Small and medium-sized enterprises and innovation financing

Hummel (2011a), who was research active with regard to SME and innovation financing in Germany, argues that the modest technology transfer is due to a lack of applied research projects

and of cooperation between enterprises and research institutions. Nevertheless, he concludes that the gap in financing capital is the most important obstacle in the technology transfer. His research results show that self-financing by capital gains is the most important type of financing for SMEs in Germany. Even though placed on subsequent ranks, bank credits and overdrafts, supplier credits, depreciation and leasing are of importance too. This applies in particular on the level of enterprises between 50 and 249 employees which achieve revenues between ten to 50 million euros per year. Public funding, guarantees, factoring, private equity and capital market financing play a minor or absolutely no role in the financing of SMEs. Nevertheless, these results could not be regarded as representative for the population of SMEs in Germany due to the rather weak response rate of 1.4%. Overall, they show a basic direction regarding the financing of SMEs in Germany.

On the level of innovation financing, Hummel (2011a) distinguishes between project sizes up to 50,000 euros, 50,000 and 200,000 euros and above 200,000 euros in SMEs with no more than 249 employees. In that respect, self-financing is the most important financing channel too which applies for every project size. Bank credits, bank overdrafts and supplier credits are also important but, nevertheless, are on the subsequent ranks. The application of public funding is rather unimportant for projects up to 50,000 euros but, nevertheless, increases in relation to the project size. Public funding takes the second rank behind self-financing of projects above 200,000 euros. On the level of that project size leasing is also important, which could be explained due to investments in fixed assets for innovation projects. Capital market and mezzanine financing do not play any role in the financing of innovation projects (Hummel 2011a). However, this conclusion should be regarded with care as initially specified and might be a consequence of the particular research questions and project sizes.

Nevertheless, the results underline the obvious dependence of SMEs on self- and bank-financing. In particular, SMEs dependence on bank financing (ECB 2010; Destatis 2011; Hummel 2011a) should be regarded as critical for the further development of the economy. SMEs are disadvantaged by banks due the lack of securities, controlling and reporting instruments (Stefanovic 2009). Hummel’s (2011a) research results confirm that the lack of securities and, moreover, the costs of bank financing are the most important obstacles for SME financing purposes. These issues are the most important on the level of enterprises up to 49 employees with less than ten million euros on revenues.

These circumstances should have intensified due to the contraction of the bank sector during the financial crisis (see section 2.4) and the modification of the minimum capital requirements for banks (BIS 2010). Thus, in order to receive bank credits for innovation or general financing purposes, SMEs have to expand their equity basis too. This underlines the assumption that alternative financing channels should be of future relevance for SME and for innovation financing purposes.

With regard to capital market financing, Hummel (2011a) refers to equity financing by shares or debt financing by corporate bonds. He argues that the application of these financing measures on the level of SMEs and innovation projects is limited. Hummel (2011a) remarks that an initial public offering in order to issue enterprise shares on the stock market is associated with transaction costs during the IPO and subsequently due to publication obligations and shareholder meetings. Corporate bonds on the other hand would be associated with large transaction costs too, and would also require minimum transaction volumes and positive ratings of the debtor. Due to these particularities, the application of capital market financing is surely limited for SMEs. Past developments of the capital market in Germany support the assumption that this financing channel is overall limited. This applies not only for SME and enterprise financing in general but in particular for the financing of innovative enterprises. In that context, the number of IPOs in Germany decreased from 142 to eight between 2000 and 2012 after standstills each in 2003, 2008 and 2009 (Statista 2015). This progress was associated by a declining number of shareholders in Germany from approx. 6.2 million in 2000 to 3.6 million in 2008. This number recovered and resulted in approx. 4.5 million shareholders in 2012 (Fey 2014). The development underlines the decreasing relevance of the capital market in Germany at least in the past decade, which, inter alia, explains the dependence of Germany’s economy on the bank sector. With regard to the further development of the capital market in Germany, Blättchen (2015) points out that the German Stock Exchange is comparatively overregulated. He points out that this would apply in particular for this market segment which is regarded as SME friendly. Blättchen (2015) argues that this overregulation of the stock market would narrow its financing contribution, in particular for the financing of technology enterprises. In that respect, he argues that from the future on, investments from private shareholders would be limited. Possible market limitations would also be caused as nowadays private investors would be completely excluded during IPOs. On the other hand, the German Stock Exchange launched a so-called venture network for innovative enterprises (Blättchen 2015). This initiative was established in 2015, as a platform for capital seeking enterprises in the expansion or the pre-IPO phase (Deutsche Börse 2015). Thus,

these past and recent developments show that the potential of the capital market in Germany is not completely exhausted and limited due to additional regulations.

