British Embassy, Vilnius, Lithuania
Working Paper: Structural
Funds and Risk Financing
– Opportunities for
Lithuania in 2007-13
Strategy & Evaluation
Strategijos ir vertinimo
P O Box 159
Kent TN14 5WT
1. Introduction - What is Risk Financing? 1
2. Risk Financing as a Regional Policy Instrument 1
3. Support to Promote Risk Financing Through Structural Funds 2
4. Advantages & Disadvantages of Risk Financing 3
5. Risk Financing – Critical Success Factors 4
6. Challenges for the New Member States 5
7. Risk Financing in Lithuania 6
8. Recommendations 7
Structural Funds and Risk Financing
1. Introduction - What is Risk Financing?
Risk capital financing is the term used to describe schemes that make public funds for
SMEs available on a basis where they can be recycled. Examples of risk financing
instruments include soft loans, venture capital and mezzanine finance, loan guarantees
and other instruments such as micro credits for very small companies.
Risk capital financing schemes must meet the European Commission’s requirements
on state aid. Normally, the schemes will have investment criteria which require them
to invest only in projects where SME beneficiaries have not been in a position to gain
access to finance on a commercial basis i.e. where there is demonstrable evidence of
2. Risk Financing as a Regional Policy Instrument
Risk capital financing is increasingly being seen by the European Commission and
member states as an effective means of improving access to finance for SMEs and a
more cost-effective policy instrument in promoting SME growth and new job creation
than conventional grant aid schemes.
Reasons for the increasing shift towards risk financing include the fact that, despite
many years of providing grant aid from the Structural Funds on a massive scale,
regional disparities have not diminished significantly. More innovative, sustainable
and cost-effective means of promoting economic (and regional) development
objectives therefore have to be considered.
Secondly, risk capital financing is a more appropriate source of financing than
conventional alternatives in the context of promoting the ‘knowledge economy’,
acknowledged in the Lisbon strategy as a key driver of job and wealth creation.
Thirdly, with increasing demands on resources arising from the major EU
enlargement process in 2004 and planned subsequent EU enlargement (possible
accession of Croatia, Bulgaria, Romania plus other potential applicant countries
including Turkey, Bosnia, Ukraine etc.), there is a need to make EU funds ‘work
harder’. Recycling funds on a revolving basis rather than allocating one-off grants is
a sustainable means of achieving this aim.
Thirdly, risk financing helps diversify the range of financial products available to
meet the financing needs of SMEs and micro-firms – important in helping to address
market failure. SMEs need access to finance to grow and develop. Whilst the
Commission does not consider that there is a general market failure in respect of the
provision of finance to SMEs, there is evidence of shortcomings in relation to some
groups of SMEs which may mean they are unable to access appropriate funding (e.g.
high-tech SMEs, micro-firms started by those from disadvantaged groups etc.).
Reasons why a commercial bank may be unable to provide finance to a viable SME
include the lack of a track record, inadequate security and a credit rating outside an
acceptable range. Risk financing schemes supported through Structural Funds can
help to improve access to finance for those SMEs that would otherwise have
difficulties obtaining finance through conventional sources.
Below we look at an example of a scheme which seeks to combine improved access
to finance for micro-firms and SMEs from specific social groups with business
support and mentoring advice in order that beneficiaries improve their chances of
business growth and survival.
Example 1: BRUSOC (‘Bruxelles sociale’) – Brusoc administers two risk financing schemes the first
providing micro credits to individuals looking to set up their own business and the second providing
seed capital through both equity and loans to micro-enterprises. BRUSOC targets the financially and
socially excluded - such as refugees, the long-term unemployed and those on low incomes.
The objectives of the micro credits scheme are to encourage entrepreneurship amongst disadvantaged
communities, to regenerate deprived urban areas and to combat social and financial exclusion.
Financial support is closely tied in to the provision of business support and advisory services – which
helps improve the survival prospects of SMEs assisted.
The scheme provides support to both new and existing businesses situated in the Objective 2 area of
Bruxelles Capitale. With regard to financing sources, both the micro credits and the seed capital
schemes are eligible for ERDF funding. European funds are co-financed by the Belgian government
and municipal authorities in Bruxelles Capitale.
There are also disadvantages inherent in traditional grant financing to companies.
Direct grants run the risk of creating market distortions and of creating a grant culture.
Other problems can include insufficient levels of grant aid financing available to meet
the needs of applicant businesses leading to disillusionment amongst companies with
regard to EU funding programmes.
This latter problem is particularly applicable in Lithuania where large numbers of
applications have been received for support with only comparatively limited grant
financing available compared with need. Risk financing helps leverage additional
financing from the private sector which means that the needs of a greater number of
businesses can be met than if only one-off grant finance is utilised.
