Since 2022, the knock-on effects of high inflation have been hitting SMEs hard. A recent OECD study covering nearly 50 countries worldwide shows that SME interest rates rose on average by a whopping 30% in 2022, heaping pressure on firms already struggling to keep up with rising costs, making banks more reluctant to lend and discouraging SMEs from taking loans for new investments. While central banks in some regions have taken first steps towards loosening monetary policy, tighter conditions for SMEs are expected to persist for some time. With a drop of nearly 2% in new SME borrowing in 2022, additional sources of finance are crucial to support vital investments in growth and greening.
Interest rates have risen sharply for SMEs
Source: Financing SMEs and Entrepreneurs 2024: An OECD Scoreboard
Other sources of finance are therefore urgently needed to balance the SME financing mix, in line with the OECD Recommendation on SME Financing, and to enable smaller firms to make critical investments in greening and digitalisation and bring innovative solutions to market.
Venture capital holds promise for many SMEs
Equity finance is a promising alternative source of finance to credit. Governments have placed a strong focus on the development of domestic venture capital (VC) markets over the last 15 years. Notwithstanding recent volatility in VC markets, there has been remarkable growth in this type of equity finance over the last 15 years, with global volumes reaching USD 445 billion in 2022, close to 15 times higher than in 2006. And dry powder – that is, the funding available for investment – is at an all-time high, reaching USD 2.59 trillion at the end of 2023. The key is now to unlock this finance and create the conditions to put venture capital within reach of a broader range of firms.
Venture capital has always been an important source of finance for young and innovative SMEs. That’s because their business models are more likely to rely on intangible assets, making traditional borrowing more difficult and less suitable for these firms. In addition, besides the funding, VC investors support entrepreneurs with technical and managerial expertise and access to networks and reputational clout, which are important drivers of business success.
However, venture capital could also be suitable for a broader range of growth-oriented small firms. To unlock this capital, we need to overcome several persistent obstacles holding back willingness to invest in innovative small firms and uptake by SMEs. These include a lack of investor-ready projects among these firms; insufficient financial literacy of SMEs and inability to make a convincing “sell” of the business plan; and reluctance of SMEs to relinquish ownership and control of their business.
A new venture for governments
Governments are working to further develop VC markets to channel growth finance to start-ups and scale-ups. According to a forthcoming OECD report which maps government support for venture capital across countries1, types of public sector engagement have been evolving in the last 10 years, with a trend towards indirect investments, which involve government participation in private VC funds and funds-of-funds. The aim is to leverage the expertise of private VC fund managers and crowd in private investment.
However, direct investments also continue to play an important role in government strategies in several countries, such as Canada, France and Germany. Through direct investments, governments still co-invest with private investors, but are better able to channel funding to strategically important sectors. By sharing risk, they can have a demonstration effect, pulling private investors into new sectors, such as energy or cleantech, where private investment would otherwise be suboptimal. For example, in the United Kingdom, VC investments in cleantech grew by 50% in 2022, totalling GBP 0.9 billion2, marking the seventh consecutive year of increased investment, in contrast with the volatility of the industry as a whole in recent years.
Public development banks have emerged as key players in government VC policies, with many setting up equity finance branches in the last 10-15 years (e.g. KfW Capital in Germany and BDC Capital in Canada). The mobilisation of large institutional investors has also taken central stage in several government VC policy strategies. Especially in Nordic countries like Denmark, Finland and Sweden, government investments have been successful in signalling the value of private VC funds to institutional investors such as pension funds and insurance companies.
Finally, some government VC policies also seek to contribute to regional development, given strong evidence that equity finance is highly concentrated in a few regions within countries, which may prevent growth-oriented companies in peripheral regions from obtaining growth capital. In the United Kingdom, VC policies have had a strong regional dimension, with the creation of specific regional funds since 2017, increased capital commitments to these funds and the creation of a regional business angel programme. In France, Bpifrance also manages regional funds, which grew 50% between 2018 and 2022. Likewise, there have been efforts to level the playing field for women entrepreneurs, who receive only a small fraction of venture capital investments. In Canada, BDC’s Thrive Platform for Women invests specifically in women’s businesses and women-led VC funds. In Germany, the share of women staffing in VC funds is one of the considerations for investment decisions. Likewise, in Sweden, the criteria for investments in funds-of-funds include having at least 40% of women’s representation in the investment team of supported VC funds.
Obviously, strengthening the supply of VC is only one half of the equation for SMEs. On the demand side, policies need to boost the financial literacy and business management skills of entrepreneurs, for example through “Finance Hubs” to help them become “investor ready”. Through mentorship, advice, and networking opportunities, incubators and accelerators can also provide a regular supply of investable businesses for VC fund managers.
Venturing forward
There is a growing risk that current credit conditions will delay business investments in growth and greening. Now is the time to broaden our SME financing toolkit, and to enhance access to VC finance. Unlocking venture capital for these firms will hinge on further efforts to engage both businesses and investors, and to share best practice across countries.
Further reading:
Ms. Miriam Koreen is the Senior Counsellor on SMEs and Head of the SME and Entrepreneurship Finance Unit at the Centre for Entrepreneurship, SMEs, Regions and Cities of the Organisation for Economic Co‑operation and Development (OECD). She leads the OECD Platform on Financing SMEs for Sustainability. From 2011 to 2018, she was Deputy Director of the Centre and Head of the SME and Entrepreneurship Division. Ms. Koreen has worked at the OECD since 2000, when she joined the OECD as an analyst on entrepreneurship and SME policies. She has served as Counsellor to the Trade Directorate, Advisor in the Office of the Secretary-General and Senior Project Manager for the OECD Innovation Strategy. She also chaired the OECD Procurement Board from 2011 to 2015. Ms. Koreen holds a M.Sc. in Development Studies from the London School of Economics and Political Science.
Marco Marcheseis a policy analyst and project coordinator at the Organisation for Economic Cooperation and Development (OECD) in the Centre for Entrepreneurship, SMEs, Regions and Cities, where he has worked since 2007. At the OECD, he has been covering comprehensive assessments of national SME and entrepreneurship policies (e.g., Brazil, Canada, Czechia, Indonesia and Vietnam, among others), as well as more thematic studies on innovation, access to finance and the green transition of SMEs. Besides the OECD, he has worked for the International Labour Office and for Italy's Prime Minister's Office.
Maria Camila Jimenez is a junior policy analyst specializing in SME and entrepreneurship finance policy. She has contributed to the preparation and finalisation of several editions of the Financing SMEs and Entrepreneurs: An OECD Scoreboard. She has also co-authored and contributed to other OECD reports on topics related to SME finance, including government support for Venture Capital Funds, the SME Policy Response to COVID-19, and Sustainable Finance for SMEs. Prior to joining the OECD, she worked in the export-promoting agency of Colombia in Mexico and in an incubator and accelerator of female entrepreneurship. Maria Camila holds a master’s degree in public administration from the London School of Economics and Political Science.