**1. Introduction**

Small and medium-sized enterprises (SMEs) are regarded as the dominant vector of economic progress, as their successful activity determines regional and country development, creates new jobs, supports market competition, and enhances innovation (Beck et al. 2005; Kersten et al. 2017; Savlovschi and Robu 2011). High flexibility and entrepreneurial spirit are the key attributes of SMEs (Thurik and Wennekers 2004). Thus, SMEs remain the crucial players in the knowledge-based economy, as they can respond flexibly to new opportunities, diversify their activities, and create new products, processes, and organization forms. Innovative activity of SMEs results in multiple applications, and their gains may be shared through knowledge and information spill-overs with other firms (Organisation for Economic Co-operation and Development, OECD 2013). In this respect, SMEs are regarded as the main driving force of innovation.

However, SMEs are quite heterogeneous (e.g., sector, size, age, profitability) and they operate in different business environments (e.g., macroeconomic factors, institutional system, financial market, banking sector). Thus, the level of their innovative activity may vary across countries, which was confirmed in prior research (e.g., Pełka 2018).

It is empirically confirmed that innovation activity of SMEs is limited by the accessibility of sufficient funds (Goujard and Guérin 2018; Hall 2010). In this respect, this study contributes to the ongoing debate on SMEs financing decisions and the existence of financing (capital) gap (Angilella and Mazzù 2015; De Moor et al. 2016; Hottenrott and Peters 2012). However, the existing body of the literature in this field remains focused on the public support for innovative SMEs, as it has been confirmed that firms may face difficulties in finding external market-based finance for intangible (knowledge-based) assets (Lee et al. 2015; Vasilescu 2014). Numerous studies have also examined the relevance of venture capital funding and recently—crowdfunding, in the context of innovative SMEs (Anwar 2018; Baldock and Mason 2015; Kijkasiwat and Phuensane 2020; Schenk 2015). The relevance of debt finance and internal funding (determined by the efficient performance) in enhancing innovation in SMEs remains relatively less explored (Kerr and Nanda 2015; Sau 2007).

Facing this research gap, the main objective of this study is to capture the cross-country differences in the innovation activity of European SMEs and then to investigate the relationship between the types of innovation and relevance of a given type of funding. In this respect, there are two main contributions of our study to the existing body of the literature. First, it contributes to the debate on the cross-country differences in SMEs innovation activity. Second, it contributes to the debate on the SMEs' financing gap as one of the fundamental drivers of their innovative activity.

In the empirical examinations, this study relies on the data provided in the Survey of Access to Finance of Enterprises (SAFE) reports (SAFE 2018). SAFE regularly analyzes numerous aspects of the European SMEs performance and thus enables to study the differences and similarities in the firms' behaviors. In this study, we use the data that reflect the types of SMEs innovation (within product, market, process, and sales) and the relevance of various types of financing to detect the similarities and the differences of SMEs performing in different European countries.

The remainder of the paper is structured as follows. In the second section, we briefly review the related literature to highlight the conceptual framework of the study. In the third section, we explain the research design and methodology. The fourth section presents and discusses the results of empirical investigations. In the final section, we conclude.

#### **2. Literature Review**

In the conceptual dimension, this study is merging two streams of literature: innovation activity of SMEs and financial management. The first part derives from the premises of the innovation theory formulated originally by J. Schumpeter, developed further by numerous researchers in the field. Within the second part, the study refers primarily to the discussion on SMEs financing decisions and the persistence of the phenomenon known as financing (capital) gap.
