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The newsletter of the Innovation and SMEs Programme





January 2002

Policy News



Fools, angels and venture capitalists

    "There is no shortage of funding for SMEs in Europe, but the terms and conditions attached can make access very hard." A recent high-level seminar on the European approach to financing innovative SMEs examined problems and best practices for companies and investors.

"In the present difficult economic climate, it is tempting to focus on the short-term agenda, but we must continue to look ahead," Erkki Liikanen told entrepreneurs and financiers. "The Lisbon goal of becoming the world's most successful and competitive knowledge-based economy remains the EU's top priority."

T he ten-year Lisbon strategy defined at the March 2000 European Council( 1 ) is based on dynamic economic growth as a means to stimulate job creation, innovation and social cohesion. Small and medium-sized enterprises (SMEs) represent over 99% of European companies and account for two-thirds of total employment. Their growth is vital to achieving the Lisbon aims, but is limited by their access to finance, especially during the early stages. For innovative companies, whose assets are largely intangible, and which may take several years to produce returns on capital, investors can be hard to find.

The October seminar in Louvain-la-Neuve, Belgium, was sponsored by the European Commission's Directorate-General for Enterprise. Examining the current limitations on finance for SMEs, it attracted more than 1,400 participants, half of whom head their own companies. Sources of finance

Sources of development finance vary, depending on the amount and the conditions. Typically, the first round comes from 'friends, family and fools' prepared to risk relatively small sums because they believe in the person or the idea. The next source is often a bank or public sector development agency, or another entrepreneur willing to invest for several years as a business angel. Angels eventually want to exit, however, and venture capital funds (VCs) are likely to supply finance at this stage. Finally, an initial public offering (IPO) opens the company to shareholders in a stock exchange.

But there is a pronounced gap between early informal investors and VCs, which expect substantial influence and whose minimum investment level is too high for most small companies. Increasingly, SMEs choose a mixture of loan guarantees and debt-equity mixes, especially as banks are reluctant to invest in young firms, which offer them low profit and high risk. Entrepreneurs' views

CEOs from SMEs in both high-tech and traditional sectors agreed widely that the EURO 10bn of capital available to support SME development in Europe is sufficient - 5,000 start-ups receive private or public sector risk capital each year. The main difficulty is sourcing funds at the right time and with the right conditions. "Business angels are vital sources of both seed finance and business experience," said Erkki Liikanen, European Commissioner for Enterprise. "Their networks are expanding rapidly in Germany, the UK and France, but much more slowly elsewhere."

When VCs become involved, however, angels - whose earlier investment involves much greater risk - may become minority shareholders, with minimal influence. One solution is to oblige VCs to buy out angels' stakes. Innovative companies are also often taken over or merged with a larger technology company, which has advantages over market flotation.

Several seminar participants had benefited from public sector financing, but this commonly involves excessive administrative procedures. More welcome is public sector support in the form of loan guarantees. All agreed that the gap in access to finance is matched by a gap in access to sound advice, the best coming from experienced entrepreneurs rather than consultancies.

There is a wide financing gap between family investment and venture capital.

Political priorities

Serge Kubla, President of the Council of EU Industry Ministers, noted that only one in 500 SMEs succeed in gaining access to venture capital. About 40% of SME finance comes from banks as overdrafts, loans or leasing, but micro-finance - loans of less than
EURO 25,000 - is too costly for banks. Finance from the public sector, angels and VCs, he said, should all be developed. Mr Kubla also noted SMEs' concern about the discussions on the Basel II capital adequacy framework( 2 ). Proposed changes in the regulations are expected to introduce different charges for credit depending on the degree of risk, making SMEs and start-ups clearly vulnerable. But Rolf Breuer, President of Deutsche Bank, pointed out that current bank lending terms do not cover the margins of risk. Basel II will take effect in 2005, but banks are already changing policies to take it into account.

Hardwick Simmons, Chairman and CEO of Europe's high-tech stock exchange, Nasdaq, urged European players to "keep pushing toward a single market". The IPO, he said, should be a European process, not fragmented across national exchanges. The harmonisation of taxation was crucial.

Fabio Colasanti, Director-General of Enterprise DG, stressed that major Commission initiatives like the action plan on financial services still left much to do. "The best way forward," he said, "is through benchmarking, round tables and conferences to identify the changes needed." The theme was taken up by Research Commissioner Philippe Busquin, who looks to the 2002 Barcelona summit for initiatives on developing best practices, access to risk capital and tax convergence. "Innovative SMEs are only 4% of all SMEs, but account for 50% of new jobs, so they are a priority," he said. The new Research Framework Programme (2002-2006) will focus on areas where EU action gives the greatest added value, like genomics, nanotechnology and ICT. SMEs will be encouraged to join collaborative studies, even in midstream. "Europe's investment in R&D is too little, and too fragmented," he stressed.

Competition Commissioner Mario Monti pointed out that European SMEs benefit from an effective antitrust policy, which protects them from abuses of market power. The Commission has also set out a new state aid policy in relation to risk capital( 3 ), adopted in May 2001. This permits public intervention to address market failures, where other investors consider the risk too great. A further proposal is expected to modernise the antitrust operational rules.

The European Investment Bank (EIB) does not fund SMEs directly, but through banks in Member States and some accession countries - as global loans, guarantees or equity holdings. In total, it has provided EURO 15 billion in global loans to 150 financial institutions, to support 60,000 SMEs. EIB Operations Chief Jean-Christophe Laloux explained that the bank is now entering risk capital actions through the European Investment Fund, in start-up or seed capital funds. The EIB is also strengthening co-ordination with the Commission since its June 2001 agreement and the development of its Innovation 2000 Initiative( 4 ). Way forward

The conclusions of the conference, together with a Commission analysis of companies' access to finance( 5 ) covering sources other than venture capital, were submitted to the Industry Council on 5 December, leading to a call on the Commission for action. Enterprise finance will continue to be dominated by bank lending, the Commission believes, but alternative sources will grow - and public sector guarantees should be used to increase significantly the availability of loans and equity finance. (1) See ' Radical response to a quantum shift ', edition 4/00.
(2) For further information, see internal_market/en/finances/banks/01-15.htm and market/en/finances/capitaladequacy/consultation.pdf
(3) State aid and risk capital, OJC 235 of 21 August 2001, available at extracts/2001_c_235_08_21_0003_0011_en.pdf
(4) See ' Complementary funding ', edition 5/01.
(5) Enterprises' access to finance. SEC (2001)1667, available from


  • R. Aernoudt, European Commission
    Enterprise DG
    Promotion of Entrepreneurship and SMEs
    Access to finance and Community programmes
    Tl. +32 2 295 9186
    Fx. +32 2 296 2154
    (email removed)