Report from the Workshop: Finance for SMEs

This report is a result of work undertaken in the context of a workshop: Finance for SMEs, held with support of the European Economic and Social Committee Employers’ Group on November 3, 2014 .

A group of discussants, together with the audience brainstormed on how to resolve problems related to access to finance of businesses at different stages of development.

Cases were presented by SMEs.

Report from the Workshop:

Finance for SMEs

List of contents

Demand and supply side ... 8

Regulatory framework- building new finance ecosystem ... 10

What’s next- the vision for the future ... 12

Annex ... 14

Cases ... 14

1. Background

Despite the fact that SMEs report less deterioration in the availability of finance from external sources, their financing conditions differ significantly across countries and are in general more difficult than those of larger companies. Rapid restructuring of banking sectors has left fewer players in some member states. Those remaining ones suffer from lower risk appetite being less inclined to provide loans to young or small businesses considering the cost-benefit analysis and risk exposure unfavourable.

Businesses have different financing needs at different stages and not meeting those needs is equal to hampering the SMEs growth. The diversified sources must cover both debt and equity based financing to reflect the varying needs and situations of businesses. Meanwhile, debt based financing is harder to access and equity based financing is evolving very slowly. Even if tax remains a national competence, this shows the need for coordinated action at European level. The removal of double taxation on equity in some countries would be one such measure.

An efficient allocation of financial resources, both public and private, is a prerequisite to ensure that taxpayers’ money benefits the community, including entrepreneurs. In order to help businesses and sustain the economy, policy-makers have taken a number of measures in order to restore access to finance via Investment Plan for Europe, new financial instruments, equity financing, long-term financing and provision of additional funds to the European Investment Bank. Nevertheless, the impact of these measures remains to be defined.

2. Introduction

The financial crisis has increased challenges of access to finance for SMEs. At a time when banking intermediation is under pressure, it is important to further explore alternative forms of financial intermediation. Various forms of finance might be more appropriate for different types of SMEs than others, e.g. grants, loans, guarantees vs. equity, and might help to bring the access to finance equation to equilibrium.

2.1. Debt

In many European countries smaller and regional bank lenders provide a higher share of SME lending than their larger peers. However, as many of these institutions now are deleveraging faster than their larger peers, their customers have struggled to find credit. In addition to these changes, rapid restructuring of entire banking sectors has left fewer players in the market, so in some member states the ability of SMEs to acquire financing became weaker. In order to meet the capital requirements and heal their balance sheets, some banks have introduced pricing caps and will not serve customers whose risk pricing falls outside those caps. Taking into account the fact that 85% of loans for businesses still come from banks, there is an urgent need to find a balance between a sustainable financial sector and meeting the financial requirements of businesses.

The EU and member states have introduced a number of additional financing instruments in order to trigger the banking sector and secure sufficient supply of traditional forms of financing. Despite these efforts, in many member states it is evident that the flow of financing to businesses remains obstructed. SMEs tend to have a smaller pool of relationships with banks. This implies a need for better understanding and reduced information asymmetry, which in turn leads to an improved dialogue, a more transparent credit history and thus a higher probability of a loan being accepted.

Demand

of SMEs

Supply by

financial

intermediaries

Bank consolidation, however, has undermined relationships with SME clients through a loss of proximity and interpersonal contact, as well as an inability or unwillingness to specialise and provide a range of services. This has led to less financing options for SMEs. Bearing in mind the strong dependence of European businesses on bank loans, there is a need to conduct a closer examination of opportunities coming from other forms of financing. Working on reviving non-bank lending, including securitisation, is crucial, since used in the right way, it could spread risk intelligently, while efficient guarantee systems could provide more capital relief to banks.

