There is no doubt that a company’s capacity for innovation is a decisive competitive factor. Only innovation can ensure higher returns, growth, and jobs in the long term. In addition to the companies themselves, all “stakeholders” benefit. However, innovation is not just about the idea itself; rather, it must also be transformed into a marketable product—and that usually entails a significant capital investment. The cash flow generated or the available credit line is not always sufficient for this purpose, so securing the necessary funding for innovation activities regularly poses a challenge, particularly for small and medium-sized enterprises (SMEs) without access to capital markets. External investors often shy away from the high risks associated with financing innovation. But from the company’s perspective as well, financing solely through debt is generally not optimal, since interest and principal payments are usually due in installments, which can place a heavy strain on the company’s liquidity, especially in the early stages of innovation development.
When Equity Capital Is Lacking
One alternative is to raise funds by strengthening the company’s equity base. In this process, a financial investor acquires a minority stake through a capital increase. This offers significant advantages for both parties: The entrepreneur retains autonomy in terms of business management; the financial investor participates in the profits and the increase in the company’s value through the shares held. Such a partnership is usually time-limited. The investment horizon typically ranges from four to seven years. Afterward, the realized increase in value is realized through an exit. The partners should clearly define how this exit should proceed in a manner acceptable to both parties. One option, for example, is a joint sale of the company to a strategic investor or the arrangement of an internal or external succession plan. Of course, a buyback by the entrepreneur is also possible if he or she now has sufficient capital of their own.
Positive Public Image
In addition to the immediate practical benefits for financing innovation, strengthening the equity base also brings two other positive effects: it can improve the credit rating and also serves as a kind of seal of approval for the company, which has convinced investors of the merits of its business model. Incidentally, a study by KfW has shown that exceptionally innovative companies are significantly more interested in equity financing than the average.
