Steinbeis: Christian, you are very active in the field of Smart Money Venture Capital. How do you see the current development in the area of financing young growing companies?
Christian: The past few years have been very successful and we are very pleased with the development of our Smart Money Venture activities so far this year. There are a number of new companies in AI, IOT and energy that we currently support within our Smart Money Venture Capital activities.
Steinbeis: Besides AI and IOT, Blockchain is on everyone's lips, there are countless conferences, contributions to Blockchain and startup companies. What is your assessment?
Christian: From our point of view, blockchain is a technology that is hype-packed, especially by the cryptocurrencies. In the areas of Trade Finance, Securities and Supply Chain, we see a number of very interesting practical applications, which also include comprehensive financing platforms.
Celsius Network, based in the US and Globacap, a UK company, are interesting examples of modern financing platforms that are also of interest to institutional financing providers. We are invested in Globacap since the seed phase and support the company accordingly.
Steinbeis: Some companies in this area partly finance themselves through ICOs.
Christian: That's right. Two companies, Telegram and EOS, together received US $ 5.7 billion in 2018 through the issuance of their ICOs. The vast majority of ICOs currently have financing volumes of US $ 50-200 million. You have to look at it in the individual case very carefully. We estimate that the default rate for companies that have funded themselves in this area over the last two years, especially through ICOs, will be very high.
Steinbeis: Why is this from your point of view?
Christian: Many ICOs were issued on the basis of so-called "white papers". These are often companies with good ideas, but mostly without proof of concept and market proof. In plain language, this means that the idea of the company first has to prove itself in practice. The normal ICOs are predominantly pre seed or seed financings with high corporate valuations. The default rates in this business stage are historically high.
Steinbeis: That means: Stay away from this asset class?
Christian: No, you can not say that on a flat rate. When examining the underlying that means: analyzing the company, the management, the team and the business model, understanding the scaling, then you also might find "the pearls" worth investing in. The asset class of ICOs is relatively new and is currently developing. Milestone-based payouts, government regulations and professional investors are accelerating the maturity of this asset class in the coming months and years.
Steinbeis: What does that mean for your Smart Money Venture approach?
Christian: From our point of view, ICOs are one of many financing options for young companies. Smart money venture capital is a combination of financing and sales support and this combination has a high relevance for the companies that make use of it because through Smart Money they receive in addition to financing access to the decision makers of their target companies on the customer side. Young growing companies with a Market Proof and Proof of Concept understand this added value and gladly make use of it.
Steinbeis: You were back at the Hannover Messe for a few days at the beginning of April, which impressions you have taken in the area of IoT.
Christian: At the Hanover Fair IoT is mainly concerned with industrial production. It is impressive to see how far German and European companies are in this area. In addition, we see many applications in the medical and automotive sector in the IoT environment.
Steinbeis: How do you assess the potential of IoT over the next few years?
Christian: According to Gartner, there are about 25 billion IoT devices by 2020, and there are currently about 5 billion devices. This illustrates the potential of IoT applications across industries. That's why we recently invested with other private investors in NBT AG, an IoT company builder in Berlin.
It is the combination of IoT and Artificial Intelligence that will be relevant in the industry today, and especially in the future.
Steinbeis: What does that mean in concrete terms?
Christian: The keyword is: intelligent factory. In recent years, companies have networked their production lines and factories, and now it's all about extracting new insights from the data - e.g. through machine learning.
Steinbeis: Machine learning, as an AI domain, describes the ability of software to adapt and improve itself based on its previous interactions with the environment. What meaning does this have in the field of production?
Christian: This means that how a person learns through experience and adapts his behavior, a program code does the same thing. When companies use intelligent software in their production facilities, they are able to analyze the behavioral patterns of machines in large volumes of data. In this way, failures of individual components can be predicted, faults and causes can be identified in advance. Companies can then also schedule service work with advance.
Steinbeis: Which companies do you see as pioneers in this area?
Christian: There are a number of companies that, in our view, set accents as suppliers in this area, such as: Beckhoff Automation, B & R Industrial Electronics, Balluff, SICK and PHOENIX CONTACT. In this context, Siemens has created a good basis for the combination with artificial intelligence in production plants with its open IoT operating system. By analyzing the operating data and measurements from sensors, the software can detect whether anomalies occur in the production plant or the installed automation solution that lead to production disruptions or failures.
