and recent research18 assessed the UK R&D tax credits as amongst the world‟s most
    attractive regimes.

4.3.8      Conclusion

    In the table below, we provide a summary of the analysis and evaluation of the tax
    incentive scheme.
        Scheme           How it          Target            Needs and             Impact           Governance         Implementation
                         works           Groups            political                              structure and
                                                           considerations                         administration
        Tax              +               +++               ++                    ++               +/-                +/-
        incentive
        scheme
                         Workings        Flexible can      Better general        Can be           Communication Scheme can
                         are often       be targeted       business              broad            and discussion     easily become
                         complex         on different      climate,              depending        with revenue       very complex and
                                         kinds of          possible              on limitation    agency is          difficult to
                                         expenditures, synergy with              of target        essential, trust   understand and
                                         sectors or        activities to         group, often     is needed          administer, high
                                         business          stimulate tax         limited                             volumes of
                                         sizes             payment               amount per                          applications
                                                                                 applicant                           expected

    18
         The ball‟s in our court: The UK technology sector at a critical juncture, Deloitte, July 2005




    Creating Financial Incentives for Innovation in Bulgaria
                                                                                                                                     41
     4.4   Loan guarantee scheme


      4.4.1       Description of scheme

           Loan guarantee schemes work by
           guaranteeing a percentage of a loan
           taken by a firm, notably innovative
           SMEs. They are usually implemented
           through a guarantor, which can be a
           public organisation or operate as a
           mutual organisation. The role of the
           guarantor is two-fold: one vis-à-vis the
           SME and one vis-à-vis the financial
           counterpart19.

           The role of guarantor vis-à-vis SME is to:

                       Facilitate access to the external financial resources without diminishing the
                        financial responsibilities of the borrower. This access to finance can prove to be a
                        catalyst for the launching and expansion of a business or investment in the
                        development of new products and processes.
                       Issue guarantees on the basis of a sound and comprehensive analysis of
                        quantitative and qualitative risks (experience, training, competence).
                       Enrich the analysis of the risks with the knowledge obtained from their close
                        proximity to the SMEs such as information about local competition, foreseeable
                        developments in technology or marketing. As a consequence, entrepreneurship is
                        stimulated and in this way, guarantee schemes contribute to job creation, a
                        suitable financial structure and attractive credit conditions.
                       Provide support to the company by giving advice and supervision in terms of
                        financial management.

           Role of guarantor vis-à-vis the financial counterpart:

                       Externalise the risk of counterpart, or part thereof.
                       Build an individualised financial file on each company, applying simplified and
                        standardised procedures.
                       Frequently supplement the financial and quantitative analysis of banks with a
                        more qualitative approach.

      4.4.2       Target groups of scheme

           The target groups of the scheme are start-ups and SMEs. As noted above, these target
           groups have particular difficulties in obtaining loan financing, and the guarantee scheme
           is designed to address this problem.


           19
                See „Innovation or your money back – how guarantee schemes promote innovative SMEs‟, BEST report (2005)




42
4.4.3   Needs and political considerations addressed

    A key barrier faced by all firms, and SMEs in particular, is the difficulties associated with
    access to loans from banks. More specifically, access to bank loans can be particularly
    difficult for SMEs in cases where they have insufficient collateral or lack a track record
    and a suitable credit history. The problem is mainly the asymmetric information facing
    external financiers (banks), since the borrowing company will know more about its ability
    and willingness to repay the loan. This manifests in a number of problems, notably for
    SMEs, outlined below:

            Limited chance of recovery of assets for lenders in case of insolvency and little
             confidence in personal guarantees.
            Contradiction between the interests of small enterprises and banks, in particular
             the contradiction between the need for personal contact on the part of the SME
             and the tendency towards standardisation of the banks.
            Reluctance among bankers to invest medium to long term in SMEs.
            Banks may be more comfortable or consider it more lucrative dealing with larger
             business customers. Frequently, however, by offering a range of services to SME
             customers the bank may consider that a worthwhile relationship with even the
             smallest enterprises could be established.

    For small firms, these difficulties are made worse by:

            The high overheads of credit back-office functions.
            Lack of a sufficient track record or credit history and/or experience.
            Weakness or even the absence of collateral offered by the SME.

    The prevalence in asymmetric information and associated problems results in many good
    investment opportunities not being taken forward, with associated lack of innovation and
    economic progress.

    A possible solution to address these problems is a loan guarantee scheme that guarantees
    a certain percentage of loans for banks, should the SME be unable to repay the loan.

