FINANCING INITIATIVES & CHALLENGES FOR SMEs

Christian SAUBLENS

EURADA

www.eurada.org info@eurada.orgAvenue des Arts 12 Bte 7 / B – 1210 Brussels / Tel. : +32 2 218 43 13 / Fax : + 32 2 218 45 83

www.eban.org info@eban.org

Foreword

All money is not the same; It’s not only a question of access to money but also

a question of life cycle of a company and about … sales and market penetration;

It’s more and more difficult for start-ups to access finance;

There is an asymmetry of information between entrepreneurs and investors;

Investment readiness is needed; There’s still a lot to be done in our regions.

1.The paradox of access to finance

Banks Venture Capitalists have money Stock Exchange

But argue that there aren’t enough good projects

What is a good project?

1.1. Trial to analyse the equity paradox

Supply:

Is there enough money available for seed and early equity?

Demand:

Are entrepreneurs aware of investors aspirations/ expectations (asymmetric information; all money is not the same)?

Are entrepreneurs ready to receive equity finance (Investment readiness)?

Are entrepreneurs proposals/ideas really innovative for investors?

1.2. Solutions

Public authorities should:

invest more in public/private partnership to share risk in this market; ensure fluidity of the risk capital market:

think in terms of a regional supply chain of equity provision; identify SME real demand, not the obvious one; invest in solutions to bottelnecks, not in fashionable tools! improve the legal, administrative and fiscal environment to increase the flow of equity for early stage investment; provide investment readiness schemes to entrepreneurs.

2. Segmentation of the market

Start-up phase First financial round Subsequent financial round

N.B:

Indirect supports Integrated actions

2.1. Start-up Phase

Seed capital fund Loans without interest and/or guarantee University and research centres spin off funds Micro-credit Public or para-public funds for creation or

innovation Public grants Reimbursable loans

2.2. First Financial Round

Business Angels Seed capital fund Banks loans/Overdraft Guarantee funds Public or para-public investment funds Regional Public venture capital Public grants Corporate venturing

2.3. Subsequent financial round

Private venture capital Bank Loans Share subscription bonus Mezzanine

OTHER TYPES Leasing Factoring

N.B.

Indirect financial support

Pre-incubation, incubation Nurseries and easy-in and easy-out workshops Tutorate (coaching, mentoring, hands-on

management)

Integrated Actions

Financial value chain Intermediation

Understanding decision process

3. Sources of financeAll money is not the same!

Seed capital : capital required for the purpose of financing projects upstream of product or service marketing. Seed capital is often essential for hi-tech projects in order to allow businesses to study, research and develop prototypes of the products that later come to constitute heir core business. Venture capital : assets temporarily invested as stock by specialised firms expecting return on investment that is both fast and very substantial, i.e. commensurate with the level of risk. Such specialised investors play a role during both start-up and development.

Informal risk capital (business angel): private individuals investing part of their personal assets in businesses and contributing their managerial skills and experience.Business Angels Networks (BANs): regional platforms that match business angels with businessmen.Early-stage finance – Start-up: funds invested downstream of research and development, in businesses that need additional finance to start marketing their products and services.

Mezzanine: intermediate layer of financing products (between equity and debt). Interest rates are often quite high.

Financial package: a combination of various sources of finance.

Corporate venturing: venture capital supplied by existing companies for the purpose of financing innovative businesses set up by their own personnel or active in industries considered to be of strategic importance.

Source of capital for enterprises

1. Initial and unorthodox ways2. Equity3. Debt finance4. Combination of equity and debt5. Public finance

Initial an unorthodox ways

Enterpreneurs savings FFF Profit reinvestments Second mortgage Personal credit cards Customer advance Delay of payments Permices sharing Employing relatives at below market salaries

Equity

Seed capital Business Angels Venture capital Corporate ventures I.P.O. and Post I.P.O.