SMEs’ use of internal and external financing, EU-28, % (2013)

Source: European Commission

2.2. Equity

In most European countries, the taxation of income from equity is more onerous than the taxation of income from debt. A reduction of this tax bias is viewed by some as a way of addressing the unsustainable reliance of the European economy on debt based financing. According to the McKinsey Global Institute, in wealthier economies such as France, Germany, Italy, Spain and the UK, the equity gap is expected to increase to EUR 2.5 trillion by 2020, while economies with less developed financial markets usually suffer from even

0% 10% 20% 30% 40% 50% 60% 70% 80% 90%100% Bank overdraft, credit line or credit cards overdraft

Leasing or hire-purchase or factoring Trade credit Bank loan Internal funds Other loan Grants or subsidised bank loan Equity Debt securities issued Subordinated loans, participation loans or similar

higher equity gap. Worldwide, the potential global equity gap in 2020 will reach EUR 9.28 trillion, but at the same time most tax systems today contain a “debt bias” offering a tax advantage to finance investments by debt.

While the relatively low level of equity financing in Europe has various causes, it can in part be addressed through a more incentivising fiscal regime. Risk financing varies between member states due to heterogeneous tax systems, encouraging a more pro-equity approach in some countries such as in Belgium and discouraging it in others such as in Germany. Despite acknowledgement that European tax regimes are generally not in favour of equity, very little has been done for the moment.

There is a need for coordinated action at European level on how to address this problem. The removal of double taxation on equity in some countries would be one such measure. Especially, in economies with mature debt markets, policy makers could consider changing the tax treatment of debt and/or equity in order to remove the bias, while also ensuring that policy changes are neutral in their impact on public revenue.

2.3. Start-ups

In order to create favourable growth conditions for start-ups, the whole financing ecosystem including the elements of debt, equity and taxation needs to be taken into account. As for fiscal incentives, it is crucial to bring in schemes to support young innovation, tax incentives both on investment and on capital gains.

Seed and Early Stage Financing

Grants, Loans

and

Guarantees

Fiscal

incentives

Equity

funds

Quantifying the value of intangible assets can be as well an important tool in the strategy of an SME for obtaining financing and increasing its competitiveness. Thus, it can be a useful component in improving access to finance, especially in those countries most affected by the crisis. Many banks already implicitly evaluate intangible assets when evaluating potential SME customers.

For example, intellectual property rights will already be taken into account in financing decisions. However, a more harmonized way of evaluation might be beneficial. Other forms of intangible assets, such as organizational capacity, are very important but extremely difficult to quantify and cannot be reasonably included in a company balance sheet. Thus, an ‘intangible assets assessment’ that focuses on these factors can only provide information that is complementary to financial accounting, rather than directly affecting balance sheet relations.

Due to the heterogeneity of intangible assets and diverse accounting practices on national level, it is questionable whether a “one size fits all” methodology could be found. An elaborated and tested - under several national regimes - list of methodologies (e.g. for each asset type one that fits all countries), nonetheless merits investigation. Such methodologies must, however, be sufficiently comprehensive and easy for SMEs themselves and their existing partners such as accountants to be able to apply and understand.

3. Workshop conclusions

3.1. Obstacles

The greatest obstacles indicated during the workshop were:

 fragmentation due to different regulations implemented across European countries,

 highly risk-averse culture both on entrepreneurs’ side as well as on financial intermediaries and policy makers’ side,

 lack of “equity culture”.

Problem: how do SMEs meet their need of capital?

It is crucial to keep in mind that a “one size fits all” approach is not feasible, as a distinction between non-bankable and bankable companies has to be made: the former are more adapted to equity, while the latter have more mature business models, they own assets to be invested as a collateral and have perspectives of long term cash flow returns. There is an important distinction between business angels and venture capital as well: the former provide more added value, while the latter come at a later stage. There is still a trade-off between the two, and the open question on how to find new forms of funds. Equity is indeed a good way for early stage financing, but then there is an empty space before venture capital, which needs to be filled as many businesses have not developed an exit strategy. Variety is the key, as more competition in offering funding to small firms leads to better offers and more reach out and synergies, e.g. peer to peer funding introducing small businesses to investors.

All these initiatives would be pointless, however, if not equipped with easiness and timing in terms of required procedures, timing and guarantees, as SMEs rely on financing that is fast and easy.

3.2. Demand and supply side

Both the European businesses and financial intermediaries face a new financial ecosystem to which they have to adapt.

