Creative Financing For The Small Fry

Europe's mid-cap businesses discover new ways to raise cash

At German farm-gear maker Claas, CEO Rüdiger A. Günther used to regard bank credit as a matter between good neighbors. Like other members of Germany's Mittelstand, or midsize-business community, Günther could count on a friendly "house banker" located near his town of Harsewinkel in northwest Germany to extend credit based on trust. But Günther, a former investment banker, years ago saw that the bank landscape was changing and that companies wouldn't always be able to depend on house banks. So Claas got creative. When the company needed cash in the late 1990s, it issued a Eurobond -- long before it was fashionable. Then last year Claas turned to a hybrid product called an equity bond. With the help of investment bank Dresdner Kleinwort Wasserstein, it sold $97 million of the bonds to institutional investors in the U.S. The 7.62% coupon was more expensive than a bank loan, but the equity bond had other charms. Claas only has to make payments when his business is profitable, and the money counts as equity on the balance sheet but as debt for German tax purposes. "Traditionally German companies work with one or two banks. We wanted to be independent," says Günther.

Claas is not the only company looking for new sources of financing. In recent years thousands of small and midsize businesses across Europe have had to scramble for capital as banks tightened their credit requirements in the face of economic uncertainty and regulatory pressure. Recently, credit has begun to ease. In an April survey by the European Central Bank, 14% of loan officers surveyed said they had loosened credit standards for small and medium-sized businesses, vs. 2% who reported tightening. That's a reversal from the year before, when 21% were tightening, vs. 4% easing. But many businesses still have trouble getting money. "It remains a subject our members are very concerned about," says Evelyn Deloirie, director general of MiddleNext, a Paris association representing mid-cap companies quoted on the Euronext exchange.


The situation is most acute in Germany. Banks such as Munich's HVB Group have struggled with bad real estate debt, forcing them to become more stingy in lending to the Mittelstand. At the same time, Germany's state-backed all-service banks and savings & loans have curtailed lending under European Union pressure to reduce risk and behave more like commercial banks. As a result, German small-business lending has plunged in the past five years, with commercial bank loans falling 8% in the fourth quarter of 2004 alone. "The banks were busy with their own problems and forgot their customers," gripes Anton Kathrein, chief executive of Kathrein Group, a maker of antennas and satellite receivers in the Bavarian town of Rosenheim.

Banks say the so-called Basel II accords, which require them to reduce exposure to bad loans, forced lenders to tighten up. Moreover, some businesses have had trouble getting loans because they haven't adjusted to modern banking standards. "That has been a huge problem in the Mittelstand, to open up their finances and allow in external advisers," says Margarita Tchouvakhina, an economist at state-owned KfW Bank Group. Bankers also complain that businesses lack the confidence to borrow. "There's no credit crunch in Germany," insists Hans-Joachim Massenberg, deputy director of the Association of German Banks. "The Mittelstand is hesitating to invest because of insecurity about the political situation and lack of optimism about the economy."

The irony is that the credit problems have arisen at a time interest rates have fallen to near-record lows. That has allowed big multinationals to borrow lavishly to expand their businesses, while even healthy smaller companies are starved for cash. Kathrein tells of a supplier who had orders but not enough cash to finance expansion -- prompting Kathrein to bail him out. It's not an isolated incident. German business dissolutions, in which solvent companies simply shut down, soared 9% in the first half of 2005. Small companies "can pay their bills, but they are denied loans," says Anne Sahm, an analyst at Creditreform, a credit rating agency.

To avoid that fate, small-business owners are looking beyond their banks. They are finding that some nontraditional methods of borrowing carry side benefits. Information technology companies have learned that leasing equipment is easier on customers' balance sheets than selling it with loans since leases don't count as debt. In Germany, leasing accounts for 24% of total business investment, excluding real estate, up from 20% in 2000. "Leasing is particularly suitable in situations where the lessee might have a problem getting funding," says Herbert Lohneiss, CEO of Siemens Financial Services.

Another tactic already widespread in most of Europe, but relatively new in Germany, is factoring, in which a business in effect borrows against its accounts receivable. The factoring specialist will typically advance a merchant or small manufacturer 70% to 90% of the value of his receivables. When the bills are collected, the specialist will hand over the rest, less a 3.5% to 4.5% fee. Last year factoring grew 29% in Germany, with 20 companies handling $55 billion in receivables. "Factoring has definitely profited from bank restructuring," says Dresdner Factoring Chief Executive Klaus Sauer.

Italy is another country where small companies are struggling to find capital. Some banks are trying to help. Italy's two largest banks, Banca Intesa and Unicredito, have promised to lend $1.2 billion at favorable rates to small and midsize companies that are developing products with new technologies. Banca Intesa has linked up with experts at technical universities who help review potential borrowers' technology and market prospects. "For small companies it's practically impossible to receive loans for R&D," says Alessandro Lotti, finance director of Bologna-based Vuelta International, a maker of high-performance wheels for racing and mountain bikes. But Vuelta recently got $1.2 million in credit from Intesa. "We used to finance the past performance, valuing creditworthiness based on tangible assets alone," says Fabio Bolognini, Intesa's marketing head for small and mid-size firms. "Now it's all about financing the future: intangible assets, product innovation, IT-driven efficiency programs."

Even German banks are slowly getting more adventurous. For example, Commerzbank (CRZBY ) is among the banks offering mezzanine financing, in which the bank takes an equity stake in a promising company at the same time it hands out a loan. The debtor regains full ownership by paying back the loan. But so far, credit hasn't eased enough to fuel a spurt in domestic investment in Germany or Italy. Most banks are waiting for the sputtering European economy to pick up. Until then, expect small business to follow the money trail -- wherever that may lead.

By Jack Ewing in Frankfurt, with Gail Edmondson in Milan and Carol Matlack in Paris

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