Steinbeis: Christian, for a long time you and your team have been dedicating a lot of energy and time to young fast growing companies and "Smart Money". What is "Smart Money" about?
Christian: "Smart Money" basically consists of two elements. Venture capital starting at 1 EUR Million per company and supporting the company in the area of business development / sales, both strategically and operatively.
Steinbeis: Why is this combination of support so important for young fast growing companies?
Christian: This basically echoes a saying from football: "Money alone does not score goals". You need a well functioning team and strikers who score goals. For most companies fresh capital and sales are the two most important limiting factors. This is exactly where we help.
Steinbeis: What are you paying attention to in this respect?
Christian: Most of the companies we are working together with have realised proof of concept and they already have first customers. They are in the midst of the next level of growth and they are in need to finance it and they need to accelerate their sales activities. Often we find that the founders are the best sales people of their own product. But it is paramount that the sales successes are reproduced and broadened. This is what needs to be developed, implemented and executed to lift the sales and the organization to the next level.
Steinbeis: Can you give us some more insights?
Christian: This very much depends on the company and their services and products. From implementing sales strategies, cold calling campaigns and wining new key account customers, it often is a mix of actions. Recently we acquired a number of new key customers for one of our companies and we are supporting them to leverage the potential of their new B2B customers.
Steinbeis: How important are your exisiting networks?
Christian: We have direct access to more then 300 owner led and stock-listed companies in the German speaking DACH region (Germany, Austria and Switzerland) on CEO/CFO level. This is very helpful, because we make use of a top down approach enabling us to find and realize sales potential and cooperation potential in a very efficient way. Parallel we generate leads outside of our existing network for the companies.
Steinbeis: Let us come back once more to finances, financing volumes, investment criteria, process and your geographic focus?
Christian: We focus very much on late series A, B , C with financing volumes ranging from EUR 1- 20 million per company. The most important investment criteria are "TTS": Team, Technology and Scalability. The whole investment process takes 2-3 months and consists of three phases: 1. Analysis of investment material 2. Investors' meetings with our financial sponsors 3. Closing and payment of the funds. We have a clear preference for European companies from all sectors.
Steinbeis: Christian, you and your team are meeting a lot of young fast growing companies during the year. What do you pay attention to?
Christian: For us there are basically three main aspects we are looking at: team, technology and scalability. The more experienced and stress resistant the team, the better. Also we want to understand the teams' vision and goals and how aligned the single team members are. This is an important topic, that can not be simply marked off at a checklist.
Steinbeis: How do you do it?
Christian: Well, basically you need to get to know the team, the founders as well as the management team to get a clear view. One of the main reasons why companies fail at this stage is because of the team. This is the reason why it is paramount to invest enough time in this area.
Steinbeis: You also mentioned scalability?
Christian: Yes, we evaluate the scalability of the firms' products and/or services. Companies like Kreditech, Crowdfox and Mapudo are good examples for scalable business models.
Steinbeis: And these are also exciting products and services
Christian: You are right. We are often enthusiastic about the products and services that are offered by the companies. More important is the question: Does the product really add value time or money wise from the customers' standpoint. If the answer is yes and is backed by relevant customers' feedback there is a good chance for scalability with the help of the right sales strategy and a good execution.
Steinbeis: Venture Capital is often sufficiently available in the seed phase but later on it gets more difficult for companies to acquire growth capital.
Christian: We also observe that it is often difficult for young fast growing companies to finance their growth after the seed phase. This also has to do with the amounts needed to finance the expansion of the business model. Companies need a lot of time to obtain new funds from new investors. And it is quite challenging for them because it is more about identifying the right potential investors then spreading a termsheet among all the potential investors. This can be very time consuming and frustrating for the young company.
Steinbeis M&I publication 1/4 2015
Steinbeis: Christian, tell us a little bit about Steinbeis please.
Christian Schulte: Steinbeis Corporate Finance & Investments (in German: Steinbeis BZ Mittelstandsfinanzierung & Investments) forms part of Steinbeis Foundation with headquarters in Frankfurt, Germany. We are a specialised provider of support and consulting services for companies in the field of financing and we also collaborate with other institutional lenders, such as pension funds, family offices and other foundations.
