Smaller companies are crucial to the success of the European economy. However, the way they are nurtured by investors and governments varies dramatically, says Joseph Mariathasan
At a glance
• The approach to smaller companies varies across Europe.
• Anglo-Saxon economies have focused more on listed markets and private equity while Germany is more bank-driven.
• France’s small and mid-cap sector has suffered as a result of the government’s preoccupation with creating national champions.
• Private equity has increased in importance over the past 15 years.
European small caps should be the engine of job creation and economic growth.
The future prosperity of Europe depends to a large extent on success of small companies. This is because of the sheer number of small companies and people employed in those companies, says Tim Creed, head of Europe at Adveq. There are more small companies in each European country than there are mid and large-sized ones.
There can be something like a 100-to-one ratio of small companies to mid-sized ones, and then another 10-100-to-one ratio of mid-sized companies to large ones. That means a ratio of between 1,000 and 10,000 small companies to large ones. Yet the approaches taken to nurture the growth of small and mid-cap companies vary dramatically between countries.
Each country has a different way of encouraging risk-taking in new companies. Marcus Ratz, a partner at European small-cap specialist Lupus Alpha in Frankfurt, points out that in the Anglo Saxon world risk-taking is encouraged through private equity (PE) and listing on stock exchanges such as London’s Alternative Investment Market. The UK has had a successful PE industry for decades.
Creed argues that PE is good not only for the UK but for all the European economies. First, through job creation and second, for the businesses themselves, as PE helps to institutionalise, professionalise and enlarge those companies. “In many cases it turns managers of companies into owners of companies and consequently drives faster growth,” he says. Finally, adds Creed, there are significant benefits to European pension funds and insurance companies.
In countries such as Germany, which has strong banking traditions, risk capital is supplied to smaller start-ups more through credit and tax benefits, says Ratz. Germany has always prided itself on the strengths of its Mittelstand – the small and mid-sized businesses that have long been the envy of other countries. But PE and venture capital is not the most common way in which they are financed. The banks, which are the backbone of the economy, are the main source of finance.
France has dramatically failed to support small and mid-sized companies, leaving the country with a shortage of up to 10,000 firms, argues Ratz. His view is that France has a poor strategy for developing new companies because the government has concentrated on creating and protecting large and mega-cap companies to produce ‘national champions’.
“France realises that something does not work, but it is embedded into the system driven by the Grande Écoles educational system. Half the graduates go into politics and the other half go to the large companies, with the emphasis on trying to create global winners,” claims Ratz.
PE has provided perhaps the biggest support for smaller companies in Europe in recent years. The PE model has evolved over the past decade, says Creed. The model today is all about helping a company and adding value by enhancing their management, improving the way they work, introducing new customers, new products and new geographies. The involvement of PE managers is greater and consequently you see greater transformation and growth.
Creed believes entrepreneurship has improved significantly over the past 10 to 15 years. This is seen not only in venture capital but also in small buy-outs where people want equity ownership. “People realise that you can earn x amount with a salary, but you can earn multiples of x if you have equity in the company that you are helping to grow.”
In Europe a number of experienced executives have built their careers in large companies over 10, 20 and 30 years and they would like to have equity ownership in these companies for the next 10 years, says Creed. It has become a common part of the European landscape, which was not the case 10 or 15 years ago.
The point about the health of small caps can also be drawn from the fact that Lupus Alpha, investing only in listed companies, has very little exposure to countries in southern Europe, whilst Adveq’s PE investments are concentrated in the UK, Nordics, Benelux and in German speaking Europe.
A positive development across Europe is an increase in risk taking, which is being led by a second wave of internet-based businesses. Berlin has a well-developed hub and venture capitalists in Germany are taking more risk following success with digital start-ups. These have little capital intensity. For that reason the initial capital at risk is limited, although the failure rate is also high.
The development of leading-edge technology in Europe tends to be based on the individual strengths of each country, says Ratz. So across Europe you can see clusters of companies in the same sector based on historical connections.
In Italy, Yoox Net-a-Porter, a strong digital franchise, comes out of the country’s focus on luxury consumer brands. Sweden is strong in online gaming, with platforms like Benson and Unibet and game creators like Evolution and Netend, which are among the leaders in their fields.
Finland has an environment shaped by the rise and fall of Nokia. As Nokia’s fortunes fell, employees became self-employed or set up subsidiaries of European companies who needed software development, in which Finland is strong.
The future for the growth of Europe’s smaller companies does look brighter. The number and quality of PE firms has increased significantly over the past 15 years, in many cases doubling or quadrupling, says Creed.
Some PE firms are now on their third of fourth fund having invested in 20 or 30 companies over the past decade. As a result there are significant skills available within the PE community which is looking for companies to invest in. As Creed points out, that in itself works as trigger for those companies. So for Europe as a whole there are more firms available and more funds looking for investment.
But Europe has some way to go compared with the US. “If you look at the success of US companies, it has been due to a culture of risk taking. If you haven’t failed at least once, you are not seen as a good entrepreneur,” says Ratz.
As he adds, that is a different way of thinking and that is why innovation is more successful in some countries than in others.
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