    Strategic fit
    There are already examples of guarantee schemes in Bulgaria. There is thus already a
    foundation to build on. However, the existing schemes are not targeted at the innovative
    activity of firms. Rather, they aim to improve lending to firms in general, notably for
    environmental improvements and they are not tailored to the objectives of the National
    Innovation Strategy.

    One of the great benefits of the guarantee scheme is that it can be adapted to meet a
    number of objectives. Accordingly, in the light of the objectives set out in the National
    Innovation Strategy, a Bulgarian loan guarantee scheme can be structured in such a way
    that it mainly benefits firms collaborating with research institutes and universities,
    investment in ICT or other innovation infrastructure etc., depending on what is needed.
    For example, if the objective is mainly to develop domestic innovation and less to
    enhance the absorption capacity of the Bulgarian economy for foreign technology, a loan

    Creating Financial Incentives for Innovation in Bulgaria
                                                                                               43
     guarantee scheme could be structured such that loans for investment in foreign
     technology and training are given fewer guarantees than the more traditional forms of
     R&D investment. This leads to a ranking of loans depending on purpose:

            General loans: no support
            Loans for spending on training: 25% loan guarantee
            Loans for investment in high-tech equipment: 40% loan guarantee
            Loans for investment in R&D: 50% loan guarantee
            Loans for investment in collaborative R&D projects between SME and
             university/research institute: 50% loan guarantee
     Moreover, it is possible to structure the loan guarantee scheme to support venture capital.
     For example, in the US, government guarantees allow the small business investment
     companies to borrow money at low rates on the capital markets. Together with privately
     raised capital, the money is then invested in SMEs. In the light of the great need for more
     venture capital, this is an option that could be considered for Bulgaria. Hence, a loan
     guarantee scheme could be designed in a manner that gives it good strategic fit.

     EU rules and funding
     Loan guarantee schemes are widely used across the EU, and encouraged by a number of
     EU institutions, as is, for example, evident in the EU Commission‟s Communication on
     „Access to finance of small and medium-sized enterprises‟. The same Communication
     emphasises that “focusing on early-stage financing, in particular guarantees and micro-
     lending” should be a key priority across Europe.
     However, the State Aid rules of the EC Treaty have a number of implications for loan
     guarantee schemes. Accordingly, guarantees must be linked to a specific financial
     transaction undertaken by SMEs and must not cover more than 80% of the amount of
     each outstanding loan, and may not be granted to SMEs in financial difficulty. The terms
     of a guarantee scheme must be based on a risk assessment for granting the guarantee and
     the premiums must reflect such risk as well as the administrative costs of the scheme. The
     State Aid rules give the EU Commission the power to assess guarantee schemes and it
     must grant authorisation before such schemes can be implemented. However, SME
     oriented schemes where the aid amounts are small (less than 100 000 Euros over a three-
     year period) are exempt from the authorisation requirement.

     With regard to funding opportunities from EU funding mechanisms, the SME Guarantee
     Facility of the European Investment Fund is highly relevant. The SME Guarantee Facility
     provides guarantees for guarantee schemes and financial institutions within the public and
     private sector that supports lending to SMEs. The facility includes micro-credit
     guarantees, equity guarantees, and guarantees for loans financing IT equipment, software
     and training. The SME Guarantee Facility has proved to be a very effective tool and since
     1998 more than 125 000 SMEs from a wide range of sectors have benefited. More than
     90% of enterprises benefiting from loan guarantees are micro-enterprises with fewer than
     10 employees and their job creation has increased significantly. Approximately 45% of
     beneficiaries are start-up firms.

     With the Competitiveness and Innovation Programme for 2007-2013, the European level
     funding for guarantee facilities is envisaged to be increased further, with a view to
     providing leverage to national instruments.


44
    Furthermore, the European Regional Development Fund has allocated 1.5 billion Euros to
    SME development in the Member States in the period 2000-2006 and this funding is
    likely to continue.

    In addition to the EU level, schemes and instruments that are designed to complement
    national efforts, the Structural Funds also provide more direct support to the development
    of national loan guarantee schemes.

    In summary, a loan guarantee scheme fits very well with EU rules and funding
    opportunities.

4.4.4   Impact of scheme

    Loan guarantee schemes have proven to be highly successful schemes for enabling
    financing for SMEs in general and innovation in particular. More specifically experience
    from the EU financial instruments shows that loan guarantees are a very efficient way to
    use limited public funds and directly address the problems of lacking collateral and
    intangible assets. This view is, for example, supported by the high leverage effect of the
    EU public funds committed to the SME Guarantee Facility. The yearly report of the SME
    Guarantee Facility for 2003 indicated that the guarantee facility made lending possible to
    SMEs that is 58 times the budgetary spending, i.e. the budgetary resources were
    155.7million Euros, which allowed guaranteeing loans worth 9.02billion Euros.
    In the Bulgarian context, where lack of collateral appears a significant barrier for
    obtaining loans by innovative firms, a loan guarantee scheme could be highly effective.

