Benjamin Boehner: «It's Also Possible Without Financial Leverage»

The high degree of innovation within the Swiss SME landscape and the lively activities in the start-up scene are the ideal environment to connect with interesting high-growth companies, writes Benjamin Boehner in his article for finews.first.

This article is published on finews.first, a forum for authors specialized in economic and financial topics.

Due to the persistently low-interest-rate environment, a significant reallocation of assets towards riskier investments and, above all, to private markets can be observed. This phenomenon can be explained by the historically higher returns of private equity compared to the stock market and the peaks at the stock markets. But the rapidly rising money supply and negative real interest rates are also motivation enough for many players to put their focus on real assets such as private equity.

In fact, jewels of growth are mainly found in the private market. Investments in innovation and in longer-term trends and upheavals offer great opportunities to achieve attractive returns. Companies that consistently focus on a megatrend or come up with real innovation, for which there is also a sales market, usually achieve disproportionately high sales and profits over long periods of time.

«It is important to distinguish between different investment strategies»

However, these so-called growth companies remain private for a much longer period before they go public – if at all. Investors who want to consistently rely on growth companies cannot avoid so-called pure plays with a focused business model. These are mostly medium-sized, often younger companies that are already in the middle of a success story even if you can't find them on the stock market yet.

In the case of private market investments, it is important to distinguish between different investment strategies. A special feature are growth equity funds, which stand out from other private equity strategies in several aspects.

While traditional buyout managers initially buy out the previous owners of a company (often with significant use of debt capital) in order to gain control of the company, growth equity managers invest directly in the company, as part of an increase in capital in order to finance investments for further growth.

«The business model is self-sustaining»

The previous owners, who have usually been responsible for the company's success, remain committed and continue to steer the fate of the company in most cases. This ensures the best possible congruence of interests between investor and management, but often also requires that investors do not hold the majority of the shares, but are invested with a significant minority.

Unlike venture capital funds, growth managers generally invest only at a point in time when most of the technological risk has already passed, the company has been successfully brought to the market, and the business model is self-sustaining.

Building on the successes and strengths already achieved, the capital raised is intended to further drive growth at a time when the achievable benefits of scale are greatest. The increased visibility compared to a very early venture capital investment significantly reduces the risk.

«Credit issues are again high on the agenda»

Growth equity funds also hardly use financial leverage – in contrast to the classic buyout strategy – but primarily invest equity. Since 2013, the average leverage (net debt/EBITDA) on leveraged buyouts has risen steadily and has now reached the peak level of 2007 before the outbreak of the global financial crisis (according to data from Stepstone).

In PwC's current «European Private Equity Trend Report», 84 percent of international investment managers stated that more than 10 percent of their portfolio companies had not met credit requirements. In comparison: In 2016, 39 percent of the buyout funds confirmed that they did not hold any investments with unfulfilled credit clauses.

Credit issues are again high on the agenda in the buyout segment; the additional flexibility offered by a company portfolio with stable balance sheets, low leverage ratios and good liquidity is clearly advantageous. By dispensing with leverage at the deal level, the already healthy financial situation of the companies in the portfolio is further strengthened through the investments.

«The report underlines why Switzerland is now ranked first in the global innovation index»

These developments clearly demonstrate the added value of a strategy such as growth equity investments, which focuses on solid and growing SMEs with healthy finances. The DACH region – especially Switzerland – is a particularly interesting region. In its 9th edition, the «Swiss Venture Capital Report» paints a clear picture of innovation.

Of the more than 2.1 billion Swiss francs in 304 transactions from 2020 described in the report, biotechnology accounted for 39 percent, followed by 24 percent for IT and communication, 10 percent for fintech, 7.8 percent for cleantech and 7.6 percent each for startups related to medical technology and digital health solutions.

These are all sectors in which Switzerland has a leading role. The «Swiss Venture Capital Report» underlines why Switzerland is now ranked first in the global innovation index for the tenth time in a row.

«The screening of companies has to be very selective»

While a growth equity fund does not provide classical venture capital, the activities and trends of the startup scene are nevertheless important: Ultimately, it is the young, innovative companies that will soon need further growth capital.

The high degree of innovation within the SME landscape and the lively activities in the start-up scene, especially in Switzerland, are the ideal environment to reach interesting, high-growth companies. However, the screening of companies has to be very selective. In addition to his experience, the growth equity manager benefits from his network, which has been built up and maintained over a period of many years.

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