• 'Hi!*. COMMISSION OF THE EUROPEAN COMVttJNITIES 
COM(93) 528 final 
Brussels, 10 November 1993 
COMMUNICATION FROM THF COMMISSION 
On the financial problems experienced by 
small and medium-sized companies: 
2 
TABLE OF CONTENTS 
I. INTRODUCTION 
H. THE PROBLEMS OF GAINING ACCESS TO FINANCE FACED BY 
DIFFERENT CATEGORIES OF SME. 
Conventional Business Start Ups 
High Risk Start-Ups 
The First Stage of Significant Expansion 
Subsequent Periods of Substantial Expansion 
HL SOURCES OF FINANCE - THEIR STRENGTHS AND WEAKNESSES. 
Banks 
Sources of Private Capital 
Off Balance Sheet Finance: 
Leasing 
Factoring 
Venture Capital and Seed Capital 
Development Capital 
Stock Markets 
Internal Resources 
IV. EXAMPLES OF SCHEMES PROVIDING FINANCE FOR SMEs. 
National 
Regional 
European Community 
Outside the European Community 
V. IDENTIFIABLE GAPS IN PROVISION AND POSSIBLE NEW 
INITIATIVES 
VI. INCREASING THE EFFECTIVENESS OF EXISTING COMMUNITY 
ACTIONS. 
VH. OVERALL CONCLUSIONS. 
ANNEXES 
ANNEX A - Examples of schemes providing finance for SMEs within the European 
Community. 
ANNEX B - Venture and Seed Capital Funding Mechanisms in the United States of 
America. 
ANNEX C The financing of SMEs in Japan. 
ANNEX D - Results of a study by the Cranfield School of Management into the 
attitude of smaller firms towards financing and financial institutions in 
Europe. 
I. INTRODUCTION 
1. This document has been produced in partial response to a request, which was 
incorporated in a Resolution of the Council dated 17th June, 1992. This asked the 
Commission to submit an estimation of what proposals were required in order to ensure a 
continuation of the policy in favour of enterprises, including general aspects of finance, in 
relation to the strategies of these enterprises to Européanise and internationalise their 
operations. In addition the Commission has already submitted its pluriannual programme 
of Community actions to reinforce enterprise policy, notably in respect of SMEs. This 
made specific reference to making an examination of the possibilities of improving access 
to finance by SMEs, and was approved by the Council on 14th June 1993. 
2. This is not the first occasion on which the importance of improving the access of 
SMEs to sources of finance has been identified as worthy of attention at the level of the 
Community. Initial recognition of the problem was contained in the Resolution of the 
Council concerning the Action Programme for SMEs (1) and re-emphasised in the 
Communication of the Commission "An Enterprise Policy for the Community". (2). That 
the Council has asked that the matter be re-examined indicates that problems remain, some 
of which may require co-ordinated action at Community level. 
3. In response to the Resolution of 1986 the Commission has produced a number of 
detailed documents on various aspects of the problem including: 
- a Communication from the Commission to the Council and the Parliament on Financial 
Engineering (3), together with a "Guide to Financial Engineering Techniques used by 
the Commission in the context of Regional Policy"; 
- a Communication on "The Role of Mutual Guarantee Systems in the financing of 
SMEs in the European Community" (4); 
- a Communication on "A Pilot Action to Stimulate Seed Capital (5); 
- a Communication to the Commission "Community Instruments to encourage the 
development of Venture Capital in the Community" (6); 
- a special report commissioned by Directorate-General XXIII "On the European Seed 
Capital Fund Scheme: Review of the first three years" (7). 
1 Council Resolution COM(86) 445 final of 7th August, 1986 
2 Communication of the Commission COM(88) 241 final of 16th May, 1988 
3 COM(86) 723 final 
4 SEC(91) 1550 final 
5 SEC(88) 1496 final 
6 SEC(91) 2414 final 
7 Dr. Gordon Murray and David Francis, Warwick Business School, May, 1992 
4. Despite the numerous studies that have been carried out, both at Community and 
national level, in relation to this subject and the wide variety of schemes that have been 
launched in an attempt to improve the access of SMEs to financial markets, claims are still 
being made by some in the small business community that major difficulties continue to 
exist, particularly when seeking finance at reasonable rates of interest without having to 
pledge excessive amounts of personal assets as security, and that these are being 
exacerbated by the current economic climate. This is said to be a sufficiently serious 
problem as to affect their ability to compete on equal terms with larger companies, and 
even in some cases to threaten their very viability. Whilst these assertions are not wholly 
supported by recent studies (8) there do appear to be certain aspects of finance in relation 
to SMEs that merit further investigation. 
5. This document does not attempt to directly examine the perennial question of the cost 
of finance to SMEs, as this has been the subject of a detailed study carried out on behalf of 
other Commission services. (9) The main finding of this study has been that in the ten 
years up to 1991 the cost of investment capital ranged between 1.5% and 12% lower in 
the USA and Japan than in the EC, affecting the relative competitivity of firms of all sizes. 
Instead the objective has been to: 
- examine the financial needs of SMEs in various stages of development; 
- look at the various sources of finance that are available and examine the extent to 
which they meet the needs identified; 
- review some of the noteworthy initiatives that exist to ease the access of SMEs to 
finance, both inside and outside the Community; 
- quantify the gaps that remain and what broad policy initiatives might be appropriate, 
both at the national level and that of the Community. 
6. In examining this problem it has been constantly borne in mind that the lending of 
money to businesses is a commercial activity undertaken for profit, that most assistance 
will continue to be provided at the national and regional level rather than that of the 
Community, and that whatever actions are taken can only supplement, or provide easier 
access to, finance provided by the market. Nevertheless, there are always two parties to 
these transactions, and if the balance of advantage tips too heavily in favour of one of them 
consideration may have to be given towards means of redressing the balance. 
One difficulty that remains constant is to ensure that the proper requirements of SMEs are 
met whilst avoiding upsetting either the balance of market forces or distorting competition. 
In particular certain groups of businesses should not be assisted by means which adversely 
affect other SMEs who do not benefit. 
8 "Financing Enterprise in Europe", 3i Cranfield European Enterprise Centre and "The Problems of Finance for 
Smaller Businesses", Small Business Research Centre, University of Cambridge, June, 1992 
9 "International Differences in the Cost of Capital", Coopers and Lybrand. 
7. In the final analysis the only reasons for intervention by national governments and the 
Community in this area is to ensure that as far as possible the creation of SMEs, and the 
expansion of those already established is not inhibited by a lack of access to capital, 
whether short, medium, or long term, and they are not prevented from taking advantage of 
the new opportunities presented by the creation of the Single Market. Were this to be the 
result employment creation, an urgent priority in the current economic situation, would be 
retarded, as would the optimum self-development of potential industrial and commercial 
"champions" within the Community. 
The importance of SMEs in Community economic activity is illustrated by the latest 
available figures (10). which show that SMEs comprise 99.9% of total enterprises, provide 
70.0% of total employment and account for 70.5% of total business turnover within the 
European Community. In addition they appear to be responsible for the creation of up to 
40% of all new employment in manufacturing. This trend appears to be strengthening, with 
SMEs being the principal if not the sole hope of providing major new jobs. These statistics 
graphically illustrate that the economic health of the Community is dependent on a 
flourishing small firms sector. 
10 "Enterprise in the Community", EUROSTAT, September, 1992 
l) 
H THE PROBLEMS OF GAINING ACCESS TO FINANCE FACED BY 
DIFFERENT CATEGORIES OF SME. 
8. The financing of SMEs cannot be regarded as being a single problem and any attempt 
at analysis has to be somewhat arbitrary, each organisation having its own particular 
requirements, such as variations in the balance between working capital and investment 
capital. Some businesses, notably in the trading and retail sectors are able to exist 
comfortably with a high ratio of short term debt to equity and to long term loans. Those 
making fixed investments with only a long term pay back ideally require a more long-term 
debt profile. 
Broadly speaking, needs differ according to the type of business and its stage of 
development. Each set of circumstances requires separate analysis, taking full account of 
investment capital requirements, if a proper perspective is to be obtained. To this end the 
following types and stages of company development are examined: 
- simple, conventional "start-ups"; 
- high risks "start-ups", particularly those involving high technology activities; 
- the first period of significant expansion; 
- subsequent periods of substantial expansion; 
9. The definitions used by the risk capital industry are of value by helping to illustrate the 
complexity of company financing: although a more flexible approach is taken in this 
document in order to avoid establishing rigid classifications which do not wholly accord 
with the situations in which SMEs may be placed. 
Seed: Financing provided to research, develop and assess an initial concept before a 
business has reached the start-up stage. 
Start-up: Financing provided to companies for product development and initial marketing. 
Companies may be in the process of being set up or have been in business for a short time, 
but have not sold their product commercially. 
Other Early Stage: Financing provided to companies that have completed the product 
development stage and require further funds to initiate commercial manufacturing and 
sales. They will not yet be generating a profit. 
Expansion: Financing provided for the growth and expansion of a company which is 
breaking even or trading profitably. Capital may be used to finance increased production 
capacity, market or product development and/or to provide additional working capital. 
Bridge Finance: Financing made available to a company in the period of transition from 
being privately owned to being publicly quoted. 
Management Buy-Out: Financing provided to enable current operating management and 
investors to acquire an existing business. 
Management Buy-In: Financing provided to enable a manager or group of managers 
from outside the company to buy in to the company with the support of venture capital 
investors. 
Turnaround: Financing made available to established businesses which have experienced 
trading difficulties, with a view to re-establishing prosperity. 
Replacement Capital: Purchase of existing shares in a company from another venture 
capital firm or from another shareholder or shareholders. 
Purchase of Quoted Shares: Purchase of shares on a public stock market. 
Neither is it wise to rely on the conventional three stage model of company development -
start-up, expansion and maturity, as situations and trends appear to be changing with 
increasing rapidity in the current market place. 
10. Even within these broad categories situations can differ to a considerable degree and it 
is difficult in practice to divide the "seed" and "start-up" stages of development. Hence it is 
only possible to look at the most usual factors that are likely to apply to the majority of 
businesses at a particular stage of development. 
Another factor is that SMEs are considerably more reliant on direct institutional finance 
(overdraft, short and long term loans) than are larger firms. In fact this is the second most 
important source of finance after retained earnings (11.) The Commission's BACH data 
base of harmonized company accounts shows that European SMEs are under capitalized in 
comparison with their equivalents in the USA. On average the percentage of working 
capital represented by "own capital" falls in the range of between 15% and 20% and in 
eight Community countries where company accounts were examined, (12) it was found 
that in all cases SMEs had a higher proportion of short term liabilities in their balance sheet 
than did large enterprises. This obviously makes them more vulnerable to external shocks. 
Also, greater reliance on short-term finance would tend to increase their financing costs in 
comparison with larger companies. 
CONVENTIONAL BUSINESS START-UPS 
11. The financial problems experienced by conventional business start-ups tend to receive 
the highest level of publicity. Probably because they are numerous and such high hopes are 
frequently placed in them as creators of new employment at a time when larger firms are 
tending to shed labour. Unfortunately, new firms of this nature are characterised by a 
failure rate of 50% in the first five years of trading, in the absence of counselling and other 
supportive measures, when the death rate approximately halves. This is a factor which 
reduces their attractiveness to financial institutions, who are unable to afford to provide 
such services. 
12. Although problems undoubtedly exist in some regions of the Community and for some 
craft firms, there is no historical evidence of a shortage of available funding for 
conventional start-ups that can show promise of achieving viability, incorporate a 
reasonable financial stake by their owners, and who are also able to offer some security 
against loans. Difficulties essentially exist for those unable to meet one or more of these 
requirements, although the current economic situation has brought problems for a wider 
range of businesses, particularly through the growth of credit rationing by banks. 
Otherwise, the major problem is that all too few of those starting a business know how to 
either assemble a convincing proposal for a bank, or to present it properly. 
11 "Financing Enterprise in Europe", ibid 
12 "The Structure of Industry Financing; a Short Inventory of Statistics", draft internal Commission document -
II/451/92 
10 
Far too few potential business proprietors undertake prior market research, including 
consideration of the potential competition they may have to face. As a result, even if they 
or their financial advisers put together a financial forecast, this is largely based on guess­
work. Common faults are to overestimate initial sales and to underestimate the time that it 
will take to reach profitability. This leads to a further under calculation of the amount of 
initial working capital required, particularly if insufficient account is taken of fiscal charges 
such as VAT, delays in payment, and for some new manufacturing firms the possibility of 
there being hold ups in the receipt of certification for their products. New businesses are 
also often more likely to incur a higher level of bad debt than established firms who know 
the market better, a factor that is usually ignored when making financial projections. 
Given these circumstances it is hardly surprising that banks are so frequently reluctant to 
lend. If they do agree to do so the tendency is for them to require a high level of security 
and/or charge an interest rate that covers their greater perceived level of risk. 
The whole question of the provision of adequate security is extremely pertinent in the case 
of SMEs seeking finance. The problem has been subjected to detailed analysis in the 
previously mentioned study on Mutual Guarantee Systems (13) as has the German national 
scheme to assist the creators of companies. 
13. The twin problems of access to finance and survival become much less acute for the 
new SME given the availability of practical low cost advice by experienced business 
people, as has been demonstrated in a number of Member States. Many Chambers of 
commerce and industrial and craft organisations have developed advice centres for 
enterprises and entrepeneurs. Most of these organisations cooperate directly with the 
clearing banks, cooperative banks and savings institutions specialised in financing SMEs, 
who offer enterprises tailored financing. In addition, the European Community Business 
Innovation Centres (E.CBICs) and their network (EBN) represent a comprehensive and 
systematised approach to addressing the aforementioned problems, i.e. creating new 
home-grown innovative companies and redeveloping existing firms in like manner in the 
less favoured regions. The regional policy approach also consists of supporting certain 
E.CBICs so as to enable them to become shareholders in the Community sponsored seed 
capital funds and their network (see paras 42 and 43). Capital provision for SMEs needs to 
form part of an overall support system which ensures that business potential is promoted 
and processed into an on going flow of prospective and redeveloping companies which it 
is possible for banks and outside investors to regard with reasonable commercial 
confidence. 
In fact, for the average small start-up the carrying out of basic market research, the 
preparation of financial projections, and the calculation of working capital requirements is 
not overly difficult once they have been shown how this should be done. This is especially 
true of persons contemplating engaging in manufacturing or any other field in which they 
prior experience as they have actual knowledge on which to base estimates of the potential 
market and their requirements in terms of plant and equipment. What they frequently do 
not possess is a sufficiently adequate level of management skills to enable them to translate 
this know-how into a marketable financial proposition, or to judge whether their 
prospective business is potentially viable. 
13 SEC(91) 1550 final 
11 
14. A potential financing gap exists where a start-up has sufficient security available to 
secure initial financing, but whilst not expanding substantially still outruns its capacity to 
raise finance, particularly during the first three to four years of its existence when it may 
not yet have had the opportunity to establish a financial track record. The same holds true 
of those who benefit from initial aids for start-ups but then discover that additional 
tranches of top up finance, or the scope for an extension of existing financial guarantees, is 
limited or non existent. 
HIGH RISK START-UPS 
15. High risk start-ups, which may be defined as new businesses established in order 
either to research or exploit a new process in an existing field or an entirely new discovery 
which may well have resulted from their own research, face a totally different situation. 
Such businesses form only a minority of all start-ups, and exhibit certain specific 
characteristics: 
- they will eventually engage in manufacturing, although not necessarily in mass 
production; 
- the management are likely to possess a high level of technical expertise; 
- the potential market will have been researched - to the extent that this is possible; 
- the market being underdeveloped or entirely new the speed of growth of sales will be 
hard to predict accurately, particularly if major product development work remains to 
be done; 
- a significant degree of financial risk exists as there is no guarantee that the project will 
ever become commercially viable. Even if it does, profitability may only be achieved 
after a number of years. There are biotechnology projects, where because of drug 
testing and certification procedures, this process has taken substantially longer than 
five years; 
- borrowing requirements are frequently substantial in relation to the amount of capital 
provided by the founders and a series of subsequent capital injections are frequently 
required before a level of profitability sufficient to sustain the activities of the company 
is achieved. Estimates as to the amount of additional finance needed to develop and 
launch a product on the market following the conclusion of the research and 
development phase obviously vary because of the widely differing situations involved, 
but generally appear to involve sums between ten and twenty times greater than the 
initial investment in R & D. 