4.4.5   Governance structure of scheme

    The governance of a loan guarantee scheme for innovation in Bulgaria can follow
    existing implementation structures for other guarantee schemes. The governance can be
    relatively simple as the major discussion takes place between the SME and his financing
    institution. The application for the guarantee is only done if the financing institution is
    otherwise satisfied with the information and plans. A limited number of institutions can
    apply and usually these are already in a well-regulated sector (which may not be the case
    of Bulgaria yet). Checking if an application meets separate criteria set by the guarantor is
    relatively easy. Financially the budget requirements can be limited at first but there is a
    risk attached for the future, if there are a significant number of defaulters on guaranteed
    loans.

4.4.6   Steps of implementation

    The experiences of loan guarantee schemes across Europe suggest that their
    implementation is relatively easy (when considering the number of firms included), with
    an ability to reach a large number of firms at little cost in terms of administration for the
    implementing body and the final beneficiary. However, it is important to stress that the
    successful implementation of a loan guarantee scheme requires reliable information from
    the SME, enabling an assessment of the financial situation of the firm and associated
    risks. A first step should therefore be to build up capacity among SMEs on how to deal


    Creating Financial Incentives for Innovation in Bulgaria
                                                                                               45
         with banks, and the type of information that they need to make available. For innovative
         firms this includes the ability to make technology assessments.

         Moreover, a critical problem with loan guarantee schemes is the potential moral hazard
         that they give rise to, as do most financial instruments for innovation. Such moral hazards
         can in part be dealt with by imposing a set of conditions on participating firms. However,
         if too stringent, such conditions can often prove very prescriptive, and impede private
         sector initiative. Any conditions imposed on firms benefiting from a loan guarantee
         scheme should therefore be balanced against the need to ensure private sector initiative.
         Furthermore, it could be argued that one can work on the assumption that a firm has an
         interest in spending the loan wisely, since the firm itself remains responsible for a large
         proportion of the loan.

         Alternatively, a mutual society, owned and managed by the beneficiaries can be set up.
         These are collective initiatives of a number of independent businesses or their
         representative organisations. They commit to granting a collective guarantee to credits
         issued to their members, who in turn take part directly or indirectly in the formation of the
         equity and the management of the scheme. The philosophy is based on the mutualisation
         of responsibility, decision-making by peers and operation within the market economy.
         These can also receive public support.

         In sum, the implementation of a loan guarantee scheme for innovation in Bulgaria could
         be relatively easy, given the foundation of existing guarantee schemes. This is not to say
         that the implementation would not have certain problems, but it is important to stress that
         any financial scheme for innovation inevitably will entail certain information
         requirements and place an administrative burden on both the implementing body and
         benefiting firm. The problems associated with the loan guarantee scheme thus, more or
         less, apply to all financial schemes.

     4.4.7   Examples of scheme

         Slovene Enterprise Fund (SEF) – Slovenia
         SEF was established to promote micro, small and medium sized companies by offering
         favourable terms for loans. SEF offers benefits for SMEs in the form of affordable
         interest rates for loans, more favourable terms and conditions for granting loans,
         guarantees for investment loans raised with commercial banks in Slovenia and grants in
         combination with indirect loans or guarantees.

         SPGM – Portugal
         SPGM has concentrated on guarantees benefiting medium-sized SMEs. The Portuguese
         Guarantee Scheme forms a fully integrated guarantee network, and is based on the
         following principles: First, the guarantees are issued by autonomous Mutual Guarantee
         Societies in which the beneficiary SME also holds a stake. Second, a counter guarantee
         mechanism is granted through the Mutual Counter Guarantee Fund, managed by SPGM.

         Vaekstfonden – Denmark
         By combining the competencies and efforts from professional financiers in loan
         guarantee, equity and mezzanine finance teams, Vaekstfonden offers an integrated


46
      approach to the provision of funding for innovative SMEs and puts together a financial
      package that is adapted to the funding needs of each SME in its portfolio.

 4.4.8     Conclusion

      In the table below, we provide a summary of the analysis and evaluation of the loan
      guarantee scheme.