Debt finance

Bank credits: Short term Long term Unsecured Micro

Commercial debt (papers) Public/semi public loans Bonds Factoring Leasing Franchising

Combination of equity and debt

Mezzanine

Public finance

Grants Reimbursable advances guarantees

4. Financing SMEs

Risk and ROI

SME size

Finance:• loans• guarantees• mezzanine

Developmentcapital

Seed capital and advice:

•BAs•Seed Funds

Source: Vaeksfonden (DK)

SMEs’ three financing circles

5. Financing Stages

Financingneeds

Financing Stage

HighRisk

LowRisk

Growth

SEED

Entrepe

neur;

Family

,

Friend

s

Seed

Capital

Business

Angels

Bank

Loans

Equity

STARTUP EARLY GROWTH

Financing stages

EXPANSION

Formal

Venture

capital

Public subsidies

MARKET GAP

I.P.OMARKET

GAP

GUARANTEES

6. Regions and access to financeCase Study of the Rhône-Alpes (F)

Source: RHONE-ALPES CREATION

PROJECTSHigh-tech

(strong potential)

INDUSTRY ANDINDUSTRIAL SERVICES

(product- or process-based innovation)

SMALL INDUSTRIES(CAPACITY SUBCONTRACTING)

SERVICES AND TRADE

(traditional, moderately innovative activities)

MICRO BUSINESSES TRADE CRAFTS

TRAINING – ADVICE- SUPPORT

Incubators CREALYS GRENOBLE

INNOEXPERT(CCI Lyon)

BUSINESS CENTRE(EM Lyon)

BUSINESS INCUBATORS

(NOVACITESFRAC CREATION)

Business development and reception service(CCI)

SponsorshipLocal platforms

Entreprendre en FranceBanks + Comité SofarisCCI + professionalsChartered accountants(ATEN)

« 3 hours – 3 days »

FINANCING

« Venture Capital » (National or International)(Sudinnova, Siparex Venture, Banexi, Partech)

« Seed capital » - National (thematic) (I Source, Emertec, BioAm,…) - Regional (Amorçage Rhône Alpes)

« Business development venture capital »Rhône-Alpes Création Banque Pop., Crédit AgricoleRhône-Dauphiné Développement

DEVELOPMENT TYPES

« Réseau Entreprendre » (Loans on trust + Sponsorship)

« ARJE » (Regional repayable short-term loans for new businesses—1-5 years)

« P.C.E. » (BDPME loans)

« Mille et Un Talents »(Regional grants)

ANVAR

LOCAL

FUNDING

REQUIREMENTS

SCALE

« Local platforms »(Loans on trust)Local initiative platformADIE

BusinessAngels

€300,000+

€300,000

to

€45,000

€45,000

to

€15,000

€15,000

to

€7,500

Sup. de Co. Grenoble

9

> Market consolidation

> Market expansion

> Market penetration

> Product enhancement

> Sales & distribution

> Product development

> Marketing & research

> Prototyping

> Market definition

> Innovation & R&D

Tier 0 Tier 1 Tier 3 Tier 4 Tier 5Tier 2

Product Development Stage

Risk Of FailureHIGH LOW

CommercialValue

R&DAngels/3F’s

Seed

VC/IIF

VC/Expansion

IPO/MBO/Trade Sale

SourcesOf Funding

Tier 3 - Post-incubation Funding Structuring Relationships etc

Tiers 4/5 - CommercialMaturity

Business Development Tiers

Tiers 0/1 - Pre-incubation Direction Collaboration Guidance Resources etc Pre-Seed funding

Tier 2 - Incubation Mentoring Seed funding Contacts Consulting Clients

Source: Presentation by Mr Lex de Lange, Managing Director, Zernike Group, made at PARTNER Focus Group in Tartu, Estonia, May 2003

7. The Commercialisation Cycle

8. Average size of deals

  Importance (%) Average size/deal (€)

  2000 2003 2000 2003

Seed 2.3 1.6 984000 494150

Replacement 2.7 4.6 2372700 6229700

Start-up 16.7 11.9 1520600 823300

Expansion 37.1 29.4 2828000 1702300

Buyouts 41.2 52.4 16635000 16917600

TOTAL 100 % 100 % 3351100 3907600

9. Demand for equity

Businesspersons are generally faced with fourtypes of issues when trying to raise equity:

cultural reluctance when it comes to opening their companies to outsiders (shareholders and managers);

difficulties in presenting themselves or their business plan in a way that accommodates the priorities and management requirements of equity suppliers;

c) project investment readiness: certain credit and venture capital tools are not adapted to the needs of all businesses at all stages of their development;

d) difficulties in identifying, and reckoning with, the administrative requirements of venture capital and credit providers. Such requirements include information on projects as well as financial and managerial data (corporate governance). Downstream of investment, businesses should also recognise the importance of regular, properly formatted reporting to investors.