Steinbeis: Steinbeis Corporate Finance & Investments is focusing on institutional loans. How do you define institutional loans?
Christian Schulte: Institutional loans are loans from for example pension funds and foundations that are granted to companies. We are talking about funds in a range between EUR 10 - 200 million per company with a credit period ranging from 5 - 10 years in addition to the loans from the company's house banks.
Steinbeis: What are the biggest benefits for the companies when they make use of institutional loans?
Christian Schulte: Long tenors, competitive conditions, a positive signalling effect for the company's house banks and low long term interest rates.
Steinbeis: Can you tell us a little about the structure and terms of the institutional loans?
Christian Schulte: The structure is very flexible, it can be senior, mezzanine or subordinated. The terms are determined on a case-by-case basis.
Steinbeis: You personally have been working in this sector for more then 10 years. Why are so many European companies making use of loans from institutional lenders recently ?
Christian Schulte: We have been observing this growing trend since 2007/2008. Medium-sized companies have been diversifying their funding sources since then and from our perspective there are basically two main reasons why they are very active:
Steinbeis: Several European companies received institutional loans with the help from Steinbeis Corporate Finance & Investments. You also work in this area with companies from southern and eastern Europe and Turkey. What are your impressions?
Christian Schulte: We love to work with companies from different countries, every case and company is different. Teamwork and a transparent process are paramount in order to succeed. We sometimes have the impression that companies from southern and eastern Europe and Turkey are even more agile and innovative then their competitors from other countries. At the same time it seems that they are facing even more financial challenges due to the limited funding power of their house banks. And here we can provide a solution.
Steinbeis: How do you see the role of the house banks in this context?
Christian Schulte: The principal banks of the companies face more restrictions due to all sorts of regulations. These regulations make it generally speaking more difficult and more expensive for banks to facilitate loans to companies - especially to companies below investment grade. Usually the house banks are welcoming institutional lenders because they help to balance and decrease the credit risk from the banks' point of view. And they appreciate the fact that institutional lenders are often more flexible and long term oriented.
Steinbeis: Where do you see the biggest demand for institutional loans right now within Europe?
Christian Schulte: Especially in Italy, Portugal, Spain, Turkey, Poland and in other Eastern European countries. We see a lot of companies in these countries with pretty high growth rates, expanding their businesses through organic growth and due to acquisitions. And they need and they make use of institutional lenders in addition to their house banks to finance their investments.
Steinbeis: What do you like about your job?
Christian Schulte: I love the fact that most of the companies we work together with are very innovative and dynamic. They come from different sectors like: Automotive, Mechanical engineering, ICT, Retail, Food, Renewable energy, to name just a few industries. One of our highlights within the whole process is visiting the company's production site and the management team. This often is amazing and it gives us the chance to learn and understand so much about the company's capabilities and strengths.
Steinbeis: What kind of information do you need to start the process with a company?
Christian Schulte: The last two annual financial statements and the target figures. We have an own rating tool, which enables us to do the analytical analysis. A rating from a credit rating agency is not necessary. We pass on the results to the company, discuss them and then we define the next steps.
Steinbeis: Thank you very much for the interview.
The statement of the business director of a mid-sized machinery manufacturer provides a good example illustrating this: "The interest terms and the structuring of the covenants were so attractive to my shareholders and me that we decided to choose very long maturities and a loan amount that was greater than we had actually planned." In early June 2014 institutional lenders extended long-term loans with seven and ten-year maturities to this company for its growth financing. The agreed interest rate for the 7-year range was fixed at 2.4% p.a. and at 2.7% p.a. for the 10-year range. Good credit worthiness and low benchmark rates are the essential factors influencing such favorable business financing.
In the background, some commercial interest rates have fallen markedly. The business customer market is so competitive that even margins are shrinking. German banks and institutional lenders like pension funds and foundations see good engagement opportunities in the segment. The strong competition among lenders is resulting in pressuring profitability and shrinking income. The current low interest rate policy of the central banks and the effects of "Basel III" have had a generally negative impact on the business of lending institutions. Added to that, companies have often no increased needs for financing and, along with restrained loan demand, their interest in commission products has likewise fallen. As a result, banks are losing income in their foreign trade, "cash management", factoring and derivatives areas. The same holds true on the other side for their deposit taking business with savings and current account deposits.