Seed Capital Funds attempt to meet the needs of high risk start-ups for equity capital, but 
the sums involved are too large for them to finance all the stages required before a product 
is marketed without additional assistance. The fact that venture capitalists and capital 
development funds are no longer interested in providing follow on finance, because earlier 
projects have all too rarely met the rates of return required by these investors and the costs 
of supervision proved disproportionately high, inevitably leading to the creation of 
financing gaps, particularly where the financing of research, technological development 
and innovation by SMEs is concerned. 
12 
16. Projects of this nature are rarely of interest to conventional banks because of the 
delayed returns and high level of risk, although they may be prepared to joint a financing 
consortium and provide a proportion of the day to day working capital facilities. Whilst 
Seed Capital Funds have been the providers of a proportion of long term finance in some 
Member States and also in the USA, their contribution is slowing down markedly, largely 
because of an inability to attract fresh funds. In any case support is only provided to about 
5% of the propositions submitted (14). More positively there is evidence of slow but 
definite growth in the direct provision of long term capital by private investors interested 
in not only taking an equity stake but providing a degree of advice. 
17. There would appear to be a greater willingness to finance high technology start-ups in 
the USA than there is in the European Community, with over half the start-up investments 
being made in high technology companies. This difference is almost certainly accounted for 
by the different characteristics of the US and European markets, the US market for high-
tech products being much larger and offering major opportunities for rapid and profitable 
expansion. 
18. Not only start-ups, but also other SMEs have particular difficulty in financing 
research, technological development and innovation due to under-capitalization, heavy 
existing debt and an absence of collateral. The relative decline in the availability of equity 
capital or subordinated debt from venture capitalists and similar sources has exacerbated 
the situation. Indeed the relative importance of high technology investment continues to 
decline. 
19. In a situation where so few propositions eventually receive financial backing it is 
highly probable that some worthwhile projects of potential value to the economies of the 
Member States will never be funded or commence operations. In certain instances this can 
well be the fault of the promoters of the scheme, either because they have made an 
unpersuasive presentation of their plan, or have directed their applications to funds not 
interested in their field of activity. Alternatively the rate of return required may be too high 
in relation to the project. It is possible that the number of viable products that are never 
developed because of poorly constructed projects could be as high as three to four per 
cent of all those put forward for consideration, but it would be quite uneconomic for 
potential financiers to attempt to restructure them, even if they possessed the management 
with the necessary range of skills, which they frequently do not. 
THE FIRST STAGE OF SIGNIFICANT EXPANSION 
20. Having survived the initial risks of establishment, and the first period of growth, many 
firms reach what might be termed the first stage of significant expansion. That is, the 
business has become established in its market and demand has grown to the point where it 
has become difficult to provide an acceptable level of service using existing facilities. 
Alternatively trading experience may have reveal an opportunity for the development of a 
product or service different from that originally offered. 
This constitutes a further period of high vulnerability, where the risks of failure are very 
real. This is particularly the case where financial and other managerial controls are 
inadequate and there is an absence of even the most basic strategic planning. A serious 
shortage of working capital can frequently result, bringing the enhanced risk of technical 
bankruptcy. That is the business, whether or not profitable, has to cease trading because it 
14 "The European Seed Capital Fund Network: Review Of The First Three Years", Warwick Business School, 
April, 1992 
13 
is unable to meet its financial commitments. It is clear that in such case the root cause of 
failure is inadequate management rather than lack of access to finance. Banks could 
perhaps do more by proffering advice, requiring regular progress reports from their SME 
customers and ensuring that deadlines for submission, once established, are observed. 
They appear better at doing this in some Member States than in others. 
21. It is at this stage of development that a more sophisticated level of advice is required, 
from financial advisers, in order to restructure the debt profile of the organisation so as to 
accord more accurately with its commitments. Working capital will be required for the 
purposes of day to day trading, whilst an additional medium term loan may be appropriate 
for the purchase of fixed assets - plant and machinery, data processing equipment etc. 
Alternatively, it may prove more attractive to factor sales invoices and lease capital 
equipment, so reducing capital requirements to a minimum. Frequently a mix of these 
financial instruments proves to be the most effective solution. In addition more suitable 
premises may be rented or leased rather than purchased outright. 
22. It is often stated that a major problem for SMEs is that there additional capital 
requirements are not progressive but consist of a series of discrete and significant leaps, 
which are initially out of proportion to the predicted returns. Where the purchase of 
substantial fixed assets are concerned this may be true, but there are alternative methods of 
coping with this problem instead of purely relying on banks. In any case this theory 
regarding staged jumps in capital requirements is not relevant in all circumstances. 
Essentially the access to finance by companies contemplating expansion largely depends on 
the degree of confidence placed in them by lenders. This has to be earned right from the 
time the business commences trading and is a factor not given the priority it deserves by 
many managements. Theoretically, providing: 
- financial information for the bank is clearly and concisely presented at the required 
intervals; 
- management accounts are kept up to date; 
- the cash position is calculated at least weekly; 
- good communications are maintained with the bank; 
- all financing options are properly considered and utilised where appropriate. 
There are no insurmountable barriers to a reasonably viable and profitable firm at the first 
stage of major expansion obtaining additional finance. An interesting initiative by German 
Banks has been to make EDP based financial planning models available to their customers, 
a service which might usefully be taken up by a wider range of financial institutions 
providing appropriate initial assistance with the preparation of the input material was 
provided. 
In practice fresh difficulties are appearing, both for firms at this stage of their development 
and those in subsequent periods of expansion. Venture capital funds are generally no 
longer providing smaller amounts of capital because of the high administrative costs, 
disappointing returns on many investments, and the lack of exit routes. This is the major 
reason why a gap in the provision of amounts of finance lying in the broad range of 70,000 
ECU to 350,000 is appearing, the size of the minimum investment having grown to ECU 
250,000, and even ECU 1 million in the case of some major lenders. This same gap, when 
adjusted for inflation, used to exist in some Member States but was thought to have been 
closed through the greater flexibility accorded to operators through financial deregulation 
14 
SUBSEQUENT PERIODS OF SUBSTANTIAL EXPANSION 
23. Where subsequent stages of material expansion are concerned there are strong 
indications that an "equity gap" could also exist, for the reasons set out above. Companies 
at a stage where they need sources of permanent capital, find their short term borrowing 
reaching a practical ceiling because of their unwillingness or inability to provide additional 
security. This can be a particularly acute problem after a period of difficult trading when 
capital resources may need to be rebuilt, either because profits have not kept pace with the 
extra demands imposed by inflation on working capital, or actual losses have been 
sustained. Another instance is when major re-adaptation is required. For example for those 
previously heavily dependent upon orders from the defence industry. 
Where substantial expansion is not contemplated some problems apparently still exist. A 
recent report in the United Kingdom (15) identified a particular difficulty for firms of 
between 50 and 500 employees in obtaining small sums to maintain a series of innovations. 
Even should actual problems not have been encountered, to be seriously undercapitalised 
and dependent on short term financial facilities is a basically unstable situation, making 
long term strategic planning extremely difficult. Ultimately this can lead to a bank, or 
banks in the case of a more substantial medium-sized enterprise, having effective control 
over the destiny of the organisation. 
For those managing an efficiently organised business who wish to escape from or avoid 
such a set of circumstances there are only limited alternatives, and even these are not 
available in all Member States. One is to approach venture capitalists or merchant banks 
for long term finance, another to float part of the equity on a stock exchange. Both involve 
the ceding of a certain amount of control. A third possibility is to deliberately restrict both 
expansion and substantial new investment so as to apply a significant proportion of 
earnings retained after tax to the reduction of borrowing. 
Such an action may have the beneficial short term effect of improving the financial 
situation, but frequently threatens future progress and profitability to a material extent, in 
particular because it limits the ability to react to changes in existing markets and to seize 
new opportunities. Reluctance on the part of mature companies to borrow in order to 
finance the operations of a business are not new. Indeed it appears that in some parts of 
the Community this attitude is quite widespread and traditional. Now this attitude is 
becoming more evident in established SMEs of all sizes in areas not previously exhibiting 
this tendency. A survey (16), which has a reputed accuracy of+/- 5%, conducted in the 
United Kingdom, in the last two weeks of July, 1992 revealed that 17% of the respondents 
had paid off their overdrafts within the previous twelve months and would be extremely 
reluctant to borrow from external sources in the future. This trend may have been 
accentuated by the current combination of a slow down in business and high real rates of 
interest, but if it were to become more widespread it would retard the pace of growth and 
innovation in the Community. 
24. Even when it is decided to consult a merchant bank or other adviser on the right 
course of action to take the business may find that it falls between two stools. Whilst its 
financial requirements may have become too large for conventional bankers, they may be 
too small to be an economically viable proposition for a merchant bank, venture capitalist 
or capital development company. 
15 Advisory Committee on Science and Technology ( 1990). 
16 Policy Unit, Institute of Directors 
15 
MANAGEMENT BUY OUTS AND MANAGEMENT BUY INS 
25. A relatively new development within the European Community has been the growth in 
popularity of Management Buy Outs (MBOs) and Management Buy Ins (MBIs). MBOs 
normally, but not exclusively, occur when a company is, in the view of all or part of its 
existing management, suffering from being part of a larger group and could be more 
dynamic and profitable if operated as an individual entity, and those managers launch an 
offer for the shares of the company. MBIs occur when a team looking at a business from 
the outside judge that it could substantially improve on the performance of the existing 
management team. MBOs in particular can lead to the creation of a new and independent 
SME. For this reason the financing of this relatively new phenomenon appears to logically 
fall within the scope of this study, although its importance in terms of the overall problem 
of the financing of SMEs is marginal. 
Finance for both the above activities has to be obtained from an institution prepared to 
take a long term view, provide a high proportion of the purchase price and required 
working capital, hoping to eventually release its investment at a profit through the flotation 
of the client company on a stock exchange, or more probably through its sale to another 
business or group of investors. Typically such institutions would be either a venture capital 
fund or a merchant bank, although normal banks may also become involved as part of a 
consortium, in order to provide short term working capital. 
There is little evidence of a shortage of available capital for such purposes, financing of 
such deals accounting for 35% of all European venture capital spending, with deals falling 
within a range of ECU 1.4 million to ECU 28 million. This is despite the fact that some 
MBOs and MBIs have been spectacularly unsuccessful, requiring major reconstructions of 
their finances. Should the success rate deteriorate further the market may be more 
selective in the schemes it is prepared to support. Nevertheless, this does not appear to be 
an area of activity where financial problems to SMEs give cause for concern. 
3) 
16 
BŒ SOURCES OF FINANCE - THEIR STRENGTHS AND WEAKNESSES 
BANKS 
26. Apart from funds raised from family, friends or associates, banks are normally the first 
source of outside finance approached by SMEs, and are the dominant source of finance in 
all Community countries (17) accounting for five sixths of their external debt finance. 
Their attitudes, together with the terms and conditions they offer differ from Member 
State to Member State, still being heavily influenced by tradition, although operating 
systems and costs are tending to converge across the Community. Most banks specialise in 
the financing of short term requirements, that is additional working capital, although 
German banks are more inclined to consider taking an equity interest. Elsewhere within the 
Community the situation has changed to some extent during the past two to three decades 
with more medium term facilities for purchases of capital goods being offered in the form 
of fixed term loans. 
Whilst banks do have the advantage of being local, and offer amounts of finance that 
would be uneconomic for other lenders to provide, they have certain disadvantages in the 
eyes of many SMEs: 
- a developing tendency to rely solely upon mechanical credit rating techniques, known 
as credit scoring; 
- the growing practice of judging the amount of security as being more important than 
the quality of the proposition put before them. This is largely because of the substantial 
losses sustain in recent years, particularly on loans to small business start-ups; 
- being unduly restrictive in their attitude towards existing companies. For example 
requesting a reduction in the amounts borrowed because of a decline in the value of 
property pledged as security, although the degree of risk to which they are exposed has 
not worsened; 
- at least in some countries, providing variable rate loans only to larger companies; 
- attempting to gain additional profit from charges such as procuration fees and high 
transmission charges on cross-border transactions. 
The normal response to such charges is that the banks are not lending their own money but 
that of their depositors and have to make a profit on such transactions. Rates of interest 
and charges, together with demands for security, have to reflect the degree of risk involved 
in financing the proposition put before them. Whatever the truth of this argument the fact 
remains that for the majority of SMEs banks will remain the sole source of outside finance. 
It is therefore of considerable concern when a considerable degree of dissatisfaction 
appears to exist among their small business customers. 
27. A possible explanation of the problem is that banks have substantially modernised 
their operations in recent years, making much greater use of information technology in the 
process. This appears to have lead to a withering away in many cases of the traditional one 
to one relationship between banker and borrower. Instead lending decisions are either 
being taken at regional centres, or even if made locally, are subject to much greater 
overview by management remote from the actual borrower. 
17 C. Mayer. Financial systems, corporate finance and economic development", CEPR ( 1989). 
17 
28. At present banks also have certain difficulties, which are reflected in the manner in 
which they deal with their customers. Their ability to lend more imaginatively and 
competitively has been undermined not only by their massive losses on loans, but also by 
the provisions of the Basle agreement on capital adequacy by the Bank for International 
Settlements. Under this accord commercial loans will require 8% capital backing, first 
residential mortgages only 4%, and investment in government securities none. This could 
affect the lending priorities of some banks and make the generality of banks more 
restrictive in their commercial lending than would otherwise be the case, leading to 
basically sound larger SMEs finding their ability to borrow reduced. 
OTHER SOURCES OF PRIVATE SECTOR CAPITAL 
29. Given that most SMEs will tend to seek finance locally the fact that various sources of 
private capital from individuals are once more developing, albeit slowly, is of significance. 
The concept of "Business Angels" is one that is rather better developed in the USA. A 
"Business Angel" is a person possessing both experience of business and free capital who 
is prepared not only to invest in local businesses but to assist their performance through 
the provision of advice on a continuing basis. It is now claimed by those involved in its 
development to be the primary source of capital for high technology and high risk start-ups 
in the US. 
The only formal official attempt to encourage the increased provision of private capital in 
this form within the European Community appears to be in the United Kingdom where five 
pilot projects are currently under way with government assistance. There the objective is 
to create a series of semi-public marriage bureaus aimed at bringing together investors and 
borrowers. This initiative is very new and progress has been slow, with the initial 
organisational phase taking much longer than anticipated. One reason may be that it is a 
long time since those with available capital have been accustomed to making direct 
minority investments in unquoted companies, coupled with the fact that they do not enjoy 
the tax advantages reputedly accruing to US investors. The fact pointed out in the 
previous Section, that the majority of small business owners are reluctant to allow 
outsiders to acquire shares in their business seems to be less of a problem where private 
investors are involved. 
Another development is the "Capital de Proximité" scheme in France. Between 30 and 
forty regional structures now exist to channel the investment of varying amounts of private 
capital into local businesses. Fourteen Local Enterprise Agencies in the United Kingdom 
have been operating a similar network for some time. 
Apparently a substantial pool of potential private investors exists in both the United 
Kingdom and Germany. In Scotland no less than 1500 investors were identified recently, 
each prepared to invest up to ECU 50,000. Many more were found willing to invest in 
excess of ECU 6,000. A recent survey (18) conducted in the United Kingdom estimated 
the availability of potential funds of between ECU 2.5 and 5 bn. In Germany there are 
apparently a considerable number prepared to invest up to ECU 125,000. The major 
problem appears to be that no mechanisms exist to bring them together with companies 
requiring additional equity. At the moment most private investors obtain information 
regarding propositions through friends and business contacts. Interestingly, one bank in the 
United Kingdom is now investigating the feasibility of creating a national data base of 
those individuals interested in investing in private companies. 
18 The financing of technology based new firms in the UK: the role of informal venture capital, Mason & Harrison 
18 
30. Local Seed Corn Capital Funds, largely capitalised by local/regional administrations 
but with some private sector involvement, have the objective of financing new businesses 
and appear to be growing in number. The level of individual advances are customarily 
quite small, but can be valuable in instances where the amount of security that can be 
offered by the owners is too low to obtain finance from conventional sources. The problem 
is that there appears to be a high failure rate amongst those receiving assistance, unless 
considerable levels of unpaid advice and support are offered. Also, some schemes seem to 
place greater importance on achieving local social and economic objectives than making 
profitable investments. 
