What can be done to help financing small companies in the EU? Images Money (remixed)
Late Payment: A big problem to SME's

Editor's note: Last week our author Nick Stone talked about the importance of supporting small and medium businesses, because these companies represent the backbone of European economy. Today our author Eva Peña expands on this topic by taking an in-depth look at one of the initiatives to strenghten small companies: The Late Payment campaign.

Amid the crisis there’s a new wave of entrepreneurial projects emerging across Europe. Although “officially” the credit crunch is over, for smaller companies some big problems remain. One urgent matter for them is how to get proper funding. For this reason small and medium businesses (SMEs) are currently searching for viable alternatives to banks. Paradoxically, although the ECB is making more cash available to banks in the Eurozone, the truth is that financial institutions keep being reluctant to lend to their family and business clients. As banks won't trust a company unless it has a long trading record, sadly many projects are left outside the lending process.  

The backbone of European economy in a financial squeeze

In the EU there are about 23 million SMEs, accounting for 98% of businesses. However, European companies are having a tough time due to cash flow problems and red tape. The EU passed the Small Business Act (SBA) in 2008 putting into place a comprehensive SME policy framework for the EU and its Member States (it applies to  all independent companies which have fewer than 250 employees: 99% of all European businesses). The SBA is a set of principles and legislative proposals that create a level playing field across the EU. 

All in all, these are reactions to the financial squeeze. The European Commission has always stressed the importance of small businesses for growth (they provided 80% of all new jobs in the past five years), and has launched several proposals to encourage banks to take the risk and foster a better understanding between banks and companies, including the Action Plan (MEMO/11/879) with financial support from the EU Budget and the EIB. Additionally uniform rules across the EU were set for the marketing of venture capital funds, making it easier for investors to raise funds, and also making it possible for venture capital funds to become bigger and provide better financial instruments for SMEs. Evidence examined by the Commission shows that a company with long-term venture capital investors is more successful than a company that needs to rely on short-term finance from banks. 

Furthermore, it is worth noting the disparity between the EU and the United States; while the average venture capital fund in the European Union contains approximately €60 million, a US counterpart has a fund size of €130 million on average. Furthermore, US venture capital funds invested around €4 million on average in each company; whereas European funds could only muster investment volumes of €2 million on average per company. 

We must also bear in mind that the new regulatory framework of Basel III has worsened the borrowing options for SMEs. Banks need higher capital charges, making it more difficult for them to give access to credit, while companies see their creditworthiness reduced.

Combatting bad payment behavior

With banks reluctant to lend, there is still an extra problem. Every year since 2010 the European Payment Index (EPI) reveals that the payment behaviour has worsened due to the poorer payment ability of customers. In the last year many companies have been asking for pan-European action, for paying suppliers late is very common in Europe, making it harder for SMEs to survive, and making it more difficult to keep the proper functioning of the Single Market. Late payment for goods or services leads some companies into bankruptcy. The Commission has adopted the Late Payments Directive (2011/7/EU) that must be integrated into national law by 16 March 2013 at the latest (check the list of Member States that have implemented the Directive here). This new EU law makes a 30-day standard invoice payment term compulsory for all businesses from 2012. After this period, a penalty interest of 7% above the ECB rate can be charged (non-Eurozone members can set their own rates above their own national base). It also states that public authorities will have to pay suppliers within 30 days after receiving an invoice. The Commission believes that the new rules, once introduced by all EU member states, could mean an extra €180 billion being made available to businesses across Europe, helping to relieve cash flow problems. These rules should also help small businesses that export to other EU countries to improve their cash flow by reducing their exposure to poor payment. Regarding this new law, the Commission is holding a campaign in the 27 Member States and also in Croatia.  This campaign will last for the whole year of 2013, and aims at increasing awareness of the new rights for small companies. Furthermore, it will also provide a forum for exchange of best practices.

Legal actions and institutional initiatives at EU level are one way to provide small European companies with capital. But there are also growing alternative players in the business funding market. For instance, there is a new model for borrowing money through companies, which offer small businesses the chance to have enough working capital, enabling them to borrow against the value of invoices once they are sent to customers. Some of these companies operate as an online marketplace, where investors meet and can lend money to businesses whenever they need it. Companies enter into a bidding process, specifying the invoice value required and the maximum interest fee the company can offer to investors. The available funds depend on the size of the invoice, and the cash is repayable once the invoices are honoured. This is a way to match lenders with borrowers in a process that ensures that participating companies are good credit risks. A big boost to European economics would be provided if all the businesses and the citizens were just paid on time.  

Photo Credits: Euros isolated on white background by Images Money via flickr remixed with Alarm clock by Batholith via wikimedia commons