         Scheme         How it          Target       Needs and         Impact           Governance        Implementation
                        works           Groups       political                          structure and
                                                     considerations                     administration
         Loan           ++              ++           +++               ++               +(+)              +(+)
         guarantee
         scheme
                        Relatively      Can be       Targets access    Depending        Structure and     No major hurdles
                        simple          defined,     to financial      on level of      administration    for
                        system, if      e.g.         sector, good      guarantee        are relatively    implementation,
                        financial       SME,         examples          and              simple,           unless more
                        structure is    high-        available         provisions a     provided the      difficult
                        in place        tech,                          significant      basic banking     assessments are
                                        start-up                       multiplier can processes are       required
                                                                       be achieved      available
      Note: (+) means possible inclusion of another (+)




4.5   Venture capital scheme




      Chris Moore, David Hornik, Jeff Clavier, Josh Kopelman, and Micheal Eisenberg during the "Venture Capital 2.0: Bright
      Future or Broken Forever?" session at the 2007 Web 2.0 Expo in San Francisco, California.




      Creating Financial Incentives for Innovation in Bulgaria
                                                                                                                          47
     4.5.1   Description of scheme

         A venture capital scheme, or risk capital scheme, promotes finance for firms with growth
         potential, based on correcting the market failures resulting in the equity gap. The scheme
         often involves establishing public-private partnerships in venture capital, by having the
         public sector invest in privately managed VC funds.

     4.5.2   Target groups of scheme

         The target group of venture capital schemes are high-tech SMEs. In addition, there are a
         number of factors specific to start-ups and SMEs that make it difficult for them to obtain
         venture capital funds. These are outlined below:

                Limited exit options for the investor, especially if there is a difference in opinion
                 between the investor and manager-founder regarding exit.
                Reluctance of the manager-founder to share control with an external partner.
                Insufficient management capacity to prepare information for and consider
                 proposals from potential investors.
                Relatively high and fixed due diligence costs, making relatively small
                 investments uneconomic.

         The problems with the financial system and the situation of SMEs result in a significant
         gap of equity finance from VC funds. This is illustrated in the figure below.




         However, to address these problems, European countries are increasingly developing
         venture capital schemes making this critical type of funding available to SMEs.

     4.5.3   Needs and political considerations addressed

         There is a pressing need for more venture capital funding in Bulgaria. The lack of venture
         capital is seen as one of the key barriers for financing innovation in Bulgaria. The reason
         for the problem is mainly that the illiquid and under-developed financial system makes
         Bulgaria an unattractive place for venture capital funds to invest.


48
    Strategic fit
    Ensuring the availability of risk capital for entrepreneurs and SMEs is an important long-
    term objective for the Bulgarian economy. Indeed, it is evident that there is a pressing
    need for more venture capital in Bulgaria. Accordingly, the improved access of start-ups
    and SMEs to venture capital is an important strategic objective. This suggests that a
    venture capital scheme would have a very good strategic fit with the current challenges
    facing Bulgaria and with the National Innovation Strategy.

    EU rules and funding
    Venture capital schemes exist in a number of EU countries and do not violate the State
    Aid rules of the EC Treaty. Indeed, developing risk capital markets is a high priority in
    the EU.

    With respect to funding, there are also opportunities offered by EU institutions. The ETF
    Start-Up Scheme supports the financing of SMEs in their start-up phase by investing in
    venture capital funds and business incubators. The funds should in particular be seed
    funds, smaller funds, funds operating regionally or funds focused on specific sectors or
    technologies, or venture capital funds financing the exploitation of R&D results. The EIF
    invests usually about 15% in the capital of a new venture fund and the rest of the
    investment must be raised from other sources. The ETF Start-Up Scheme mostly benefits
    entrepreneurial growth companies in an innovative technology or service area.

    The ETF Start-Up Scheme has proven an effective instrument that has increased the
    supply of venture capital to SMEs, particularly in the early stages of development and in
    the high technology sectors where there is an identified market failure. So far, more than
    200 companies with high growth potential have benefited.

    The use of national financial intermediaries and national programmes make it possible for
    the ETF Start-Up Scheme to be tailored to the different financing traditions and market
    circumstances of the participating countries.

    In addition, after Bulgaria‟s accession to the EU, Structural Funds can be used for venture
    capital schemes, highlighting the priority given to these types of schemes by the EU.

    In sum, venture capital schemes fit very well with EU rules and funding opportunities.

4.5.4   Impact of scheme

    The experiences of countries that have introduced venture capital schemes are generally
    positive. Although the introduction of many of the schemes is too recent to allow for
    adequate evaluation, it appears as if the schemes target a clear gap in much need of being
    addressed.