OFF BALANCE SHEET FINANCE 
LEASING 
31. Leasing can be an extremely important financial instrument for SMEs where the 
acquisition of fixed assets such as plant, machinery and vehicles is concerned. Involving as 
it does the making of regular payments over a fixed period it avoids the tying up of 
significant amounts of valuable working capital. Payments should be financed from 
revenues arising from the use of the items leased. Normally the only security required by 
the leasing company is that provided by the asset itself. 
A problem with leasing is that this avenue may well be closed to newly created businesses 
unless outside guarantors are available, as a two to three year trading history is often 
demanded. In addition a new company is unlikely to be making sufficient profit to take full 
advantage of the payments being offsettable against tax. In any case, these tax advantages 
are tending to be reduced. In these particular circumstances leasing is a very expensive 
and inappropriate form of finance. 
FACTORING 
32. Factoring allows SMEs to finance a higher level of trading than would otherwise be 
the case through the earlier receipt of money owed by customers. For example a factoring 
company might advance 80% of the value of an invoice immediately following its despatch 
to a customer, with the balance, less factoring costs, being due on payment of the invoice 
or at a pre-determined date. Factoring techniques have developed to the point where a 
variety of facilities are available and which can be matched to the needs of the customer: 
This is a most useful and appropriate financial instrument for SMEs, although not usually 
open to the newer firm because their turnover would be insufficiently high to qualify. 
However, many who could make use of it are discouraged by the apparent cost. In fact, if 
the increased cash flow and reduced or eliminated bad debts are taken into account the 
charges are not as high as they at first appear. Savings can also arise if the factoring 
company takes over administration of the sales ledger, although these disappear if the 
SME uses a computer software system that updates the sales ledger and sales day book 
immediately after the completion of an invoice. Even so, factoring could probably be 
utilised with advantage by many more SMEs, particularly as fears that customers may be 
offended by the introduction of a third party into the transaction appear to be largely 
unfounded. 
19 
VENTURE CAPITAL AND SEED CAPITAL 
33. Venture Capital Funds came into being in order to fill the need for a source of longer 
term equity finance. As has been seen this is particularly important in the case of high risk 
start ups; the financing of research, technological development and innovation; for well 
established SMEs contemplating significant expansion; and management buy outs and 
management buy ins. 
Those assisting with the financing of product development and start-ups are normally 
known as Seed Capital Funds, in order to distinguish them from main stream Venture 
Capital Funds which normally invest in established companies. They are currently facing 
particular difficulties in raising funds, anyone investing in them having to see a major cash 
outflow during the early years of any fund, make provision for possible further cash 
injections, and possibly only begin to see a positive return after five to ten years. Managers 
also face the heavy cost of making initial investigations into propositions put to them and 
providing a high level of management support to those in whom they invest. 
The concept of venture capital originated in the USA but spread to Europe during the 
1980s, providing significant amounts of capital for a considerable number of firms, but 
still limited in terms of the total stock. A factor now causing difficulty is that in the mid 
1980s the venture capital industry promised the investment institutions rates of return on 
capital that it proved incapable of achieving. 
Decisions whether or not to investment in a particular proposition are made on the basis of 
a detailed company plan and accompanying financial projections, but the assessment of 
whether or not to invest is frequently determined in the final analysis by the perceived 
quality of the management team. 
Finance is normally provided through a combination of loans and investment in the equity 
of the company, or through pure equity participation. An executive of the fund is 
sometimes appointed to the board of directors in order to provide advice and safeguard the 
interests of investors. In some instances this is this factor that puts off existing 
shareholders from seeking venture capital, even if this would otherwise be in their interest 
and that of the company they control. 
In the early days of European venture capital some of the investments were relatively 
small. As the sector has become more mature the objectives of those running funds has 
changed, with the emphasis being on investment in more established companies and 
management buy outs, seldom contemplating investments of less than ECU 250,000. This 
creates a problem for many expanding SMEs, who are only looking for amounts of 
between ECU 10,000 and 100,000. There were a number of reasons for the reorientation 
of priorities: the amount of time required to supervise many small investments proving out 
of proportion to the return; the number of companies that failed was too high; and there 
was a difficulty in releasing the investment at the end of the planned period. As a 
consequence, the major venture capital funds now tend to be risk averse. 
In addition only a limited number of projects can be supported because of the time needed 
to assess propositions. There also had to be enough experienced personnel available to 
undertake proper supervision of client companies once investments have to be made. A 
complaint from clients is that too often this advice is confined to financial matters rather 
than other strategic considerations. 
Another major problem facing funds, together with those in whom they invest, is that they 
need to realise their investments after a certain period. This would ideally be five years, but 
is more often ten to twelve where a high technology company that is supported from start­
up is concerned. Possible exit routes should be planned at the time the original investment 
is made, although this is not always done. 
20 
The advantage of venture capitalists is that they will supposedly provide finance in 
circumstances when it is unavailable from any other source. The disadvantage for 
management is a partial loss of control, which can be substantial if the business does not 
perform as well as predicted, and having to orientate the objectives of the business to the 
needs of investors. This can lead to a situation where, after five or more years of strong 
growth they are virtually forced to sell the business to a larger organisation, or see the 
venture fund's equity stake sold on to another group of investors. 
A problem that currently exists within the EC is the uneven distribution of funds. In 1992 
some 89% of all investments were concentrated in the United Kingdom (39%), France 
(21%), Germany (13%), Italy (11%) and the Netherlands (5%). Total cross-border 
investments within the Community only amounted to 7.9% of the total. 
DEVELOPMENT CAPITAL 
34. This form of financing has a longer history than has venture capital. The main 
difference between the two is that development capital companies are prepared to take a 
longer view and do not require a pre-planned exit route. Probably because their degree of 
long term financial commitment is smaller. 
Why this source of funds may have enjoyed limited popularity as a financing vehicle is that 
up to 90% of the funds advanced will bear market rates of interest and be repayable in five 
years at most. The remainder is normally advanced through the purchase of convertible 
preference shares in the company, which will eventually secure 25% to 40% of the total 
equity when converted, the proportion depending on the valuation of the company at that 
time. After conversion the client company will frequently be expected to pay up to one 
third of after tax profits to ordinary shareholders in the form of dividends. 
This makes the use of a development capital company only really suitable for companies 
anticipating high levels of profitability in the short to medium term. Otherwise, not only 
will repayment of the loan place a strain on working capital, the need to maintain a high 
level of dividends will affect the ability of the company to finance future growth through 
the medium of retained earnings. In view of the above factors development capital 
companies will only be of assistance to a very small proportion of SMEs and thus will not 
make a significant contribution to solving their financial problems. 
STOCK MARKETS 
35. Stock markets are under developed in a number of the Member States and the 
majority only have a limited number of companies quoted on them. As an example the 
Athens Stock Exchange had, as of 31.12.1991, only 157 companies listed on the main 
market and 8 on the Parallel Market. Through its approval of the Directive Concerning the 
Coordinating of the Conditions of Admission to a Stock Exchange Listing (19) the 
Council has emphasised the importance it attaches to the achievement of a greater number 
of companies being listed on stock exchanges, including suitable businesses with a 
comparatively short history, through the reduction of unnecessary barriers to this process. 
19 Council Directive 89/298/EEC of 17th April, 1989 
21 
Nevertheless, this method of raising permanent capital is currently of limited value to all 
but a tiny minority of small limited companies. This is not just because of the difficulty of 
achieving a successful flotation under current economic conditions but also on account of: 
- the high costs of the procedure for obtaining a listing, not least accountancy and legal 
charges; 
- the extra expenses of a recurring nature: higher accountancy fees; the drawing up and 
publication of annual reports in a much more detailed form; the holding of much larger 
annual general meetings etc; 
- shares in the majority of small public companies are relatively illiquid, being rarely 
traded even when listed on the most active of the European Stock Exchanges; 
- whilst it may be possible to arrange an initial listing and placing or public offer of a 
portion of the equity, the relatively illiquidity of this stock can make raising of finance 
through subsequent issues well nigh impossible, unless there is a radical advance in the 
trading and profitability of the company concerned. 
It also has to be recognized that, even in the USA, the stock markets have become a 
negative contributor to enterprise funding, with a growing trend since 1984 for companies 
to re-purchase their shares (20). 
INTERNAL RESOURCES 
36. Virtually all companies, with the exception of a handful of exceptionally well managed 
businesses, can reduce their need for capital through the improvement of management 
controls and: 
- maintaining a tight control on stocks, reducing the level to the minimum consistent 
with providing the required level of service; 
- having a definite sales ledger management policy, including clear procedures for the 
prompt pursuit of overdue accounts; 
- calculating the true cost of all operations, including the degree of working capital 
absorption; 
- examining the potential savings arising from the contracting out of internally provided 
support services such as transport. 
20 C. Mayer, ibid. 
22 
The importance of proper management of debt by SMEs is illustrated by an analysis of 
balance sheets in the United Kingdom (21) which revealed that creditors formed a higher 
proportion of liabilities for small than for large firms. In manufacturing trade creditors 
comprised 35.3% of liabilities for small firms and 23.6% for large. For non-manufacturing 
firms the figures were even more significant; 41.9% for small firms, 12.9% for large. This 
situation is replicated in the Community as a whole, where trade creditor financing is even 
more important than short term bank finance (22). Despite the strikingly better situation of 
large firms in the non-manufacturing sector vis-a-vis trade creditors, some still manage to 
finance all their stocks on trade credit, illustrating the benefits that accrue from tight 
management controls. 
A problem is that such exercises are frequently only undertaken by the management of 
SMEs when they are facing a financial situation varying in severity between an emergency 
and a crisis. Cuts may then be made without sufficient regard being taken to longer term 
objectives, should these have even been defined. Whilst the economies made may enable a 
business to survive in the short term, reductions in the wrong areas could well adversely 
affect long term viability. 
21 Hughes, A. The problems of finance for smaller businesses, Small Business Research Centre Working Paper 
No.15,1991. 
22 BACH: DG H Database. 
23 
IV EXAMPLES OF SCHEMES PROVIDING FINANCE FOR SMEs 
NATIONAL AND REGIONAL 
37. The main sources of conventional funding available to SMEs have been detailed in the 
previous section. This, however, only provides a partial picture as a whole variety of 
additional schemes offering assistance exist. So many in fact that it has been impossible to 
obtain details of all of them. Consequently the approach taken in this section has been to 
summarise the main types of scheme available. Where any appear worthy of further 
explanation details have been set out in Annex A. 
38. Sources of finance vary considerably. Some schemes are largely backed by public 
funds, even if delivery is through private sector bodies such as banks. Others are 
administered by public or semi-public bodies, but depend on the private sector for the 
provision of risk capital for onward lending. A third category are wholly privately financed 
and administered. 
As far as national schemes are concerned, all Member States use packages of financial 
instruments in order to support SMEs in terms of their financial requirements. According 
to a recent analysis (23) these fall into three broad categories. Some countries, including 
the Netherlands and the United Kingdom, rely mainly on the provision of loan guarantees. 
Others, including Belgium, Greece, Ireland and Italy, provide support through grants for 
investments, soft loans and/or interest rate subsidies. Finally, a minority which includes 
Belgium, France, the Netherlands and Germany, are involved to a varying degree in the 
supply of risk capital to SMEs. 
39. Examples of nationally organised systems include: 
(i) Government sponsored schemes to guarantee loans made to SMEs who lack both 
a track record and adequate security to offer a bank; 
(ii) Those offering full or partial support, in the form of loans or grants, for 
expenditure in the fields of technology and research and development; 
(iii) The provision of loans to help with the cost of penetrating new export markets; 
(iv) Income support for those previously unemployed during their first year of self-
employment; 
(v) Grants or low interest rate loans on offer in specific areas of deprivation. Some 
have the objective of aimed at assisting deprived inner city areas, others at encouraging 
diversification in predominantly rural regions; 
(vi) Sectorally or regionally organised Mutual Guarantee Systems which provide 
guarantees on loans for rebuilding and modernization of premises, the opening of new 
branches, transfers of ownership, the provision of working capital etc. 
(vii) Loans by Mortgage Credit Banks for the purchase of property, and sometimes 
even machinery, which are secured on the value of the asset itself. 
(viii) Long term loans provided by private institutions with government backing, at 
favourable rates of interest, for environmental improvements and energy saving measures. 
23 "Gateways to Growth", a paper by the Research Institute for Small and Medium-sized Businesses, Netherlands 
(October, 1992). 
0 
24 
(ix) Small loans by the same organisations for general purposes of between 6,400 ECU 
and 95,000 ECU in one case, but with an average value of 32,000 ECU. 
(x) Venture capital type investments made by similar private bodies, but without 
government support. 
(xi) European savings banks have developed separate venture capital companies in a 
number of Member States and savings banks are the main promoters of Epargne 
Developpment, a European development capital company based in Paris. 
REGIONAL 
40. Those most worthy of note include: 
(i) Regional Venture Capital Funds. These appear to be growing in importance. 
(ii) Regional incentive grants or low interest loans falling within the guide-lines for aid to 
SMEs established by the Commission. These are available for a variety of purposes 
including the purchase or leasing of premises, and even feasibility studies in certain 
instances. 
EUROPEAN COMMUNITY 
41. The objective of the Commission, taking account of the limited amount of funding 
actually available for this purpose, has been to avoid duplication of national and regional 
schemes, instead helping to fill gaps in provision, investigating new possibilities, and 
promoting best practice, by means of demonstration and pilot projects. Efforts have been 
concentrated on the stimulation of the provision of seed and venture capital, the encourage 
of networking between providers, the better use of the results of Community Research and 
Development projects, and the alleviation of disadvantages suffered in the peripheral and 
less well developed regions through a series of programmes financed by the Structural 
Funds. Outline details are provided below. Further particulars are contained in Annex A. 
42. The Seed Capital Pilot Project was established following the adoption of the 1989-94 
pilot action to stimulate the provision of seed capital within the European Community(24). 
Twenty five such funds were approved for support by means of reimbursable advances 
covering 50% of operating costs within the first five years of their existence. In addition, 
15 European Community Business Innovation Centres in the assisted areas of the 
Community availed themselves of the option of receiving capital from the E.C.BIC budget 
line in order to allow them to become shareholders in the funds and thus strengthen their 
role in providing management and technical support to prospective recipients of seed 
capital funding. All of the 24 are now operational and one well on the way to reaching 
that stage. As at June, 1993, 141 investment projects had been finalised. 
24 OJ C 204,3.8.1991 at page 10 
25 
The overall objective is to foster enterprise creation in the Community by strengthening 
the financing opportunities available to new enterprises and improving the quality and 
survival rate of "seed stage projects". The typical proposition receiving support is one with 
a relatively long development phase, often involving new technology, and which, by its 
nature, offers both high risks and high returns. 
A report on the first three years of operations was prepared by the Warwick Business 
School at the request of the Commission (25). A summary of the findings are contained in 
Annex A, but the principal conclusions were that this Community initiative had not only 
led to the creation of Funds which might otherwise not have existed, but indirectly helped 
in the raising from the private sector of twice as much additional funding for those projects 
that required it. 
43. At the same time as supporting the establishment of the above funds the Commission 
has built up a European Network of Seed Capital Funds in cooperation with the European 
Venture Capital Association. The objective of this pilot initiative is to encourage the 
training of venture capitalists, stimulate cross-border initiatives, and promote the exchange 
of information 
44. The Commission is also providing support for the expansion of the provision of risk 
capital facilities within the Community, in particular through the Venture Consort and 
Eurotech Capital programmes. The objective of Venture Consort is to encourage 
investment by venture capital companies in small and medium sized enterprises in all 
industrial and service sectors through the formation of transnational syndicates. Aid is 
given towards the search for partners, establishment costs and a contribution to the 
investment itself in the form of a repayable advance of up to 30% of the input, or 300,000 
ECU, whichever is the smaller. 
