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.