    However, risk capital markets, and therefore venture capital schemes, do not exist in
    vacuum but are inextricably linked to the wider financial and entrepreneurial
    environment. Developing risk capital markets must therefore take account of the whole


    Creating Financial Incentives for Innovation in Bulgaria
                                                                                                49
         chain of investment, from the preparedness of entrepreneurs to the exit mechanisms for
         investors.
         In Bulgaria, the immaturity and non-liquidity of the financial markets, and resultant
         limited exit opportunities, may well deter private investors (foreign and domestic) from
         participating in the scheme in the short term. Consequently, the short-term impact of a
         VC scheme may be limited.

         Moreover, limited support mechanisms for entrepreneurs and start-up may result in
         limited investment opportunities for venture capital funds. Accordingly, the development
         of a venture capital scheme must go hand-in-hand with wider support mechanisms for
         entrepreneurs and start-ups, and suitable reforms to the financial system.

         Notwithstanding these difficulties, it is clear that there is a desperate need for venture
         capital in Bulgaria, and in time, when the financial system is more developed and the
         support mechanisms for entrepreneurs and start-ups are more mature, a VC scheme may
         prove highly successful.

     4.5.5   Implementation of scheme

         The best VC schemes are designed such that they work with the market mechanism and
         provide incentives to funds to improve their performance. This involves the following:
                Working with the private sector. About 80% of programmes in Europe require
                 that the participating venture capital funds are private and function on a fully
                 commercial basis.
                Making the performance of funds fully transparent. Approximately two-thirds of
                 VC schemes in Europe select funds on the basis of their competence and track
                 record. A large majority of the participating funds are profit-oriented and their
                 results are publicly available.
                Emphasising efficiency. About two-thirds of VC schemes in Europe require co-
                 financing from the private sector and limit the participation of the public sector to
                 a certain percentage.
                Delivering funds effectively. Ensuring that the management costs of the
                 participating funds are in line with normal industry practices. Moreover, a large
                 majority of VC schemes in Europe limit the investment period of the fund.
                Giving the funds the right incentives. Most schemes have several instruments at
                 their disposal, having the possibility of using both equity investments and
                 subordinated loans and other equity-like instruments. Most public sector equity
                 investments are made with the same conditions as the private investments. Some
                 VC schemes in Europe limit the public sector share of the fund profits.
                Making the scheme useful in the long term. Many schemes in Europe have been
                 formally evaluated and had their effect on the final beneficiary firms assessed.

     4.5.6   Governance structure of scheme

         The governance of the venture capital scheme requires the existence and collaboration of
         private investors. Accordingly, the successful implementation of the venture capital
         scheme relies, to a significant extent, on the buy-in of private investors. As the presence
         of private venture capital investors in Bulgaria is currently limited, it is difficult to assess


50
    whether the implementation of a venture capital scheme will succeed. However, in the
    medium to long run, when the private VC market has developed, it may become easier to
    implement.

4.5.7     Examples of scheme

    Netherlands
    The venture capital scheme in the Netherlands is based on the principle of supporting
    market-based decisions on investment in innovative firms. This is done through a funds-
    of-funds approach, where the government invests in a number of venture capital funds
    that in turn invests in innovative firms. All the venture capital firms in which the
    government invests include private investors as well.

    Good practice lessons from the Dutch VC scheme:

                 Don‟t disturb the market. Only when there is a market or system failure, public
                  intervention is acceptable.
                 The intervention must be market oriented. The market selects and is the lead
                  investor/funder.
                 Stimulate access to finance by improving the risk-return profile for early stage
                  venture capital funds. Prevent “death-by-fees” through critical mass of fund size
                  and smart fund constructions, don‟t subsidise management fees.
                 Intervention requires an integrated approach; a mix of instruments covering
                  finances, R&D support, coaching, use of incubators, etc, to improve the success
                  rate of SMEs and the governmental efforts.
                 The fund-of-fund approach with professional private venture capital funds has a
                  better risk-return profile.
                 National initiatives are limited to operate within a national context. These
                  constraints the market conform business model of venture funds. Co-intervention
                  and stimulating pan-European approaches by the EC could tackle this constraint.

4.5.8     Conclusion

    In the table below, we provide a summary of the analysis and evaluation of the VC
    scheme.