SMEs

Financial

intermediaries

Debt

SMEs should pay greater attention to valuation of their intangible assets such as patents and intellectual property. In their pursuit of finance, SMEs need to prepare thoroughly and search for affordable advice on how to sell their project and how to run a financing process. New entrepreneurs must be aware that, especially at an early stage, their risk profile is elevated. That is why rushing into action and undertaking a project too early might prove fatal. Instead, defining a good value proposition, in terms of added services, market competition, building a sense of community etc. might have a more long lasting impact on companies’ survival. In their search for finance, SMEs should expand their scope looking at various forms of financing.

A set of recommendations for financial institutions, on the other hand, referred mainly to an unexploited space for collaboration amongst financial institutions and investors (banks, equity funds, High-Net-Worth (HNW) investors etc.) and their pace of action, e.g. banks need to move more quickly by speeding up their decisions and being flexible. Banks, however, who should function as intermediaries, encounter problems of asymmetry of information, lack of trust and risk aversion, which endanger the accomplishment of their objectives.

Potential investors should start to embed themselves at all levels in the business. Alternative forms of financing are provided by new actors, such as institutional investors, venture capital, funds, along with the support of policy intervention in favour of SMEs, and forms of

Equity

Start-up

financing

Financial

intermediaries

Debt

SMEs

grow

co-financing. There might be room to rethink the model, introducing different financial and intermediary channels, but the open question is whether alternative models can co-habit.

3.3. Regulatory framework- building new finance ecosystem

It is important to consider the soft and hard regulatory measures in the context of a broader economic development strategy and being aware how different pieces of legislation interact with each other in order to avoid unintended consequences.



Supply side

Policy makers must promote better public investment, increased transparency and information on public and EU funds. Currently, the greatest attention is given to the Capital Markets Union and the Investment Plan for Europe, but the eye of the legislator should also focus on cultivating new forms of financing via the introduction of new EU standards, such as a passport scheme for lenders to overcome cross border barriers in order to create new lending channels supplying the market with alternative forms of financing.

Beyond the passports there is an issue of creating tax incentives for private investors, e.g. via co-investment and fund-of-fund models, as a way to leverage private sector investment. Lack of experienced investors, particular in equity investment, is not an issue that can be easily tackled, however. Taking into account the changing landscape of financing, it would be desirable to encourage recently created online transactional financial providers, promote diffusion of intermediary platforms which connect SMEs to investors, encourage new entrants in the financial sector to boost competition and to increase the openness and the transparency of financial intermediaries, especially banks.

EU financing is too heavily based on subsidies. Therefore, EU money should be spent more wisely by creating an entrepreneur friendly environment so that people want to start their own business, hire people and grow. Only a true entrepreneurial environment provides oxygen to SMEs.



Demand side

From the SME's point of view, there are many ways to finance a company (subsidies, loans, equity, etc.), but they have to keep in mind that the focus should be on financing the company through revenues, i.e. customers. Too many entrepreneurs, even before having an established business model, think of how they can finance their companies without taking into account their customers. Of course, the other ways such as loans, subsidies, equity are useful, but they should be used to sustain the development and not as the primary source of income for the company.

On the demand side in addition to the provision of various forms of financing, it would be of immense assistance to help SMEs to understand which options are available for them thanks to the creation a database for alternative finance providers across the EU. There is already a portal Access to EU finance offered by the European Commission. However, it offers only an indication of what is available in the market, as it gives a reference to finance supported by the EU only. There is much more beyond the EU supported financial instruments such as local and regional initiatives.

Another aspect to keep in mind is shortage of innovative entrepreneurs willing and able to start and grow companies. Very often the reasons cited include lack of confidence, weak second chance culture, fragmentation of markets or problems with achievement of required economies of scale.



Regulatory environment

The actors both on the demand and the supply side are not able to function effectively without a well-designed framework for the financial ecosystem. There is a need for EU institutions to break down cross border barriers by harmonising regulations across EU member states, which constitute an important challenge for small investors and better implement already existing regulations. The policy makers, and the financial industry itself, should insist on the quality of credit, exploiting free available information (e.g. open data). In such case having credit scores would help to alleviate asymmetry of information. Being faced with risk-averse society as a whole could be also targeted by implementation of soft regulations on culture and education in order to ameliorate financial literacy of the civil society.

