The new Risk Finance Guidelines

Many thanks to Gian Marco Galletti of Kings College for sending in this commentary on the new Risk Finance Guidelines

As shown from practical experience, Small and Medium Enterprises (SMEs) face significant difficulties in gaining access to finance. In the absence of proven track records, as for instance financial and bank statements, young SMEs are unable to demonstrate their credit-worthiness or the soundness of their business plans to private investors. The active screening, usually carried out by investors before providing funds to larger companies, may not be worth the investment in SMEs due to its excessive costs in relation to the value of the investment. This creates a “funding gap”. When granting public funds to an SME, Member States are required to demonstrate the existence of such funding gap. This is the rationale underlying the new risk finance guidelines, adopted by the Commission in January in the context of the ongoing programme of State Aid Modernisation.

At the outset, it is useful to remind ourselves that the new guidelines should be read together with the section on risk finance in the draft new General Block Exemption Regulation (GBER). The GBER specifically exempts certain categories of non-problematic aid from prior Commission scrutiny. Aid schemes that do not fulfil all the conditions of the GBER need to be notified to the Commission, who will assess them on a case-by-case basis in light of the compatibility criteria set out in the new guidelines.

The new guidelines will enter into force on 1 July 2014 and remain valid until 31 December 2020, a timetable that is aligned with the timetable for the draft new GBER. The guidelines introduce the following main changes, compared to the position under the current risk capital guidelines (which are prolonged until 30 June 2014):

  • The companies eligible to receive risk-finance aids include not only SMEs from seed/start up and expansion stages but also SMEs at later growth stages, small midcaps (up to 499 employees) and innovative midcaps (up to 1500 employees and with R&D and innovation costs representing 10% of total operating costs);
  • The 70% minimum equity requirement is abolished and a wider range of financial instruments are allowed (equity, quasi-equity, loans, guarantees or hybrid instruments);
  • The categories of notifiable measures are the following: (i) measures that target firms not fulfilling all the conditions of the GBER, (ii) measures with different design parameters than those stipulated in the GBER, and (iii) measures with large budgets above the threshold defined in the GBER (€100 million). The specific threshold for annual investment tranches (€1.5 million) is no longer imposed and has been replaced by a one-off amount of €15 million;
  • The previous guidelines set out two different degrees of compatibility assessment: (i) a “standard” assessment relying on the same compatibility criteria as laid down in the GBER, except for a higher threshold for the annual investment tranches (up to €2.5 million), and (ii) a “detailed” assessment for measures, mentioned in a white list, requiring specific evidence of market failure beyond the presumed equity gap and justifications as to the incentive effect and proportionality of the aid. Under the current guidelines, all notifiable measures will be subject to a “substantive” assessment, carried out on the basis of the “common principles for the assessment of compatibility” (an improved version of the old “balancing test”);
  • The flat 50% private participation rate (reduced to 30% in assisted areas) and the distinction between assisted and non-assisted areas are abolished and a new system, whereby the private capital participation ratio is tailored in function of the inherent riskiness of the investee, is introduced. For instance, as to investments into SMEs before their first commercial sale, the private capital participation requirement will be as low as 10%, to take account of the reluctance of private investors to provide funding at this stage. As the target companies become more established, the required rate of private investment increases (up to 60%);
  • Tax incentives to natural person investors are now exempted from the notification requirement, whereas the previous guidelines did not set out any specific compatibility conditions and each measure required an individual assessment. As to corporate investors, clearer rules for the provision of fiscal incentives are identified;
  • In line with the objectives of State Aid Modernisation, an ex-post evaluation is required for certain categories of aid schemes (i.e. large schemes, schemes with regional or narrow sectoral focus and schemes with novel characteristics) for the purpose of assessing their effectiveness and their actual impact on competition.

 The broadened scope of the new rules in terms of covered companies and the widening of the range of admissible financial instruments, which align the rules with market reality, should be welcomed. Similarly, the substitution of the previously required private participation rate with a more flexible system reduces the undue degree of restrictiveness of the old discipline.

 However, the “softer” version of the compatibility assessment – the so-called “standard assessment” – in the previous rules has not been reproduced in the new guidelines and the whole assessment system has been replaced by compatibility conditions which are expressed in considerable detail. As a result, establishing the compatibility of risk finance aid measures in the future may turn out to be a more difficult exercise than would have been the case for “standard assessment” cases under the old rules. The trade-off is a significantly expanded exemption for risk finance measures in the GBER. The result is that Member States will therefore have a strong incentive to make use of the GBER as much as possible. In this context, State aid lawyers will likely deal with an increased amount of requests for legal advice on how to make State measures compliant with the conditions provided for by the GBER, thereby avoiding the more detailed and uncertain assessment under the new guidelines.   


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