3. Support to Promote Risk Financing Through Structural Funds
A key question is what sort of support is available to promote risk financing through
the Structural Funds (SFs)?. Within the framework of the SFs, there is considerable
scope for the use of risk capital financing. In regions eligible for SFs support, risk
capital financing backed by the SFs may be provided through risk capital funds and
other non-grant forms of financing for SMEs, subject to finding the necessary co-
financing and meeting state aid rules.
To encourage the greater use of risk financing instruments in regional policy, the
2000-06 Structural Fund Regulations allow Member States the option of providing an
additional 10% of assistance to SMEs for those parts of an investment project funded
in other ways than through direct grant aid. The development of risk capital financing
instruments supported through the SFs can also be supported through the provision of
Technical Assistance, the exchange of experiences and through the strengthening of
administrative capacities (the latter only eligible from 2013).
As familiarity has grown with regard to the use of risk financing instruments amongst
national and regional authorities, so SF expenditure on risk capital financing has
increased, with a marked rise between the 1994-99 and 2000-06 programming
periods. Notwithstanding, the proportion of expenditure being devoted to risk
financing measures as a proportion of total SFs expenditure remains low. Moreover,
there remain considerable variations with regard to the level of expenditure being
devoted to risk financing measures between member states.
Below we briefly review the relative advantages and disadvantages of risk financing
instruments. We consider critical success factors and good practices in the utilisation
of risk capital financing. Recent examples of risk financing measures being supported
through the SFs are then highlighted.
4. Advantages & Disadvantages of Risk Financing
Research suggests that risk financing:
Is better suited to the needs of the ‘knowledge economy’ than traditional grant
aid. The availability of risk and innovation financing are important
Public funds can be recycled improving the sustainability and cost-
effectiveness of SFs expenditure compared with more traditional interventions
Enables the Structural Funds to leverage additional private financing so
increasing the total resources available to pursue regional policy objectives
Helps improve access to finance for SMEs particularly in [perceived] high
risk sectors and / or where there is evidence of market failure (e.g. provision of
In the case of seed/ VC funds, SMEs not only receive a capital injection but
often also receive ongoing mentoring support and business advice from
experienced business professionals
Helps to diversify the range of publicly funded financial support measures for
Enables the financial expertise and knowledge of the private sector to be
tapped into particularly where the private sector is involved in helping to
manage risk capital financing schemes.
With regard to disadvantages, there can be considerable complexities in setting up
risk capital financing schemes, particularly in demonstrating that state aid rules have
been correctly adhered to. Where a scheme may constitute a state aid, there is a
statutory requirement to notify the proposed scheme to the European Commission’s
Competition Directorate which then determines whether or not the scheme constitutes
a state aid. If the scheme is subsequently classified as a state aid, the Commission
then assesses whether the scheme complies with the exemptions in Article 87(3) of
the EC Treaty. Adhering to the state aid rules can absorb significant management time
and requires professional advice from financial and legal advisers1.
A second potential drawback is that SMEs and micro-firms in some member states
have not been as enthusiastic with regard to risk financing instruments compared with
more conventional funding schemes. For example, in Italy, a number of SFs-financed
For more detailed guidance on the application of the state aid rules in respect of risk financing
instruments, please consult CSES’ Guide to Risk Capital Financing for DG REGIO, available in
multiple Community languages
venture capital schemes were set up in the 1994-99 period but were unsuccessful due
to low take-up rates. This reflected a lack of familiarity amongst SMEs with
innovative financial instruments, adverse attitudes to risk and an unwillingness to
finance growth through equity financing since this meant partially relinquishing
ownership and control. Clearly, if potential beneficiaries demonstrate little interest in
risk capital financing measures, there are risks with regard to low absorption rates and
consequent N+2 problems etc.
5. Risk Financing – Critical Success Factors
We now consider critical success factors in setting up and operating risk capital
financing schemes drawing on good practice experience. Previous experience
suggests that there are a number of critical success factors in the use of risk capital
financing financed through Structural Funds. These include:
The need for a good understanding amongst those involved in implementing
Structural Funds (managing authority, implementing agencies etc.) with
regard to the benefits of risk financing instruments
The extent to which the private sector is willing to provide co-financing
support as well as fund management / risk management expertise.
