KfW-Research. Economic Observer. No. 7, February 2005.

Transcription

1 KfW-Research. Economic Observer. No. 7, February 2005.

2 FINANCING INNOVATION AND RESEARCH INVESTMENTS FOR SMES: BETEILIGUNGSKAPITAL CHALLENGES, PROMOTIONAL IN DEUTSCHLAND. APPROACHES AND RECOMMENDATIONS FOR EU SUPPORT. In March 2000 the Lisbon European Council set the goal to transform Europe into the world's most competitive and dynamic knowledge-based economy. However, the recently published mid term evaluation by the former Prime Minister of the Netherlands, Wim Kok, states a disappointing delivery so far. To reach the target of spending 3 % of GDP for R&D it is essential to increase the level of R&D expenditure by private companies. In the past years, promotional banks in Europe have set up specific financing schemes to support R&D investments of SMEs, which contribute around a quarter to business R&D in the EU. KfW together with nine other promotional institutions (Network of European Financial Institutions -NEFI 1) has recently published a survey which shows that, depending on the stage of the life cycle and the innovation intensity of the investment, four main clusters of promotional financing programs can be observed, which each share similarities in their characteristics 2) : Category I Programs support founders of high-tech companies in their pre-seed and seed stage carrying out top of the art research. Category II Programs target enterprises which realise R& D projects but are situated in the later stage of their life-cycle. Category III Programs target at SMEs in the early/seed stage of their life cycle trying to realise an innovative business idea, which does not necessarily involve high-tech research, and Category IV Programs target the vast majority of innovative projects initiated by companies in their later stage with relatively low innovation intensity. 1) ALMI (Sweden), BDPME (France), Finnvera (Finland), Hipoteku Banka (Latvia), ICO (Spain), KfW Bankengruppe (Germany), MCC (Italy), MFB (Hungary), SNCI (Luxembourg) and SZRB (Slovakia) 2) The survey was conducted in April Some of the mentioned programmes have in the meantime been redesigned, and some additional promotional programmes have been launched that are not yet described in the survey. 2

3 P R O G R A M F O C U S I N N O V A T I O N R E S E A R C H Innovation Intensity III BDPME Equity Guarantee Techno. Development KfW BTU Early Stage ALMI Innovation Loan I BDPME Biotech Guarantee KfW FUTOUR IV ICO Innovation Loan KfW ERP Innovation Loan KfW ERP Innovation Equity BDPME Equity Guarantee Capital SME BDPME Innovation Development Contract II MCC National Research Facility Fund MCC law 598 research program Seed Start-up Growth Expansion EARLY STAGE INVESTMENT STAGE The survey of NEFI identifies a clear financing gap in Europe for highpotential pre-seed, seed and start-up companies with a strong R&D focus (Category I). These newly founded companies can be spin-offs from existing companies and scientific institutions or private individuals becoming entrepreneurs. Their R& D projects are complex and costly, potential for success is high, but difficult to assess and track record or collateral is not available - these elements result in market failure as no funds are available for this target group. Therefore, these companies need public 3

4 support at the beginning of their life cycle. The objective of a financing scheme for this target group is to support R&D which clearly exceeds the state of the art and has the potential for commercial success, and to make the new companies ready for private investors. For an efficient use of public funds, a strict selection of companies must be made to clearly identify high-potential projects. NEFI proposes a European financing scheme jointly implemented by EU financing institutions and national promotional banks. Through a strict and lean selection process at national level carried out by independent institutions, only very promising projects would be accepted for subsequent financial support. National promotional institutions and the EC would then jointly provide financing to these new companies through a financing mix of grants and quasi-equity (silent participations). The latter allowing the public investor to participate in the success of the company (up side sharing). Innovative seed and early stage companies (Category III) need primarily equity or mezzanine capital with equity character to pursue their innovative business ideas. To enhance existing national promotional schemes for these companies, the EU should broaden the scope of existing EU guarantee support schemes (e.g. open the equity guarantee scheme under successor of the Multiannual Programme to equity or mezzanine schemes of banks). Later stage companies involved in research(category II) or in an innovative business field (Category IV) are often not suited for pure equity investors. The character of their investment however makes it difficult for them to offer collateral to banks and subsequently to access bank loans. NEFI experience shows that mezzanine capital (with loan characteristics) can be 4

5 the financing solution for these companies. The advantage of mezzanine capital is that it does not require collateral, it is subordinated to senior loans in case of default, and it strengthens the equity base of the SME allowing access to additional loans for investments. NEFI therefore recommends to design a EU support scheme to enhance and trigger promotional mezzanine financing instruments offered by national promotional institutions to innovative and research intensive SMEs. The support could take the form of a counter guarantee to promotional banks to cover their so-called unexpected losses. For those risks, banks normally have to set aside equity capital, which can be substituted by such a guarantee. By covering unexpected losses through budget resources / a guarantee, the EU would highly leverage the introduction of mezzanine capital for innovation investments of small companies into the market. NEFI experience shows that research intensive companies need networks in order to fully exploit their innovative potential. The 6th Framework Program for Research and Technological Development (FWP) has the objective to support the establishment of European networks between companies and research institutions. However, the support mechanisms of the program do not take account of the specific situation of small companies. The result is that SMEs so far only benefit to a very small extent from the 6th FWP. NEFI therefore proposes to design new and more effective support mechanisms for research intensive and innovative SMEs for the 7th Framework Program, based on the experience with promoting this target group. 5

