The European Commission facilitates access to credit for SMEs

The Commission proposes to strengthen existing aid and new uniform rules on the marketing of funds of venture capital.

The new regulation will make it easier for venture capitalists to raise funds across Europe for the benefit of start-ups. The approach is simple: once a set of requirements is met, all qualifying fund managers can raise capital under the designation “European Venture Capital Fund” across the EU. No longer will they have to meet complicated requirements which are different in every Member State. By introducing a single rulebook, venture capital funds will have the potential to attract more capital commitments and become bigger.

In addition to the measures presented last week, including €1.4 billion of new financial guarantees under the Programme for the Competitiveness of Enterprises and SMEs (COSME (2014-2020) - IP/11/1476), the European Investment Bank will keep its SME loan activity at a sustained pace, close to the 2011 level of €10 billion.

SME Action plan
Europe’s economic success depends largely on the growth of small- and medium- sized enterprises (SMEs) achieving their potential. SMEs contribute more than half of the total value added in the non-financial business economy and provided 80% of all new jobs in Europe in the past five years. The European Commission is presenting in an Action Plan the various policies that it is pursuing to make access to finance easier for Europe’s 23 million SMEs and to provide a significant contribution to growth. Proposed regulatory and other measures aim at maintaining the flow of credit to SMEs and to improving their access to capital markets, by increasing the visibility to investors of SME markets and SME shares, and by reducing the regulatory and administrative burden.

Venture capital for SMEs
Venture capital, which provides early finance to start-ups, forms an important source of long-term investment to young and innovative small- and medium-sized enterprises (SMEs). However, small fund sizes and only being able to provide low levels of capital have prevented them from playing a more important role in start-up financing. As a result, SMEs continue to depend on short-term bank loans. But in the context of the current crisis, marked by a fall in lending to the real economy, it can be very difficult for such companies to access this type of loan.

Evidence examined by the Commission shows that a company with long-term venture capital investors is more successful than a company that needs to rely on short-term finance from banks. This is commonly attributed to the rigorous screening that a venture capital fund undertakes prior to investing in a company. But the average European venture capital fund is small and far beneath the optimal size necessary for a diversified investment strategy to make a meaningful capital contribution to individual companies and thereby produce real impact. While the average venture capital fund in the European Union contains approximately €60 million, a U.S. counterpart has a fund size of €130 million on average.1 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.2 Furthermore, U.S. 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 U.S. were on average €2.2 million per company while early-stage capital contributions in the EU were on average €400 000 per company. 3

Bigger venture capital funds mean more capital for individual companies and will give the funds the ability to specialise in particular sectors such as information technology, biotechnology or health care. This is turn should help SMEs have a more competitive edge in the global marketplace.

Key elements of the proposal on venture capital:
The proposal lays down a uniform “single rule book” governing the marketing of funds under the designation “European Venture Capital Funds”. A “European Venture Capital Fund” is defined by three essential requirements: 1. It invests 70% of the capital committed by its sponsors in SMEs; 2. it provides equity or quasi-equity finance to these SMEs (i.e. ‘fresh capital’); and 3. it does not use leverage (i.e. the fund does not invest more capital than that committed by investors so is not indebted). All funds that operate under this designation must abide by uniform rules and quality standards (including disclosure standards to investors and operational requirements) when they raise funds across the EU. The “single rule book” will ensure investors know exactly what they get when they invest in European Venture Capital Funds.

The proposal creates a uniform approach for the categories of investors which are eligible to commit capital to a “European Venture Capital Fund”. Eligible investors will be professional investors as defined in the 2004 Markets in Financial Instruments Directive (MiFID - see IP/04/546) and certain other traditional venture capital investors (such as high net-worth individuals or business angels). The uniform rules on venture capital investors will make sure that marketing can be tailor-made to the needs of these investor categories.

The Regulation will provide all managers of qualifying venture capital funds with a European marketing passport allowing access to eligible investors across the EU. This is a marked improvement over the existing rules in the area of asset management, in particular the 2011 Alternative Investment Fund Managers Directive (AIFMD - see MEMO/10/572) as the existing passport provided under AIFMD is only applicable to managers whose assets under management are above a threshold of €500 million. In addition, the rules of the AIFMD create a legal framework typically aimed at hedge funds and private equity firms, and are less suitable for the typical venture capital fund which would get a tailor-made regime.

Next steps:
The proposal on Venture Capital now passes to the European Parliament and the Council (Member States) for negotiation and adoption under the co-decision procedure.

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