VCs and small firms unite against AIFM directive

Entrepreneurs and investors attack proposed regulation of private equity and VC funds

22 April 2010 15:02

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Small businesses and VC firms across Europe have spoken out against EU proposals to regulate hedge funds and private equity groups.

The EU’s draft Alternative Investment Fund Management (AIFM) directive, which is due to go before the European Parliament next month, seeks to regulate various types of alternative investment fund, including private equity and venture capital (VC) funds, in response to the global financial crisis.

Opponents say the measures, which would impose greater disclosure requirements on venture-backed businesses, would put VC funds and their portfolio companies at a competitive disadvantage.

More than 500 EU small and medium-sized businesses have signed a letter that was sent to the members of two European Parliament committees (ECON and JURI) last week, addressing their “grave concerns”.

“[The] proposals would prejudice private equity and venture capital-backed companies such as ours, and ultimately restrict access to finance for Europe’s growth companies,” it said.

“We can see no justification to prejudice our companies. Efforts to do so would distort the market, harm finance for innovation and company growth and ultimately inhibit Europe’s economic recovery.”

The directive, if passed in its current form, would require venture-backed businesses to disclose policies relating to research and development, which critics argue would place them at a competitive disadvantage compared to firms who have alternate funding sources and would therefore not be forced to make similar disclosures.

As well as the ‘transparency’ measures that would increase regulation on venture-backed firms, the proposed directive would also mean financiers in EU member states would only be allowed to do business with EU-based hedge funds, a move that has been criticised as protectionist.

Les Gabb, finance partner at Advent Venture Partners, said hedge funds had been the primary target of the proposals, but private equity was “included as a late addition as a result of political pressure", with venture capital following as a subsection of private equity.

“Venture capital does not use debt and does not actively trade securities. It therefore has no place in this directive,” he said.

“The directive as drafted will add significantly to the costs and administration of VC firms, specifically due to increased capital requirements and costs associated with valuations and depositaries. VC is already struggling to raise funds and unnecessary regulation will only worsen a difficult situation by further reducing the sector’s competitiveness.”

He added that any subsequent reduction in the number of VC firms “will reduce the capital available to small and medium sized businesses who already have greatly reduced access to long term finance from banks”.

Jos White, founder of MessageLabs and early stage VC firm Notion Capital, told Growing Business that the proposed legislation was a ‘blunt instrument’ that makes no distinction between various types of finance.

"Aside from the far reaching implications of this controversial protectionist directive if it goes ahead (not least a reduction of investment into the UK and Europe), what has really frustrated me is the lumping of venture capital, private equity and hedge funds into a ‘catch-all’ group,” he said.

“Venture capital invests in early stage, high growth companies, and in this way it invests in innovation and creativity that challenges and improves the status quo. Growing businesses are indisputably one of the most important drivers of growth and recovery during a downturn.

“Hedge funds and private equity are more about clever financial engineering involving complicated things like leveraged debt, buy-outs and short positions. These funds have their own practitioners and professionals – as such, they need their own category to be referred to,” he added.

The EU’s legal affairs department, JURI, was scheduled to frame an important part of the AIFM directive on April 19, but the vote was delayed by the recent travel chaos caused by the eruption of an Icelandic volcano.

Critics of the proposed regulation hope the delays might help private equity and VC firms push for changes to the directive’s text.The vote has been rescheduled for April 28.