A review of the Scheme (26( revealed: 
- that in 1988 and 1989, of the eligible number of transnational investment deals that 
took place in the market, almost one third were financed by Venture Consort; 
- a leverage ratio of private investment in equity to Community funds of just over 6:1 
was achieved; 
- there was a concentration of investments in high technology propositions, as a 
consequence of the priority given to innovative projects; however, there was a low 
level of demand for innovation in traditional manufacturing and service sectors; 
- the distribution of the portfolio by investment countries showed a geographical spread 
more balanced than that observed for overall venture capital activity in the 
Community: hence the scheme has also contributed towards decreasing differences in 
the supply of venture capital between Member States. 
The Eurotech Capital scheme became operational in 1990. The object is to stimulate 
private capital funding of transnational high technology projects and thus encourage SMEs 
to undertake new transnational ventures. 
25 "The European Seed Capital Fund Network: Review of the First Three Years", ibid 
26 Review of the Venture Consort Scheme, KPMG Management Consultants 
26 
At present, Eurotech Capital consists of a network of 11 financial entities, which have 
agreed to invest approximately ECU 170 million in SMEs involved in transnational high 
technology projects. Each of these entities has an investment capacity of at least 
ECU 50 million, of which a minimum of 20% is committed to high technology 
investments. In return for this commitment, they benefit from a Community financial 
contribution and two services: Eurotech Data, an expert information service, and 
Eurotech Innvest, a project identification service. 
45. One of the action lines of the SPRINT programme is designed to bring together firms 
having innovative projects with potential investors. This process is facilitated through the 
holding of a number of fora attended by firms from several countries looking for financing 
with financiers, also from several countries, looking for investment opportunities. Twelve 
of these are scheduled to be held in a range of European cities in the period until the end of 
1993. Those held so far have resulted in approximately half of the firms attending securing 
financial support. Organisation of these fora has been delegated to associations of venture 
capitalists, and attendees are being selected by a panel drawn from national venture capital 
associations. 
SPRINT Technology Performance Financing has been launched to stimulate the uptake of 
new technology in traditional industries. In practice this means that a supplier can install 
new technology in a customer firm and receive payments from the acquirer over a two to 
three year period, depending upon the attainment of predefined performance targets. A 
third party source of finance, usually a commercial bank, is also involved in order to 
provide unsecured advance funding to the supplier firm to bridge the gap in payments. 
These advances are repaid out of the performance payments received. Typically the bank 
will advance between 60 and 80% of the cost of the project and will be paid back in a 
series of instalments over a period of two to three years. Payment schedules are negotiated 
in the light of pre-determined performance targets for the equipment. If the technology 
does not work as well as stipulated, users need not pay the full amount. The value of 
projects ranges between 50,000 and 200,000 ECU, meaning that they are of direct interest 
to the more substantial SME. 
SPRINT provides a partial safety net to participating banks by underwriting a proportion 
of their risk, although whether to make an initial advance is entirely up to the financial 
institution concerned. The programme has signed up a core group of large commercial 
banks to implement and manage the TPF scheme during a two-year pilot phase. The aim is 
that when the pilot phase is over most of the banks will continue their TPF programme 
without further Commission support. Moreover it is anticipated that because of the 
competitive nature of the financial services industry the use of TPF will spread rapidly to 
the rest of the financial community. 
46. Mutual Guarantee Systems were identified by the Commission (27) as an effective 
means of improving the access of SMEs to sources of financing. The main role of such 
systems, and the exact operational details vary considerably, is to enable SMEs to provide 
each other, by coming together in a cooperative system, with the necessary guarantees to 
obtain funding from banks. Another important function is to help SMEs to prepare 
financial presentations to banks, which gain credibility from the fact that many of the 
Systems are activity based and have detailed market knowledge against which they can test 
business plans and financial projections. 
27 SEC(91 ) 1550 final, September, 1991 
27 
The Commission has stated its intention to encourage the growth of Mutual Guarantee 
Systems in a number of ways. Notably by helping in the establishment of a European 
Guarantee Association (actually established 10.11.92) and by providing aid for studies, 
seminars and conferences which will make these Systems better known, and in the process 
assist in the formation of new ones. 
47. Although many SMEs throughout the Community appear to face financing problems 
to a greater or lesser extent, these tend to be more acute in the less developed regions for 
a number of reasons: the smaller average size of SME; the less developed financial sector; 
distances from main financial centres etc. Within the framework of regional policies, and 
since the reform of the Community Structural Funds, the Commission has also been able to 
assist in the creation of SMEs in depressed areas as a means of generating wealth and 
employment. 
In this context Community support for SMEs takes three forms: 
- the co-financing of national schemes of regional assistance that have as their objective 
the stimulation of productive investment; 
- supporting the provision of advisory services to business; 
- encouraging the development of sources of finance other than bank loans: the Seed 
Capital Scheme largely financed by the ERDF; factoring and leasing facilities; the 
creation of guarantee funds; interest rate subventions; the development of venture 
capital; and the encouragement of mutual guarantee systems. 
48. Loans at advantageous rates of interest (between 2% and 6% below market rates) are 
also available through financial intermediaries. These are financed by global loans from the 
European Investment Bank, which passes on the advantage arising from its status as a 
highly rated borrower on the international financial markets. These loans are administered 
in a variety of different ways. In Portugal one savings bank has nine different credit lines, 
partially financed through this source, covering agriculture, fishing, industry, tourism and 
services. Finance is provided through a mixture of grants and credits, and a full range of 
separate supporting facilities are offered through other organisations established by the 
savings bank. These include leasing, insurance, investment funds and venture capital. Other 
savings bank schemes known to be utilising EIB loans are operating in Denmark, France 
and Italy. 
OUTSIDE THE EUROPEAN COMMUNITY 
THE UNITED STATES OF AMERICA 
49. The United States has a longer experience of schemes for the provision of both start 
up and venture capital than any country within the Community. Indeed, the market in these 
instruments is showing signs of reaching maturity. In 1990 the number of venture capital 
firms declined for the first time, although the funds under management increased slightly 
28 
Recent years have seen medical and health related businesses receive the greatest share of 
financing. This was followed by software development and telephone and data 
communications. On the other hand private venture firms invested more than 70% of their 
capital in high technology industries (28). 
Firms supported by venture capital have apparently been a positive factor in job creation, 
even at a time of rising unemployment. One survey (29) estimated that 401 start-up 
companies generated 58,000 new jobs in 1990. It must be remembered that "start-up" is 
defined differently in the US, frequently covering a five year period from the actual 
foundation of the business. During that five year period the firms surveyed had spend $1.3 
billion (ECU 1.02 bn) in new process and product research, generated three and a half 
times the number of positions for highly skilled professionals than did the average US 
company, and required 30% less funds than the largest 500 US companies in order to 
generate a new job. 
50. The range of programmes in the US is very wide, seemingly with no two being exactly 
alike because of the widely differing conditions in which they operate, but when viewed in 
broad terms they fall under the same headings as in the Community: 
- public programmes; 
- programmes that are effectively a partnership between the public authorities and 
private sector sources of capital; 
- totally private initiatives. 
51. The role of the Federal Government is to act as a catalyst and facilitator for the 
provision by both state governments and the private sector of finance for small business 
development. As far as direct funding is concerned, federal agencies are a major source of 
research and development financing through the provision of grants, direct equity funding 
by them being prohibited. A detailed description of Federal Programmes is set out in 
Annex B. In outline the significant ones involve: 
- providing matching funding together with the individual states for the finance of 
technology based start-ups under the Corporations for Innovative Development (CIDs) 
programme; 
- direct funding of research and development through the Small Business Innovation 
Research Programme (SBIR). Any Federal Agency with a budget in excess of $100 
million (ECU 78 million) being forced to participate; 
- the Small Business Investment Company Programme (SBIC), which provides a source 
of finance for small companies experiencing difficulty in raising equity or loan capital 
from conventional sources through the giving of low interest loans to supplement the 
private capital raised by SBICs. Despite cuts in Federal financial support during the 
second half of the 1980s 350 separate funds still exist, representing $13 billion (ECU 
10 bn) of financing facilities for small business; 
- the Loan Guarantee Scheme offered by the Small Business Administration, which was 
the first of its kind and covers 90% of approved loans. 
28 "US Industrial Outlook", US Department of Commerce 
29 Coopers & Lybrand, USA. 
29 
52. The reduction in federal spending on small business financing has been 
counterbalanced to some extent by an increase in initiatives by both state and local 
governments involving four basic approaches: 
(i) direct investment in companies through publicly funded agencies; 
(ii) investment in venture capital funds, often through the use of state pension funds, 
something which has its parallels within the Community; 
(iii) providing special tax incentives for private investors; 
(iv) promoting development of the business infrastructure through the support of 
entrepreneurs and funding research and development projects. 
The number of these programmes that are wholly public is relatively small and, in the main, 
these are funded by public pension funds. The majority of public initiatives operate 
relatively independently within a legislative framework, being funded either by a state 
government financial appropriation, or even in some instances a state lottery. Private 
programmes fall into two groups. First there are private limited partnerships that are 
capitalised by public pension funds. Secondly, those funded by private sector investors 
who receive tax credits as a consequence. Most of the larger funds have a bias towards 
assisting firms in the high technology sector. 
53. One study (30) financed by the Commission examined the focus and overall coverage 
of fourteen of these funds as they appeared to represent a good cross section of the whole 
sector. Of the half with a defined focus five out of seven concentrated on the support of 
high technology firms. Only 3 out of the 14 were not prepared to support both seed and 
early stage development. Two of the programmes provided equity funding only; six 
provided equity and/or debt finance; one provided debt finance only; four provided grants 
and received any payback in the form of royalties; and one provided debt finance and/or 
grants. This survey probably under estimates the overall bias in the majority of state 
programmes towards early stage finance 
54. On the basis of US experience essential elements in the establishment of a range of 
successful programmes which appear equally applicable in Europe, include: 
- identifying gaps in financial provision in the area or sector targeted and ensuring that 
those businesses supported do not experience later difficulties in obtaining follow-up 
funding; 
- establishing a specific investment policy allowing managers to build a diversified 
portfolio and avoiding over exposure to any one sector, unless high technology is 
mvolved, when specialisation in one closely defined area appears to pay dividends; 
- ensuring that the management team possesses not only financial skills and an ability to 
assess a variety of businesses, but experience in the sectors of activity targeted. Where 
the appraisal of high technology investments are concerned it may frequently be 
necessary to call on assistance from experienced persons from outside the management 
team; 
30 Survey of Public Authority Programmes for promoting the supply of Venture and Seed Capital in the USA -
Venture Economics Ltd., June, 1988 
30 
- obtaining maximum leverage of own funds by mobilising the highest possible level of 
additional private sector investment. A proportion of public funding appears to give 
added credibility to a project, especially if a lower rate of return is set for the public 
funds; 
- programmes must have the correct level of funds needed to achieve their objectives. If 
funds are too great there will be a pressure on management to make hurried investment 
decisions, if too low worthwhile propositions will have to be turned away, lowering 
public confidence in the initiative; 
- administrative costs should not be under-estimated. This is particularly important 
where early stage and start-up investments are concerned; 
- ensuring that funds do not compete with existing private sector provision. In certain 
circumstances it may be prudent to include "lender of last resort" provisions; 
- striking a balance between receiving sufficient information from the applicant company 
and creating a deterrent through the use of over complicated procedures. It is essential 
to incorporate a rapid decision making process once all the required information has 
been received; 
securing a sufficient commitment of cash by the entrepreneur to seriously involve them 
in the financial risks of the enterprise; 
- matching the projected returns on investment with the objectives set for the 
programme; 
- ensuring the financial instruments used are appropriate to the needs of the business 
being financed. Financing structures for start-ups must not require heavy repayments in 
the early years; 
- formulating an "exit strategy" prior to any investment of equity capital being made and 
agreeing this with the owners of the business, particularly where flotation on a stock 
exchange or acquisition by another organisation may not be realistic objectives. 
Otherwise the fund can eventually end up with a portfolio of unrealisable investments; 
- all programmes being subjected to regular periodic views in order to ensure that they 
continue to meet both their objectives and the requirements of the market. 
55. Experience in the US has shown that is difficult to even begin to judge the success or 
failure of any programme until it has been in existence for at least five years. With many 
US funds having been in existence for a shorter period this makes an overall assessment of 
their success difficult. 
56. What any study of the US demonstrates is the importance of the regional factor. Local 
circumstances have to be taken into account when programmes are launched. Care must 
nevertheless be taken when seeking to transpose American experience to a European 
context. The US has a different legislative and tax structure, with the individual states 
having a much wider competence than the Federal authorities in this field. Attitudes also 
differ towards entrepreneurship, with a generally more positive attitude to risk taking. 
57. One relatively new US initiative that is well worthy of investigation is the 
establishment of funds exclusively for the purposes of product development by established 
companies and where the fund is remunerated by a royalty on net sales. This can be as 
high as 5%. 
31 
JAPAN 
58. In order to compare the financial problems of SMEs in Japan with those in the 
Community, and the significance of the various governmental schemes offering special 
finance to them, it is first necessary to understand their position within the economy, the 
sources through which they have historically obtained finance, and the serious financial 
constraints with which they are now having to cope. Differences in definition are not 
apparently so large as to make comparisons meaningless. 
In 1963 the Japanese government, as part of its economic policy regarding small 
businesses, enacted a law which expressly defined the type of firm falling into the category. 
If either of two criteria, expressed in terms of equity capital and number of employees 
were met, a firm was officially regarded as being small. In manufacturing, mining, 
construction and transportation the value of equity capital must be Yen 100 million 
(ECU 636,000 approx) or less and 300 or fewer be employed (1000 in mining). For 
wholesaling the levels are Yen 30 million (ECU 190,000 approx) and 100 persons or less. 
For those engaged in retailing or other services Yen 10 million (ECU 63,000 approx) or 
50 employees. 
Japan's economic success is often attributed to the achievements of large corporations. 
This greatly under rates the extent to which small firms are a dominant factor in the 
national economy, which is partially explained by the quite sizable firms that fall within the 
criteria set out in the previous paragraph. Of the 421,749 enterprises engaged in 
manufacturing at the end of 1989, 99.1% were small businesses. These accounted for 
72.5% of sectoral employment and 51.8% of turnover. (31) In wholesaling, based on 1988 
figures the contribution of small firms was even greater. No less than 99.3% of all 
enterprises were small, providing 85.8% of employment and 62.1% of sales. 
Unsurprisingly, given the difficulties of opening large retail units in Japan, in retailing 
99.5% of enterprises were small, providing the vast majority of employment (88%) and 
accounting for a very high proportion of sales (78.5%). (32) 
According to Japanese sources, (33) the importance of small businesses stems not only 
from their numerical superiority but because of their flexible responses to changing 
conditions. Over the past few decades, small businesses have made significant 
contributions to Japan's ability to meet effectively such problems of lack of capital, 
inadequate supply of skilled labour, difficult business climates in some sectors, and the 
need to develop and introduce technology that contributes to the efficient use of resources. 
Examples are the introduction after the 1973 oil shock of mo 2 energy efficient equipment 
and production processes, and over a number of years, pollution abatement equipment. It 
is reported that, prior to the current economic down turn, small firms were aggressively 
seeking out and employing new techniques to improve efficiency and the quality of their 
products. It is significant that historically SMEs had a 40% share of private sector 
investment, although there has been a sharp down turn in monetary terms since April, 
1990. 
31 Japanese Census of Manufactures 1989. 
32 Japanese Census of Commerce 1988. 
33 Annual Report of the Small Business Fiance Corporation of Japan, 1991. 
32 
59. It would appear that although the EC, unlike Japan, lacks precise definitions as to 
what constitutes an SME, the overall contribution to the respective economies of the SME 
sector is not dissimilar, once the relative inefficiency and over manning in the Japanese 
wholesaling and retailing sectors is allowed for. On the other hand Japanese SMEs appear 
to be more willing to invest in up to date processes and equipment. It is impossible to 
judge to what extent this is based on independent decisions by management in these SMEs, 
or as a result of pressure from the larger organisations to whom so many in the 
manufacturing sector act as long-term suppliers of components. The fact that they have 
historically been able to fund such investments makes the avenues through which they 
obtain finance of particular interest, at the same time the current financial and economic 
situation must be taken into account in order to provide a balanced picture. 
60. In broad terms (more specific information in contained in Annex C), and according to 
the previously mentioned report, (34) at the end of March, 1991 the commercial banks 
(city banks plus regional banks) accounted for about 65% of total loans to SMEs for 
investment in plant and equipment. Government institutions provided just under 11%, and 
the balance was derived from a variety of other private financial institutions, particularly 
credit associations. 