The need for clear investment criteria to be set and for the target market for
the risk financing scheme to be clearly defined
The need for appropriate risk assessment procedures to be put in place to
ensure that funds are managed professionally [and on a sustainable basis]
The importance of positive attitudes to risk amongst potential beneficiaries
Research by CSES suggests that there is considerable variation with regard to the
usage of risk capital financing between member states. More needs to be done to raise
awareness about the potential benefits of risk financing to public authorities as well as
to spread good practices with regard to setting up and operating risk capital schemes.
Experience suggests that private sector expertise is often important in the setting up
and operation of risk capital financing schemes both in relation to securing adequate
co-financing support and in the application of a rigorous, commercial-oriented
approach in screening applications for funding, applying investment criteria and in
devising and implementing risk management criteria and procedures.
It is therefore important that public authorities communicate the potential benefits of
involvement in publicly funded risk capital financing schemes to the private sector to
secure their participation and active involvement. This is particularly important in
respect of seed and / or venture capital schemes where the nature of investment and
the level of screening, monitoring and risk management needed is much more
complex than for other types of risk capital instruments such as soft loans.
Appropriate investment criteria need to be drawn up to provide a framework through
which funding applications can be assessed. Linked to this is the need to define how
funds will be targeted and how criteria might be drawn up to enable fund managers to
prioritise funding applications in line with the overall targeting strategy. Thought
needs to be given as to whether a given risk capital scheme will be sectorally focused
or should be targeted at a much broader group of potential beneficiaries e.g. high-tech
SMEs. In defining target groups, the overall SFs programming strategy (i.e. SPD)
should be taken into close account.
A sound approach to risk management based on commercial principles is essential in
ensuring that risk capital schemes financed through SFs prove sustainable and cost-
effective. While SMEs receiving seed-financing are likely to carry a higher element of
risk than that would normally be acceptable to a bank/ other commercial providers
there is a need for risk to be managed professionally to maximise the fund’s
effectiveness and to reduce the level of business failures. Below is a good example of
a highly professional approach to managing a SFs-backed risk capital fund:
Example 2: Merseyside Investment Fund (MIF), UK, Objective 1 programme – MSIF provides
seed and venture capital to several dozen companies and has instituted an ‘early warning system’
whereby businesses identified as being at high risk of failing are provided with regular mentoring
advice and support from experienced business practitioners. This proactive approach has reduced the
incidence of business failures.
Lastly, an important pre-requisite is that market demand amongst the target group
should be tested prior to developing risk financing measures to ascertain that there is
genuine latent demand amongst businesses for such instruments. Evaluation work by
CSES on risk financing in the Structural Funds in the 1994-99 period suggested that
there remain significant cultural and attitudinal obstacles to participation in risk
financing schemes amongst SMEs/ micro-firms in some member states.
6. Challenges for the New Member States
There are a number of challenges in implementing risk financing instruments through
Structural Funds in the new member states. These include:
Lack of awareness amongst national and regional authorities with regard to the
potential benefits of risk financing schemes as opposed to conventional
financing means in regions eligible for Structural Funds
Lack of experience and knowledge with regard to how to go about setting up
and operating risk financing schemes
The complexity of Structural Funds and the challenge of implementing the
programmes for the first time (leaving little time to experiment with more
innovative ways of utilising the funds)
The need for closer partnership working between public authorities
responsible for managing Structural Funds and private sector financial
Lack of familiarity with state aid rules
With regard to challenges faced by the new member states, these mainly stem from
the lack of previous experience of implementing risk capital financing schemes which
are publicly financed. This in itself should not prove an insurmountable obstacle
although clearly a steep learning curve will be required.
In light of the current low level of capacity in this area, there is a need for good
practice exemplars to be diffused more widely. Case studies undertaken by CSES on
the study ‘Guide to Risk Financing in Regional Policy’ illustrating risk financing
schemes currently in operation should help in this respect.
7. Risk Financing in Lithuania – Tentative Beginnings, Significant
There is no explicit provision in the Lithuanian Objective 1 2004-06 Single
Programming Document for the usage of risk financing instruments. There were
difficulties in including risk financing measures in the current programming period
because of the complexities involved - state aid issues, lack of previous experience in
implementing risk financing schemes etc. and the brevity of the current programming
period (3 years). The Ministry of Economy therefore chose to delay the introduction
of risk financing schemes until 2007-13.
However, there is a growing recognition at a policy level with regard to the potential
positive role of risk capital financing through Structural Funds in Lithuania for a
number of reasons including:
Likelihood that SF resources will be reduced in the next programming period
due to economic growth, increased pressure on EU resources from continuing
process of EU enlargement
There is therefore a need to consider more sustainable sources of financing
such as revolving public funds
Huge demand amongst small and medium businesses for grants. Insufficient
resources to meet the capital requirements of Lithuanian businesses
The need to promote a knowledge economy in Lithuania
As a result of the increased interest in risk financing, the Ministry of Economy
recently set up a working group to identify the sorts of financial instruments that
might be piloted, to assess current provision (public and private) and to consider what
sorts of schemes might be set up in the next programming period.
