Venture capital firms in Iran’s legal system: Part two
Posted on 03 August, 2018 by Omran Mohammadi
In the second of a four-part series, international trade law expert Omran Mohammadi looks at the history of Iran’s venture capital firms, its legal framework and related issues.
There are some favourable rules for those venture capitals that work in the startup and stock exchange market. These favourable rules are usually aimed to reduce risks and encourage venture capitals to engage in these markets. These rules mostly include funding and facilities for venture capitals.
In the evolution of legal approaches, two generations of venture capitals have been created. The first generation came from temporary legislation in 2000. The second generation is the latest and current generation of venture capitals. And of course, the divider between these two generations is about the favourable rules, otherwise it was always allowed to create a venture capital without seeking to use these rules.
Types of venture capital organisations
As an introduction I must explain a special type of legislation. Macro-planning in Iran is in the form of temporary acts adopted by the parliament for the duration of five years. This act is called “Economic, Social, and Cultural Development Plan”. We refer to it as “Development Plan”. Currently, we are performing the sixth Development Plan.
If this act is a temporary act, what happens to its legacy after its duration elapses? What if an act resulted in creating an organisation with special tasks? Should this organisation be eliminated after the five years or it will continue to perform?
Although there is no acceptable answer to this question for all situations due to wording and approaches toward these acts’ legacies, it is safe to say when the timeframe for this act elapses, these organisations will continue to perform although the establishment of new organisations and institutions upon the elapsed Act is not allowed. Of course we have some different approaches toward this too. For example in the third Development Plan, the judicial branch was allowed to admit and train its own lawyers. Normally, after this duration (five years) and the adoption of a new Development Plan we must believe that this authority is over, however the judicial branch still submits its own lawyers upon that act. This should not create a general practice.
In the third Development Plan adopted in 2000, there was an article about venture capitals. This article which was located under the section titled “Development of Science and Technology”, allowed the government (the executive branch) to lead venture capital’s market through participation. Here’s the translation of the article.
Article Number 100:
“In order to create basis for private participation and private investment and; in order to support technological researches and activities and; in order to increase quality and quantity of these technological researches and activities specially in applicable and developmental technologies; the government is allowed to participate in the establishment of non-governmental funds.
“The government is also responsible for the reinforcement of existing governmental funds. The government shall create measures to enable these funds to use subsidies for their facilities while performing this Development Plan.
“The statute for newly established funds and instructions for the participation of the government, banks, and the private sector in the fund’s resources and also the organisational status, aims, and duties for funds will be determined by the Board of Ministers.”
This article created the first generation of venture capitals. As it is clear from this article, this generation had no limitation in their scope of activities. They didn’t have to serve special types of startups such as knowledge-based companies. Despite the fact that this article didn’t mention any limitations about the receiver of the services, the regulation to implement this article created some limitations.
Obviously, a regulation cannot change the scope of the original act however in this case it happened. As the article stated, the Board of Ministers was responsible to adopt the regulation. This regulation was adopted three years later in 2003. As the lifetime for the act was five years, the whole purpose of the article was restricted to two years due to the late adoption of the regulation.
Using this article and its regulation, 18 venture capitals were established.
Trial and errors of a governmental venture capital
The article and its regulation were a temporary legislation for five years, thus after this timeframe, it was not allowed to establish a fund using this legislation.
In this period till the next generation of venture capitals, establishing a venture capital was completely a private business. Of course, those funds that were established according to that legislation still continue to perform and use the facilities stated in the article and its regulation.
As I mentioned, the scope of activities in the original legislation was very wide which could cover all startups. The only limitation was about the definition of research and technology programmes in the Implementation Regulation.
A decade later, in 2010, Parliament adopted an act titled: “Commercialisation of Inventions and Innovations and Supporting Knowledge-Based Companies”.
According to Article number 3 of this Act, support available for knowledge-based companies are: 1- Exemption from tax, customs fees, customs duties, export duties, and export charges for 15 years. 2- Financing for the production costs and distribution costs wholly or partly through low-interest and interest-free loans.
Article number 5 of this act created a governmental fund responsible for the second privilege; financing for production costs and distribution costs wholly or partly through low-interest and interest-free loans.
This fund is called the “Innovation Fund”.
This was a crucial stage in which the government found out that the first generation of venture capitals was not a successful experiment, however instead of going the more acceptable way, decided to create the “Innovation Fund”.
