Max Burger-Calderon is a partner with Apax
Partners Group and is also chairman of the EVCA (European Venture Capital Association).
There were 30,000 insolvencies in Germany last year and family businesses are finding it harder to procure credit from banks with their increasingly stringent lending criteria. Private equity managers may be the answer to a tailor-made financial strategy, explains Max Burger-Calderon
In many respects entrepreneurs in Germany are a special breed. On the one hand, by international comparison, their scope for entrepreneurial action is restricted by extensive legal regulations and sizable tax burdens. On the other hand, in spite of these conditions, Germany's Mittelstand has established itself as a central pillar of the economy. The overwhelming majority of the 3.3 million companies in Germany belong to this bracket and these small- and medium-sized enterprises account for the lion's share of the jobs created in Germany.
In turn, some 80% of all Mittelstand companies are family owned enterprises and a considerable share of them will be having to deal with succession issues in the coming years – in an environment that is determined by turbulent markets and tough competition. In this context, a host of financing issues are emerging that will have to be addressed. If, in the forefield or in the course of making the transition from one generation to the next, the course is to be set for further growth, this will naturally be associated with high capital requirements. Other company founders or owners may have already made the decision to secure their assets and their retirement by selling their firms. However, many may still have to find potential buyers, and this may involve offering a long-time managing director a financially viable purchasing solution. Moreover, in many cases, passing the business on to the next generation may quite simply present liquidity problems, entailing compensation payments to heirs and meeting inheritance tax burdens.
The historical backdrop
Against this backdrop, the current and far reaching changes in the financial sector will be of decisive significance. In explaining the current situation it is well worth casting a glance at historic developments. Germany's Mittelstand, according to the present definition, only emerged after World War II and was born out of a century shaped by societal turmoil, inflation and wars. At the outset, the capital market in Germany was in ruins, and consequently the Mittelstand grew and flourished over decades thanks to credit furnished by banks and savings banks. Entrepreneurial risk capital was provided in the form of loans. But times have changed. Today, when small- and medium-sized enterprises turn to their bank managers to discuss loan issues, the response elicited – to put it mildly – is usually one of decided reserve and credit negotiations prove an arduous undertaking. According to surveys conducted in 2001, around 30 to 40% of Mittelstand companies confirmed experiencing problems in procuring credit facilities. In 2002, their number had risen to between 50 and 60%. And there are good reasons for this development. As latecomer losers of the new economy boom, the banks have non-performing loans and declining business written all over their balance sheets. Add to this the malaise of the global economy that has resulted in a record figure of more than 30,000 insolvencies in Germany last year and the increasing need to hedge against risks. As a result of these developments the banks' corporate customers find themselves the victims of a wave of radical change, as banks are passing on the pressure on their own margins to their clients in the form of more stringent lending criteria and conditions.
New approaches in capital procurement
Today, Germany's Mittelstand finds itself in a tight financing squeeze. At the same time, the way out of this impasse has already been mapped out. As other industrial nations have exemplified, the road ahead can only consist of boosting company equity ratios, a factor that German companies have tended to neglect to date. This will call for new partners and structures, like those that US companies have been drawing on for decades. On the other side of the Atlantic private equity companies play a prominent role in providing capital. Year after year, they collect billions of dollars from institutional investors such as insurance companies and pension funds, and funnel this capital into selected companies in need of financing. In the United States today, private equity companies rank as widely accepted and reliable partners in capital procurement. And this should come as no great surprise: this is not a case of ruthless 'raiders' gutting corporations along the lines of the villains in the film Wall Street. The investment experts at work here are committed to assisting entrepreneurs in achieving their objectives by providing prudent advice and capital backing. It is only logical that this concept is gaining increasing interest in Europe.
The search for the right investors
According to current estimations by the Institut für Mittelstandsforschung, some 400,000 small- and medium-sized enterprises in Germany will be faced with succession issues in the next five years. According to the specific interests, the emphasis may be on securing the economic position of individual owner/family members and a just distribution of assets. On the other hand, the future viability of the company may be the crucial issue, or all of these aspects together. In view of these objectives the sale of the company or the involvement of a solvent partner will be debated in many instances. One of the most obvious options is to look for interested parties in the company's own market environment. A strategic investor of this kind is usually seeking to strengthen its own market position by such an engagement. The investing company is banking on the acquisition generating synergy effects, extending existing product ranges and will adapt the purchased company as required to meet these objectives. There is a lot at stake, especially from the viewpoint of the company founder. Most of all a risk that the company will no longer be what it used to be. If these options are not deemed desirable or expedient, traditional bank credits are a financing alternative. As mentioned above, the market conditions for loans have been tightened. In view of the increasingly stringent lending criteria, companies will be confronted with considerably stricter loan approval conditions: beginning with collateral to be furnished through to the need to consistently convince the lending party of the expediency of strategies and long-term planning. In any case, the loan will repeatedly restrict financial mobility due to the ongoing burden of interest and repayment.
In contrast, the involvement of a financial investor and any consulting provided offers decided advantages. As a matter of principal, private equity companies do not take influence on the strategic objectives and operational measures of the respective companies. Rather, their aim is to establish a partnership-based relationship with company management and contribute extensive know-how and contacts with the aim of generating gains in value that will benefit both sides. In most instances private equity provides the desired injection of capital without burdening the company with ongoing interest payments. Moreover, the equity investment company does not invoice consulting fees for the services provided, and the entrepreneur will not be personally liable for the additional capital provided. The price paid for the involvement of the financial investor is dependent on the investor's participation in the enhancement of company value. It is this increase in value that is of the the most interest for the former owner and the heirs to the company, should they exist.
Solutions are always individual affairs
In addressing succession issues (ie, if the company owner remained childless or the heirs quarrel about the company's future), family businesses are confronted with a complex problem where the economic environment, company perspectives and private life aspects are all tightly intermeshed. In view of this fact one should not expect standardised solutions that would be expedient in every instance. Equity investment companies can make significant contributions to individually expedient solutions. With their management know-how they can help in optimising company processes and also provide convincing answers to capital procurement questions. These answers will be dependent on the individual aims and objectives of the entrepreneur. Therefore the management teams will focus on the wishes or particular problems and worries of the company owner.
The right solutions can be found if all parties involved address the problems at hand. Private equity managers are used to thinking long-term and are also capable of conducting preparatory discussions over a period of two or three years. In such decisive, pivotal issues, the paramount concern must be to establish good chemistry between the main players and create a foundation of trust in the course of extensive one-on-one talks. In many instances, the private equity manager is also called on to deal with private financial matters. In all instances, however, experienced private equity managers will be able to present financing strategies – that have already been successful in other cases – and develop these strategies to suit the entrepreneur. The pivotal issue will always be the capitalisation of the given company. It is also worth pointing out that the extent of changes will always be a very individual issue.
Whatever the solution, one thing is for certain: there are no standard, out of the box solutions. Today's private equity managers are experts that devise tailored solutions in close cooperation with their clients. Their involvement can make a valuable contribution to the ongoing and future viability of the company, the affluence of owners and their families, and especially towards enhancing the company's earning power and corporate value.