M&A corner: EU and government subsidies – boon or bane to SMEs?

Written by on October 16, 2012 in Business, Perspectives - No comments

One should not look a gift horse in the mouth, as the saying goes, so forgive me if I raise an unorthodox point of view: free money, in the form of EU or government grants to small and medium-sized enterprises (SMEs), is not necessarily a good thing.

Why not? I start from the premise that the greatest need for SMEs is to increase competitiveness. To the extent that a business is competitive, it will increase its market share, exports and profits, as well as generate more jobs and taxes, helping everyone to live in the lifestyle in which they would like.

My rationale for the deleterious effects of subsidies basically falls into three broad categories.

From competing to begging
Most SMEs are unused to thinking in the bureaucratic terms that tender applications require. It therefore creates a major drain in resources to put together the tender documents and do the necessary lobbying. Even if one engages an outside firm, it still requires the company’s senior management or owners to contribute a huge amount of information. Just monitoring the availability of various grants is almost a full-time job.

For management, there is a loss of focus from the things that truly increase competitiveness. Companies become expert at “ticking the boxes” of subsidy applications, rather than doing their utmost to become competitive. Worse, there may be distortions in a company’s behaviour: for example, a company may decide to make a new investment that it might not otherwise make, or hire people that it would not otherwise hire.

Perhaps most dangerous of all is if the persistent pursuit of subsidies creates a paradigm shift in the way business owners and managers think, from competing to begging.

Distortion of the playing field and transparency
Are subsidies allocated on a strictly meritocratic basis? Let’s not kid ourselves: while a good number of funds may be handed out on a meritocratic basis, there is a constant stream of stories that lead one to the conclusion that “who you know” might have at least as much influence as “what you know” in the allocation of grants. Cynics, right or wrong, may come to the conclusion that the subsidy system becomes a way for government to reward supporters for their loyalty.

In any country, typically a fraction of one per cent of companies receives any kind of grant. It is fiendishly difficult for a government bureaucrat to define the optimum criteria and to pick the deserving companies.

The cost and inefficiency of administration
On the government side, creating and staffing the programmes that allocate and administer the grants, and on the corporate side, the cost of preparing the applications and then the bureaucracy of monitoring and compliance over the subsequent years, eats up an enormous amount of time and resources. While I have no objective data, my “best guess” is that at least 20 to 30 per cent of the grant amounts would be absorbed by the costs for both government and the companies. So why spend 100 to get a benefit of 70 or 80?

I would tend to think that society (and SMEs) would be better off if taxes could be reduced by the same amount of the grants. No preferences. This has the advantage of being egalitarian and fully transparent. And removing or reducing some of the high taxes that help make businesses less competitive (such as payroll and social security taxes), would probably contribute a great deal more to competitiveness than grants or subsidies.

Just to give you an example: several years ago, I was involved in one of these grant applications. When we had no response for several months, we contacted the ministry and found that they had simply “lost” our file!

Where, in my opinion, government funding of private sector might have a legitimate role, is filling in gaps that the private market is unable to fill, such as research or innovation.

I am not immune to the school of thought that in this post-Lehman era, SMEs need additional funding. It boils down to political philosophy as to whether you believe that government should be “picking winners”, or if they have money to spare, to increase liquidity to businesses by reducing taxes.

My own feeling is that government has a very poor track record of picking winners. I understand that even the EU has realised some of the limitations of providing grants to SMEs, but, perhaps due to inertia, grant funding nevertheless continues.

There are few things that could do more to improve competitiveness than to create a sustainable and consistent reduction in taxes. That is the perhaps the benchmark against which grant programmes should be measured.

(Photo: svilen001/sxc.hu)

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About the Author

Les Nemethy is CEO of Euro-Phoenix Financial Advisors Ltd. (www.europhoenix.com), a Central European corporate finance company focused on mergers & acquisitions. He is the author of Business Exit Planning, published by John Wiley & Sons, available on Amazon, and Успешно излизане от бизнеса, published by Klasika I Stil Publishing House in Bulgaria.