6 Experience in financing R&D and innovation shows that it is difficult to assess the viability and the potential success of R&D projects. This assessment is however an important factor for the financing decision of equity investors and banks. Though all partner banks possess of individual tools and processes to ensure that projects are carefully selected, a comparison on a European level can not be made. NEFI therefore proposes to elaborate a technological rating as an evaluation tool which could be sponsored by the European Commission. Such an evaluation tool should provide an integrated analysis of the level of innovation taking into account the technical feasibility of a project, the company's managerial and organisational skills as well as the market opportunities of the innovation. The benefit of such a technological rating would be that promising projects could easier be identified, easier be compared and thus more carefully be selected by those who engage in providing equity and loans especially to Early Stage companies. The NEFI survey with more details on the specific financing challenges encountered by SMEs investing in innovations, as well as on different existing promotional approaches and NEFI recommendations can be downloaded at Authors: Claudia Mori, Tatjana Bruns 6

7 PRIVATE EQUITY IN GERMANY AND GREAT BRITAIN A COMPARISON OF MARKET STRUCTURES. Based on an extensive survey of private equity companies in Germany and Great Britain, conducted in close cooperation with a German-British group of researchers, KfW Bankengruppe (KfW banking group) has recently published new insights on market structures and behaviour patterns in the German Private Equity Markets 1). This survey was addressed to all members of the German Venture Capital and Private Equity Association (BVK) and the British Venture Capital Association (BVCA). Now a comparison of the German and British private equity markets has been presented, which provides a number of new and additional information 2). Selected results of the study are summarized here. STRUCTURES AND BEHAVIOUR OF EQUITY PROVIDERS. Why comparing the German and British private equity markets? There are several reasons for choosing these countries for comparison. Among these reasons we find a differing financial, institutional and regulatory framework impinging upon the private equity industry and different development paths in the evolution of the industries of both countries. Against this background, the study reveals remarkable differences of the two markets: Firstly, there is a differing concentration of market actors with respect to specific stages of financing. German private equity companies specialize more frequently on early-stage investments than their British counterparts, who on average concentrate rather on the later-stage segment. 1) Cf. Economic Observer No and the full study to be downloaded at 2) See the full study which can be downloaded at 7

8 Illustration 1: Specialisation on financing phase Early Stage (n = 35/13) 21,7 32,7 Germany Great Britain No Specialisation 29,0 (n = 31/19) 31,7 Later Stage 38,3 (n = 41/28) 46, in % of all enterprises surveyed A differing focus with respect to investment stages corresponds with differing investment sizes realized. On average commitments in Great Britain have higher volumes than those in Germany, though in the area of earlystage financings British private equity companies are also willing to accept smaller commitments than their German counterparts. Major differences also exist in the handling of financing requests: The share of financing requests which is accepted (5 %) is roughly equal in both countries. But in Germany private equity companies spend much more time and effort on the appraisal of individual investments than their British counterparts do. Nevertheless, the German companies relatively more often use standardized rating procedures to appraise investments. This difference is even more pronounced when we look at the intensity put into handling a deal after contract conclusion: In Great Britain almost all deals are handled hands-on, whereas this applies to only half of the deals in Germany. This also corresponds with the different importance of 8

9 mezzanine financing forms in the two countries, which are represented much more strongly in Germany than in Great Britain. As for funding sources, the funding structure of private equity companies mainly reflects the obvious differences in the economic and financial structures of the two countries. The private equity segment in Germany is dominated by group-internal financing and borrowing from banks while in Great Britain private equity is provided on a large scale by private individuals and institutional investors. The investments themselves are also orientated towards the general structure of the respective industry and go primarily to those industries, which are the focus of the respective national economy. MARKET GAPS AND PROMOTION. The survey also looked at the question as to what extent both markets ensure that the demand for private equity is actually covered and in which areas additional promotion is required. The share of private equity companies that make out a permanent lack of private equity is roughly equal in both countries (just under 70 %). In Germany gaps in the supply of private equity are primarily made out in the service sector and the low-tech sector of the producing industry and in Great Britain this concerns rather the sectors of IT, telecommunications, media and life sciences. Additional important insights were gained with regard to gaps in the range of products offered for specific financing stages: In particular in the field of early-phase financing demand often exceeds the supply of private equity companies in both countries; this is especially so in the British market. This might at least partly be due to the fact that promotion in Germany strongly focuses on early-stage financing. 9

10 Illustration 2: long-term private equity supply gaps IT, Telecom., Media 22,9 30,0 Branches Germany Great Britain Other Services Manufacturing, high tech 10,0 21,4 15,0 28,6 Manufacturing, low tech 12,5 48,6 Life Science 15,7 25,0 Other Industries 7,5 15,7 Specialisation on the financing phasen Seed Start-up 52,9 71,4 75,0 77,5 Expansion MBO / MBI Replacement Bridge 5,7 2,5 4,3 5,0 4,3 7,5 10,0 20,0 Turnaround 15,0 40, percentage of firms that identified market gap 10

11 CONCLUSION. It is obvious that the private equity markets in Germany and Great Britain took off from different starting points and, under unequal conditions, experienced different developments. Differences in how the markets function are partly due to the differing structures of the market participants and their portfolios. Though one cannot say that the German private-equity market, which is primarily dominated by financing through commercial banks and by group-internal financing, is stuck in the infant stage, it might probably be fair to say that it still has clear development potentials, especially when compared with the UK market. Author: Dr. Jörg Fischer 11

12 KfW Bankengruppe Economic Department Palmengartenstrasse 5 9, Frankfurt am Main Phone , Fax Infocenter KfW Förderbank Phone , Fax infocenter@kfw-foerderbank.de Infocenter KfW Mittelstandsbank Phone , Fax infocenter@kfw-mittelstandsbank.de