‘Undertaking In Difficulty’: A Potential Hurdle for Start-ups in Securing Innovation Grant Funding

Start-ups in need of financial support

Flanders hosts more than 2,500 start-ups. With over 38,000 employees, these young ventures play a pivotal role in driving economic prosperity. As catalysts for job creation, start-ups are the driving force behind Europe’s and Flanders' additional job growth, outpacing any individual sector each year.

The journey to successful company growth and commercialisation is not without its challenges. Operating in a pre-revenue phase, many start-ups grapple with rapid expenditure of resources. Transforming innovative ground-breaking ideas into viable businesses requires significant financial backing.

Innovation grants for R&D financial support

To access financial support, grant funding offers a valuable option. It provides non-dilutive funding, enabling entrepreneurs to retain ownership and control over their companies while pursuing their innovative visions. Government grants are specifically designed to incentivise companies to take on more risk and thereby boost a dynamic environment for Flemish innovative companies, and by extension, Flemish start-ups.

With an allocation of € 2.15 billion in 2023, Flanders surpasses the European average in government R&D support spending relative to its Gross Domestic Product. This is a testament to the region's commitment to nurturing research-driven growth and development. Yet, it is often start-up companies that may find themselves missing out on this much needed financial support.

The ‘Undertaking In Difficulty’ (UID) status

While being cash-burning is often inherently part of the journey towards commercial viability, it can hinder a start-up’s ability to secure innovation grant funding, subject to State aid regulations. These regulations prohibit a company classified as an Undertaking in Difficulty (UID) from receiving funding.

By definition, an UID is a company that is in financial distress or on the verge of insolvency. According to the guidelines set forth by the European Commission (EC), this is the case when the deduction of accumulated losses from reserves (and all other elements generally considered as part of the own funds of the company) leads to a negative cumulative amount that exceeds half of the subscribed share capital.

UID exceptions and associated funding limits

There are exceptions to these State aid regulations. Firstly, specifically for SMEs, they cannot be considered an UID if they are in existence for less than three years (Article 2, point 18 of the General Block Exemption Regulation, GBER). Secondly, start-ups can receive funding as an UID when they have been in existence for more than 3 but less than 5 years, subject to certain obligations and restrictions (Article 22 of the GBER). This funding is capped at a one-off amount of up to € 500.000, which can be increased by a factor of 1.5 when the company is located within the EU regional support area. Innovative small companies can receive a one-off amount of up to € 1 million, which can similarly be potentially increased by a factor of 1.5 depending on their geographical location.

When rules misfit their purpose …

Companies thus face stringent rules and limitations when seeking financial assistance from government sources, with State aid regulations acting as the necessary gatekeepers. The underlying rationale is clear and correct: striking an equilibrium between supporting companies and promoting responsible fiscal practices to prevent misuse of state funds and distortion of market competition.

However, as with any regulatory framework, there's a nuance to consider. The rules may not always align seamlessly with the reality of start-up dynamics. Start-up companies are known for their high-risk, high-reward nature. As they forge ahead, investing heavily in R&D and expansion, they may find themselves classified as an UID, and hence ineligible for the much-needed grant funding.

Specific examples

Some start-up companies unfortunately do classify as an UID without actually being in financial difficulty. Below are two specific examples to illustrate this further:

1. It’s not uncommon for a start-up to have affiliations with other companies,sharing over 50% of its ownership. In such a case, the company’s age limit to appeal to the UID exception, related to a start-up that is in existence for less than 3 (or 5) years, applies not only to the start-up itself but also to the each company of the consolidated group it’s affiliated with.

This means that if one of the companies in the consolidated group is in existence for more than 3 (or 5) years, the start-up no longer qualifies under the UID exception relating to the company’s age. Despite the financial stability of the consolidated group, the start-up will be classified as an UID.

If that same start-up were to operate independently and were under 3 (or 5) years old, it would qualify for grant funding by leveraging the UID exception. This disparity raises questions about the fairness of competition for which the regulatory framework was constructed. The question is: How can we then ensure a true level playing field for start-ups in their competition with other economic actors?

2. Despite having been in existence for over 3 (or 5) years, some companies may still not yet be profitable. Innovations are often the result of years, if not decades, of dedication and perseverance in risky research and development before market entry. In the life sciences sector, for example, it takes on average 10 to 15 years for a medicinal product to enter the market. For medical devices, the time-to-market is estimated at 3 to 7 years or more.

Such companies, when stand-alone, often rely on financing by venture capital funds. However, securing this type of funding is very timing-dependent, involving efforts to convince (new) investors in consecutive fundraising rounds. Once these companies surpass the age of 3 (or 5) years, limited resources in anticipation of the next capital round may lead them to be classified as an UID. Under these circumstances, entrepreneurs don’t have access to public funding and are thus forced to depend on a next capital round where their ownership and control over their companies are diluted. At the same time, these entrepreneurs may be confronted with the inability to leverage a successfully realised grant as a persuasive tool to attract new investors.

Time to rethink the rules?

We firmly believe that non-viable businesses should not be the recipients of State aid. However, we agree with the European Startup Network and Invest Europe that the UID definition needs revision, particularly for start-up companies. Innovation grant funding should be accessible to all companies with long-term financially viability, regardless f their financing or ownership structure.

To accurately capture undertakings that are truly in difficulty, it’s essential to establish a comprehensive framework that assesses the future potential of start-ups, gauging their long-term financial viability. Therefore, we would like to call for a reassessment of the UID classification criteria by the EC to ensure innovative start-ups receive the financial support they rightly deserve. In doing so, it will help support the Flemish start-up ecosystem and thereby the Flemish economy.