4.

What’s next- the vision for the future

This report highlights the importance of looking at access to finance matters from a broader perspective bearing in mind the interdependence of the actors, legislation and systems. It is as impossible to detach supply from demand side of financing as it is to dismantle the financial ecosystem from the broader economic framework.

Financial

ecosystem

Financing instruments

and intermediaries

-Supply side-

Regulatory

environment

Entrepreneurial

ecosystem

-Demand side-

 As the range of financing options seems set to become increasingly fragmented, provide guidance to SMEs on options, plus investment-readiness support via intermediaries

 Widen the choice amongst institutions and available options: more banks, more institutions for alternative forms of financing (peer-to-peer, crowdfunding); more financial products (factoring financing, assets, supply chain finance)

 Increase opportunity for SMEs to “shop around” from one financial provider to the other, according to their needs

 Provide SMEs with more funding vehicles and EU financing (i.e. European Investment Fund)

 Improve the provision of information to SMEs on available financing instruments, both public and private

 Increase the range of options available for borrowers, encouraging new financial providers

 Foster a more entrepreneurial and risk-taking culture

 Break down cross-border barriers to borrowing and lending to make the single market a reality for investors and entrepreneurs alike

 Introduce new regulations to harmonise national systems where appropriate

 Create a genuine single market, not only for finance

 Put in place more equity-friendly tax regimes

Cases

 Presented by Vincent Jocquet

http://www.arguslabs.com/

About Vincent

After researching product iterations in high technology startups financed by venture capital, Vincent joined the valuation & business modeling team of a large professional service firm before pivoting his own career towards leading the finance and operations activities at the context-aware startup Argus Labs. While occupying the financial driver’s seat of a young and dynamic technology startup, the struggle for cash is inextricably part of his day-to-day activities.

About Argus Labs

In the ever-improving as-is world guided by input-based analytics there is an evident need for accurate detection and conscious identification of the parameters that make up that input, which will enable disruptive opportunities to gather information and provide context towards both supplier and consumer of the input-driven product offering. Argus Labs commercializes deep learning algorithms to ambiently sense, understand and predict context and human behavior. Based on mobile, sensor and linked data, Argus Labs provides unique characterizations, profiles and predictions accessible through a cloud API and mobile SDK. Our long-term aim is to develop algorithms that are capable of making machines emotionally aware of their user.

Case study

Most starting entrepreneurs realize that the struggle is part of the story but the mission of exploring state-of-the-art intelligence and disrupting established technologies outweighs the odds of failure. In order to enable the necessary level of creativity and provide enough room to maneuver, a new business will need to satisfy its shareholders and control its cash burn. If you have plenty of cash available, it’s easy to keep everyone happy, but as from the moment your liquidity is endangered, the oil in the machine will disappear together with the upside potential. In that respect, every beginning business owner should be a cash flow aficionado.

In 2012, Filip Maertens founded Argus Labs and convinced his peers to invest startup money for one third of the equity to support an envisioned team of 4 developers with nothing but the credibility of his own personality. When Argus Labs progressed six months into the development of its proprietary consumer application, more money was needed and a network of business angels was willing to take on the risk for the potential above-market return.

Even with sufficient angel money the conversion of an idea into a minimum viable product takes far more effort than originally estimated. Although iterating is part of creating new products, no investor is waiting for this kind of news. When pivoting is supported, expectations increase and more money is necessary.

After raising money from business angels, who are mostly relying on their own track record to drive their investment decisions, money can be found by venture capital funds, characterized by a lot more requirements to fulfill and a decision process that is much more time consuming, often keeping a startup too long in the dark. Argus Labs is in the middle of raising its first series A round which will enable the company to drive business development and expand internationally.

 Presented by Jonathan Schockaert http://listminut.com/

About Jonathan

Jonathan Schockaert, 25 years old, was born and raised in Belgium by a family of entrepreneurs and always wanted to build his own company. Jonathan studied Business Engineering, with a Master Degree in Entrepreneurship. He started really young, taking part in different entrepreneurial initiatives during his teenage years. He is now the co-founder and CEO of ListMinut.com, with which he recently raised funds.

