White knight or grasshopper?
How private equity financing can help to globalize SME companies
Summary: Private Equity funds help small and medium-sized enterprises to finance growth by offering capital in exchange for shares. The investors actively support internationalization, which many banks are skeptical about. But not every medium-sized company should get a foreign master into their own house – the chemistry between the investor and the seller must be right.
by Florian Willershausen
European banks literally throw good money after bad. For three percent per annum, one would think, the savings bank laces a loan for expansion abroad. Finally, medium-sized company may target the internationalization that the globalized world itself demands from the screwdriver in Schaffhausen: the engineering office in Romania should have been bought long ago, in Poland a factory must finally be produced, and the devaluation of the Russian ruble encourages to produce polymer components for the auto industry at competitive prices dedicated to exports! However, if the entrepreneur presents these plans to the bank adviser, the disappointment follows immediately: if he grants a loan for internationalization, the interest burden will suddenly be greater than expected.
More than ever, German banks are cheating with globalization. If the expansion is to lead to Eastern Europe, the risk managers’ lamps turn red: sanctions, currency risks, missing government guarantees. Banks are slowing down SMEs on their way east. An alternative is to raise a private equity capital to discover new markets. Their willingness to take risks is greater than with banks: A coherent internationalization strategy as the basis for future growth can be a good “story” for such financiers.
As a rule, a private equity investor provides equity capital to companies for three to seven years – with no interest. His goal is to increase the equity value significantly during this period and thus later to achieve an above-average return with the sale of the shares. The increase in value is also the objective of the seller, presuming that he remains a shareholder in the company or its spin-off. In most cases, the equity partner provides support to the existing management, no matter whether he is a majority or minority investor. However, when implementing growth strategies – be it expansion, upscaling of the product line or restructuring – private equity investors are on hand with their experience. Ideally, the private equity investor is a “white knight” who leads the mid-sized company into a better future. In any case, no “grasshopper” as he has been blamed by European politicians a couple of years ago.
The Russian Direct Investment Fund (RDIF), which is controlled by Vneshekonombank (VEB) and whose fixed assets amount to around ten billion dollars, is particularly suitable in Russia. The aim of the state fund is to attract foreign capital as a co-investor in projects – especially if it flows into projects with a localization share. According to the company, more than $ 30 billion has been generated since its inception in 2011 by foreign co-investors. Among others, our Creon Energy Fund invests in engineering companies that design components for the local oil and gas industry in the region, as well as in the production of products and specialty chemicals based on oil, gas and polymers – precursors currently in Russia available at competitive prices.
However, such a merger poses risks for both the SME and the investor: For the owner of a family business, it may be difficult to closely align business development strategies with a partner. This requires a high degree of transparency, willingness to conciliate on strategic issues, sophisticated (and expensive) reporting system. Conversely, the investor is interested in understanding the substance of the company, risks and weaknesses. He is also obliged to do so by the regulator, which demands extensive audits and reporting obligations in the interest of investors and investors in alternative investment funds (AIF). Therefore, he sends an army of lawyers and accountants to literally turn every stone in the targeted company. Not every “patriarch” likes this due diligence.
Partnering with a private equity investor is like a marriage. It is advisable to get to know the other person well in advance, to check the strengths and weaknesses and, as it were, to regulate the marriage contract down to the smallest detail. This also includes the question of what rights and duties the shareholder has, under what conditions he can also take control of the management. In the run-up, the so-called exit strategy must also look like: selling to a strategic investor, another fund, the IPO or the resale. In this aspect, admittedly, there should be a big difference to marriage.
Florian Willershausen is a former business journalist (Handelsblatt, WirtschaftsWoche). Since 2016, he has been working for Creon Capital, whose private equity funds invest in engineering companies, oil and gas processing companies with a focus on Russia. Behind the Creon Energy Fund is Creon Energy, an established consulting and management company that is well connected in Eastern Europe’s Oil & Gas Downstream industry, helping to bring the fund’s assets to active management.