The European Commission is hoping to encourage more cross-border venture capital investing, but proposed reforms may actually impact access to capital for businesses.

The European Commission is hoping to encourage more cross-border venture capital investing, but proposed reforms may actually impact access to capital for businesses. Newly-appointed European Private Equity and Venture Capital Association chairman and partner at The Riverside Company Karsten Langer explains the challenges.

Small and medium-sized enterprises (SMEs) are the backbone of the European economy and have been responsible for the lion’s share of job creation since the start of the financial crisis. In particular, the high potential and aspirational companies that attract venture capital and private equity make a disproportionate contribution to the competitiveness and health of Europe’s economies.

EU policymakers recognise this and there are multiple initiatives to attract capital for SMEs. But crisis-driven legislation designed to curtail imbalances and systemic risks elsewhere in the financial system runs the real risk of limiting the available capital for investment into SMEs.

This month’s consultation on a new European venture capital regime is a direct consequence of the AIFMD Directive, which is legislation initially drafted to mitigate trading strategies of hedge funds. Following political pressure by the time of its adoption by the European Parliament last November, its scope had been expanded to include fund managers who invest in businesses with more than €500 million (£450 million) in total assets under management.

Investors with less than this amount don’t have to comply. But there are two problems. Firstly, unless funds comply with the full directive they cannot get a pan-European fundraising ‘passport’ allowing them to fundraise outside their own country. That means raising funds for investment into SMEs is complex and expensive.

Second, even if a fund manager plans to raise money for SME investment only domestically, many of the large institutions are highly likely to only invest with managers that are fully compliant with the prevailing legislation.

EVCA has argued for the Commission to remedy these unintended consequences. The resulting consultation looks at how a lighter touch regime for venture capital funds could be put in place so that such fund managers achieve a fund marketing passport and the regulatory stamp of approval required to attract private sector investors. This is potentially good news for SME capital provision, but as always, the implementation will be crucial.

First of all, any regime should be optional, since such funds present no systemic risk, and the requirements may not be right for everyone.

Secondly, policymakers should ensure that all fund managers with less than €500 million are able to qualify for this regime. After all, most if not all such managers invest mainly in SMEs – in fact more than 90 per cent of all investments by such managers go into SMEs.

The danger is that there is a false qualification made around a narrow definition of venture capital. This would leave out a large swathe of managers that invest in Europe’s SMEs, providing growth capital, generational transmission capital, and the like. By excluding these fund managers from the new proposed regulatory regime, the ultimate result would be to decrease the overall pool of capital available for SME investment.

As Britain’s business owners and entrepreneurs know, SMEs in different sectors and different stages of development require equity capital from different types of providers to achieve their ambitions. A committed equity provider often contributes with more than capital, opening doors and providing strategic and operational support, and can also help attract relatively cheaper debt finance to further enhance investment and growth. This heterogeneity is something to be encouraged and nurtured.

High-potential SMEs across all sectors deserve the backing of committed equity providers. Encouraging such investment is precisely what Europe needs in order to stay and competitive and grow. The Commission should not miss this opportunity.