Despite the tough competition, however, credit terms will remain at their present level for a while longer. No bank willingly surrenders its market position, not least because for many institutions commercial lending is part of their core business. However, if it becomes apparent that increasing income and profitability is impossible, many participants can be expected to withdraw from entire segments and branches. Moreover, higher equity requirements for banks and higher securitization of outstanding loans in individual risk classes could lead to a reduction in loan portfolios. Such a scenario would lead to a credit crunch.
That being the case, in the wake of the introduction of "Basel III" higher prices can be expected for loans with maturities greater than one year. In addition, term-congruent refinancing and low interest rate policies will induce earnings problems that also makes it conceivable that the banking landscape will shrink. Mergers would then be the likely method for making the adjustment.
From the firms' perspective, the situation is advantageous right now because it strengthens their negotiating position. Many companies even use the opportunity to negotiate lines of credit that will often involve resetting prices, collateral and maturities or extending them in advance. And they reposition their financing over a broader foundation and they use the option of obtaining long-term institutional financings as an additional building block.
In this sense, the stated desire of a CFO to get acquisition financing with a minimum 10-year maturity is perfectly understandable. Since everything looked good, his company in the foods industry got its funding from non-bank lenders. Finally, it has not been that long ago, when loans from banks were significantly more expensive and difficult to get - especially for firms with lower credit ratings. Back then in addition some credit lines were cancelled by banks. Which is reflected today in the fact that, besides maturities and interest rates, the source of credit funds also plays a very important role for companies.
Thus, mid-sized companies should review their needs for the next few years and take advantage now of the low interest rates to secure their financing. The use of new structural elements – for example institutional loans from institutional lenders – will enhance their independence from banks. That diversification will pay off at the latest when the times change once again.
Dieter Dorn and Christian Schulte / Managing Partner Steinbeis Corporate Finance and Investments
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"Four to five years is the maximum - longer financing terms are not provided by the principal bankers." This is an observation frequently made in personal discussion by many corporate managers responsible for procuring financing. The continuing financial crisis and the requirements under Basle III are two major reasons why this is unlikely to change in the foreseeable future.
However, corporate investment and financing projects, for example to expand production, open and develop new business lines or acquire other companies, often entail far longer financing horizons than 4 to 5 years. Consequently, companies already need to look out for follow-on financing after 2 or 3 years have passed. And this also entails a wide range of risks and uncertainties: the interest rate at the time of the refinancing, macroeconomic developments and the company’s own situation.
The current low level of interest rates, long maturities and the use of additional non-bank sources of outside capital are major reasons why companies seek to use financings provided by non-bank lenders. Pension funds and foundations play a major role in this regard as financial intermediaries. Their funds are deposited for the long term and may also be disbursed in the form of corporate loans. The parameters are: a financing period of 5 to 12 years, a financing volume per company of € 20 million to € 200 million, no furnishing of collateral, and a bullet structure or variable repayments. The coupon rate is fixed for the entire term at the start, so that corporate borrowers can benefit from the present low interest rates for a long time. The level of the coupon rate depends on the long-term capital market rates in place at the time of closing and the credit worthiness of the company concerned.
From the first meeting to fund disbursal, the procedure often takes less than eight weeks. Companies usually use the outside financing obtained for investments, as a strategic reserve or to refinance short-term debt. An owner-managed company in North-Rhine Westphalia recently received app. € 200 million with a bullet maturity of 10 years from institutional lenders in the context of an acquisition financing. The terms were better than those of the short-term financings provided by banks. Not only the company is very satisfied with this solution; the banks involved also value the supporting financing by other lenders.
Alongside conventional bank loans, these funds represent a second financing pillar which grows along with the company’s other financings. In fact, foundations and pension funds think and operate similarly to owner-managed companies: Their aim is to secure existing corporate assets for the next generation. The financings obtained from these sources serve as a stable long-term foundation for the continued growth of a company, and they also contribute to making its financing structure more balanced and maturity-matched.
Christian Schulte / Managing Partner Steinbeis Corporate Finance and Investments