Brussels considers bold plan to finance start-ups

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The European Union is considering an ambitious plan to help business start-ups find financing, EURACTIV has learned. Within two years, the EU wants to ensure that venture capital funds established in any member state can function and invest freely throughout the bloc by adopting a new legislative regime.

Policymakers also want to test the feasibility of an online platform for matching offers and requests for venture capital within the Enterprise Europe Network, according to a draft of the Small Business Act review, obtained by EURACTIV.

The first draft, written in December, is currently being extensively revised and it is unclear if the proposals will make it into the final recommendations for improving the Small Business Act. The review is now expected to be published in late February.

While EURACTIV was unable to obtain a copy of the latest version, which is now about 10 pages instead of the original 16, it included a request for much more money for SME bank loans under the Competitiveness and Innovation Framework Programme, according to a person who has seen the document.

The Commission declined to comment on the draft document or the ongoing debate between directors-general at the EU executive.

"This does not mean there is a problem. The inter-service consultation aims at collegiality," said Charlotte Arwidi, a Commission spokeswoman. "Changing the scope of a proposal is part of the daily routine. What we aim for is to have a really ambitious SBA review."

Nevertheless, the December draft and new focus on bank loans show the EU is looking for bold ways to tackle one of the most urgent problems facing small and medium-sized companies: access to finance.

Trouble getting funding is consistently ranked the second or third most pressing challenges these businesses face, according to regular surveys by the European Central Bank. The recession followed by the sovereign debt crisis was like a one-two punch for SMEs.

As if getting a bank loan wasn't hard enough when the eurozone economy was shrinking, now SMEs are competing for loans against finance ministers for high-risk countries like Portugal and Ireland. And new capital requirements for banks, under rules known as Basel III, also could reduce loans and increase costs, the banking industry warns.

Venture capital going to Asia, US

"The current legislative regime has made the EU unpopular with venture capitalists, who have geared their focus towards Asia and the United States," said Patrick Gibbels of the European Small Business Alliance.

But the situation has never been easy for start-ups. Banks have remained the primary source for entrepreneurs because the market for venture capital funding is thin and fragmented. Venture capital funds typically invest in companies in the development stage in exchange for an ownership stake in the company. But they are hampered from lending across borders because of different legal systems and tax issues, as well as areas of expertise.

"One of the issues in the European Union is there is no united investment environment. Unfortunately, you are confronted with 27 different jurisdictions with 27 different rules and you have to learn them one by one," said Joachim Grill, chief executive of See Equity Group, a private equity group that invests in renewable-energy technology.

His company focuses on start-up companies in Germany, Switzerland and Austria, because of the common language and also because of the number of high-tech opportunities. "It’s difficult in Italy and France, and we don't see much going on there to justify the effort," he said, explaining that legal systems are so different he would have to spend "$100,000 just to learn the ropes".

And as for most of the new EU members, Grill says, "we are totally uninterested in anything east of Vienna: nothing in the former Eastern Bloc. There are too many issues, like who owns the patent and who is the true owner of the company".

Indeed, the European Investment Fund (EIF) plays a critical role in Eastern member states. Without vibrant capital markets or a strong entrepreneurial culture, the EIF provides certain financial guarantees that are essential to attract investors.

National governments' role

National governments have also been playing a more active role in many countries, including the United Kingdom, France, Portugal and the Nordic countries (see examples below).

In Italy this month, for instance, banks agreed in principle to extend a debt moratorium to cover SMEs that pledge to grow and innovate, and the Czech Republic plans to announce details in the coming weeks of a €48 million seed-fund for start-ups.

But getting them to agree on common frameworks and tax policies, and more importantly, take action, remains a challenge, says Vesa Vanhanen, the Commission's deputy head of unit for financing SMEs, entrepreneurs and innovators at DG Enterprise and Industry. Only Finland recognises cross-border venture capital rules.

In Western Finland, Marko Tamminiemi got €18,000 in EU regional funds to pay for machines to make his new saw mill more efficient.

He got help from the Centre for Economic Development, Transport and the Environment, saying, "without their help, I would have lost my nerve".

And there were still many sleepless nights waiting for the money he applied in September 2009. "I thought I'd get the money two or three months later, but in the end it took six months," he said. "I nearly had a cash crisis because I thought that I'd get the money when I actually invested."

