Brussels, 7th January 2008
In order to finance and stimulate innovation of small and medium-sized enterprises (SMEs), the European Commission has proposed measures to boost cross-border investments of venture capital funds. Up to now venture capital funds, which are vitally important for the financing of growing innovative small companies, face too many problems to overcome different national regulations for cross-border fundraising and investment. For this reason they often don't reach the necessary critical mass. Therefore the European Commission advocates a broad partnership with and between Member States to work towards mutual recognition of the current national frameworks for venture capital funds.
Commission Vice-President Günter Verheugen, responsible for enterprise and industry, said: “Stimulating cross-border operations will help venture capital funds to specialise and diversify their portfolios. This is particularly important for smaller funds and allows smaller countries to benefit from larger venture capital markets. With the proposed partnership approach, the Commission invites the Member States and the industry to work together for a more integrated European venture capital market."
In Europe, the venture capital market is fragmented with currently 27 different operating environments. This adversely affects both fundraising and investing. Operating across borders is increasingly complex and smaller funds tend to avoid investing outside their home jurisdictions. Especially in smaller or emerging venture capital markets, funds have difficulties in expanding, growing and getting a critical mass of deals.
A better regulatory framework will lower operational costs and risks, raise returns, increase flow of venture capital and improve the functioning of venture capital markets. This will particularly benefit innovative SMEs.
The Commission believes that to remove barriers to cross-border venture capital investing and fundraising venture capital structures that are functioning well could be adopted and recognised in other Member States. The Commission invites the Member States, when reviewing existing or adopting new legislation, to enable cross-border operations and consider mutual recognition of venture capital funds. National authorities could recognise that funds domiciled in another Member State and operating in their market are already subject to the regulatory regime of their home country. The proposed solution implies that national authorities should have mutually acceptable levels of supervision and transparency on venture capital funds.
In order to benefit from a possible source of venture capital, the Commission invites the Member States, where it is not yet the case, to extend the ‘prudent person rule’ to those institutional investors that are not yet covered by it. Member States are in addition invited to encourage the development of competitive clusters and promote more liquid alternative stock markets to facilitate investor exits.
Importance of venture capital financing for innovative small companies
While innovative SMEs are a relatively small proportion of small companies, they have the potential to yield high benefits in creating new jobs and developing new technologies. A recent industry study (EVCA, see below) reported that companies in the EU receiving private equity and venture capital created one million new jobs between 2000 and 2004; over 60% of these jobs were created by venture capital backed companies and employment in these companies grew by 30% per annum. In addition, innovative and growth-oriented firms backed by venture capital spend on average 45% of their total expenses on R&D. This amounts to an average €3.4 million per company yearly or €50 500 per employee, which is six times higher than in the EU-25 top 500 R&D spenders.
Moreover, venture capital is being increasingly important for environmental sustainability (€1.25 billion was raised in 2006). Sustainable venture capital funds invest in the range of €1-5 million with focus on early-stage and typical investments in renewable energies and clean technologies.
What is venture capital?
Venture capital in particular provides a vital source of external finance for growing companies, generally in return for a share in the company. Financing innovative SMEs is considered by many finance providers as an unattractive activity due to high transaction costs and low returns given the risk incurred, especially at the early-stage. Venture capital is a professional equity co-invested with the entrepreneur to fund an early stage or expansion investment. To compensate for the higher risk, venture capital investors expect higher than average returns.