In accordance with the research results of Hummel (2011a), the application of PE and VC for SME and innovation financing is also limited. Based on an investor perspective, Hummel (2011a) argues that PE and VC investors are rather selective, are focused on particular types of enterprise sizes or industry branches, and, moreover, are investing in different life cycles. In addition, these investors have clear return expectations. Hence, these limitations make an overall application in the field of smaller enterprises difficult. On the other hand, Hummel’s (2011a) research results show that the loss of autonomy represents the most important reason for SMEs to deny the application of PE and VC. The more detailed interpretation of Hummel’s (2011a) results show that smaller enterprises up to 49 employees and ten million euros on revenues, simply have difficulties in receiving equity financing. The insignificance of equity financing in Germany is also underlined by the rather small volume of the German PE and VC market. Average calculations, which are based on the annual investments of domestic PE and VC firms in 2010, 2011 and 2012, show that investors in the UK realised approx. 18.8 billion euros on equity investments per year, investors in France approx. 6.8 billion euros per year and German PE and VC firms approx. 4.8 billion euros per year (EVCA 2013). In relation to these average calculations for 2010, 2011 and 2012, the German PE and VC market represents only approx. 26% of UK’s market investment volume. More detailed calculations in that respect are introduced in section 4.1. The comparatively smaller PE and VC market in Germany could also be an explanation for the large proportion of public support in the German PE and VC market. This applies not only for early-stage but also for later-stage investments of PE and VC firms (Zimmermann and Fischer 2003; Achleitner et al. 2006; Achleitner et al. 2010). These issues are discussed in greater detail in chapter four.

With regard to public funding for innovation purposes, the research results show that their importance is increasing in relation to the project size. Public funding takes the second place after self-financing on the level of projects above 200,000 euros. Even though the sample members complain due to long-lasting processing procedures, they appreciate the cost advantage of public funding. On the other hand, public funding is of minor importance for SME financing in general (Hummel 2011a). A more detailed interpretation regarding public subsidies from the federal level for innovation projects is shown by the research results from Belitz et al. (2012). Their research show that the amounts of research grants for SMEs which are issued by federal

departments more than doubled between 2005 and 2010. In that respect, these research grants without the contribution of the defence department increased by approx. 17.6% from 2005 to 2007, and by approx. 57.9% from 2008 to 2010 (Belitz et al. 2012). Furthermore, they agree with the research findings of Hummel (2011a) that self-financing would be the most important source for SMEs regarding the financing of innovation projects. They calculate that approx. 69% of the R&D expenses are self-financed by cash-flows or reserves, approx. 25% by public subsidies and approx. 6% by both private and public bank loans. Nevertheless, it should be considered that these results are limited to those enterprises which received public subsidies from the German economic department and the department for education and research between 2005 and 2010. Thus, these results are not representative for the entire economy.

These basic clarifications regarding SME and innovation financing in Germany show that there is a large dependence of SMEs on their self-financing capacity and on bank financing. Schumpeter (1985 and 1987) argues that enterprise financing is important, not only for the implementation of factor combinations but also for the diffusion of innovations. Therefore, financing constraints could be regarded as rather critical for the further development of the economy.

Nevertheless, the successful transformation of technologies and the reorganisation of the economy also require entrepreneurial activity. Research data show that the relation of enterprise foundings and liquidations ran from an annual surplus of 54,000 in 2005 to an annual loss of 24,000 in 2012. This information is derived from enterprises which are either registered in the trade register or employ at least one employee. Enterprise foundings in the agriculture sector, freelancing and sideline foundations are not considered. This significant decline is accompanied with a decreasing number of sideline foundations, which decreased from a surplus over liquidations from 131,000 in 2005 to 84,000 in 2012 (IfM 2014). On the other hand, the number of freelancers increased by 130% between 1994 and 2014 (Welter 2015). Welter (2015) argues that the founding behaviour has changed due to the technological possibilities and society’s development. This means that nowadays enterprise founding in its simplest way would just require knowledge, networks and internet access. She (Welter 2015) concludes that the barriers for enterprise founding would be lower than in former times and enterprise founding in general would be more project oriented. Thus, the relevance of financing capital on the one hand and specific requirements regarding the entrepreneur on the other hand would have stepped aside. Even though Germany obviously suffers from a decreasing proportion of commercial enterprise

founding, Welter (2015) concludes that the present enterprise foundings would fulfil their economic role. Enterprise foundings would not only stimulate competition and thus would initiate the further development of the economy but would also prompt the bigger-sized enterprises to carry out ongoing research and development.

This is surely a simplification of reality by considering the R&D activity in Germany between 2008 and 2012. Welter (2015) qualifies the contribution of the freelancers in the economy and points out that the proportion of freelancers which permanently work without any employees increased by 83% between 1992 and 2012. Thus, it could be assumed that freelancing is more of an employment alternative due to economy’s development in Germany after the millennium turn. The value added of this increasing number of freelancers is surely too small in order to compensate for the gap of commercial company foundings. In economic terms, it could be concluded that there is not only a decreasing entrepreneurial activity, which is associated with an increasing number of freelancers, but that Germany also suffers from a decreasing innovation success (see section 2.6.2) and a capital gap for SME and innovation financing (see section 2.6.3).