The position when long-term operating funds are included is broadly the same, but with 
two main differences. Firstly, loans for investment in plant and equipment account for 
under a third of total loans, showing a significant proportion of fixed investment being 
undertaken out of retained profits, probably because of the more favourable tax treatment 
given to SMEs. Secondly, the National (People's) Financial Corporations, which derives its 
fiinds from private savings, and the Shoko Chukin Bank (Central Bank for Industrial 
Commercial Cooperatives) play a greater role in the provision of operating fiinds. 
A MITI publication, (35) makes particular mention of credit guarantee arrangements 
enabling SMEs, which typically have a low net worth, to borrow more easily from private 
sector financial institutions. Comparisons of the total amount guarantied in 1989, Yen 
10,208,248 million (ECU 78,172 million), against total loans outstanding of Yen 
288,200,000 million (ECU 2,206,000 million), illustrate that guarantied borrowing, whilst 
still very significant, probably covers only a small portion of total SME borrowing from 
private sector financial institutions, with the bulk being raised on purely commercial terms, 
although this cannot be stated with absolute certainty. 
A further source of finance is provided by Japanese local authority incentives aimed at 
attracting inward investment. It has been impossible to quantify the scale of these, or the 
extent to which SMEs benefit. 
61. Recently SMEs in Japan have been suffering from serious financial problems. Start-up 
costs have been higher, increasing by 60% between 1983 and 1991, (36) partly because of 
the increased price of land. As a result the need for external funding from financial 
institutions increased from 35.2% in 1982 to 42.2% in 1990, with an actual peak of 43.7% 
in 1987. (37) As a result of the generally low net worth of SMEs this made borrowing 
difficult, although during the 1980s commercial financing organisations were largely able 
to meet demand because of the ease with which they could finance themselves directly 
through share issues or share-linked bond issues. 
34 Annual Report of the Small Business Finance Corporation of Japan, 1991. 
35 Outline of Small and Medium Enterprise Policies of the Japanese Government, 1991. 
36 Small and Medium Enterprise Agency, "Survey on Start-ups", December, 1991. 
37 Ministry of Finance "Statistical Annual Report of Incorporated Enterprises". 
33 
The drastic falls in both the stock market and the value of land, beginning in 1991, have 
radically altered this situation. Not only has the financial capacity of private lenders been 
reduced, they are taking an increasingly cautious attitude to lending because of the high 
level of bad loans on their books. In an attempt to strengthen their capital position and 
improve profitability they have raised interest margins on loans, with SMEs feeling the 
worst effects. 
The interest rate reductions effected by the Bank of Japan since mid-1991 were apparently 
seriously influenced by this factor. Lending by public sector institutions has increased, but 
this has done nothing more than partially offset the fall in loans from other sources. A large 
part of the economic stimulatory package announced at the end of August, 1992 consisted 
of measures which extend the opportunities for SMEs to borrow from public sector 
financial institutions for investment in plant and equipment. Whilst this will represent an 
increase of some 10% in the level of government financing for such investments, the 
overall effect could only be marginal. 
62. Finance from public sources has been available to SMEs since the passing in 1963 of 
the Medium and Small Enterprise Modernization Promotion Law. The government has 
established three financial institutions (the Small Business Finance Corporation, the 
People's Finance Corporation and the Small Business Credit Insurance Corporation) to 
furnish small and medium-sized enterprises with funds for their business operations and to 
promote specific policy objectives. These are supposed to qualitatively and quantitatively 
complement finance available from private banks. 
In brief (further particulars are contained in Annex C), four different programmes currently 
exist. 
1. A special loans system, providing loans at concessionary rates of interest in order to 
achieve certain objectives, such as improving the industrial structure, prevention of 
pollution, energy saving etc. 
2. Loans aimed at improving the management of SMEs, which is operated in conjunction 
with the Societies and Chambers of Commerce and Industry. Such loans are obtainable 
without the lodging of collateral or guarantees. 
3. The Public Credit Supplementation System which provides loan guarantees and 
insurance. 
4. The Financial Assistance System for Small Business Rer iforcement which appears to 
be aimed at aiding restructuring by companies. Funds are provided by the private sector as 
well as by national and local government, a high rate of gearing apparently being achieved. 
63. Whilst it has not been possible to examine the assistance given in the less favoured 
regions, it would seem that, in general, Japanese SMEs face similar financial problems to 
their Community brethren and are currently experiencing an equally difficult situation. 
Whilst government assistance, particularly loans for capital investment is significant, and 
may well have assisted SMEs to embrace new technology more easily, it is not 
overwhelmingly large. In the same way loan guarantees, whilst important, appear to only 
affect a minor proportion of all loans, although this view is based on a rough and ready 
estimate. 
34 
The most significant features, which might well be worthy of note when considering 
measures to ease the financial problems of SMEs within the Community, appear to be that: 
except in the case of loan guarantees financial assistance from public sources is 
regarded as being supplemental to that available from the private sector: 
- some loans, at beneficial rates of interest, are specifically targeted at enabling SMEs to 
more easily meet public policy objectives i.e., pollution control and energy saving; 
- the importance of providing funds specifically for those SMEs having to restructure, 
and who may find difficulty in raising private sector funds, has been recognised; 
- financial assistance is given specifically towards schemes aimed at improving the 
quality of management within a company. 
The direction of these initiatives indicate that they must have been introduced following 
comprehensive analysis and are specifically targeted at reducing the most critical financial 
problems facing SMEs. What the present difficulties of Japanese SMEs illustrate is that no 
measures of official assistance can wholly shelter them from market forces. 
35 
V. IDENTIFIABLE GAPS IN PROVISION AND POSSIBLE NEW INITIATIVES 
64. To summarise the financial problems that have been identified: for conventional start­
ups and similar businesses in the first stage of significant expansion the problem is more a 
lack of management skills than shortage of available finance. Nevertheless, difficulties do 
exist and the current economic climate exacerbates this situation, making problems of 
access to finance more acute for an increasing number of businesses. The most acute 
problems occur in the case of high risk start-ups and well established companies 
contemplating a significant degree of expansion, or financial reconstruction following a 
period of difficult trading. In the case of Management Buy Outs and Management Buy Ins 
the situation regarding the availability of finance appears to be broadly satisfactory. 
65. The most significant reasons for the existence of these problems include: 
(i) the lack of management and financial skills by many contemplating the establishment 
of new enterprises, making it difficult for them to draw up and present satisfactory 
business and financial forecasts; 
(ii) the restricted amount of security that can be offered to banks by many potential 
business borrowers. This problem is not confined to start-ups and very small firms, and is 
exacerbated in some Member States by restrictions on what will be accepted as security 
i.e. personal life insurance policies; 
(iii) the inadequacy of management controls in many expanding companies, which 
exacerbates shortages of working capital, coupled with an ignorance of available EDP 
systems that might correct the situation; 
(iv) the high and irrecoverable costs involved in the supervision and assistance of SMEs 
receiving small loans; 
(v) the need for adaptation by many SMEs, especially for those whose major activities lie 
within the defence sector, although many more firms need to react positively to structural 
changes within their traditional markets; 
(vi) the lack of networking between regional financial centres and their lack of knowledge 
regarding the actual financial needs of SMEs ; 
(vii) the inadequate number of marriage bureaus that exist to bring together private 
investors and SMEs seeking finance; 
(viii) the ignorance of many SMEs regarding financial techniques such as financing and 
leasing, and sources of finance other than banks; 
(ix) the apparently declining supply of funds for early stage development and for true 
venture capital activities leading to the appearance of a financing gaps, broadly in the 
range of 70,000 to 350,000 ECU in some parts of the Community (38), but also quite 
frequently for much smaller amounts; 
(x) the increasingly rigid lending policies of banks, largely brought about by a 
combination of the economic climate and their weakened capital bases; 
38 "Financial Times" 21.9.92 and "Report of the Early Stage Committee of the European Venture Capital 
Association to the Commission, 20.10.92. 
36 
(xi) the present reluctance of some leasing companies to finance the acquisition of plant 
and machinery; 
(xii) the relatively short investment horizons of many venture capital and capital 
development companies, together with a growing aversion of the majority to take risks; 
(xiii) a lack of suitable exit routes for venture capital companies, so making it difficult 
for them to realise their investments; 
(xiv) the almost total lack of properly functioning "over the counter" stock markets on 
the American pattern within the Community; 
(xv)the over-rigid categorisation of investments by lenders, leading to the creation of gaps 
in the provision of follow-on funding. 
66. In response a number of new initiatives seem possible, although at this stage only 
broad indications can be provided as to the options available, more detailed consideration 
being required before definite actions can be launched. Whilst in most instances this would 
involve action at the level of the individual Member State, there are instances where joint 
action, or at Community level alone, would be appropriate. For example, the relative under 
capitalization of Community SMEs compared with their US and Japanese counterparts and 
the wide disparities in financial provision that exist between the more developed and less 
favoured regions of the Community. In both instances examples of best practice would be 
best collected at Community level. 
67. New and original initiatives to improve managerial and financial skills must be 
introduced urgently. An essential first step would be to build on those schemes already 
offering integrated and comprehensive advice and counselling for new and existing 
businesses in some member states. Those have been organized by, amongst others, the 
chambers of commerce or the industrial and craft organisations of those states. If these 
were developed, then together with those schemes offered through the European 
Community Business Innovation Centres and their network, essential advice services 
would be available within a reasonable distance of the majority of businesses operating in 
the Community. Experience has shown that physically counselling by an experienced 
business person on their own premises has far greater impact on those running smaller 
businesses than any formal course of training. This is not to say that the provision of 
distance learning materials would not be of value, but their main purposes would be to 
build on advice that had already been proffered and accepted. 
For those about to establish themselves in business, one recommendation would be to 
make any access to financial and other assistance conditional upon attendance at courses 
providing basic instruction in management skills, as this can lead to at least the halving of 
death rates among new businesses. 
Where better established SMEs and the improvement of their management control systems 
was involved, this would almost certainly require the use of outside professional advisers. 
Official intervention should probably be limited to ensuring that all involved in providing 
advice were able to provide evidence from a recognised professional association that they 
were able to demonstrate a minimum level of competence, together with meeting a portion 
of their fees in approved cases. 
Introduction of programmes would clearly be the responsibility of national and/or regional 
organisations, although actual implementation might well be carried out by semi-public or 
private commercial organisations in some instances. 
37 
68. The cost of investigating, supervising and advising the recipients of smaller longer 
term loans and equity injections of the venture capital type (up to ECU 150,000, but more 
in certain instances) appears to make them commercially unattractive and difficult to 
obtain as a consequence. There would appear to be three broad policy options. Firstly, to 
do nothing on the grounds that the scale of the problem was too large for official action to 
have any worthwhile impact, leaving any solutions to emerge from the market place. 
Secondly, to assist financial institutions with the costs of supervision in appropriate and 
approved cases. Thirdly to mobilise existing advice and counselling resources in order to 
assist. 
Assuming rejection of the first option, both the second and third merit further 
consideration, although not without their problems. The third option is the most attractive, 
particularly as the cost would be likely to be lower, and would certainly be possible to put 
into effect in certain areas within the Community, but in others it might be difficult to find 
advisers of the right calibre. Also, in many instances, the providers of funds would have to 
carry out their own "due diligence" investigations, so leading to a degree of duplication 
and a reduction in the cost advantage. For the counsellors to carry out such work would 
be extremely time consuming, diverting their attention from equally worthy clients, and 
would raise questions of professional liability in the event of problems arising 
subsequently. 
The second option would almost certainly be more costly in the short term and care would 
have to be taken to see that any support given was not used to reduce the proper 
commercial risks associated with investments of this nature. Any assistance towards the 
cost of initial investigations should be in the form of advances rather than grants and be 
wholly or partially repayable within a fixed period, based on a formula related to the 
overall success of a defined portfolio of investments. Costs would be further reduced if 
more "business angels" could be induced to take part in syndicates making loans. They 
could then both assist with initial investigations and act as non-executive directors 
representing the interests of outside investors. This would have the additional advantage, 
particularly in the case of seed capital funds, of increasing the number of proposals that 
could be given detailed consideration. In view of the lack of practical experience with this 
second policy option and the need to identify a mutually acceptable scheme for public 
support for such an initiative, it would be advisable initially to explore its viability by 
means of fact-finding pilot projects. 
Inevitably most schemes, of whichever type, would have to take place at national and 
regional level in order to ensure that local needs were met. In the less favoured regions, 
Structural Fund co-financing may be made available for measures to improve the access 
for enterprises to the capital market, particularly by the provision of guarantees and equity 
participation. On a Community-wide basis however the Commission could assist through 
the carrying out of further studies, the dissemination of information about the most 
successful schemes of each type, and the launching of a number of pilot projects, so that 
the benefits of wider access to development finance were available to concerned SMEs, 
wherever they were located in the Community. 
69. The provision of national and local government guarantees for loans, or the 
underwriting of part of the obligations of organisations having the same function, has 
clearly proved its value. There now seems a need to review these schemes in order to 
ensure that the needs of the medium sized company experiencing difficulty in obtaining 
urgently needed finance are fully taken into account. It has however to be appreciated that 
these schemes can never be wholly financially viable unless the access premiums paid by 
SMEs are set at such a level as to make them unattractive. Despite this, providing the 
criteria are established with some care, the high degree of leverage created by a relatively 
small net public financial contribution makes this a very cost effective exercise. 
38 
An interesting initiative, also in the context of providing loan guarantees and managerial 
support is the new financial engineering project which is included in the proposed Fourth 
R&D Framework Programme. Its objective is to improve, through an appropriate 
Community action respecting the subsidiarity principle, the European environment for the 
financing of the exploitation, adaptation and dissemination of technologies. 
This will comprise: 
- indirect measures which aim to reinforce the communication between financiers and 
the promoters of technological projects, to support the establishment of effective 
systems for mobilising private capital and the exit from investments, to and to promote 
the most appropriate legal structures; 
- pilot actions which will aim to establish or test financial mechanisms for the absorption 
of research results and technologies by SMEs. The technology performance financing 
scheme started under the SPRINT programme will be continued and a new instrument 
compatible with those of the Member States and adapted to national contexts will be 
established. In accordance with established agreements, its management will be 
entrusted to public or private specialist financial intermediaries selected in the different 
Member States particularly for their ability to provide equity co-financing. This scheme 
should facilitate the granting of loan guarantees, interest rate subsidies and measures to 
support associated technical and managerial assistance. 
More should also be done to encourage the formation of more Mutual Guarantee Systems. 
These have the advantage of a flexible structure, making them adaptable to local or 
regional needs, or in some cases sectors of activity. By bringing SMEs together, either as a 
group or within a local organisation, they can build a sense of community as well as 
stimulating local economic activity, and have proved their worth in countries both inside 
and outside the Community. 
To build on this success and to widen the availability of these systems would appear to be 
a practical way of easing the access to finance of a substantial body of SMEs, not least 
new firms and those in the crafts sector. If such a beneficial process is to take place two 
questions will have to be addressed. Firstly, the extent to which assistance is given towards 
the costs of establishment. Secondly, whether public administrations are prepared to 
should the burden of being guarantors of last resort, particularly in the early years of a 
scheme when reserve funds may be inadequate. It is recommended that these questions be 
the subject of further study. 
70. One form of financial assistance that appears to be lacking is in the field of product 
development. Specifically for firms having to adapt their activities, especially as a result of 
reductions in defence expenditure or fundamental changes in their traditional market place. 
A small number of Venture Capital Funds devoted to assisting product development have 
been established in the USA (see paragraph 57). It would seem appropriate for the 
Commission to prepare a study into the overall situation in the Community and how the 
establishment of funds of this type could be encouraged. 
71. The same problem also manifests itself in the case of individual entrepreneurs, such as 
those engaged in research within universities or institutes. Frequently, when the objective 
is solely to develop a technology to the point where intellectual property rights can be 
registered and the idea become a marketable proposition, involvement of a Seed Capital 
Fund through the normal means of investing in a company is inappropriate and inordinately 
expensive. A possible answer to this problem has recently been introduced by one venture 
capital fund in the United Kingdom. 