If the Commission can push through its bold plan for a common framework for venture capital, it would be a huge boost for innovation and economic growth. Small and medium-sized enterprises, which employ between 10 and 250 employees, employ two-thirds of the labour force and are responsible for the bulk of new job creation.

A more fluid and common financial market would sharpen Europe's competitive edge against the United States, where many European start-ups look for financing.

Dutch company's 'nightmare'

Huub Maas, chief executive of Medimate, a developer of hand-held medical diagnostic machines in the Netherlands, said the search for funding is "the nightmare of small businesses".

The four-year-old company has already raised €3.5 million in grants (including €2.7 million in EU regional funds) and another €1 million in private equity loans. For almost a year, Maas has been spending more than half of his time looking to raise another €3 million so Medimate can launch its products for sale in several European countries later this year.

He complains that it's difficult for traditional banks to handle innovative companies with technical issues. "They cannot handle the [cash] burn rate in their spread sheets," he said, while Medimate is too small for most Dutch private equity funds to invest in.

Until this month, Maas and his finance manager had never heard of the European Investment Bank (EIB), which financed loans, averaging €150,000, to about 60,000 SMEs throughout the EU last year.

France

The French Ministry of the Economy has implemented many measures to help finance SMEs. Some tax credits are available for new businesses. In addition, angel investors, wealthy enough to pay the Impôt de solidarité sur la fortune (solidarity tax on wealth), could deduct 75% of their investments in SMEs last year with a limit of €50,000 (this year, the deduction drops to 50% with a limit of €45,000). This tax credit increased the equity of SMEs by more than €1 billion last year.

In 2008, the French government also signed an agreement with banks to help SME get financing. This gave banks access to €17 billion in bankbook and sustainable development accounts. The government also created a public bank, Oséo, to help companies to get funding.

French SMEs would benefit from a more harmonised fiscal policy in Europe because the French tax rate is 34%, compared to 12.5% in the Baltic States, 15% in Ireland and 30% in Germany.

Bulgaria

One of most important financing opportunity for Bulgarian SMEs is the 2007-2013 programme called 'Development of the Competitiveness of the Bulgarian Economy', which is funded by the European Regional Development Fund and co-financed with €1.1 billion from the national budget. 

More than €50 million has been earmarked for modernisation of enterprises and more than €25 million for innovative companies. But only high-tech companies with significant sales volumes qualify.

In 2009, the government budgeted €250 million for the Bulgarian Development Bank to finance SMEs. About half of that money has been distributed to 13 banks to provide medium and long-term loans, pre-export funding and support for projects from the EU Cohesion Funds.

In addition, the Bulgarian Development Bank can finance up to 75% of the value of the investment project under the programme for financing of small and medium-sized enterprises. The entrepreneur must put up at least 25% (VAT exclusive) of its value. The loans range from 30,000 Bulgarian Leva (BGN) to BGN 400,000 (€15,340 to €204,531) and must be repaid within four years.

A National Guarantee Fund was also established to ensure financial guarantees for SMEs that don't have enough collateral to repay a loan. That reduces the risk for banks and makes SME loans more attractive.

Czech Republic

According to Karel Havlicek from the Association of Small and Medium-Sized Enterprises and Crafts (AMSP), ministries can only help SMEs indirectly.

They can support them with guarantees for loans provided by the Czech-Moravian Guarantee and Development Bank or the Export Guarantee and Insurance Corporation, or set conditions for financing from the Czech Export Bank.

"Very interesting is the idea of seed-funds, mainly for start-up projects," Havlicek said.

Last year the Ministry of Industry and Trade of the Czech Republic announced its plan to establish a seed-fund. This month it should introduce the whole project. At the moment it is known that the fund will dispose of 1.2 billion Czech crowns (around €48 million). The main source of it will come from Operational Programme Enterprise and Innovations (OPEI), but participation of the state and private investors is also expected.

"The state will use the fund to purchase shares in specific innovational projects," Czech Minister of Industry and Trade Martin Kocourek said.

Post-crisis, banks remain more reluctant about financing SMEs and are not prepared to make long-term investments, according to the AMSP.

But Jan Matousek, spokesman of the Czech Banking Association (CBA), maintains that Czech banks' support for SME's is sufficient and low-interest loans are available.

