“Despite stories of successful expansion based on external funding, most Mittelstand firms remain resolutely conservative about their financing”
In 2013, the Stollberg-Germany machine parts manufacturer PTF Pfuller GmbH took a first step into the US market by opening a sales operation in Sturtevant, Wisconsin. Managing director Oliver Zintl says the move should help the medium-sized business boost its exports to the US. If all goes well, it plans to open a 50-person manufacturing site at the location within the next five years.
PTF has not chosen a route typical among German SMEs to fund its export growth. Most Mittelstand companies – usually family-owned German SMEs with strong export profiles – choose to finance overseas expansion through internal funds. But PTF attracted funds from SME equity investor Silver Investment Partners in 2011. Since then, the company has grown rapidly, investing €500,000 in new machinery for its plants in Germany and in Suzhou, China, buying two German SMEs, and opening the sales branch in Wisconsin.
Despite such stories of successful expansion based on external funding, most Mittelstand firms remain resolutely conservative about their financing; companies like PTF are the exception. Research by Deutsche Bank shows German SMEs are increasingly likely to use internal funds to support export expansion and increasingly unlikely to use bank loans or external sources.i
Relying on retained profits to fund export growth has a number of advantages. This form of financing attracts tax relief; there is no bank interest to pay; the owner-manager does not have to surrender equity to investors; and, in Germany at least, using internal funds suits the aspirations of most Mittelstand companies to remain independent over the long term.
On the other hand, relying on retained earnings can also slow the pace of an SMEs export growth, causing it to lose some market opportunities. “Some people say that German SMEs are not very profit oriented,” says Dr Michael Lloyd, senior research fellow at the Global Policy Institute, a research institute of London Metropolitan University, “but then, German SMEs often reinvest up to 90% of their surplus into the business to help it grow. Culturally, there is a mind-set among German entrepreneurs that favours slower, but stable growth.”
For a few companies, such as PTF, “slow and steady” is not sufficient to allow them to seize opportunities in fast-moving markets. To cover the costs of researching new markets, developing new technologies for export markets, extending production capacity, adding inventory and gearing up supply chains to boost exports, some German SMEs look externally for funding. For many, this means turning to local co-operative and savings banks. Like the Mittelstand businesses they serve, these banks have a culture of long-term investing, and commonly provide export finance loans for up to 20-30 years. Interest rates are risk-adjusted depending on the circumstances of the SME borrower.
This works for most SME borrowers in Germany. About 82% of SME bank loan applications in Germany are approved, compared to only 50% for UK SMEs.ii But there are hurdles for smaller applicants, in Germany as well as Europe-wide. According to the European Central Bank, larger European SMEs more likely to obtain bank loans than their smaller counterparts.iii
Where banks hesitate to extend a loan, they may offer mezzanine debt, in which the lender can take shares in the company if the debt is unpaid. They might also offer equity deals, such as PTF’s, in which the lender acquires shares outright. Where given a choice, however, German entrepreneurs rarely take either option, preferring simple loans, to avoid diluting their shareholdings.
Start-ups—which by definition have no track record or retained earnings to draw on—can have the toughest time of all in obtaining bank loans. But some have found innovative solutions. Walter Haimerl, managing director of the Leonberg, Germany-based laser cutting and welding start-up Haimerl Lasertechnik, for example, had to find a different source when his bank refused a €500,000 loan to buy a laser cutter he needed to boost production capacity.
Mr. Haimerl turned to the vendor of the cutting machine, Stuttgart, Germany-headquartered Trumpf. It had set up Trumpf Financial Services to help firms acquire its products. Nicola Leibiger-Kammüller, Trumpf’s president, says that the firm understands the business of its customers, and its risk is low. If a borrower defaults, Trumpf can take back the machine. Other corporations selling high-cost equipment, such as the Munich, Germany-based engineering conglomerate Siemens, offer similar financing deals to start-ups and to well-established SMEs looking to expand their export capacity.
A small number of German SMEs, particularly high technology IT start-ups, seek funding from venture capitalists, although they often find that the scale and scope of their operations is too small to interest such investors. The average investment size in Germany–€780,000—is often too small to attract global venture capitalists accustomed to the average €6m investment in US-based start-ups. Nor do many venture capitalists adopt the long-term break-even perspective of German start-ups; even German-based venture capitalists, who presumably understand their countrymen’s longer-term thinking, tend to expect a high proportion of their SME investments to break even within 18 months.iv
Beyond banks, vendor lenders, and venture capitalists, some enterprising SMEs in Germany turn to capital markets—floating stocks and bonds—for external financing. Thomas Schaffer, chief financial officer of the Leverkusen, Germany-based biopharmaceutical company Biofrontera, says it chose to go to the capital markets to fund its global expansion. The firm listed on the Frankfurt Stock Exchange in 2007 and floated on London’s small cap market AIM in 2014.
Listing on AIM has given Biofrontera access to UK institutional investors at the cost of a few hundred thousand euros in listing, legal and accounting fees. “You find very few institutional investors that invest in small caps or biotech in Germany,” he explains. “They tend to go for large caps and blue chips.” In the UK, he adds, there are experienced investors who are potentially interested in financing the global expansion of non-UK companies. But they insist on a London listing. The London listing has helped Biofrontera build a stronger shareholder base to finance its future export plans, including expansion in the US, if its products receive regulatory approval from the US Food and Drug Administration agency.
Schaffer admits it would be unrealistic for the company to adopt the slow track favoured by many of his countrymen. “Biofrontera needs to exploit the patents on its products before they expire,” he says, “and that requires access to a large and educated investor base”.
i “Making a difference: German SMEs and their financing environment,” 2013. DB Research
ii “FSB Voice of Small Business Index,” Quarter 3 2014, Federation of Small Businesses, UK
iii “Survey on the access to finance of small and medium-sized enterprises in the euro area,” 2014. European Central Bank
iv “A slow climb: business creation in Germany,” 5 October, 2013, The Economist