Report recommends public sector sponsorship to support innovative SMEs
A report prepared for the European Commission has examined the needs of European SMEs (small and medium sized enterprises) with regard to access to finance, and recommended the introduction of public sector sponsorship to help close the venture gap as well as a greater role for the European Investment Fund. The report, carried out by Bannock Consulting at the request of the Enterprise DG, makes a distinction between a venture gap and a risk capital gap, both of which it claims are present in the EU. Transaction sizes for both gaps range typically between 100,000 euro and 1 million euro. The venture gap, according to the report, mainly concerns pure equity, and applies to about 5,000 small, young, innovative and very high risk firms with high potential growth, which are too small to be institutionally funded by venture capitalists. Fixed transaction and monitoring costs are largely the cause of the venture gap, making it uneconomic for even small commercial funds being raised to make small investments, even if they have very high potential returns on account of their portfolio return targets. The risk capital gap, which extends beyond equity to mezzanine debt and debt equity hybrid financing applies to about 100,000 to 200,000 firms annually, which cover a much wider range of ages, sizes, sectors and circumstances. These companies are moderate growth and risk opportunities that require external risk capital. The report highlights the fact that there are very few European players actively investing in this area of SME finance, leaving it to banks and venture investors, and claims that one of the reasons for this is the lack of network economies in terms of shared knowledge and specialised support services for financiers. The report suggests that both gaps exist to varying extents in all EU Member States, although there is no empirical evidence to support this claim. The two gaps are however less significant in the USA due to more developed informal investor activity. The paper underlines the fact that some EU countries have achieved some progress through guarantee programmes, but the authors suggest that they have perhaps placed too much emphasis on the venture gap. 'Profitable market operation in this segment requires only a marginal extension of formal venture activity and capacity building. Venture investment in SMEs is different mainly in scale and running costs, but not substantially in risk and return characteristics. It is easy to overspend public resources on this type of scheme, and subsidy rates are too high in some countries.' To address the risk capital gap, the report recommends a new form of intervention: public sector sponsorship of moderate cost leverage financing for selected private SME investment companies. The report authors are however sceptical about guarantees and soft leverage programmes that reduce downside risk, claiming that they 'are expensive, have to be rationed, and do carry the danger of distorting investment behaviour. [...] If such schemes are to be employed, they should be evaluated by how well, and how quickly, professional and market-hardened investing capacity has been increased, rather than by simple volume measures of investment undertaken.' The paper recommends that the European Investment Fund (EIF) builds on its established market position and experience in both the venture and mezzanine markets by experimenting with a leverage programme to increase the supply of capital in the risk capital gap. It suggests that, in the early stages, funding could come from the European Investment Bank (EIB), leading to a credit guarantee from the EIF later on. At Member State level, the report advises that each country build up its mainstream venture capital activities to a satisfactory level, using benchmarks related to the level of GDP as well as the number of SMEs in the country. A reasonable target level for venture investment would be 0.2 per cent of GDP, according to the report. In 2000, this figure had been achieved or exceeded by six Member States: Belgium, Denmark, Finland, the Netherlands, Sweden and the UK. The paper highlights the success of a loss sharing guarantee introduced in the Netherlands, and suggests other EU Member States consider this initiative.
Kraje
Finland