        Scheme         How it      Target     Needs and        Impact      Governance       Implementation
                       works       Groups     political                    structure and
                                              considerations               administration
        Venture        +           ++         ++++             +/- short   +                - (short term)
        Capital                                                term                         + (long term)
        scheme                                                 +++ long
                                                               term




    Creating Financial Incentives for Innovation in Bulgaria
                                                                                                             51
     4.6   TOP Technology Institutes


           Experience from a Dutch policy measure
           called TOP Technology Institutes (TTIs)
           has been included in this report in the
           very final phase of its preparation
           following the request of the Ministry of
           Economy and Energy. Its inclusion
           reflects the intention of the Bulgarian
           government to develop knowledge and
           competence centres in important for the
           country fields20. TTIs as a policy
           measure realises a similar strategic
           intention. Other countries can offer
           experience in building up centres of excellence or other types of knowledge and
           competence centres.

           An interesting case is the one of the region of Flanders, Belgium21. In the present decade
           a certain „horizontalisation‟ of the science, technology and innovation (STI) support
           system in Flanders has been observed, with the establishment of different support
           schemes independent of sectors and/or technologies. In due time the policy-makers got
           aware of the need for more focused support in order to provide the necessary „critical
           mass‟ needed and a such to make a „real‟ difference. As a consequence, a certain
           rationalisation came in place replacing the more „ad hoc‟ initiatives. At this time the term
           „poles of excellence‟ was coined, referring to a selection of institutes dealing with
           specific technologies/sectors. In the course of 2004, the initiative was taken to set up the
           Interdisciplinary Institute for Broadband Technology (IBBT) as a response to the
           economic crisis in the ICT sector. This clearly has been a „bottom-up‟ and „demand-
           driven‟ initiative to strengthen the economic potential of the ICT sector in Flanders.
           Looking at the size of the support that IBBT receives (€ 17 million/year), it falls in the
           category of research centres like IMEC (Interuniversity Micro-Electronics Centre), VIB
           (Flemish interdisciplinary Institute for Biotechnology) and VITO (Flemish Institute for
           Technological Research). The concept underlying IBBT is rather unique; it is a virtual
           institute alike VIB but with the difference that IBBT funding is allocated on a project
           basis instead of a departmental basis (VIB). The first half of 2004 was characterised by a
           whole series of initiatives for new “poles of excellence” The following initiatives fall
           under this classification: Flamac (Flanders‟ Material Centre), MIP (Environmental

           20
                National Reform Programme (2007-2009), p. 60
           21
                Arnold Verbeek, Elissavet Lykogianni, Valentijn Bilsen, Veerle Minne and Geert Steurs, Assessing the impact of the Flemish

           centres of excellence, Working paper, IDEA, member of ECORYS Group, 2007




52
     Innovation Platform), Flanders‟ FOOD (knowledge diffusion in the food sector), and
     Flanders‟ DC (Flanders‟ district of creativity focussing on international and interregional
     collaboration on the topics of creativity and innovation).

     The recent trend of „virtuality‟ of the “poles of excellence” does not mean such cannot be
     established on the basis of existing (physically at one place) knowledge and competence
     centres. This is rather defined by the location of the knowledge in the country/region.
4.6.1 Description

     There are several different forms and methods to fund technology or sector-specific
     institutes, with the aim of generating excellent research in a focused and organised way.
     In the Netherlands most TOP-institutes are virtual in nature. It is a form of cooperation
     between existing R&D institutes and universities in a concerted approach to a specific
     technology field. Usually a programme board or steering group determines the main
     fields of research to be covered and different research groups from existing universities
     submit proposals. The programme board then decides which proposals receive funding.

     The decision to fund the institute or the programme is made on a relatively general
     proposal that is later worked out in detail.

     The amount of funding is usually between 50% and 33%; the remainder comes from the
     institutes themselves and from interested industry partners, either in kind or in the form of
     contributions.
     The choice for “virtual” rather than “real” institutes (with buildings, facilities, dedicated
     staff etc) is partly determined by the temporary nature of the funding and the goal to
     redirect existing research rather than significantly expanding the total research effort.
     Such science and technology institutes can also be placed at one physical place or build
     up around an existing R&D unit.

4.6.2   Target groups

     The recipients of funding are mostly the universities/R&D institutes. In order to have an
     economically more useful result the influence of the industrial partners on the formulation
     of the research programme and the specific projects must be strong. The present thinking
     in the Netherlands is that industry should have the lead in formulating problems, targets
     and requirements that the programme is meant to address. The translation of the results of
     pure fundamental research to possible applications and opportunities is an important
     issue.