About ListMinut.com

ListMinut.com is active in the “sharing economy”, a concept built around the sharing of human and physical resources. Sharing economy is becoming bigger and bigger with companies like Über, AirBnb, TaskRabbit, BlaBlaCar, etc. and raises many questions. ListMinut is an Internet platform which allows its users to outsource their daily chores to reliable individuals nearby. Mowing the lawn, finding a babysitter, assembling IKEA furniture- people do not always have the time, the willingness or the skills to do it by themselves.

ListMinut.com is now also active in the B2B sector, allowing big corporates which want to take care of their employees’ well-being to give them an easy access to those kind of services.

Case study

We created the company in February 2013 and we started looking for investors 6 months later and the least I can say is that it was not easy. The biggest problem was that it is too time consuming. During a year, I was working almost full-time on finding investors, which means that I was not able to focus on building the business at the time it needed it the most.

in the sharing economy. All the regulations are different between the countries and this makes our international expansion harder. Belgium is really specific, regulations are even different between the north and the south of the country and 30% of our expenses during the first year were dedicated to the legal studies etc. All those different regulations are a barrier to the international expansion and development of startups.

We were looking for smart money and we have been to France, Luxembourg and even Gibraltar to find it. All were bad decisions because our business is local and we needed to find investors who can bring us more than money (i.e. knowledge of the market, etc.). This costs us some money and a lot of time but we earned experience.

 Presented by Xavier Corman http://edebex.com

About Xavier

Xavier is a serial entrepreneur. From 2009 to 2013, he was a shared CFO between different SMEs. In 2013, he started an exciting new venture: edebex.com.

About Edebex

Edebex is a marketplace where companies that want to improve their cash flow can sell commercial receivables to other companies with cash to invest. After a successful series A raised in 2014, Edebex keeps growing quickly and becomes a reference in the Eurozone.

Case study

SME with financial troubles?

SME with a fast growth requiring more and more cash flow? Start-up with scarce equity?

All those companies cannot be financed by the traditional banking system. Indeed, it is very difficult to get short-term financing by the banks.

For two reasons:

1. Bank regulation is stronger than before. To finance risky borrower (as SME are mainly considered) in a short-term basis, the banking regulations (Basel II and III) require much more equity to overcome possible defaults.

2. The management cost of a small loan or a sizable loan is the same. Qualified human resources are precious. Thus, banks prefer to lend large amounts to low-risk companies.

This problem is partially solved with Edebex. As a marketplace for non-overdue commercial receivables, SME sell an asset (the commercial receivable). To valuate correctly this asset, Edebex analyse the quality of the debtor and not the borrower.

With an intense use of web technologies, the required qualified human resources are lower than the classic banking industry. For the buyers of commercial receivables, the return that an investor can expect with the purchase of receivables is much higher than the return of any short-term investment. The risk is limited by the audit of each invoice and by the credit insurance that covers each receivable.

For all those reasons, Edebex is a real opportunity for SME looking for fast and easy short-term financing. Edebex belongs to the huge movement of disinshort-termediation and the peer-to-peer financing that participates to the potential renewal of the economy.

Sicily Farmhouses Limited and Sicily Travel and Training Services Limited

 Presented by Mario Spiteri

About Mario

After a career as a CFO spanning more than 22 years mainly in the financial services industry, Mario Spiteri (Maltese) teamed up with an architect and civil engineer friend, Giovan Battista Palma (Italian) in 2006 to set up Sicily Farmhouses Limited, primarily with the objective of converting old rural buildings in South East Sicily mainly for the holiday homes market. Over the past 8 years, the company ventured into other businesses including property intermediation in Malta, vacation rentals in Malta, insurance services and tourism services within Sicily, in this latter case via Sicily Travel and Training Services Limited, which was set up in 2012.