39 
This is known as Product Development Investment and the objective is to finance projects 
to the point where a method of producing a product can be licensed to a larger 
manufacturer. Apparently there is a ready market place for product developments of this 
nature. A "shell company" is used as a vehicle, having injected into it the rights to the 
intellectual property by the inventor and the first tranche of financial support from the 
fund. The originator of the idea is contracted and paid by the shell company to develop the 
idea and further cash is injected on a monthly basis so that the project can be wound up 
immediately should it cease to be viable. If and when a manufacturing process is licensed 
to a manufacturer fees received are paid into the company, with the financing company 
recovering its expenses first. Afterwards royalties are divided on a pre-agreed basis. 
The advantage of this concept is that the originator does not have to find capital in order 
to complete a project and is not forced to become involved in the management of a trading 
company. Overall legal fees can be substantially reduced and ideas are brought to the 
market by companies that are in a better position to exploit them fully than a new business 
in the early development stage. The same type of vehicle has also been applied to develop 
specific products for an established company. 
It will take some years before it is possible to judge the worth of this new initiative. It 
does, however, demonstrate an original approach to solving the problem of developing 
projects, particularly those with a high technological content. It would appear worthwhile 
examining the feasibility of the Commission launching a study into how to encourage the 
creation of more product development vehicles of this nature. It has to be acknowledged 
that this will not provide a total solution as there are firms and individuals who, whilst 
wholly dependent for success on the technology they are developing, are unable to protect 
this by means of patents. The time and costs may be too high for a small firm, and larger 
competitors can often find their way round a patent even should one be granted, making 
the process uneconomic. 
72. There appear to be two areas where networks to improve the links between potential 
investors, particularly private investors and those seeking funds could be improved. The 
first is through assisting the development of links between regional financial centres and 
the training of staff in those centres so that they acquire expertise in the financing needs of 
SMEs, so enabling them to bring together companies with appropriate institutional 
investors from another centre. It has been indicated by those engaged in this field of 
activity that initiatives of this nature will be carried out in due course by the regional 
financial centres themselves, although not in the present financial climate. In view of the 
financial problems that have been seen to exist, there would be value in exploring how the 
process might be expedited, to the benefit of SMEs in some thirty regions of the 
Community where distinct regional financial centres exist. 
Another possible initiative, taking account of the findings that a largely untapped and 
potentially substantial pool of private investors exists, would be to build on a current pilot 
action in one Member State establishing marriage bureaus bringing together private 
investors and SMEs needing finance. Actions would have to be based at local or regional 
levels, as research has shown that private investors are not generally interested in making 
investments in companies located more than 150 kilometres from their base. 
Apparently, in at least one Member State, there is a degree of uncertainty about the 
application of the law governing the provision of financial services which is leading to 
financial advisers avoiding this area of activity. Whilst investors must be protected, those 
seeking to take equity stakes in private companies are likely to be reasonably sophisticated 
in financial matters and it would appear important for the Commission and Member States 
to ensure that Community and national legislation is not framed in such a way as to 
needlessly inhibit this form of activity. 
40 
73. Certain factors affecting access by SMEs to finance do not fall into such convenient 
categories as those considered above and any proposals to alleviate them have to be drawn 
up in the light of two major questions. The first is whether present restrictive lending 
policies by financial institutions will be relaxed when economic activity picks up. The 
second, whether as some predict, the 1990s will be an era of comparative shortage of 
investment finance, particularly when compared with the 1980s. 
In regard to the first, history shows that a severe economic down turn, with the substantial 
increase in bad debts that it brings in its train, colours the attitude of lenders for a 
considerable period, perhaps as long as ten to fifteen years. It would be prudent to assume 
that this will again hold true and that it will be less easy to obtain business finance in the 
next few years than it has been in the recent past. Those in what are judged to be high risk 
categories will certainly face particular problems in such circumstances and many may 
have to endure higher interest spreads, increased fees, and credit rationing. 
It is less easy to judge whether an actual physical shortage of capital will make this 
situation worse, but the signs are not altogether encouraging. As has been seen banks and 
other institutional investors have suffered substantial losses because of business failures, 
declines in the value of property and other fixed assets, and defaults on loans, including 
those of sovereign governments. Although significant numbers apparently remain, many 
individuals who might normally have been expected to invest will also have had their 
ability to do so undermined by recent economic conditions, particularly by declines in 
property values in some Member States Additionally, nearly all governments are facing 
budgetary pressures which will limit their ability to intervene actively through the creation 
of new initiatives, even should they wish to do so. 
It would, therefore, be wise for policy making purposes to estimate that financial 
conditions will remain tight for at least the next five years. If the situation recovers more 
quickly that should be viewed as being a bonus. This could effect the whole perception of 
the internal market programme in the eyes not only of SMEs but the general population, 
virtually half of whom are employed by firms in this sector. It follows that it would be in 
the general interest to see what actions might be taken to ease the situation. 
74. One area in which national and/or regional governments can influence the need for 
access to additional capital is through their taxation policies. For example: 
- the more capital that can be reinvested, as opposed to being paid in corporate taxation, 
the less the need to tap outside sources. A very important consideration for many 
European SMEs, who are under-capitalised in comparison with their counterparts in 
Japan and the USA; 
- the move to a cash accounting system for value added tax can have a beneficial impact 
on the working capital requirements of SMEs; 
carefully worked out tax incentives for private investors could mobilise significant 
extra sources of equity capital. 
Obviously this is something that has to be examined by each administration in the light of 
its budgetary and legal situation and policy objectives. Some examples of current initiatives 
have been included in Annex A. 
41 
75. In drawing up and prioritising solutions to the specific problems identified as making 
it more difficult to gain access to finance it is important not to accord any one source a 
greater degree of importance than it deserves. Venture Capital receives a great deal of 
publicity but less than 5% of SMEs will ever be suitable or eligible to make use of 
commercial sources, as will less than 1% of total start-ups. Also, whilst it is important as a 
policy objective that an efficient "over the counter" market in shares develops in the 
Community this will assist only a small percentage of those in receipt of venture capital 
investments, and is likely to prove difficult to achieve in practice. Why this method of 
raising finance is important is not because of the number of SMEs who will benefit, but 
because they are the ones who will probably grow fastest and make the greatest relative 
contribution to growth and employment creation. A US survey of 5.6 million SMEs (39) 
showed that the most successful 5% accounted for 77% of all growth, with the top 10% 
accounting for no less than 87%. 
The Community requires a wider availability of true venture capital if dynamic high 
technology and developing medium-sized companies are to have access to the scale of 
funds needed to take advantage of the opportunities created by the Single Market and to 
compete on world markets. Venture Capital Funds will not provide the hoped for support 
for these objectives unless their difficulties are addressed. An example is where a 
management buy out is financed which revitalises a company previously constricted within 
the confines of a larger group. Should expansion be sufficient to lead to a full stock market 
listing the whole exercise could have positive results. If not, the only alternative, except for 
the rare possibility of a redemption of the loan by management, may be a sale of the 
company to another large group. 
This can work well with old and new management cooperating well, but the history of 
takeovers is littered with examples where the objectives were not realised and the new 
acquisition did not flourish. So often this led to a "rationalisation" process being launched; 
a curtailment of future projects; and a slowing down in activity. This was almost inevitably 
followed by disagreements between old and new management, leading to the departure of 
the former. 
Such a result largely vitiates the original objectives of the exercise if viewed in the light of 
the economic health of the Community, which requires the development of a steady flow 
of companies to the point where they can make a significant contribution to economic 
activity, the creation of employment and the maintenance of competition. If this objective 
is to be achieved some action will be required to enable investment by venture capitalists 
to invest in the wider range of companies than is presently the case, and to examine ways 
of providing them with exit routes which do not damage the future development prospects 
of the company concerned. 
It is unlikely to be possible to induce commercial venture capitalists to make a greater 
number of investments, as they can only subject a finite number of applications to the final 
and more detailed stage of "due diligence" examination. What needs to be examined is 
how existing funds might be induced to widen their investment criteria, particularly so as 
to include a proportion of higher risk start-ups, and more investing institutions encouraged 
to invest in the more entrepreneurial seed capital funds. 
This may require consideration of some refundable contribution to administrative 
overheads in specific circumstances and the creation of guarantee funds where suitable 
ones do not exist. This idea would require much more detailed examination but it should 
be made clear that a contribution to the guarantee fund would be expected from companies 
in which investments were made as well as from the public authorities. 
39 Professor Birch, Mass. Institute of Technology. 
42 
76. The problem will still remain of those firms who need additional long term equity but 
cannot gain access to normal venture capital funds. An option would be to encourage the 
creation of local/regional funds, perhaps with some level of official financial backing, but 
also tapping other sources of capital and forms of support, such as large firms, universities, 
research institutes, and private investors, on at least an equal basis. There are objections to 
such an approach, not least that it might be difficult to build a management team capable 
of administering the fund, and this would have to be addressed through the organisation of 
appropriate training and the incorporation of appropriate financial incentives. 
77. For the majority of SMEs, the only source of outside finance will remain their bank, 
including in certain member states, the large European network of the cooperative banks, 
savings institutions, and clearing banks specialised in the financing of SMEs.. It has been 
seen how the present difficulties of these institutions is causing problems for SMEs of all 
sizes. Apart from the SPRINT Technology Performance Financing Schemes there is 
probably little that can be done by public authorities, other than to improve the availability 
of financial guarantees. Generally, the role of the Community is unlikely to extend beyond 
the extension of guarantees in respect of certain programmes associated with research and 
development and seed and venture capital. For the rest, some banks are already launching 
experimental schemes to provide relatively small amounts of equity capital to SMEs and to 
securitise export trade receivables. Also, certain encouraging developments can be noted 
in the banking sector: 
- the Italian government is proposing to repeal a law dating from 1936 which effectively 
prevents SMEs developing a one to one relationship with a bank and negotiating short 
term financial facilities: 
- the Association of Greek Banks is in process of developing an improved mechanism 
for lending to small firms; 
- a bank in the United Kingdom has introduced a pilot scheme whereby small firms are 
provided with security of funding for a five year period at a slightly enhanced rate of 
interest providing they meet certain financial reporting conditions. 
It seems necessary to see whether or not these are successful, and even built upon by 
others, before considering, in cooperation with banks, whether other initiatives are 
necessary. 
78. Whilst the current reluctance of some leasing companies to finance plant and 
equipment is unhelpful, in present economic circumstances it is understandable. The 
probability is that attitudes will change with the onset of economic recovery and that this is 
not a situation that requires consideration unless it unexpectedly persists. One the other 
hand SMEs could benefit if more independent advice as to the advantages of factoring 
were made available at the local level. 
79. Neither is it going to be easy to alter the relatively short investment horizons of many 
financial institutions. They have to have regard to the interests of their investors, who wish 
to see a return on their investment within a reasonable timescale. Although those pension 
funds who have invested in this field could take a longer term view even they would not 
wish to have their money tied up in relatively or totally illiquid investments indefinitely. 
43 
What is required is a more assured exit route than is currently available in the case of the 
majority of potential investments, taking account of the underdevelopment of secondary 
markets in the Community. Consideration should be given to the advisability and 
possibility of promoting the development in Europe of securities markets such as 
NASDAQ (National Association of Securities Dealers Automated Quotations System), 
which operates in the United States, on the basis, inter alia, of work by the Association of 
European Regional Finance Centres and by Europe's Venture Capital Association, (40) 
and in close conjunction with other Community policies, including innovation policy. 
80. The criteria for schemes assisting firms should not of themselves be so constructed as 
to lead to the creation of financing gaps. It has been noted that in the US potential 
investors do not compartmentalize themselves in the same way as in the Community. Thus, 
a fund providing seed capital plans from the beginning at what stage further investment 
may be required and which sources may be called upon. Schemes designed to assist start­
ups, and indeed other categories of SMEs should be encouraged to make similar 
provisions. This will be more easily achievable where projects are in receipt of public 
funds. 
40 EVCA Early Stage Committee, Report to the Commission of the European Communities, 20th October, 1992, 
roneo. 
44 
VL INCREASING THE EFFECTIVENESS OF EXISTING COMMISSION 
ACTIONS. 
OVERALL CONSIDERATIONS 
81. A major problem to be faced when formulating policies in this area is a lack of 
coherent statistics covering the whole European Community. In some instances these are 
apparently not even available on a national level. Specific examples include: 
- the rates of business births and deaths. Ideally these should cover at least a three year 
period in order to indicate trends. Without such figures it is impossible to know 
whether or not existing start-up programmes are succeeding, and of the businesses that 
have ceased trading, how many are relatively new and how many mature; 
- movements by number of companies into different size categories, preventing any 
estimation as to whether companies with say 20 to 50 employees are growing or 
declining in numbers. It is impossible, therefore to discover whether a negative trend 
exists in relation to any particular size category; 
- the amount of capital employed by SMEs, and the percentage division between "own" 
and "borrowed" capital; 
- figures regarding the importance of leasing and other off balance sheet financing 
methods to SMEs; 
- the net increase in employment generated by SMEs in their first three years of life in 
comparison with firms in other size categories. 
Whilst it is possible to draw on statistics from other sources they have their drawbacks, 
making this is far from satisfactory situation. Policies could be far better focussed if better 
statistics were available. 
It is understood that some additional demographic information on SMEs (births, deaths, 
size class shifts, the weight of young enterprises in job creation etc) will begin to become 
available around the end of 1993. As to financial variables, the adoption of a new 
Community legal text on business statistics, which will cover this point, is scheduled for 
the first half of 1994. It is to be earnestly hoped that it will be possible to adhere to, or 
even improve upon, these deadlines. Any remedial measures taken should not lead to a 
materially greater burden of form filling for SMEs. In many instances sample surveys 
and/or the use of new estimation techniques would be quite sufficient for the purpose. 
SPECIFIC PROGRAMMES 
THE EUROPEAN SEED CAPITAL FUND SCHEME 
82. It is still far too early in the life of the Scheme to be able to make any meaningful 
assessment of the longer term outcome, either in regard to the success of the funds or the 
projects in which they invest, but that there have been only ten failures on the 141 
investments made to date is encouraging. Experience shows that it can require ten years of 
actual operations before it is possible to begin to make an objective appraisal of the 
performance of a fund. 
45 
As far as the Seed Capital Scheme itself is concerned, its initial pilot phase has coincided 
with an overall down turn in the availability of seed capital. In the view of researchers at 
the Fraunhofer-Institut fur Systemtechnik und Innovationsforschung in Germany, if 
Community support were now reduced and not replaced from other sources, there would 
be a decline in the availability of seed capital for high technology start-ups. In the view of 
providers of seed capital participating in an Anglo-German workshop on the subject, held 
in the United Kingdom at the end of September, 1992, the Seed Capital Fund Network 
was both imaginative and valuable. 
As noted under Point 75, the Community needs more entrepreneurial seed and venture 
capital funds in order that those with good new ideas for products and processes may have 
money for their development and its most dynamic and growing companies receive the 
additional equity funding they require in order to maintain their impetus. The European 
Community using its resources and influence has successfully stimulated funding for seed 
capital and the support of start-ups, not least in the field of high technology. Despite this 
achievement, with private institutional provision of venture capital for early stage 
investments in decline (from 25.4% in 1985, of which seed capital 2.9%, to 5.3% and 
0.6% respectively in 1992) and with an unbalanced dispersal of funds throughout the EC, 
there seems a major need for this work to be continued under a structure more appropriate 
to long term operations.. 
This makes it necessary to devote continued attention to tackling the problems identified 
by existing funds within the Scheme. These include: 
(i) the relatively small size of most fiinds, making administrative costs disproportionately 
heavy. This was only conceived as being a pilot action and valuable lessons for the future 
have already been learned as a result. It would not, therefore, be a disaster if repayment of 
some advances had to be delayed. The priority is to ensure, as far as is possible, that all 
funds reach viability. If the performance of some is affected by the requirement to take 
more account of local or regional social development requirements than to engage in 
profitable investment, it should be for official local bodies to take over part of the running 
costs. The remainder of the existing funds are in process of raising more fiinds , so as to 
increase their money available for investment to at least ECU 5 million. 
(ii) a demand for additional training and information provision has been identified and the 
Commission is providing this through the medium of the Seed Capital Network. 
(iii) greater emphasis needs to be placed on the projects receiving investment expanding 
their sales into new markets. There is a clear need to explore the degree to which the 
established network could facilitate inter-country trading within the Community. 