4.6.3   Needs and political considerations addressed

     Strategic fit
         The TTI concept is useful for Bulgaria as it can help focussing existing research
         programmes on industrial needs (less of „free‟ academic research). It seems that in
         Bulgaria the universities focus on education and applied research for industry while
         the fundamental research is carried out by the Academy of Sciences and other
         specialised institutes. So, there is not only a „wall‟ between industrial and academic
         R&D but also a „wall‟ between fundamental and applied research. TTIs can help

     Creating Financial Incentives for Innovation in Bulgaria
                                                                                                  53
             bringing more focus into these categories. There are three conditions under which the
             concept can work:
                There has to be a fundamental research basis in Bulgarian know-how institutes
                 and these institutes must be willing to transfer part of their research programme
                 and the corresponding budget to the TTI (Note that this does not mean these
                 institutes get less money, on the contrary, they get more as the companies supply
                 funds and as the state supplies extra funds);
                There have to be companies that are interested in collaborating and in sharing the
                 financial burden;
                The state must be willing to allocate extra money.

         EU rules and funding
         Funding of TOP institutes can be achieved within the R&D framework directive, as the
         focus of the research is usually either fundamental or industrial, allowing significant
         subsidy percentages. If no subsidy is given to any of the participating industrial partners
         the EU restrictions are minimal. One important facet is the policy with respect to
         Intellectual Property Rights (IPR). If subsidized research leads to patents with an
         economic value these cannot be transferred to individual businesses other than by paying
         a market-determined fee. Otherwise it could be interpreted as indirect state-support.

     4.6.4   Impact

         The impact of such a TOP institute is something that is not directly visible from the start.
         It will in time form a centre, a focus for research in a specific field which attracts new
         initiatives, becomes the natural established partner for industry. It should also be
         internationally recognizable. However this is not achieved in one or two years. Building
         up such a structure takes at least one research period of 3-4 years. Preferably funding
         should be secured for a period of 8 years, in order to gain a significant research portfolio.

     4.6.5   Implementation

         The experience in the Netherlands is that decisions of this nature (often comprising tens
         of millions of euro‟s for long periods) are inherently political in nature. A heavy advisory
         body can examine the R&D agenda, the level of support from industry and the foreseen
         economic results. Each decision is however, a tailor-made solution, because the questions
         and organizations in each sector can differ widely. Implementing a “simple” subsidy
         scheme is difficult and will in all probability need to be adapted on a regular basis. A
         system with open calls is unworkable for programmes of this size and complexity.
         In essence each funding decision is a separate issue, detailing conditions, costs, etc. in a
         contract between the funding department or agency and the entity carrying out the R&D
         programme.

     4.6.6   Governance structure

         Due to the variable nature of the TOP institutes different governance structures have been
         used. The general structure usually consists of a small management/administrative office,
         supporting a steering group or a board consisting of the funding partners. Often a
         foundation is set up, in order to separate the activities organizationally from the physical
         institute where the office is located. Because the research programmes are quite often too


54
large to administer as a whole separate themes or research areas within the general
programme are defined and managed by lead investigators, under a scientific director.
Examples of governance structures are available for the Dutch situation. Below is an
example of a governance structure for the TOP Institute Food and Nutrition. TOP
Institute (TI) Food and Nutrition is a unique public/private partnership that generates
vision on scientific breakthroughs in food and nutrition, resulting in the development of
innovative products and technologies that respond to consumer demands for safe, tasty
and healthy foods22.




22
     www.tifn.nl




Creating Financial Incentives for Innovation in Bulgaria
                                                                                        55
     4.7   Conclusions and recommendations

           It is evident from the above, that there
           are a number of options available for
           policymakers to address the serious
           challenge of improving access to
           finance for innovation. Eventually, all
           of these schemes may play a role in
           stimulating innovation in Bulgaria.
           However, at this stage, it is important
           to focus on the scheme or schemes that
           will provide the greatest benefits to the
           Bulgarian economy and society.
           Accordingly, there has to be a
           prioritisation of schemes.

           In view of the analysis and evaluation
           above, it is clear that some schemes
           may be of more strategic importance
           and/or have a greater immediate impact, whilst others may prove less beneficial or be
           more effective at a later stage. In table below, we summarise our evaluation of the
           different schemes.

           Moreover, it is important not to see each individual instrument as an isolated intervention,
           but as belonging to a wider set of policies and instruments designed to encourage
           innovation. An instrument should thus not merely be evaluated on its own isolated merits,
           but also on how the instrument interacts with other policies and instruments. This calls for
           an assessment of all five schemes coupled with existing schemes and instruments
           supporting innovation in Bulgaria.