10. Priorities for equity and loan providers

Availability of guarantees Perceived ability to repay the loan Company track record Rating

Banks

Meeting or matching of individual entrepreneurs with business angels

Atmosphere of trust between individuals Credible business plan in the eyes of the Business Angel Good management Fiscal incentives Market knowledge of the entrepreneur Availability of exit route Return on investment (capital gain)

Business angels orinformal investors and Spin-off corporate venturing

Personal relationship based on trust Family, Friends and Fools

Eligibility CriteriaEquity providers

Business plan credibility Readiness to cooperate with a tutor

Loans on trust

Stamina as well as technical and financial skills/abilities Guarantees

Innovative nature of business projects Business plan quality Management team

Repayable short-term loans

Business plan credibility Business plan with patent technology Track record (over previous years) Ability to grow fast and deliver quick ROI Management team quality

Venture capital andFinancial corporate venturing

New jobs Investment in productive tools

Public funding

Business plan Proprietary technology (IP) High growth Good management Tax incentives from government

Institutional investors

Business plan quality Perception of the innovative nature of the project Intellectual property High growth potential Government tax policies

Seed capital funds

Innovative nature of the project in relation to the company’s core business Industry-specific usefulness of the project, in particular from a technological standpoint Business plan quality Good management Tax incentives

Corporate venturing

Viability and consolidation At least three years in existence Positive results at least once within twelve months prior to application

More than €1.5 million in shareholder’s equity Ability to publish quarterly results Public recommendation by analyst Positive media attention Government tax policies Capable and experienced management team Prominent Board Experienced team of financial, legal and underwriter advisers New business concept Large market share Record of high growth or high growth potential

New capital markets

11. Demand driven schemes

Investment readiness Business Plan evaluation Business Plan improvements Business Plan presentation Investment readiness

Integrated Finance Entrepreneurs and all equity providers as advisors

12. Improving the « demand side » Investment readiness scheme (UK, Australia,…) 5

main components:

Critical evaluation of business plan, Knowledge of funding sources, Understanding of timing and amounts to be expected from

finding applications, Perceiving the needs and expectations of the different

investors (banks, B.A., V.C.,…) Training in submitting business proposals demonstrate

that the business proposal is a « good risk » for the investor.

B.A. academy (F, DK, D,…)

2 main components:

a) Business angels: bringing potential to become serial angels (not training but capacity building);

b) Business Angels Network management: improving the market place. BAN is a place where angels meet with entrepreneurs.

13. The role of public authorities at the regional level

Support for the setting up and financing of the operational cost of a regional business angels network;

Setting up of seed capital funds; Support for repayable short-term loan schemes; Setting up of investment capital funds; Deployment of guarantee schemes; Priority access for innovative SMEs to public

procurement;

14. Financial Supply ChainBanks

GarantiesLeasing

Factoring

Infrastructure:business angels networks,

incubators, etc.

Advice: investment readiness, tutorship

Expertise: professional

fund managers

Own resources

FFF VCLoans on trust

Pre-seedLoans for investors

Reimbursable advance payments

IPOBA

CorporateVenturing

Seedcapital

FFF : Family, Friends, FoolsBA : Business angelsVC : Venture capitalIPO : Initial Public Offering

GrantsMicro-credits

Other public support

Prerequisites

Tools

• Informal private investor with smart money (finance+expertise)

• Investment 25 000 - 250 000 euro

• Willing to share their managerial skills, specialist knowledge and networks

• Often prefer to invest in their region of residence

• Seeking profit, but also fun

What is a business angel?

