Venture capital market has ‘hit the bottom’

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This article is part of our special report European Business Summit.

Europe's fledgling venture capital market has hit a ''trough'' and needs public money to stimulate its return to growth, according to the European Investment Fund – the EU's long-term investment body. EURACTIV reports from the European Business Summit (EBS) in Brussels.

Richard Pelly, chief executive of the European Investment Fund, said that while some are predicting the death of venture capital in Europe, he sees great opportunities, provided that the right kind of backing is given.

Failure to develop a well-functioning venture capital system would scupper Europe's efforts to build an innovative SME-led knowledge economy, he added.

''My personal view is that venture capital industry is quite young in Europe and that it is at the bottom of a trough. There are great ideas out there at the moment. Now support is required from public institutions,'' Pelly told the EBS.

Public money will account for between 30% and 50% of venture capital at the bottom of the business cycle in order to stimulate private capital over the next three-to-five years, Pelly said.

The EIF provided around 37% of the public money invested in venture capital last year.

Pelly says there is no shortage of bright ideas in Europe and that history suggests return on investments made at this point of the business cycle are often stronger than those enjoyed when confidence is high.

"Risk averseness often lasts too long. Investors need to be encouraged back into the market – and this is part of the role public money can play," according to the EIF chief.

Regulatory changes will 'exacerbate' crisis

However, he warned that new regulations could make life more difficult for the sector just as innovative companies are looking to invest in new ideas.

''The difficulties the venture capital industry has faced will be exacerbated by regulatory changes, for sure,'' the EIF chief said.

Pelly's comments echo complaints by industry, which has said the forthcoming Hedge Funds Directive will make venture capital less attractive (EURACTIV 07/05/10).

Venture capitalists warn that new transparency rules contained in the Alternative Investment Fund Managers' Directive (AIFMD) will force venture-backed SMEs to publish commercially sensitive information.

This could incentivise firms to choose other sources of financing, according to critics of the directive.

SMEs need funds – fast

Pelly said the time it takes for EIF funds to reach SMEs should be reduced from one year to six months. This view was shared by other panellists speaking at an EBS session on how SMEs can drive economic recovery.

The European Commission's SME envoy, Françoise Le Bail, said the EU was working to simplify funding schemes for small firms. She also suggested that Europe's flagship research fund – FP7 – is unattractive to most SMEs due to its focus on R&D and the red tape involved in the application process.

Le Bail suggested FP7 could be reoriented towards innovation, a move she said could hold greater appeal for SMEs.

There were also calls from industry leaders to find ways of helping SMEs to access capital markets without having to face the level of oversight currently demanded of publicly-listed companies.

Hugh Morgan-Williams, chairman of BusinessEurope's SME Committee, said there had been a ''sea change'' in Europe over the past five years, putting SMEs at the centre of policymaking.

However, he said a major barrier to Europe's much-vaunted knowledge economy is the lack of a single European patent.

Morgan-Williams said Europe's banks do not have enough working capital to meet the financial needs of SMEs. ''They have different priorities, like building up their balance sheets and making sure bigger companies – who are seen as brining less risk – have funding,'' he said. 

According to Morgan-Williams, the price SMEs are asked to pay for credit is also a major problem, with some UK companies forced to pay interest rates of above 10% even though interest rates are low and governments are offering credit guarantees.

He said the translation of the Small Business Act (SBA) into national initiatives remains ''patchy'', with some member states continuing to make businesses wait up to 300 days for payments – despite commitments to make payments promptly.

Sky Europe founder and serial entrepreneur Christian Mandl said the cost of getting professional advice is a major hurdle for young companies. Smaller firms must have ways of accessing capital markets at a lower cost and with less reporting requirements than larger firms, he suggested. Mandl said legal fees in excess of €1 million can put fast-growing companies off floating on the stock exchange.

Mandl complained that it can take about six months to raise capital because of the due diligence required of SMEs. This, he said, is in stark contrast to how quickly major, complex financial institutions were bailed out during the height of the financial crisis in 2008.

In order to make entrepreneurship more attractive, Mandl wants to see the social welfare system reformed.

''The welfare state supports employees much better than entrepreneurs. There is no safety net for those who try to start their own business. We need more bridges between employee status and entrepreneur status. For example, we could have 'entrepreneurial leave' – which would be similar to maternity leave – to allow people to take time off to try out a business venture, safe in the knowledge that they can return to their job if it fails,'' he said.

Françoise Le Bail, the EU's SME Envoy, said the big story for the coming decade will be innovation for SMEs. ''We have tended to talk about innovation for big companies but must now focus on innovative small firms,'' she said.

She suggested that SMEs who fail to secure EU funds could be compensated with a certificate of quality which states that their project was considered to be worthwhile, despite not winning financial support.

''Even if they don't get money they should get some kind of label they can bring to a bank or use when applying for structural funds which says their project is a quality project, even though they didn't get FP7 funds for whatever reason,'' the SME envoy said.

Le Bail said efforts to support small firms were ongoing, notably through the Small Business Act. Some countries and regions have implemented the Act to the letter, but others have some catching up to do, she said.

She said supporting high-quality clusters will also be an important part of EU SME policy, as small firms do better in that kind of environment.

Speaking about intellectual property generated by SMEs, Le Bail said Europe will have ''no credibility'' on innovation unless it makes a breakthrough on a European patent.

Tuomo Tuikka of VTT Technical Research Centre in Finland said innovative clusters could help develop an environment where new inventions are possible. ''I forecast that within two or three years every one of us will be paying for things in shops and train stations using mobile phones. This is an example of innovation that grew out of a Finnish Eureka cluster,'' he said.

He said innovations arise out of connecting companies, large and small, in an ecosystem that supports invention.

Large companies can help SMEs along the path to new high-tech industries, said Tuikka, and smaller firms can find their own niche in that environment.

Christophe Leclercq, founder and publisher of EURACTIV and moderator of the debate, said that compared to the billions of euro spent bailing out the banks, the level of support for SMEs is ''peanuts''.

He said innovation should become the central message of the Europe 2020 job strategy – a move that would help communicate the plan to stakeholders across Europe.

Leclercq added that intellectual property reform is essential given that most start-ups have no collateral other than their ideas and their reputation.

Rebooting Europe's venture capital market is seen as essential to stimulating innovation. This is likely to feature in the EU's forthcoming innovation and research strategy (EURACTIV 18/02/10).

The EU has stepped up its investment in the venture capital industry and will make a €1 billion fund available by the end of 2012 (EURACTIV 23/03/10).

The European Investment Fund (EIF) has been mandated to increase its relative stakes in venture capital funds to ensure that they are large enough to support the development of innovative new technologies.

The €1 billion fund, known as the Mezzanine Mandate for Growth (MFG), has already approved a number of deals and will be fully operational in around 18 months' time.

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