Small companies head to Brussels for financing

For a small company looking for finance, all roads are pointing to Brussels these days. Applications to some of the European Commission’s new SME-financing programmes are soaring, and yet more initiatives are on the way, according to senior officials at a roundtable debate organised by Science|Business.

Demand for two EU loan-guarantee programmes, the InnovFin SME guarantee under Horizon 2020 and the Loan Guarantee Facility under COSME, is running at “more than double the budget” available, said Jean-David Malo, an official in the Commission’s Directorate-General for Research and Innovation. And a new equity investments programme targeting mainly SMEs, “very likely will be proposed soon,” he said.

Since the 2008 economic crisis, the EU has been greatly expanding its support to small and medium-sized companies. In the crunch, bank loans have been harder than ever for new and little companies to get – and so to fill the gap, several new EU programmes have been created. They include grants for R&D, government guarantees for small-company loans, training and networking programmes, and facilities to make indirect equity investments. 

The sums are large. For instance, in the Horizon 2020 research and innovation programme, the European Parliament in 2013 mandated that at least 20 per cent of the cumulated budgets allocated to societal challenges and leadership in enabling and industrial technologies programmes will go to SMEs.

In addition, a number of complementary debt and equity facilities have been launched under Horizon 2020 and COSME to support the growth of high-risk SMEs.

Under Horizon 2020, the Access to Risk Finance programme, the InnovFin SME guarantee and the InnovFin SME VC are providing guarantees and equity financing to early-stage innovative SMEs and small mid-caps. Under COSME, the Loan Gurantee Facility (LGF) and the Equity Facility for Growth are providing guarantees and financing to high-risk SMEs in the growth stage. The LGF is supporting companies with loans up to €150,000 while the InnovFin SME guarantee offers guarantees for loans up to €7.5 million.

Demand for these programmes is very high from SMEs throughout the EU. But the demand is huge from Spain, Italy and other economically struggling member-states, where national budgets have been slashed and bank financing is scarce.

But there’s more on the way from Brussels, as discussed at the Science|Business Network meeting on 29 September. The year-old European Fund for Strategic Investments (EFSI) is expected to generate €315 billion in short-term investments, of which €75 billion will go to small companies. Also, the recently launched Capital Markets Union plan is expected to cut red tape for SMEs looking for financing opportunities. “This is a long-term view but it will also generate investments in the short-term,” said Malo.

The financing problem

One major weakness of these programmes is “that up until now we have not attracted enough traditional investors, in particular the private sector, and more precisely the venture capital area” said Malo. The current economic environment “should lead the European government to adapt their regulations and frame conditions to ease access to finance while creating incentives for venture capital interested in small companies,” said Monica Dietl, Director of the COST Association.

SMEs are facing lots of difficulties in accessing finance. “According to European Commission research, one third of European SMEs are not able to get the full bank financing they need, while only 10 per cent of the larger companies indicate the same problem” said the director of the Commission’s COSME Program, Kristin Schreiber.

This is something that the EU and national governments are trying to solve by offering small companies a broader choice of financing instruments which fit their timeline and interests. “We are proposing a series of products that will accompany the SMEs at different moments of their life cycle,” Malo noted. 

But, “there is a need to do more, especially regarding investments in equity from early to growth and later stages (…) in close cooperation with national institutions,” said Malo, who suggested that initiatives in this area should be launched very soon. The goal is to attract private investors to finance venture capital funds, but also to allow co-investments and to support funds of funds.

Less tax for innovation investments

In this equation, national tax incentives are crucial, but often times, member states have conflicting interests. Taxation systems could offer incentives for SMEs, but the odds of finance ministers doing that are slim, argued Paul Rübig, an Austrian member of the European Parliament and chair of its technology assessments committee. For a typical finance minister, he said, “if you spend money on pensions and social systems you are re-elected.” But the public might be less open to initiatives that require government spending in research and development and other growth strategies.

Generally, Rübig said that national tax systems are not doing enough to incentivise entrepreneurs.

Small companies carry the burden of risk-taking whereas national governments will just collect taxes when these companies become successful. “The public service is fighting with you for being successful,” said Rübig. According to him, this is not how thing should work; rather member states should think of ways to incentivise start-ups and SMEs.

One incentive in some EU countries is the so-called patent box, that allows companies that own a patented technology to have a tax break on revenues generated from that patent. That kind of incentive has been used in Germany and Britain.

But in Europe there are not many tax incentives for equity funding. “It is much more favourable for a company to take on debt than it is for any of them to have any equity finance whatsoever,” said Kay Swinburne, a Welsh member of the European Parliament and an expert in finance. “That has got to change,” she added.

The European banking sector was affected by the crisis in 2008, and it now operates under a tighter regulatory regime. “We created a safer environment but we have restricted the capital that can come back out from the banking sector,” Swinburne noted.

About 80 per cent of the financing of European companies comes from bank loans, whereas in the US only 20 per cent of the financing is made through such services.  “We are massively exposed to any reduction in lending capacity, and companies are finding it tough,” said Swinburne.

Using IP to raise finance

To avoid banking institutions, innovative SMEs could also rely on intellectual property (IP) assets. Clever IP management can help small firms convincing the right investors to commit to long-term risky projects.

“Intellectual property is one possible source of financing,” said Raymond Hegarty, Managing Director at Intellectual Ventures, an IP investment fund. “The days when asking for €100,000 more on the promise that you will make a profit in the future are gone and now you need to show ways in which you can make money,” he added.  

“Commercialising IP can be one way of generating extra income as well as confirming the value of the underlying ideas,” Hegarty concluded.

But for SMEs, realising the value of their IP is not a straightforward process. One major problem is the difficulty of putting a price on intangible assets such as patents, trademarks and copyright. Banks and venture capitalists will rarely take a risk on something that is too difficult to value.

For obvious reasons, only a small share of SMEs will choose very specialised funding routes, while the goal is to “boost investment across the board,” said Swinburne.

Broader measures, such as facilitating the access to a large functioning internal market and helping the development of a competitive venture capital market, will consolidate the immediate impact of investment packages and will incentivise the private sector to take over. “We have to reach a normal phase where financing is led by the private sector and not by the public sector,” said Schreiber.