About Sicily Farmhouses & Sicily Travel and Training Services

Conversion of old rural buildings in Sicily to holiday homes, construction of bungalows and villas in Sicily, management of a portfolio of up market apartments in Malta and Gozo for holiday rentals, property intermediation in Malta, insurance services and tourism services within Sicily.

Case study

The business relies for its finance requirements on the initial capital injection of the two partners, which has enabled it to build a portfolio of Property stock in Sicily and Malta on which the company seeks to add value by improving the various individual properties as necessary. As a result, all business areas which the company is involved in rely primarily on own capital and, to a very small extent, supplier credit. The company has recently secured bank finance from a local bank for the purchase of an apartment for rental in a top location in

Malta and is planning to add another ten units over the next two years financed in this manner and/or through the reinvestment of profits so as to build up its Malta rental property portfolio. The company also assists its holiday home clients in procuring bank finance, usually in the form of equity release loans for up to twenty years from Maltese banks for the purpose of acquiring a holiday home in Sicily. Such bank loans are usually secured by properties located in Malta. The company's activities in the tourism field, where the company organises group tours to Sicily for clients from Malta, Scandinavia, China, the United States and the United Kingdom, are relatively finance neutral since the company usually manages to balance the timing of receipts with payments.

Thank you for their valuable contributions to

Xavier Corman, Edebex

Willo Eurlings, Dutch Chamber of Commerce

Darren Hart, Santander Vincent Jocquet, Argus Labs

TomaszKozlowski, European Investment Fund

LiamMorris, European Commission

AngusSanders, Funding Circle

JonathanSchockaert, ListMinut

MarioSpiteri, Sicily Farmhouses Ltd., Sicily Travel and Training Services Ltd.

CvetoStantic, EESC Employers' Group

KarenE.Wilson, Bruegel, OECD

MiguelVallsMaseda, EUROCHAMBRES

Editors

Ben Butters, EUROCHAMBRES

Elisa Facchetti, EUROCHAMBRES

Participants

Michael Agate Federation of Small Businesses

Jayne Almond Federation of Small Businesses

Héctor Benítez López High Council of Chambers of Commerce of Spain

Alexandra Boehne DIHK

Friedrich Brieger IHK Berlin

Ben Butters EUROCHAMBRES

Xavier Corman Edebex

Xavier Coronas Guinart CCI Barcelona

Omar Cutajar Malta Business Bureau

Martine Diss European Commission

Louis-Marie Durand Euralia

Willo Eurlings Dutch Chamber of Commerce and Industry

Elisa Facchetti EUROCHAMBRES

Raymond Frenken European Banking Federation

Jakub Gloser Ecorys

Darren Hart Santander

Daniel Hart EUROCHAMBRES

Myrthe Hooijman Kamer van Koophandel

Vincent Jocquet Argus Labs

Tomasz Kozlowski EIF

Jan Lichota The Brewers of Europe

Dragica Martinovic Croatian Chamber

Iwona Mertin EUROCHAMBRES

Liam Morris European Commission

Sandra Penning CCI Paris/Ile-de-France

Jose Luis Pérez-Lozana Redondo

High Council of Chambers of Commerce of Spain, Brussels Office

Rainer Plentl Finpoint Limited

Jessica Pujol Vendrell Plus Europe Association

Marie-Elisabeth Rusling CCI FRANCE

Angus Sanders Funding Circle

Jonathan Schockaert ListMinut

Mario Spiteri MBB, Sicily Farmhouses Ltd. and Sicily Travel and Training Services Ltd.

Katrin Sturm AECM

Miguel Valls Maseda CCI Barcelona, EUROCHAMBRES

Kristof Van Kerkhoven KBC Group

Marie Vaugeois CCI Pays de la Loire

Christophe Verboomen EVCA

Riccardo Viaggi European Builders Confederation EBC

Aleksander Vigne Małopolska Region Brussels Office

Karen Wilson Bruegel, OECD

Herwig Wutscher EU-Büro der WKÖ

Gordana Zrnic Chamber of Commerce and Industry of Serbia

Recommended reading:

Restoring financing and growth to Europe’s SMEs, Bain & Company, Inc. Survey on the access to finance of enterprises (SAFE), European Central Bank