(iv) it appears necessary to study whether or not the eventual viability of funds within the 
Scheme might not require a revision of some of the criteria governing their operations in 
order to allow a certain degree of additional flexibility. 
(v) the review has revealed that whilst the financial advice offered to companies receiving 
funds is good, other advice in fields such as marketing is less helpful. This indicates that 
the range of entrepreneurial skills and experience within the management team needs to be 
broadened. This can only become economically possible if the average size of fund, or the 
amount of financial assistance given, is increased. 
46 
What this pilot project has revealed is that official support and encouragement of venture 
and seed capital funds can attract substantial private sector financial participation and, if 
the schemes are properly structured and supervised, achieve an encouragingly low early 
failure rate amongst those projects in which investments are made. For the Community to 
carry on this exercise permanently would be inappropriate, action at national and regional 
level based on the lessons learned would appear to be preferable. Even so, the network 
established between funds has proved its worth and deserves to have support maintained 
on a long term basis. 
VENTURE CONSORT 
83. The Review referred to in Section IV revealed that the assistance made available by 
the Commission was of the greatest value in encouraging investors to participate in trans­
national syndicates. The administration of the Scheme was also commented upon 
favourably. Despite this there were a number of suggestions regarding adjustments that 
could be made, notably by extending assistance to funds that were not members of the 
European Venture Capital Association. A need was also identified to try to stimulate more 
support for innovation in traditional areas of activity. A particular problem identified was 
that the costs for funds participating in trans-national syndicates were significantly higher 
than for those operating in only one market. There was also a higher degree of risk. 
In order to counter the problems identified, the scheme was modified by adding a new 
facility to cover the costs incurred by the syndicate members in establishing the syndicate: 
cost of searching for syndicate partners and syndicate set-up expenses. 
Priority was also given to innovation, particularly in economic sectors that are termed 
traditional. 
Accompanying measures (information services etc.) are also foreseen in order to reduce 
the costs of transnational syndication for all operators. 
FUND FOR EXPLOITATION OF COMMUNITY R&D RESULTS BY SMEs. 
84. Details of this new proposal by the Commission, within the context of the Fourth R & 
D Framework Programme, have been set out in paragraph 69. It has become increasingly 
clear that major difficulties exist in achieving the optimum exploitation of discoveries made 
under the Community R & TD programmes. Many of these arise because of shortages of 
suitable finance and/or financial guarantees. It is anticipated that this programme will have 
a beneficial long term effect on the better provision of support for businesses attempting to 
bring new products and processes to the market. 
47 
EUROTECH CAPITAL 
85. A first detailed evaluation of the scheme will be performed as foreseen by the end of 
1993. It can already be noticed that the programme has succeeded in attracting major 
venture capital funds committed to transnational high technology projects and covering 
most of the Member States. The immediate objective is to complete the network by adding 
more entities in order to achieve the best possible geographical coverage of the 
Community, hence making fiinds available to SMEs wherever they are located within the 
Community. 
THE EUROPEAN INVESTMENT BANK 
86. On 13th December, 1992 the Council approved the establishment of a new European 
Investment Fund to be operated by the European Investment Bank with an initial 
capitalization of ECU 2bn Initially the Fund will issue guarantees in the framework of 
global loans to banking institutions, but it will later take an equity participation in 
investment vehicles providing SME financing. This could in the long term provide leverage 
of up to eight times the capital guarantied or advanced. In addition, a decision was made at 
the European Council in Copenhagen to institute a further financing facility, which would 
make an additional ECU 1 bn available to SMEs at concessionary rates of interest (a 
maximum of 3% over five years) in instances where the investment will lead to the creation 
of new employment. These new facilities, whilst not solving the complex problems of 
access to finance by SMEs, will make a significant additional contribution. In addition it is 
anticipated that the new Cohesion Fund will also increase the supply of risk capital 
available in assisted regions. 
48 
VH OVERALL CONCLUSIONS 
87. Financial problems exist for too many SMEs and are tending to worsen. The problems 
within the Member States are broadly similar although they may differ in magnitude, and 
the optimum economic development of the Community could be retarded by this 
development. 
At the same time there are a considerable number of public and private schemes designed 
to assist at SMEs with their financial problems at local, regional, national and Community 
level. What appears to be absent is any form of linkage between them, which could 
promote best practice, reduce the danger of duplication, and obviate any waste of financial 
resources, at a time when these are not in abundant supply. In order to improve delivery it 
would seem necessary to clarify policy objectives in relation to SMEs, both at the national 
level and that of the Community. The time may also be ripe for making an independent 
comparative evaluation of at least the major schemes so as to define their strengths and 
weaknesses and to provide a firm basis for the refinement and expansion of existing 
policies aimed at reducing the size and impact of existing equity gaps. 
The objective of the Commission in implementing Community policy must be to avoid 
duplication of national and regional efforts, but instead help to fill gaps in provision, 
investigate new possibilities, and promote best practice . This would particularly apply in 
relation to the stimulation of the provision of seed and venture capital, the encourage of 
networking between providers of capital, the better use of the results of Community 
Research and Development projects, and the continuation of efforts to alleviate the 
disadvantages suffered in the peripheral and less well developed regions. 
It is clearly impossible to resolve all the problems related to finance experienced by SMEs 
though official initiatives, but significant improvements could be made through judicious 
measures. It has been seen that the difficulties of the generality of firms could be partially 
eased through their taking action to make more efficient use of their financial resources by 
better financial planning, coupled with an improvement in the standard of information that 
they provide to their bankers. Where they could be assisted is through the making of 
management training and enterprise counselling more accessible, together with a greater 
availability of financial guarantees for those unable to lodge sufficient collateral. 
It is important that the problems arising out of difficulties of access to finance should be 
addressed in relation to all SMEs, right down to the very smallest, but for the optimum 
economic development of the Community it would seem necessary to concentrate special 
attention on the problems of the five to ten per cent of businesses that have the capacity, 
given advice and appropriate financial support, to achieve rapid growth. The majority 
falling into this category will require long term equity finance, available in the main from 
Seed Capital, Venture Capital and Development Capital Funds, which is why these sources 
of finance have received such a high degree of attention, although of little or no interest to 
the majority of firms. 
It follows that priority should be given to the consideration of measures to stimulate the 
growth and further creation of funds of this nature, particularly those with a bias towards 
making investments in areas of high technology. One advantage of taking action in this 
field is that public authorities will not be placed in the invidious position of picking 
"winners", for which no proven method currently exists. This would be the role of private 
investors. 
49 
What these investors state they require most is aid towards the cost of investigating 
propositions, together with the development of an infrastructure which will provide them 
with better exit routes at the end of their planned period of investment. Whether more 
ambitious forms of support should be contemplated will require careful consideration, 
particularly as it would not be right for public funds to be used in order to reduce those 
risks which are inseparable from investments of this nature. 
If carefully planned, and fully coordinated with existing initiatives, the proposed measures 
should not require a large increment to the current level of public funding, although there 
would be an increase in contingent liabilities arising out of the extension of guarantee 
schemes. Indeed, if given time, they should prove largely self-financing through stimulating 
an increased production of higher value added products within the Community, have a 
favourable effect on levels of unemployment, and result in an increase in tax yields, both 
from those re-employed and the businesses in which they will be working. To take no 
action would carry the risk of threatening the future competitiveness of the Community in 
a number of developing areas of industrial and commercial activity. The choice would 
appear to be clear. 
50 
ANNEX A 
EXAMPLES OF SCHEMES PROVIDING FINANCE FOR SMEs WITHIN THE 
EUROPEAN COMMUNITY 
NATIONAL AND REGIONAL 
1. A government sponsored scheme to guarantee loans made to SMEs who lack 
both a track record and security to offer a bank has existed in the United Kingdom since 
1981. Up to the end of 1991 30,000 loans had been approved totalling £940 million. In 
recent years the failure rate of businesses receiving such loans has been rising but is still 
comparable to the failure rate for all businesses. The scheme has always operated at a loss. 
In the 1993 Finance Act certain changes were made in order to widen the scope so as to 
make more established companies eligible and reduce the guarantee costs. Premiums were 
reduced to 0.5% on fixed rate and 1.5% on variable rate loans, but now apply to the whole 
loan rather than just the guarantied portion (these were 70% normally, 85% in certain 
inner city areas). The level of guarantee was increased to 85% for all loans, and the upper 
limit raised from £100,000 to £250,000 for established businesses only. 
2. Mutual Guarantee Systems in Germany have, since their foundation, approved 
approximately 100,000 guarantees for a total of 8 billion DM, covering loans amounting to 
11 million DM. Fifty six percent out of a total of some 4,000 granted annually are applied 
to the establishment of new businesses. Guarantees are provided for loans, the support of 
leasing contracts, and investments in SMEs. No dividends are paid, any surplus funds 
theoretically being transferred to reserves. 
A prerequisite for assistance being granted is that any application from a firm should be 
accompanied by a letter from a bank stating their willingness to take over that part of the 
risk not covered by a guarantee, which can vary between 50% and 80% of the total sum to 
be advanced, with an upper limit (subject to some exceptions) of 1 million DM. The 
average term of guarantee is ten years, although this can run to 23 years in the case of 
construction projects. A procuration fee of 1% of the guarantied sum is payable on 
application, a further guarantee commission, normally an additional 1% is payable on 
completion. 
3. Under another German scheme, mutual guarantee organisations of this type can 
guarantee 70% of equity investments made by sister organisations known as 
Mittelstandische Beteiligungsgesellschaften. These are able to invest up to 1 million DM in 
both new and existing SMEs. Almost 40% of total sums invested are venture capital type 
financing of innovative projects. Participation is on a silent partner basis and guarantees 
are not asked from the owners of the firm. Loans are normally due for repayment after ten 
years and serve to fill the gap not covered by bank loans. Rates of interest charged are 
0.5% over inter-bank rates. Banks provide the balance of finance required as working 
capital at approximately 1% over inter-bank rates. 
4. In Denmark the government provides co-financing, through grants of up to 50% 
to newly established businesses, for the cost of new product development, or the cost of 
penetrating new markets. Other small firms are eligible for repayable loans, to be devoted 
to the same objectives. 
51 
5. In the Netherlands PPM, a private equity participation scheme established in 
1981, guarantees half of any losses made on individual investments, principally in 
companies with less than 100 employees and for a period of up to six years (12 years in the 
case of property). Companies receiving PPM supported funds have been shown to have 
had a substantial and favourable impact on employment. 
6. In 1989 the German Federal Ministry for Research and Development launched 
the "Investment Capital for New Technology Based Firms" pilot scheme (BJTU) with the 
aim of supplying indirect assistance for firms in this category. The objective was to create 
a sufficient supply of risk capital both for their research and development operations and 
the market entry phase. 
Two investment models are provided: 
The co-investment model: in which the Technologie-Beteiligungsgesellschaft mbH (BTG) 
makes an investment of up to DM 1 million in a company as a sleeping partner providing 
the lead investor provides at least the same amount. In the first three years after the 
investment is made the lead investor can tender its stake to the BTG, which is forced to 
acquire it, but at a discount of between 40 and 60%. Durinjg the same period the BTGs 
stake can be purchased by the lead investor, but at a premium, which is generally 25%. 
This model is designed to appeal to profit orientated venture capital companies without 
refinancing problems, as it enables them to limit their losses but maximise their profits if 
the investee company prospers. 
The refinancing model: is offered in cases where funds are suffering refinancing problems. 
Currently the second option is proving more popular, with calls on funds of DM 50 million 
as against DM 30 million. To date investments by banks and regional funds have proved 
more successful than those made by venture capital funds. The German government has 
expressed its willingness to invest DM 150 million in each fund, to continue its support of 
investments made for a ten year period, and is prepared to contemplate a 25% loss. 
7. In the United Kingdom some fifty Regional Venture Capital Funds, excluding 
branches of national financial organisations such as 3i, have been specifically 
identified (41), the majority having been established during the last ten years. Most are 
small, having only between five million and twenty million pounds to invest, but have the 
ability to bring about local syndication of larger deals. They also provide a local focal point 
for the attraction of money from larger financial centres. 
One fund invests only in small and medium-sized companies in its immediate geographical 
area with existing turnovers of between 700,000 ECU and 6.88 million ECU, with the 
average capital injection being 400,000 ECU. Funds are normally provided either for 
expansion or the funding of a management buy out. Companies are selected on the basis of 
a careful assessment by the fund managers who have wide industrial and commercial 
experience. Noteworthy is that the amount of time devoted to management support is 
substantial, involving for example the implementation of improvements in management 
systems and providing training in strategic management. To date 20 companies have been 
supported to a total value of 8.8 million ECU. The results have been so encouraging that 
another fund is being created which will be wholly financed by private sector capital. 
Broadly similar schemes have been identified in Sevilla (Spain), Shannon (Ireland) and the 
Toscana region in Italy. 
41 "Financial Times", supplement on Venture Capital, 25.9.1992 
52 
In Belgium the BRUSTART scheme was established in order to provide access to venture 
capital to start-ups or growing new companies of less than five years of age operating in 
the Brussels region. Loans, which are normally for a period of seven years at market rates 
of interest, are provided without guarantees where necessary. The availability of 
management advice and support is a specific feature. 
The Flanders Region Take-Off Fund GIMV has been in operation since 1989. This offers 
finance for growth or product diversification to firms established for less than three years. 
Firms involved in property or operating small shops are excluded. Entrepreneurs under 35 
years of age, who have not previously started a firm, have had access to loans for 
investments in fixed assets, capital goods and intellectual property from a special fund 
since 1990. 
8. The ANVAR organisation has twenty two regional offices suppling its services to 
SMEs in metropolitan France. Its role, as a state funded organisation, is to support the 
development of innovation in small and medium sized firms. During its twelve years of 
operations assistance has been provided to more than 15,000 companies. 
ANVAR will supply up to 40% of the finance required for approved projects, without an 
upper limit. This is given as an interest-free advance, repayable only if the project is 
successful. Provision of this finance provides the resources for the mounting of proper 
feasibility studies and the use of outside expertise and consultancy where required. 
Evidence of this support in turn gives confidence to other financial backers. 
In collaboration with the European Venture Capital Association and the SPRINT 
programme it also organises investment seminars where those seeking finance can meet 
with financial institutions. In appropriate instances it can also provide assistance for 
projects carried out in conjunction with foreign companies or research agencies. Financial 
help is also provided both towards the costs involved in technology transfer and the 
registration of intellectual property rights overseas. 
9. Other examples of guarantee schemes include: 
France: Sociétés de Développement Régional - are regional development companies 
which are empowered to provide loan guarantees for business start-ups. In addition they 
provide long and medium term soft loans and are permitted to hold up to 35% of the 
equity capital in an enterprise.. 
Italy: has the Medio Credito Centrale (Central Agency for Guarantees). Taking account of 
the additional facilities provided by the Consorzio Fidi and the Co-operativa di garanzia 
Italy has the highest number of mutual guarantee schemes in the Community. 
Spain: has established, with Community assistance, the SOGASA agency for guarantees. 
This includes 25 mutual guarantee funds, the Institute for Small and Medium Enterprises 
and the Official Credit Institute. The objective is to provide a reguarantee facility. 
10. Three Community countries have venture capital type schemes in addition to 
those listed earlier: 
France: Thirteen locally based Sociétés Financières pour l'Innovation are allowed to 
participate to the extent of 30% of a firm's capital. In addition a number of schemes (Fonds 
Communs de Placement à Risques, Sociétés de Capital Risque and Sociétés 
d'Investissement à Capital Fixes) have been introduced in order to make the provision of 
seed and venture capital more attractive to private investors. 
53 
Italy: Law 317 provides for participatory loans by venture capital funds. 
Ireland: possesses Early Start Technology Funds, which provide seed capital for high 
technology start-ups. 
In addition the Spanish government has recently introduced a number of measures to 
facilitate the financing of SMEs including: 
- preferential credits issued by the Official Credit Institute; 
- a credit line of Pes. 100 milliard, to assist SMEs with productive long term investment 
in 1993-94, using banks and savings banks as intermediaries. 
- Pes. 10 milliard available for reduced rate loans to small firms wishing to acquire high 
technology equipment. 
In the United Kingdom the Highlands and Islands Development Board offers: 
- long term loans of between five and twenty years based on the importance of the 
investment and the number of jobs to be created; 
- loans with an interest rate subsidy; 
- the provision of specially built industrial/commercial buildings with a fifteen year 
option for the business to buy. 
