Reflections on a Revision of the Definition of the EU SME

The European Commission provides a definition of the SME intended to create a level playing field across Europe for businesses applying for grants or other assistance intended only for SMEs. This definition has been in force since January 1, 2005. Without going into too much technical detail, the definition consists of the following three rules, namely that the — The company has less than 250 employees, — That either its turnover is less than €50M or its balance sheet is less than €43M, — That these numbers are computed based on weighted totals from the company and related entities, depending on whether the company is considered to be "autonomous", "partnered" or "linked." This definition was challenged by the EVCA in 2009 and by Business Europe 2017. Both made the point that the definition as it stands is unfair to VC-backed enterprise on the basis that some VC-backed start-ups risked exclusion from SME support programs because the SME definition would consider them "linked to" or "partnered with" giant financial actors, unfairly inflating their size and pushing them beyond the threshold of eligibility for SME programs. Access to SME programs by VC backed enterprise is not the only issue at stake for a possible revision of the definition of the SME. It is possible that other issues may arise in the aftermath of the pandemic, and as an unintended consequence of efforts to support business and employment in the coming years. So, now is a good time to look into this in more detail to see if there is a need to revise the definition of the SME in Europe, or if it is advisable to create exceptions for the treatment of VC-backed enterprise in order to avoid their unfair treatment or exclusion from important sources of SME support. In its letter of 2009, the EVCA referred to the case of Italy, suggesting that this would provide a better model for the case of VC-backed enterprise. Although the letter did not go further in specifying what was good about the Italian definition, this provide an interesting place to start to explore the scope for a possible revision. The Italian definition, still in use today, considers a business to be medium sized if its turnover is less than €355M and if it employs less than 500 people. This is very different from that employed by the EU and begs the question as to how one might decide the… — Criteria to use, how many and in what combination — Thresholds that mark the boundary between small, medium, and large enterprise — Related entities to be considered a part of the company in order to determine its "true" size A search of the literature reveals that there are at least 50 different definitions of small business in application around the world. Although the literature is not extensive, it does refer to the principles at work, the criteria applied, various debates about the relevance of different criteria as well as the role of models for SME growth in all of these debates. One of the most important criteria is "industry policy." The most comprehensive information was obtained in the case of the US. This was pieced together mainly from a careful reading of documents available on or referred to from the website of the Small Business Administration (SBA). In this was it was possible to put together a comprehensive picture of how small business size standards are determined in the US, their origin in government procurement programs going back to the 1920s and their evolution up until today. The original motivation for small business size standards in the US was a need to rationalize programs for small set-aside, that reserved up to 23% of all federal procurement for the small business sector. They are revised once a decade and size standards revised in 2009 were updated once again in 2019. The size standards for small business set-aside vary from sector to sector and are adjusted between major revision based on indexes such as the rate of inflation or worker productivity. In the 2019 revision… — Size standards for 532 sectors are based only on the number of employees. The upper limits ranging from 100 to 1,500 depending on the sector. — Size standards for 505 sectors are based on turnover alone. The upper limits for these ranging from $1M to $41.5M depending on the sector. — A small number of sectors have size standards based on their total assets, with the upper limit being $600M. The main criteria applied for access to the SBIR small business research and innovation programs, intended to encourage the participation of small business in federally funded research programs is that they employ no more than 500 people. It is interesting to note that the US federal government provides a "right of rebuttal" to companies that feel they have been wrongly excluded from small business programs. The rules relating to autonomy, ownership and control are quite different from those employed in the EU, but no less complex or difficult to apply. The issue of access to small business programs by VC- or PE-backed enterprise has also been a subject of debate. It has been a subject of great controversy in the context of the PPP program intended to help business affected by the pandemic. Since 2012, federal agencies have been given the possibility to extend the definition of small business to companies that are majority owned by VC or PE funds, on the basis of the so called "section 5107 authority." The choice has been left up to the individual agencies to decide if they will adopt this new rule or not. Not all have done so. Many are unsure if it is necessary or right. Nevertheless, this facility has been evaluated and so far, there has been no adverse impact on research or competition, and it looks set to continue in future. There was no complex arithmetic behind the legislation. It was based simply on a belief that it would encourage innovative science based small business to seek support from the VC- or PE- sector, without fear of being excluded from sources of research funding reserved for small business. The most recent evolution on this front, has been the granting access by VC- and PE-backed enterprise to the Pay-check Protection Program (PPP), at least a part of which was managed by the SBA. Recently released data has been examined by industry analysts and journalists. Key observations include… — Almost 10,000 VC- and PE-backed companies (9,657) received PPP loan support — They received $14.3B of the approximately $500B distributed — 4,800 PE- and VC-backed recipients had raised funding rounds in 2018 to 2020 — 2,267 of those raised funding in 2019 — 3 of the top 5 investors whose portfolio companies applied for help were start-up accelerators such as Techstars and Y Combinator To conclude: — The idea of a single definition for all of the EU and for all policy purposes, though understandable, may be too ambitious and risks depriving fast growing small business in Europe from resources which may help them succeed, especially in the context of dramatic shocks to both business and consumers due to the pandemic. — In particular the rules for ownership and control are too complex and should be revised. Perhaps with a view to carving out exceptions to the general rule, for cases where it is clearly in the public interest. This requires a clear understanding of what public interest is at stake in this case. — There is considerable variation in the way small business is identified around the world, in terms of the criteria used, in terms of the thresholds applied and in terms of what other entities to include in order to determine the "true" size of the enterprise. — It may be useful to go back to basics and argue ab-initio as to what the definition should be, in order to achieve explicit policy goals, and to avoid unintended consequences which are clearly identified in advance and against which proposed definitions can be tested. With a view to clarifying issues of public interest, these are referred to in the main text and further elaborated upon in a series of annexes intended to clarify the role of VC in the growth of small business, the difference between VC and PE, the complex web of relationships that characterize the LP-GP-PC universe, the challenges they face now and those they may face in the future.