           Accordingly, it is also important to assess whether the schemes as a collective address the
           financing needs for different stages of the innovation process. If the schemes are all
           targeted at the same stage of the innovation process, they are likely to act as substitutes
           for each other, while schemes that target different problem stages of the innovation
           process are more likely to complement each other. In the table below, we illustrate how
           the different schemes can target different stages of the innovation process, and thus
           generate the greatest collective impact on innovation in Bulgaria.




56
             Idea Basic        Applied    Feasibility Technology   Products      Ability to    Market       Market
                   Research Research                   Development and Process   Manufacture   Entry        Development
                                                                   Development
Innovation    X                                X             X          X
Fund
Voucher       X        X           X           X             X
scheme
Techno                             X           X             X          X
starters
Tax           X        X           X           X             X          X
incentives
Loan                                                         X          X              X         X
guarantee
Venture                                                                                X         X               X
capital
TTIs          X        X           X                         X          X




  It is evident from the table above that the schemes discussed in this report, coupled with
  the existing Innovation Fund, are likely to target all the stages in the innovation process.
  Moreover, the emphasis of the schemes is clearly on the stages from applied research to
  product and process development. This overlap between schemes can be justified by the
  particular difficulties associated with financing these stages of the innovation process,
  often referred to as the „valley of death‟. Having three or four schemes addressing these
  difficult stages will provide alternative options to start-ups and SMEs, increasing the
  likelihood of overall take-up of financing opportunities.

  Based on these conclusions, our recommendation is to move ahead with a gradual process
  with wide stakeholder involvement, such that the most pressing needs are addressed. This
  should include extensive consultations with SME representatives and representatives
  from the financial sector and the research community. Without these key stakeholders on
  board, a financial instrument is unlikely to be appropriately tailored to the needs of
  Bulgaria, and will thus not succeed in achieving improved innovation outcomes.

  This process has already begun with the implementation of a technostarter scheme, and
  could be taken further with the design and implementation of a pilot voucher scheme. The
  voucher scheme is very simple to implement, and a pilot scheme administered under the
  auspices of the SME Agency could be set up fairly quickly. Such a pilot scheme could
  potentially be funded by ERDF funds, upon membership of the EU.

  The pilot voucher scheme should be coupled with considerations of how the loan
  guarantee scheme and tax incentive scheme can be best tailored for Bulgaria. Both of
  these schemes are potentially attractive instruments, given the Bulgarian context, but need
  to be designed such as best to address the needs of SMEs. We recommend that a design
  process resulting in more concrete and detailed proposals be initiated. With respect to the
  loan guarantee scheme, special consideration should also be given to the possibilities of
  funding the scheme with Structural Funds. While the venture capital scheme is of long-


  Creating Financial Incentives for Innovation in Bulgaria
                                                                                                       57
     term interest, it may currently be too early to consider. However, with the membership of
     the EU, the venture capital scheme should be considered as a possible initiative to fund
     with Structural Funds.

      Scheme      How     Target   Needs and        Impact Governance        Implementation Recommendations
                  it      Groups political                  structure and
                  works            considerations           administration
      Voucher     ++++    +++      ++++             ++      +++              ++++             Should consider
      scheme                                                                                  immediate
                                                                                              implementation of
                                                                                              pilot scheme.
      Techno      +++     +++      +++              ++      ++               ++               Provide for
      starter                                                                                 continues
      scheme                                                                                  implementation of
                                                                                              scheme
      Tax         +       +++      ++               ++      +/-              +/-              Move forward with
      incentive                                                                               specifying scheme
      scheme                                                                                  for BG. Think
                                                                                              carefully about how
                                                                                              to address possible
                                                                                              weaknesses of
                                                                                              scheme.


      Loan        ++      ++       +++              ++      +                +                Move forward with
      guarantee                                                                               thinking of
      scheme                                                                                  specification of
                                                                                              scheme for BG.
      Venture     +       ++       ++++             +/-     +                - (short term)   Has long-term
      capital                                       short                    + (long term)    potential, but
      scheme                                        term                                      perhaps too early to
                                                    +++                                       consider moving
                                                    long                                      forward with such a
                                                    term                                      scheme.
                                                                                              Wait for financial
                                                                                              system and support
                                                                                              structures for
                                                                                              entrepreneurs and
                                                                                              start-ups to become
                                                                                              more mature.
      TTIs        +++     +++      +++              ++      ++               ++               Provide for
                                                                                              continues
                                                                                              implementation of
                                                                                              scheme




58
5 Annex 1: Selected schemes for innovation by stage of enterprising




  Note: Selection concerns EU members states




  Creating Financial Incentives for Innovation in Bulgaria



                                                                      59

				
DOCUMENT INFO
Description: Incentive Scheme at Management Development Institutes document sample