Lancashire Enterprise provides loans against which royalties on sales (once the breakeven 
point has been reached) are paid throughout the agreed term, even should repayment be 
made earlier. The first year of a loan is normally interest free. 
11. Italy: offers direct subsidies for investment in new companies under Law 44, although 
this only applies to those to be located in the Mezzogiorno. 
France: The Haute-Garonne region offers some 100 subsidies per year to assist with the 
establishment of new enterprises. The average advance is ECU 3,500 per application. 
Aquitaine offers grants to established companies based on the number of new jobs created. 
The amount varies between ECU 1,500 and ECU 3,000 per job, with a maximum limit of 
thirty jobs. 
12. Most Member States do not offer specific tax incentives wanting to respect the 
principle of tax neutrality. Those that do exist include: 
France: No social security payments are required for a certain period following the 
establishment of a new enterprise. 
Greece: a new enterprise tax exemption for those with gross profits of less than 1 million 
drs. 
Italy: provides a 50% reduction in the amount of tax payable during the first ten years of 
its life by a new firm located in the Mezzogiorno; 
Spain: accelerated investment right offs (up to 80% for new investments), together with 
greater ability to carry forward losses. 
54 
In addition, partial, total or conditional exemptions are granted from local taxes in certain 
instances. 
EUROPEAN COMMUNITY 
1. The Seed Capital Pilot Project has a series of criteria. As well as requiring that 
funds only invest in the creation or development of enterprises which need management 
and financial support prior to turning to more traditional sources other investment criteria 
are: 
- a requirement for external seed capital of not more than ECU 350,000; 
- existing capital investment of no more than ECU 50,000; 
- annual sales of less than ECU 100,000; 
- less than 10 employees; 
- a total value of share capital, at the seed funding share price, of not more than ECU 
1,500,000. 
These are very much upper limits. The typical investment is more likely to be in the range 
of ECU 25,000 to ECU 100,000, with the business considerably smaller and less 
developed than might be indicated by the above parameters. 
The Warwick Business School report, which surveyed twenty-one of the funds, reported 
that they had so far raised ECU 36.2 million, and that three quarters of the funds had 
money for investment of less than ECU 2 million. It is estimated that ECU 18.7 million of 
the above funding would not have been raised without the support provided by the 
Commumty, which had added credibility to the projects. 
In the 18 months since lending operations actually commenced ECU 16.106 million had 
been invested in 141 enterprises, an average of ECU 114227 per project. Fund managers 
intended to eventually invest in 377 separate projects. 
For 69% of the projects the funds were able to provide sufficient finance, but the others 
had raised an average of ECU 351,000 from other sources. It appears that this would have 
been more difficult without the backing or active assistance of a fund. Apparently this 
Community initiative has not only led to the creation of funds which might otherwise not 
exist, but indirectly helped in the raising from the private sector of twice as much 
additional funding for those projects that required it. 
2. The Eurotech Capital scheme concentrates on private capital funding of transnational 
projects in the field of high technology. At present, the Eurotech Capital label has been 
awarded to 11 financial entities specialized in high technology investments. Each entity has 
an investment capacity of at least ECU 50 million, of which at least 20% must be 
committed to transnational high technology projects, with SMEs being given priority. The 
funds available currently stand at ECU 170 million. 
55 
In order to qualify, projects must comply with the following criteria: 
• To be classed as high-technology projects, they must: 
fall under a Community or European research and development programme 
(BRITE, EURAM, ESPRIT, EUREKA etc); or, 
come under a national research programme; or, 
constitute a significant advance on existing technology. 
• To be classed as transnational projects, they must: 
come under a Community or European research and development programme; 
or, 
have a research phase and an industrial application phase in two or more 
countries; or, 
have shareholders from two or more countries. 
3. The objective of the Venture Consort Scheme is the stimulation of a Single Market in 
the Community for venture capital through support for new transnational syndicates 
investing in small and medium-sized companies. 
All industrial or service sectors are considered as being eligible but a degree of priority is 
given to the: 
a) encouragement of innovation, particularly in economic sectors that are traditionally 
termed "traditional"; and 
b) reduction of gaps in the supply of venture capital that currently exist in certain 
regions. 
The Venture Consort Scheme comprises two types of facility: 
a) a non-refundable contribution to a new transnational syndicate to help limit the 
additional expenses resulting from the transnational nature of the operation (up to ECU 
13,000); and 
b) a refundable advance to the investee company. The maximum amount of the 
contribution available to any one investee is 30% of the syndicate's total capital 
contribution in the investee company, subject to a maximum or ECU 300,000. In principle, 
the advance will be repayable after five years. 
4. Within the PEDIP programme, two risk capital partnerships have been established. 
These concentrate their activities in Northern and Southern Portugal respectively. An 
interest rate subvention scheme, provided by the ERDF and administered by the Caixa 
Gérai de Depositos, encourages local SME participation in projects deemed essential for 
the development of the Portuguese regions. 
56 
ANNEX B 
VENTURE AND SEED CAPITAL FUNDING MECHANISMS IN THE UNITED 
STATES OF AMERICA. 
Private Venture Capital. 
The returns sought by private venture capitalists in the US are in the order of 35% per 
annum for pure venture capital investment and around 20% to 25% for subordinated debt 
finance. Those sought on product development programmes are typically between two and 
five times the amount invested. Given the relatively long time scale of many investments, 
perhaps up to ten years, and the many investments that fail to achieve a worthwhile return 
means that it is necessary for those US firms that are successful to provide this level of 
return if the programme is to do more than break even at best. The truth is that the 
majority of funds established as a result of state initiatives have failed to do so; 
It is believed that one factor in the recent decline in the number of active venture capital 
funds in the US is the 30% increase in capital gains tax since 1988. Another, the 
withdrawal of many corporate financial and industrial groups because of the poor 
investment results funds had achieved. Whilst over the past twenty years the average 
annual return to investors has been 15%, with the top quartile earning 21.3%, this conceals 
the fact that over the last five years average returns have been only 5.8%, with the top 
quartile of funds earning 13.1%. Due to the difficulties experienced in raising finance total 
disbursements fell in 1990 to $1.9 billion from $3.4 billion in 1989. This meant that 1500 
firms, 100 less than in the previous year, received financial support. In addition the total 
number receiving start-up assistance declined to 259, or 10% of total financial support, 
with 74% doing to finance expansion or management buy outs. 
Pension funds, whether public or private accounted for 53% of total US private venture 
capital funding in 1990, endowments and foundations another 13% and individuals and 
families 11%. The latter is the fastest growing source. 
Federal Programmes. 
Federal programmes comprise: 
(i) Corporations for Innovative Development (CIDs), launched in 1979 in order to 
provide financing for technology based start-ups that were at too early a stage of 
development to attract funding from conventional sources. CIDs are state sponsored, 
independent, non-profit making bodies partially funded by the individual States. Federal 
participation is limited to matching state funding. 
(ii) Direct funding for research and development is provided through the Small Business 
Innovation Research Programme (SBIR), established in 1982. Whilst most federal 
programmes have suffered reductions in their finances during the 80s those for SBIR have 
actually been increased. Any federal agency with a budget in excess of $100 million has 
been required to establish such a programme, setting aside a percentage of its funding 
specifically for small businesses. The goal has been to increase SBIR grants to 1.25% of 
the external budgets of the agencies concerned. 
57 
(iii) Community Development Corporations were established in 1968, with the objective 
of mobilising private funds in depressed areas with the assistance of grants in order to 
encourage the formation of new businesses. This has been a failure with only two CDCs 
actually formed, illustrating the difficulty of attracting local finance in areas without an 
entrepreneurial tradition. 
(iv) The most significant federal financial initiative is the Small Business Investment 
Company Programme (SBIC), established in 1958 following twenty years of study into the 
problems of the financing of small businesses which had revealed that no institutional 
structure existed to make equity finance available to them. The basic concept was to 
provide a new financing vehicle for small companies experiencing difficulty in raising 
equity or loan capital from conventional sources. This was to be achieved by the giving of 
low interest loans to supplement the private capital raised by the SBICs. 
In its early years the programme was characterised by over eagerness, with under 
capitalised funds being supported, many of which subsequently failed. As a result the 
supporting legislation was modified and SBICs now have to have a minimum capital of $1 
million in order to be approved. After its initial problems the programme has achieved a 
number of important objectives: it introduced the private sector to the concept of financing 
small businesses; the overall level of demand and the potential for investment was 
demonstrated; it provided an entry vehicle into venture capital investment for many banks; 
and the SBICs served as a training ground for future venture capitalists. On the debit side 
it is rumoured to be suffering from over cumbersome administrative procedures. 
By the second half of the 80s overall cuts in federal programmes had their effect, sharply 
reducing the number of new SBICs because of uncertainty regarding the future availability 
of low interest government finance. This has also lead to some reduction in numbers but 
about 350 still exist, deploying no less than $13 billion in private capital. 
(v) The Loan Guarantee Scheme offered by the Small Business Administration should not 
be overlooked as it was not only the first, but is rather more generous than some if its 
imitators, covering 90% of the amount of approved loans. 
Suggestions have been made, notably in the US Senate on 16th June, 1992, that a further 
scheme called the Small Business Capital Access Programme should be introduced. This 
would operate on a portfolio rather than loan by loan basis, with the guarantees being on 
the total portfolio held by a financial institution. This would be similar to a programme 
established by the State of Michigan which has led to 950 loans being made since 1986, to 
a total value of $48.5 million dollars, and with the lending exceeding the state governments 
obligations by a ratio of 20:1. In the case of the new proposal schemes would also be 
operated by the individual states, with they and the federal authorities each guaranteeing 
3.5% of the loan portfolio 
State Programmes. 
Most of the larger State backed funds have a bias towards assisting firms in the high 
technology sector. They may be contrasted with the Maine Capital Corporation, which 
although established in 1980 has only $2 million of available funds obtained from private 
investors and a matching federal grant. This provides equity capital for all SMEs, with the 
exception of start-ups, with the prime objective of creating employment. This undoubtedly 
reflects the problems faced by a large and sparsely populated state with a number of 
declining industries such as ship building and fishing and much seasonal employment in the 
tourist industry, demonstrating the importance of matching funding objectives with local 
conditions. 
58 
Recent Proposals: 
In his State of the Union Address on 17th February 1993 President Clinton made certain 
new proposals in relation to improving the financial circumstances of SMEs: 
a) a permanent investment tax credit on equipment of 7% in 1993 and 1994 and 5% 
thereafter. 
b) capital gains tax relief for investors in small businesses, allowing an exclusion of 50% 
of the gains earned on stock investments in companies capitalized at less than $25 million 
when held for at least five years. 
c) an increase in the level of funds available under the SB A loan guarantee programme. 
At the same time it is proposed that the level of guarantee be reduced to 75% from 90% in 
order to encourage greater scrutiny, by lenders, of loan proposals. 
59 
ANNEXC 
THE FINANCING OF SMEs IN JAPAN. 
The government has established three financial institutions to furnish SMEs with funds for 
their business operations and to promote specific policy objectives. This financing is meant 
to complement that available from private banks 
(i) Special loans system: The Small Business Finance Corporation and the People's 
Finance Corporation provide special low interest rates (2.5% in 1989, but as high as 6% 
for much of 1991) to be used for specific purposes, such as improving industrial 
structures, preventing pollution, saving energy etc. 
(ii) Loans aimed at improving the management of small scale enterprises: The People's 
Finance Corporation provides financing for improving the management skills in small 
enterprises. This commenced in 1983 to assist the Management Improvement 
Dissemination Programme conducted by the Societies of Commerce and Industry and the 
Chamber of Commerce and Industry. Small enterprises can borrow money under this 
scheme without having to provide collateral, or have a guarantor. 
(iii) The System of Credit Guarantees and Credit Insurance: This is officially known as the 
Public Credit Supplementation System and assists SMEs to borrow money from private 
banks by acting as official guarantor and providing insurance. Requests for a guarantee are 
initially submitted to a Credit Guarantee Association, which are located in 52 cities 
throughout Japan. Should the requirements of the Association be met, funding will be 
guarantied, enabling the applicant to borrow from a private bank. In turn, the Association 
will insure the amount guarantied with the Small Business Credit Insurance Corporation. 
Should there be a default on the loan the local Association will repay the bank the 
outstanding balance. It will in turn receive between 70 and 80% of the loss from the Small 
Business Credit Insurance Corporation. Should the Association, which has now become 
the debtor, recover any part of the loan it will have to repay between 70 and 80% of the 
amount recovered to the SBCIC. 
(iv) Financial Assistance System for Small Business Reinforcement: Many SMEs need to 
restructure because of changes in the market place, the development of new technologies, 
or even in the case of a retailer, the opening of a Superstore in the locality. This scheme 
was established in 1980 in order to assist in just that type of situation. This is a tripartite 
venture between national and local government and private financial institutions, the latter 
having official funds channelled to them through the Credit Guarantee Associations. The 
private institutions then add their own funds, with the total being specifically available to 
provide fundinjg for the restructuring of small firms. In this way a high level of gearing is 
apparently achieved. 
60 
ANNEX D 
RESULTS OF A STUDY BY THE EUROPEAN ENTERPRISE CENTRE AT THE 
CRANFEELD SCHOOL OF MANAGEMENT INTO THE ATTITUDE OF 
SMALLER FIRMS TOWARDS FINANCING AND FINANCIAL INSTITUTIONS 
IN EUROPE 
The report represents the views of 739 companies from Britain (156), France (168), 
Germany (151), Italy (129) and Spain (135), out of 6000 approached. Although this means 
that the sample may not be statistically balanced the number of companies surveyed 
probably means that the indications given are significant, although not conclusive. The 
results may be summarised as follows. 
OWNERSHIP AND CONTROL 
In most of the companies the manager or their family owned a substantial proportion of 
the equity. This was most popular in Italy and least popular in Britain. Only 12% had some 
voting equity owned by venture capital companies. Most were in Britain (43%) and France 
(40%). A further 21% reported that some of their equity capital was owned by other types 
of financial institution, with Britain at 39% and France with 27% again being the countries 
where this was most common. 
FINANCING STRUCTURES 
These were fundamentally different in each country. Taking gearing (total debt divided by 
shareholder's funds) as the yardstick this was generally lowest in Britain and France, with 
British firms having the highest proportion of short term debt, particularly overdrafts, only 
25% ever used long term loans. German companies had the highest proportion of long 
term debt and preferred short term loans to overdrafts, with only 47% ever using the 
latter. Britain had the highest proportion of compames with no debt (31%) and Spain the 
lowest (10%). 
One notable feature was that the smaller the company, whichever the country in which it 
was located, the greater its reliance on overdraft finance. 
61 
LEASING AND HIRE PURCHASE 
Leasing and hire purchase were popular in all countries other than Italy where it only 
represented 6% of total debt. In France, where it was most used it accounted for 19% of 
total debt. 
RAISING FUNDS 
In all countries smaller companies felt that long term loans were less easy to obtain than 
did larger companies. This is consistent with their use of overdraft finance. Most 
companies believed equity finance, from any source, was in short supply and difficult to 
obtain. Generally, most companies in all the countries (67-78%) thought it difficult to 
obtain from institutions. 
Most popular was the use of internal funds, followed short term loans. Equity finance from 
financial institutions was consistently the last choice, a preference particularly marked in 
smaller firms. 
COSTS AND COLLATERAL 
Variations existed from country to country in the views expressed about the costs of 
different forms of finance, but there was no evidence that smaller firms faced higher costs. 
There were however significant differences in the incidence of the provision of security 
against loans from country to country. Most British (74%), German (82%) and Italian 
(56%) companies provided collateral against their loans. Fewer companies did so in France 
(41%) and Spain (47%) . 
INFORMATION AND ADVICE 
"Knowledge of business by all providers of finance was seen as "average to poor" in most 
countries. Helpfulness of advice was also only rated as "average". Opinions about 
institutional providers of equity were little different from those about providers of 
overdraft and loan finance. 
ISSN 0254-1475 
COM (93) 528 final 
DOCUMENTS 
EN 10 08 
Catalogue number : CB-CO-93-561-EN-C 
ISBN 92-77-60179-5 
Office for Official Publications of the European Communities 
L-2985 Luxembourg