Brussels seeks to boost SMEs’ access to venture capital

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The European Commission proposed yesterday (7 December) a new regulation that is supposed to make it easier for venture capitalists to raise funds across the EU and lend more money to innovators and start-up businesses.

“We need to help young innovators and SMEs to become more innovative and competitive facilitating their access to funding,” Internal Market Commissioner Michel Barnier told a press conference.

EU executive research shows that a company with long-term venture capital investors is more successful than a company that has to rely on short-term finance from banks. However, strict screening criteria and limited funds make it difficult for companies to access this capital.

While the average venture capital fund in the European Union contains approximately €60 million, a US counterpart has a fund size of €130 million on average, according to independent research.

Economic studies show that venture capital funds can make a real difference for the industries they invest in once their size reaches approximately €280 million, the Commission has pointed out.

“If you listen to the bosses and workers of SMEs, this single market is more a straightjacket than a land of opportunity,” said Barnier, stressing that the EU is way behind the US when it comes to access loans for innovative SMEs.

Only 2% of the credit needs are covered by venture capital, five times less than in the US, added Barnier, noting that venture capital has been the driving force behind some of the most vibrant sectors of the US economy – notably Silicon Valley.

Today the US continues to be home to the largest venture capital industry in the world, investing $20 billion (€15 billion) in 2010. In contrast, venture capital investments made by European-based funds totaled $5 billion (€3.7 billion) in 2010, a quarter of the US level.

Furthermore, US venture capital funds invested around €4 million on average in each company; whereas European funds could only muster investment volumes of €2 million on average per company. Early-stage capital investments in the US were on average €2.2 million, against an average €400,000 per company in the EU.

The EU regulation is supposed to introduce a single rule book so that venture capitals funds will be able to attract investors across borders and boost the fund levels, thus avoiding complicated requirement which are different in every member state.

Bigger venture capital funds mean more capital for individual companies, especially in key sectors such as information technology, biotechnology or health care.

“This should help SMEs have a more competitive edge in the global marketplace,” said Barnier.

Tax systems hinder uptake

The European SME employers’ organisation warned, however, that the measures presented by the EU executive will remain on paper unless they are accompanied by reforms in national tax systems, which currently hinder the uptake and provision of these financial instruments.

“The proposal covers the right problems, but it will not change the status quo unless member states step up to the plate. In fact, national taxation systems are the main obstacle to the provision and the uptake of venture capital and equity, as the interests paid on loans can be written off in companies’ balance sheets, while dividends must be paid out of taxed income,” said UEAPME economic and fiscal policy director Gerhard Huemer.

According to UEAPME, EU countries are well aware of the fact, but have so far refused to reform their tax systems to bring equity on a par with loans.

“We hope to be proven wrong, but our expectations on them acting now are unfortunately very low,” Huemer added.

Smoothing social businesses' path

The Commission also came up with the proposal for a regulation to introduce a new European Social Entrepreneurship Funds label. To get a label the fund will have to prove that 70% of the capital received by investors is spent in supporting social business.

"Social businesses embody just the kind of smart, inclusive and sustainable growth and innovation that is so important for today's European economy. Our new measures will help build these businesses across Europe, ensuring they get the financial support they need so that they can grow – especially in these times of crisis," said Barnier.

Currently, investors struggle to identify funds that are investing in social businesses and this can undermine trust in the social business market.

The regulation adopted yesterday creates a common brand. With this label, investors will know that the majority of their investment is going into social businesses. In addition, the common EU-wide brand will make it much easier for investors throughout the EU to locate these funds.

As part of an action plan to improve SMEs' access to cash, the Commission said it would reinforce its loan guarantee and venture capital facilities under the Programme for the Competitiveness of Enterprises and SMEs (COSME).

These loan guarantees are used when entrepreneurs don't have enough money for  collateral and the bank is reticent to provide a loan. Ninety percent of the SMEs that benefit from this have 10 or fewer employees and this is the category that has most difficulties getting a loan. The average guaranteed loan is about €65 000, the Commission said.

The European Chambers of commerce umbrella organisation, EUROCHAMBRES, noted that a European-level guarantee fund for debt and equity financing could have a powerful leverage effect in easing SMEs’ liquidity.  "While the action plan does not go this far, it delivers a positive signal and we will monitor closely the next steps,” said Arnaldo Abruzzini, secretary-general of EUROCHAMBRES.

EVCA, the organisation representing the European private equity and venture capital sector, welcomed the Commission move. "At this time of severe credit constraint, such equity investment is vital if SMEs are able to grow and to help drive Europe out of its current malaise. A tailored fundraising passport for managers of venture and enterprise capital funds is an important step towards achieving this," said Karsten Langer, chairman of EVCA.

"It is now crucial to ensure that the percentage and type of 'qualifying assets' required to achieve the passport fully reflect the practical circumstances of Europe's venture and enterprise capital providers. We will engage with the European Parliament and Council on this, in the hope that this regulation will be rapidly adopted and Europe's aspirational SMEs can get on investing for the future," added Langer.

"We are also cautiously encouraged by the Commission's decisions to carry out a study on the 
relationship between regulation and venture capital investment by banks and insurance 
companies. The capacity of venture and enterprise capital funds to invest in Europe's SMEs has 
been put at serious risk by a regulation which could, as an unintended consequence, destabilise 
the system, jeopardise growth and deter long-term investment." 

Philippe de Backer, Belgian Liberal MEP, who is responsible for ALDE's positions on EU venture capital, said he was very satisfied that the Commission finally made a proposal to create an internal venture capital market. 

"To this regard I fully support the introduction of a European passport for venture capital funds. It will enable investors from one member state to work much more easily across borders and in other member states of the EU. This is a big step forward to a real internal market. At the same time, we have to ensure that the flexibility and diversity of venture capital funds are guaranteed, as otherwise it is not certain that especially smaller companies will actually benefit from future new rules," he said.

The Small Business Act for Europe (SBA) was originally adopted in June 2008.

The SBA applies to all companies which have fewer than 250 employees. This means 99% of all the businesses in the European Union.

The SBA aims to improve the conditions for entrepreneurship by adapting policies and regulations at both European and national levels.

It is hoped that such changes will encourage the growth and development of small and medium-sized enterprises (SMEs) throughout the EU.

The SBA review (published on 23 February 2011) presents an overview of the progress achieved in implementing the Small Business Act.

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