The New Europe: Small Business

By Lucia Sconosciuto

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Women working in an industry

Abandoning centrally planned economies, in the early 1990s, meant a rediscovery of small-scale entrepreneurship in all countries where the EBRD operates.

After decades of state hostility towards business creativity and initiative, the new economic order offered plenty of opportunities: from opening a bakery to producing furniture or running a law firm.

“In the Baltic states, it felt as if anyone with an idea could establish a small business and hope to see it grow,” recalled Rolands Repsa of the EBRD Small Business Support programme.

At the same time, hardly anyone had any experience of operating a business in a growing market economy.

Before the arrival of communism, small and medium-sized enterprises (SMEs) played a fundamental role in the economies of central Europe and the Baltics. In the 1930s, they employed more than two-thirds of the labour force in Czechoslovakia and Hungary. By 1989, however, they accounted for less than one third of the countries’ employment.

The EBRD’s approach to SME development in the transition economies of the eight countries that later joined the EU in 2004 thus focussed mostly on indirect support through improving the business environment, increasing small business access to finance and strengthening their know-how through advisory services.

In the 1990s, as new businesses began to emerge, their potential to invigorate the market and introduce more competition was hampered by the overall deficiencies of the business environment, from the lack of adequate infrastructure to the underdeveloped financial sector and bureaucratic red tape.

On the legal transition front, the EBRD supported the reform of laws on secured lending in Hungary, Latvia and in the Slovak Republic, which provided more chance of survival ro SMEs in need of cash.

“In 1991, assets secured by commercial banks in exchange for a loan had to be physically removed from the borrower: for example, a business had to give up the use of its machinery to be deposited with the bank in order to obtain a loan”,” explained Frederique Dahan, EBRD lead counsel who dealt with some of these reform projects.

The EBRD also intervened directly in the development of the financial sector to increase small business’s access to finance. For a newly launched enterprise the shortage of capital could spell the end of the business.

“The lack of current assets seriously limited the opportunities for investments,” said Lolita Bemhena, CEO of Spilva, a Latvian company specialising in producing canned vegetables and established after the privatisation of a Soviet collective farm.

It was through its investments via local financial intermediaries that the EBRD had perhaps the most immediate impact. Financing was initially channelled through central banks and, later on, through local commercial banks and investments in equity funds with a focus on SMEs.

This helped the Bank not only to reach millions of small businesses indirectly but also to provide support to participating financial institutions in gaining experience with developing financial instruments tailored to SME lending.

For instance, in 1999 the EBRD and the EU launched the SME Finance Facility in the EU accession countries of central and eastern Europe. The Facility financed small businesses through 67 credit lines via local banks and leasing companies and included technical assistance to train loan officers in managing small loans.

In total, over 74,000 sub-loans worth € 1.6 billion have been extended to small businesses in the EU8 countries. Poland was the largest recipient country with a total of €262 million lent to over 33,200 sub-investments, followed by Hungary and the Czech and Slovak republics. Many of the participating banks continued to focus on SMEs after they accessed EBRD credit lines.

The Bank also invested in small businesses through equity funds. “Equity finance is particularly important for younger firms that are learning and have more volatile revenues,” explained Anne Fossemalle, EBRD Director of the Equity Funds team.

According to Ms Fossemalle, providers of equity finance contribute to SME development not only by offering capital but also by exposing small entrepreneurs to the expertise of fund managers, thus improving SMEs’ corporate governance and providing assistance beyond finance alone.

The Bank has developed integrated approaches in Poland and the Baltic States, focussing on specific transition gaps and providing a combination of policy dialogue and investments.

In the Baltics this methodology has just been launched: the Bank has committed €20 million to BaltCap Private Equity Fund II and has recently decide to commit €10 million to BPM Mezzanine Fund, which operates in both Poland and the Baltic States, and will invest principally in SMEs.

“More Polish companies now look to move outside their home markets, both east and west,” said Bill Watson, Managing Partner of Venture 4 Capital Eastern Europe Fund in which the EBRD has an almost 20 per cent share. “Regional private equity can help this process with the knowledge and experience from outside the home market and unlock the potential of SMEs for further growth.”

The EBRD also worked to build entrepreneurs’ managerial capacity by offering industry expert advice and promoting the development of the local consultancy market. This was the purpose of the first Business Advisory Service launched in 1995 in the Baltic states, a programme the Bank replicated in many countries.

Ms Bemhena’s company Spilva carried out several projects under the scheme, from creating a brand identity to obtaining ISO standard certifications. “We introduced the latest knowledge and technology,” she said. “As a result we became the market leader in Latvia and today we export our quality food to 15 countries."

During its nine years, the programme carried out over 1,600 projects to improve companies’ market performance, management effectiveness and introduce efficient management systems.

The EBRD has shown it can magnify the impact of its financing by supporting capacity building and policy dialogue that ensures sustainable change. The Bank will continue to apply this formula through its new Small Business Initiative.

Although the fate of individual enterprises is determined by market competition, the Bank has strengthened the institutions that promote a healthy business environment. Individuals with great business ideas can thus more easily build a better future.

This is another in our series of articles titled the New Europe about our work in the EU8, countries of Poland, Latvia, Lithuania, Estonia, the Czech and Slovak Republics, Hungary and Slovenia.

 
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