In common with other new member states, Lithuania already has some limited
experience with regard to managing risk capital financing schemes involving public
funds and private management expertise. For example, approximately 8 million euros
of PHARE funding was used to finance two SME credit lines. These were
implemented through local commercial banks and provided businesses with start-up
capital in the form of ‘soft’ loans at favourable interest rates. The credit lines recently
expired after 10 years of operation and the Ministry of Finance wrote to the
Commission to determine how these funds might be recycled in future (probably
though INVEGA, although initial research suggests that some businesses would
prefer the previous approach working through commercial banks).
Secondly, INVEGA, the guarantees agency, provides state-backed guarantees to
Lithuanian SMEs which are counter-guaranteed by the European Investment Fund. In
recognition of the growing capital requirements of small and medium sized businesses
in Lithuania, the maximum guarantee size has recently been increased from 1m to 2m
litas. If the loan is co-financed through SFs, loans of up to 3m litas can be granted.
For new investment, up to 80% of total loan value can be guaranteed and in the case
of loans used to finance working capital, up to 50% can be guaranteed.
Loans are exempt from state aids under the de minimis rules and are counter-
indemnified by the European Investment Fund (EIF). Moreover, whereas previously
INVEGA only dealt with small businesses, it can now issue guarantees to medium
sized companies with up to 100 employees. Banks are the main mechanism through
which INVEGA guarantees are promoted. However, INVEGA also promotes its
activities through SMEDA’s nationwide network of business information centres. In
theory, guarantees of up to 25,000 euros can also be issued in respect of micro credits
– although in practice the micro credit scheme has yet to get underway since the
European Commission is currently reviewing the proposed scheme and has yet to
make a decision with regard to whether it can go ahead.
As well as the expertise of public agencies such as INVEGA, Lithuania also has
private sector expertise in the venture capital field. A number of key players such as
Hermis Capital and Bridge Capital are active in the field. This expertise could be
drawn on in helping to set up and operate risk financing funds supported through
In summary, the use of risk financing instruments in the 2007-13 programming period
is a significant opportunity for Lithuania to improve the sustainability and cost-
effectiveness of interventions. As well as helping to improve access to finance for
SMEs, it has the potential to increase the supply of risk financing, particularly
important given the objective of transforming Lithuania into a knowledge-driven
Our assessment suggests that action at both a policy and a practical level is needed in
a number of areas in relation to risk financing and future Structural Funds in
Lithuania. Below we provide a number of recommendations:
Risk Capital Financing and Structural Funds in Lithuania: Recommendations
Risk capital financing instruments should be widely used in the 2007-13 programming period
in Lithuania to increase the sustainability of SF interventions and to encourage the growth and
development of knowledge-intensive businesses
A feasibility study should be undertaken of risk capital schemes drawing on lessons from
existing schemes in other EU Member States to share and diffuse good practices. As a
minimum, an assessment of lessons from previous experience in implementing such schemes
in Lithuania should be carried out 2
Risk financing schemes should be piloted using national funds in the current period to gain
experience and understanding of how to implement ‘financial engineering’ schemes in the
The Ministry of Economy should further develop its capacity to implement risk capital
financing measures in 2007-13. It should then make its expertise available to intermediaries
likely to be involved in the future implementation of risk financing schemes (INVEGA, banks,
VC funds etc.). An effort should be made in improving understanding of state aids issues and
Close partnership-working should be encouraged between the public and private sectors in
developing/ implementing risk financing schemes. The public sector needs the private sector’s
According to research by CSES/ PPMI, a number of years ago an attempt was made to introduce
SME credit lines financed through the Phare programme but these suffered from significant
shortcomings such as a lack of stability in the banking sector, poor design and inefficient management
financial, legal and management expertise to devise, operate and oversee successful schemes
Positive messages should be disseminated to small firms with regard to how risk financing
measures might benefit their businesses (e.g. equity financing, access to mentoring support
etc.). Key stakeholders such as the Ministry of Economy, LVPA and other business support
agencies e.g. the Chambers of Commerce, SMEDA and Business and Information Centres
clearly have a role here
Mark Whittle, CSES
For a more comprehensive guide to risk capital financing, please consult the Centre
for Strategy & Evaluation Service’s 2002 publication for DG REGIO ‘Guide to Risk
Financing in Regional Policy’, available in Lithuanian from
The English version is available from www.cses.co.uk/publications