But they both agree that the European Union is not an important player in SME financing and the CBA says the EU should not intervene in the private sector. 

Matousek said legislative regulation in this area is very complicated and the EU has already introduce too many initiatives. Now it should wait and evaluate effectivity of the current initiatives, he said.

Slovakia

Access to finance is one of the biggest obstacles for Slovak small and medium-sized enterprises. There are no comprehensive financial instruments to support SMEs in Slovakia, according to Štefan Vrátny, director of BIC Brastislava. Neither venture capital funds nor traditional loan products are working, he said.

The new government, led by centre-right Prime Minister Iveta Radi?ová, took power last summer. In its programme it identified access to venture capital as an important priority to improve the business climate.

Vrátny also stressed that it is more difficult for SMEs to borrow than for bigger companies. He called for greater involvement of Slovak Guarantee and Development Bank, which can provide guarantees for SMEs.

According to National Bank of Slovakia, banks still consider this sector very risky and are still cautious. On the other hand, due to the uncertain economic situation in the euro zone, most SMEs are still postponing their investment activities and are not as interested in bank loans as they were before the crisis.

Alena Walterová, a spokesperson for VÚB bank (a member of the Intesa Sanpaolo Group) pointed out that the majority of SMEs are looking for operating loans to cover regular expenses.

The financial situation of SMEs may worsen this year because of tax changes approved as part of austerity measures. VAT temporarily rose from 19% to 20% at the beginning of this year and many tax exemptions were abolished. The government also set flat-rate expenses for self-employed to 40%. This measure will especially hit vocational trades, which were previously allowed to apply a flat-rate of 60%.

Germany

The credit crunch for SMEs has not been felt in Germany, where gross domestic product grew 3.6% last year. Today, small- and medium-sized companies feel positive about their access to finance, according to a report this month by the German Association for Small and Medium-sized Businesses (BVMW).

Almost 80% see their financing options as fair, good or very good. Many companies don't need to borrow to invest in their business because they have enough profits, the BVMW reports. Some bigger SMEs can even raise money in capital markets.

Still, some banks started special funds in the beginning of 2010 to strengthen the equity base for SMEs. Deutsche Bank, for example, set aside €300 million, and the Sparkassen (German savings banks) have €550 million.

The public 'Germany Fund' closed at the end of last year. It was established by the government to help SMEs in the crisis. The fund was stocked with €40 billion, but companies only tapped into €10 billion.

The culture of venture capital financing in Germany is still weak. Only 20% of entrepeneurs would consider seeking money from a business angel or venture capital fund, a study last year by the German Chambers of Industry and Commerce (DIHK) found. "A wider range in this area would be helpful," said Mary Heidenreich of DIHK in an interview.

The legal framework in Germany causes uncertainty for international investors, Heidenreich explained. Foreign investors were not sure if they had to pay additional taxes on their profits in Germany. Therefore, big investors such as US pension funds and universities usually avoid investing in German venture capital funds.

Public institutions and banks already play a big role in financing entrepreneurship, according to the Global Entrepreneurship Monitoring. Michael Holz, SME expert at the Institute for SME Research in Bonn, concludes: "There is no real need for additional European action due to the big variety of national support programmes for SMEs and entrepreneurs."

Small- and medium-sized enterprises (SMEs) consistently rank "access to finance" as the second or third biggest challenge to their growth and, at times, survival. Half of new businesses fail within the first five years.

Since the financial crisis, SMEs across Europe have been badly hit by cashflow problems. The combination of late payments and reduced access to credit threatens to put thousands of firms out of business. In fact, there were a record number of bankruptcies in 2010 in nine European Union countries: France, Spain, the Netherlands, Belgium, Switzerland, Austria, Finland, Ireland and Portugal.

The European Council formally adopted the Late Payments Directive this month, but it will take years to implement. In 2008, the European Investment Bank said it would launch a €30 billion fund to help SMEs through the crisis, but that limit was reached at the end of last year. (The EIB says more money is available for SMEs, if participating banks request funds.)  

SMEs are the economic backbone of Europe. They employ nearly two-thirds of the EU's private sector workforce and are responsible for the creation of one in every two new jobs. Nearly half of the two million European industrial SMEs are market innovators, which makes SMEs crucial to Europe's economic recovery.

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