The true purpose of these regulations
What is the more acceptable way? My rudimentary knowledge of economics suggests that if the government tries to enhance a sector, replacement of existing institutions with a governmental organisation should not be an option. Venture capitals already existed in this market for almost 10 years. If they weren’t able to enhance the market using a numerous amount of public budget and public support, is it in any way logical to create an identical governmental twin with the same purpose and resource?
The first expected outcome is that this fund will emaciate the existing venture capitals both the first generation and the independent venture capitals.
Since the first generation of venture capitals benefited from the public budget, it is quite clear that the problem is not about resources.
What comes to mind is that the purpose of these regulations was not to enhance venture capitalism. Because if so, there are many other low-cost options with high efficiency. It seems that in this period, instead of being a beneficiary, the venture capitals were a target of laws and regulations.
If the goal is to enhance the venture capitalism, the instrument must address to these institutions, directly or indirectly.
Unfortunately, the first generation was created in an act addressing the Development of Science and Technology and the second generation came into existence through an amendment to the act of “Commercialisation of Inventions and Innovations and Supporting Knowledge-Based Companies”.
This chronology clearly means that the venture capitalism doesn’t have an independent concept in the legislature’s mind.
Again, in my rudimentary knowledge in economic sciences, all of these troubles and failures could have been avoided by a simple insurance policy.
An insurance policy will reduce the risk. The main parameter that differs a venture capital from a regular investor is the level of risks that a venture capital undertakes. The government can simply offer an insurance for all venture capital investments in startup companies. In this way, first, venture capitalism in startups will grow in the private sector where it belongs, second, there is no need to allocate any current budget, and third, the risk of corruption will reduce.
In this experience, when the government realised the existing venture capitals weren’t able to enhance the market, it decided to create a parallel institution. This parallel institution was fully funded by the public budget.
When a series of private institutions weren’t successful in a purely private business even though the government pays half of their capital, it shows either the public budget itself is the problem or there is something other than their resources. Because if the money that was allocated to them had any acceptable outcome there would be no need to intervene again. If they were so unsuccessful that caused the need to change the rules, why should we think that an instrument we once used, would have a different outcome this time? Especially an instrument like the governmental intervention. We can still say that it was a trial and error path but we have to learn from our mistakes.
Ironically, five years later, when the legislatures realized that this fund also couldn’t reach the goals, what did they do? They surprised us. Keep reading to see the second generation of venture capitals.
An insurance policy covering the risks in venture capital contracts is like the simplest way to encourage venture capitalism.
There are some sorts of insurance in the “Innovation Fund” but none of them are an “actual” insurance. Section number four of the regulation of the fund is titled “Insurances”. What is under this section, by any interpretation, is not an insurance. It is all about optional guarantees that the fund may provide for a company in case of a loan or tender. Even these guarantees are limited to a part of the whole payment; i.e. the company has to pay for these guarantees and in case they couldn’t afford it, the fund will compensate the remaining amount.
Even if it might sound uneven it still could work if the whole fund’s structure was unified: the main facilities in this fund are available for those companies that have at least 50 employees with five years of experience. In this case, the fund will pay up to 20% of the commercialisation expenses.
Other facilities in this fund are available for companies that have a strong commercialisation ability.
If a technology company would have these qualifications there should be no problem to find an investor. This is clearly another sign.
Still it is not too late to initiate an insurance policy but its condition has to be in compliance with the current artificially disturbed prospect.
This fund can also participate in the establishment of new venture capitals under the same conditions as the first generation of venture capitals. In the long list of legislation inaccuracies in this market, this is a fascinating progress. The original act that created the fund didn’t mention this authority however the regulation did. In another distortion, the regulation ignored one of the most important parts of this act. According to this act, one of the purposes is:
to create a sufficient insurance coverage in order to reduce the risks in technological and innovative products in all stages of the production and distribution.
Second generation of venture capitals in the startup market
The second generation of venture capitals came into existence in 2015. In this year, the parliament adopted an act called: “The Act for the Removal of Obstacles for Competitive Production and the Improvement of the Financial System”. Article number 44 of this act added an article to the act of “Commercialisation of Inventions and Innovations and Supporting Knowledge-Based Companies”. This article has been added to the article number 5 of this act which is about the “Innovation Fund”.
This added article is exactly the article number 100 of the Third Development Plan. Again, the Board of Ministers is in charge of the regulation for this article and again, this regulation was quite the same as the regulation for the application of article number 100 of the Third Development Plan. On August 2, 2015, the Board of Ministers adopted the regulation for the application of this article and their sample statute.
- Omran Mohammadi is a first-class attorney in the Iran Bar Association and master in international trade law. A version of this article was originally published by TechRasa.
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