A reluctant faith in SMEs

Europe’s neglected small- and medium-sized enterprises (SMEs) are a sorry lot. Bursting with potential, yet starved of cash, they are at a severe disadvantage compared with their counterparts in the US. European venture capitalists, it seems, are reluctant to place their faith in SMEs.

Differences in transatlantic attitudes to business risk have been apparent as far back as the 19th century. In ‘Democracy in America’, the French historian Alexis de Toqueville made much of contrasts between the hard-working individualism characterising Americans and the languid old world values of Europe.

Today the contrast, however clichéd, appears to hold true. In the boomtime environment of Silicon Valley in the US, where business, innovation and opportunity rub shoulders, technologically savvy venture capitalists embrace risk with striking alacrity. Small start-ups prosper and thrive.

The EU, on the other hand, has never been perceived as a particularly good breeding-ground for dynamic and innovative SMEs. At first glance, European venture capitalists are simply not as fearless as their US counterparts.

The US venture capital market for start-ups is far more advanced than the EU market. John Sammis, minister-counsellor at the US mission to the EU in Brussels, is unsure why. "European companies tend to excel at incremental improvements in technology, whereas US companies are bigger on transformative technologies with commercial value," he muses. Working out whether the dynamism of the US venture capitalism market is a product or a cause of US SME productivity, however, throws up more questions than answers.

He points out that failure is less of a stigma in the US. "Many successful entrepreneurs in the US have failed in previous times," he says. "In Europe, those who have [undergone] bankruptcies in the past will have trouble finding finance."

Frank Brown, dean of the business school INSEAD, laments the growing gap in Europe between world-class players, such as Nokia and Philips, and minnow-like SMEs. "In financing, cumbersome and fragmented laws make it difficult for venture capital to move across borders," he says. "This means badly needed seed-money isn’t getting to some of the fledgling hi-tech companies that need it."

Brown thinks that the Lisbon Agenda’s aim to make the EU the world’s most competitive knowledge economy by 2010 will not be achieved unless more focus is given to SMEs "that employ more than half of the workforce in Europe".

SMEs would doubtless be happy to play their part in bringing this laudable ambition to life if only more venture capital would come their way. Sammis expresses confidence that the general process of economic reform in the EU will probably spawn more innovation, which in turn will stimulate the investment market.

SME productivity gains are lagging far behind the US, according to a report prepared for the 2007 EU Spring Council by the Work Foundation, a think-tank, so the sector badly needs a shot in the arm. Over the past year, the European Commission has launched three major initiatives aimed at boosting investment in SMEs.

Public funds may go some way towards taking the edge off risky investments, but cannot and should not make up for massive gaps in private investments.

Stamina and cash

Getting a business off the ground in most cases requires energy, stamina and substantial amounts of cash. Although the first two resources may be in abundant supply, the third is usually harder to come by. The world of finance is hardly flinging its doors open to small businesses.

Improving SMEs’ access to capital will be crucial in ramping up EU growth and competitiveness in the coming years. A number of EU measures aimed at bridging the divide between small- and medium-sized enterprises, and investors and banks have been launched over the past year.

Three European Commission initiatives, in particular, stand out:

• The competitiveness and innovation programme (CIP)

The programme, launched at the beginning of this year, aims to dedicate €1 billion to providing financial leverage to SMEs over the coming six years. Through CIP, SMEs should gain access to €30bn worth of finance. Funds are channelled through the European Investment Fund, which specialises in providing risk capital and guarantee instruments to businesses. Some 40,000 SMEs are expected to benefit. Although largely welcomed by SMEs, Gerhard Huemer, director of economic and fiscal policy at SME umbrella group UEAPME, worries that the fund will devitalise the venture capital market. "Taxpayers’ money is invested in venture capital funds," he says. "But this doesn’t create any incentive for the private sector to help SMEs."

• Joint European Resources for Micro to Medium Enterprises (Jeremie)

A regional aid scheme dedicated to smaller businesses, Jeremie aims to improve access to finance for SMEs in EU regions. The scheme will allow national and local administrations to use part of their structural fund allocations to finance small businesses through loans, equity, venture capital and guarantees. Advisory and technical assistance are also provided. "What is positive there is that the funds are actually provided at regional level. But, then again, we need to look at how distribution is organised. That is something the Commission will hopefully ensure through its network," says Natascha Waltke, SME adviser at employers’ lobby BusinessEurope.

• State aid guidelines

Part of the state aid action plan, a programme for reform of EU state aid policy set up two years ago, the guidelines released last year aim to set clear rules for public cash injections. The goal of the guidelines is to ease access to capital in cases of market failure. A ‘safe harbour’ of €1.5 million investment over 12 months is set for each company assisted. Authorities have to fulfil stringent criteria proving that state funding will leverage private investment, target market failures and be proportionate, so as to avoid competition distortions. "The guidelines provide more possibilities. It’s helpful," says Huemer. "It doesn’t solve all the problems, but it provides some incentives to do something."

Europe’s neglected small- and medium-sized enterprises (SMEs) are a sorry lot. Bursting with potential, yet starved of cash, they are at a severe disadvantage compared with their counterparts in the US. European venture capitalists, it seems, are reluctant to place their faith in SMEs.