02 November 2015

VoxEU: European SMEs’ struggle to raise equity capital

Promoting greater equity involvement and improving access to and information on all of the various funding options would do much to boost SMEs' growth, which has been heavily underscored in the CMU Action Plan.

SME growth is firmly on the EU political agenda and has been heavily underscored in the European Commission’s Capital Markets Union (CMU) action plan. The reason is simple: throughout the EU, small and medium-sized businesses – which make up 99% of all companies in the region – are struggling to raise capital, particularly during the critical development phase.

Part of the problem is a general lack of awareness about the various sources of funding available. European small businesses tend to lean heavily on financing sources such as banks, and are often unaware of the existence of additional funding sources. Data from the Association for Financial Markets in Europe’s Bridging the Growth Gap report show that three times as much bank lending is provided to EU SMEs compared to their US equivalents.

This higher reliance on term lending has led to a lack of other sources of financing – such as venture capital and angel investing – being fully developed for SMEs in the EU. Yet, for start-ups or growing companies with negative cash flows, equity finance may be more suitable than loans.

Indeed, European SMEs are lagging behind their US counterparts in developing more diverse funding options. Currently, two thirds of EU SME business finance is bank-led, while in the US the majority of SMEs rely on other forms of finance than bank debt, including capital markets finance.

This could be due in part to the fact that Europe’s savings market structures are less geared towards equity investing. EU pension funds provide a mere €4.3 trillion in investable assets, compared to €14.9 trillion in the US.

At the same time, Europe’s SMEs also have trouble knowing where to find public funding, particularly cross-border funding. The multitude of financing available and the fragmented nature of pan-European support measures often make it difficult for SMEs to access funding opportunities.

Encouraging diversity in SME funding

[...] The US benefits from greater diversity and flexibility of funding sources. US private pension funds play a bigger role and their appetite for risk is greater than in Europe. For example, they invest more in the equity asset class than their European peers (53% of funds managed in the US versus 37% in Europe).

In the US, friends, family, and other private investors provide 33% of SME financing, compared with just 9% in Europe. And in 2014, business angels in the US invested €19.9 billion in SMEs compared to only €5.5 billion in Europe. The private equity and venture capital (VC) sector is also less developed in Europe. For instance, venture capitals invested €43 billion in US SMEs in 2014 compared to only €9 billion in Europe (EY 2015).

Venture capitals and business angels play a valuable role in the rapid evolution of the latest-generation entrepreneurial companies in the US. In addition to capital, they help with strategy and business contacts. Often, their expertise is invaluable to young businesses. In this respect, properly structured and regulated crowdfunding is important too, particularly for the smallest of SMEs. [...]

Cross-border funding opportunities

Another barrier for SMEs is identifying and accessing cross-border funding opportunities, despite the fact that many governments and pan-European institutions provide extensive loan and equity support.  

For example, public institutions provide funding and advice to small businesses in a number of EU member states. [...]

Then there are also pan-European support initiatives provided by the European Investment Bank and the European Investment Fund, which provide funds to partner intermediaries such as banks, private equity funds, and microfinance institutions in each member state.

[...] A more comprehensive and flexible approach to SME financing in Europe could thus be beneficial to growth.

Full article in VoxEU

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