The Regulation on European Venture Capital Funds

Updated: June 26, 2020 | 4 minute read

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This article deals with Small to Medium Enterprises (SMEs) and their financing. The 2008 financial crisis brought the European Commission (EC) to revisit previous efforts made to strengthen the risk capital market, making European SMEs more competitive globally.

The situation led to a decision to promote a new regulation 'The European Venture Capital Regulation' – which sets to regulate European Venture Capital Funds. This was essential for the EC as the EU's economic climate was considered to deter Venture Capital finance, a finance tool considered as a significant contributor both to filling the financing gap faced by SMEs and also to help innovative entrepreneurs take their idea to commercial levels.

The Regulation on European Venture Capital Funds – A New Opportunity for SMEs?

Investment in innovation often depends on the availability of finance. This statement evidences the relationship between the two sides of the capital market, the deficit units requiring finance and the surplus units providing finance. The most prominent and widely used forms are customarily described as debt and equity financing. Over time these two general categories of finance have evolved. They have been reconstituted and re-engineered, to some extent even converged to create new solutions and instruments for the provision of finance, all of which are generally aimed at meeting the long term financial demands of entities.

At a European level, the most prominent form of finance used is that of the traditional credit lines, which account for 80% of their finance and the users of such are predominantly Small to Medium Enterprises ‘SMEs’. This given the fact that more than 99% of all European businesses are SMEs and of which are estimated to provide two out of three of the private sector jobs and contribute to more than half of the total value-added created by businesses in the European Union ‘EU’.

On this basis, there is little doubt that SMEs are central economic drivers within the EU and are considered to be an essential source for the creation of jobs whilst representing the seed for future established companies.

However, it is primarily understood that SMEs are highly vulnerable given that they would find it more challenging to downsize as they:

  • Are already small;
  • Are individually less diversified in their economic activities;
  • Have a weaker financial structure;
  • Have a lower or no credit rating; and
  • Are heavily dependent on credit with little or no other forms of financing options.

All factors resulted in the need to develop appropriate risk capital markets back in 2008 during the economic crisis.

The Regulation was explicitly designed to overcome the main constraints to the proliferation of this form of financing, which was then fragmented and dispersed legislation of venture capital funds across the EU when compared with competing for global centres of high-tech and innovation. The use of regulation, being directly applicable throughout the Community further served to highlight the extent of the dedication to the promotion of a Europe wide European Venture Capital Fund label.

However, the dedicated regulation focused on mitigating the regulatory fragmentation, which may in itself not be considered to be the sole culprit of stalling Venture Capital financing within the community. As there are other deep rooted cultural issues, such as the inherent trait of risk aversion, the lack of European serial entrepreneurs, as opposed to the Anglo-American culture, are most evident across the EU and are therefore, jointly considered to be deterrents to the venture capital ecosystem within the EU.

Apart from the dedicated Regulation the EC has further for the past years organised an SME week. The latest edition of this year’s SME week focused on the promotion of entrepreneurship which based on statistical data 61% of the Maltese prefer being employed rather than self-employed and therefore a culture which is evidently risk-averse which often shy away from being an ‘Entrepreneur’.

The 2013 edition of SME week further aimed at giving recognition to entrepreneurs for contributing to Europe’s welfare, jobs, innovation and competitiveness. This coupled with private initiatives, such as the “Startup Weekend NEXT programme” further foster and ignited a positive sentiment towards entrepreneurship on a local sphere.

It must, therefore, be said that the success of this Regulation across the EU and even in Malta widely depends on factors which are external to it. Based on the multiple factors which are affecting the European Venture Capital Malta, Policy Makers and even SMEs would effectively have to wait in order to the gauge the success of this new attempt to stimulate the risk capital market in terms of reaching the intended results, that of making European SMEs competitive on a global sphere.

The content of this article is intended to provide a general guide on the subject matter. Specialist advice should be sought regarding your specific circumstances.

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Written By

Luke Cann, Partner, Advisory Services 

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