15. BA Networks in Europe

Business Angel Network

Private or semi-public body whose aim is to match entrepreneurs looking for

equity with Business Angels

- Business angels are an old tool-- Business angels networks are new tools-

Services Provided by BANs

Creating awareness of the Business Angel concept Identification of BAs Assistance to entrepreneurs and BAs Training activities for BAs Matching BAs and entrepreneurs

Business Angel networks in Europe

66

132

155177

197

282

0

50

100

150

200

250

300

1999 2000 2001 2002 2003 2004

Source EBAN 2004

Business Angel syndication

The gathering of several business angels into an informal consortium for the purpose of creating a critical mass of funds above what each business angel could—or would be prepared to—invest. This term also applies to the pooling of competencies in order to offer more managerial skills than any individual business angel could display.

The benefits of syndication

Increasing the level of financing of a project; Diluting the risk to take for individual investors; Broadening the panel of possible investment sectors In some countries syndication allows for eligibility to a

fiscal regime equivalent to that of formal risk capital

investors.

An investment fund dedicated to the provision of equity finance to SMEs in which business angels have already invested in. The co-investment fund invests under the same terms and conditions as the angels, on a pari-passu basis.

The fund is run by an independent management team,which trusts to a large extent the due diligence work done by the business angels.

In some cases (side-car funds), angels that are already part of an investment structure (BAN) pool resources into a fund for specific investments, in parallel to the activities operated at the BAN level.

First fund launched in December 2002 and is managed by Greater London Enterprise (www.londonseedcapital.com).

16. Co-investment funds

17. Loan on trust

Average loan 5.000 € free of interest 2-3 years leverage impact for bank loans.

Network of 237 organisations every where in France.

Ex: in 20 years49.100 loans325,5 millions € of loans on trust1.320 millions € of bank loans111.000 jobs created.

In 2004, with 1 € loan on trust 6 € bank loans were secured by entrepreneurs.

Calvados department, 2004 77 loans min 3.000 € max 30.000 €.

18. Understanding the Decision making process

Advantage Pedagogy Public answer by real demand and not by offer Provision of non-financial support services

SME FUNDING PATHWAYSHas your business plan been found to be robust by a specialised organisation ?

Are you prepared to accept third-party

shareholders in your SME?

You should consider asking for the provision of:• specialised advice• (pre-)incubation services• business development funding• entrepreneurship trainingYou can enter a business plan or business development competition

Are you ready to meet potential investors?

Do you have personal

guarantees?

Attend an investment readiness training course

Get in touch with:A bank to secure:• a loan• a financial lease• micro-creditPublic authorities to apply for subsidies, including in the form of reduced interest ratesA factoring corporation

Contact an organisation that provides:guaranteesloans on trustsubsidies

YES NO

YES NO

NO YES YESNO

Source: EURADA, December 2003

Understanding the Decision Path

Is your product / service ready for the market?

YES NO

Check the existence of support from:• innovation grants• incubation• technology centres• seed capital firms• public authorities• universities and technological parks

How much equity /money do you expect to need?

BANKS (If banks say no)

Up to €250,000

Contact:•a business angel•a regional business angels network•a corporate venturing firm•a local financing company

€500,000-1,500,000

Contact:•a business angels syndicate•a seed capital or other public or private fund specialising in start-ups•a regional public equity participation fund•an industrial reconversion company

Over 3,000,000

Contact:•a public or private venture capital firm•a regional equity participation fund•an organisation that specialises in bond issues

Also check the attractiveness of your project—as adequately funded—with:•banks•guarantee firms•public authorities to secure subsidies and grants•venture capital funds

Finally, consider:• an MBO (Management buyout)• an IPO (Initial Public Offering)

Source: EURADA, December 2003

For more information

EUROPEAN BUSINESS ANGEL NETWORK

Avenue des Arts 12, Bte 7

B- 1210 Brussels

T.: + 32 (0)2 218 43 13

F.: +32 (0)2 218 45 83

info@eban.org

www.eban.org