04/14/2020

SME financing in the “corona crisis”

Update briefing “KfW Quick Loan 2020” and consequences for the transaction practice

In reaction to the criticism expressed in literature and business, the federal government readjusted the State aid programs for small and medium-sized enterprises adopted on March 27, 2020 (see our April 3, 2020 publication). The fact that in practical implementation companies’ principal banks would have to bear at least 10% of the credit risk themselves turned out to be a stumbling block for KfW loans.

With the “KfW Quick Loan 2020,”[1] the federal government now intends to create a solution for healthy SMEs that do not receive interim financing although their loss of sales and losses are caused by the government measures taken to contain the “COVID-19 pandemic.”

The federal government is building on programs that already exist in a similar form in Austria (“aws Bridging Guarantees for SMEs and sole proprietorships”),[2] and in Switzerland (“COVID-19- Joint and Several Guarantees”).[3] The differences between the three rapid loan programs are summarized in the overview below.

This update briefing serves to outline

for which companies the KfW Quick Loan is suitable,
which companies will not receive it, and
what consequences the KfW Quick Loan has for SME corporate transactions.

Overall, the KfW Quick Loan is a good option of enabling profitable SMEs to obtain interim financing quickly and easily. Micro-enterprises (fewer than 10 employees) and non-profitable companies, however, such as startups or companies that have made high investments in recent years, will not receive the Quick Loan. Companies and, in general, SMEs that want to survive the possibly longer-lasting corona crisis in the long term and prepare themselves for an expected recession without incurring high debt burdens through KfW loans, thus reducing their enterprise values, should only use State aid as “help for self-help.” They should not postpone their succession and growth plans in favor of a high, supposedly “favorable,” level of debt, but rather use strategic cooperation and suitable equity investors to counteract the losses incurred (that will continue to increase despite borrowing) through digitization strategies and organic and possibly inorganic growth in view of the impending downturn and the expected consolidation trend. Medium-sized entrepreneurial families, family offices, and private equity investors may play a key role if fair conditions are negotiated and the “corona crisis” is not unilaterally used to “squeeze” valuations, but rather to distribute the economic “corona risk” on both sides by way of balanced pricing and transaction provisions.

Application requirements for the KfW Quick Loan

Companies with up to 50 employees
operating on the market at least since January 1, 2019
profitable in 2019 or on average over the last three (3) years
written assurance that they were financially sound at December 31, 2019 and were not in distress.[4]
Prior to granting a loan, the company’s principal bank will review the number of employees, sales, and actual profit generated.
A going-concern forecast is not required.
Application is only possible until December 31, 2020.

Terms of the KfW Quick Loan

KfW exempts the companies’ principal banks from 100% of the liability.
Therefore no collateral is necessary.
Loan volume limited to three (3) months’ sales. For companies with up to 50 employees also limited to EUR 500,000, for companies with more than 50 employees also limited to EUR 800,000.
The loan may be drawn within one month of the commitment, drawing the loan in tranches is possible.
No commitment fee. Interest rate is currently fixed at 3% annually and may change in line with capital market developments.
Loan term 10 years, repayment in equal instalments. A grace period of up to two (2) years is intended to be possible. No prepayment penalty in the event of unscheduled or early repayment.
When it will be possible to apply for the KfW Quick Loans and when they will be paid out for the first time is still unclear, as the program is still subject to approval by the EU Commission.
In advance, companies are advised to draw up a liquidity preview and to seek discussion with their principal banks so that applications for the loan may be filed for without delay after approval by the EU Commission. In the absence of risk assessment, the loans should then be disbursed very quickly.

Exclusion criteria for the KfW Quick Loan

Micro-enterprises with up to 10 employees and self-employed individuals are not covered by the KfW Quick Loan. If the conditions are met, however, they may draw on the one-off payment under the KfW emergency aid.
Weaker performing companies are excluded, which failed to make a profit in 2019 and on average over the last three (3) years. It is specifically such companies, however, that will also have poor chances of obtaining the remaining KfW loans, since the principal bank is not released from 100% of the credit risks.
Rescheduling or redemption of credit line drawings is not permitted.
Distribution of profits during the repayment term is not permitted. This does not include standard market remuneration of business owners.
No combination of the KfW Quick Loan with other KfW loans or with instruments of the Economic Stabilization Fund.

Consequences for transactions in the SME sector

Since the KfW Quick Loan may be repaid at any time without prepayment penalty, it will be able to support transaction preparations already in progress by stabilizing the company. As soon as, for example, a succession solution or M&A transaction has been successfully negotiated, funds that are not required may be repaid free of charge (closing condition).
Business owners who do not wish to unconditionally accept a ”corona” discount on the purchase price, which may be demanded by buyers, are able to use the KfW Quick Loan to achieve a “more aggressive” earn-out negotiated in return. This is the case because the Quick Loan allows them to make the investments to grow faster after the end of the COVID-19 restrictions.
In the aforementioned case, but also in general, earn-out provisions in the purchase agreement should, however, in the interest of both parties, be adapted to the market environment in fairness, since all competitors will also lose sales.
In the case of existing buy-and-build structures, portfolio companies, which have been profitable in recent years, may take advantage of a KfW Quick Loan. Even if debt rescheduling is not permitted, this may indirectly promote the stability of the entire group.
The KfW Quick Loan may also be used to finance planning or transaction costs, for instance for transactions in progress or for urgent pending successor solutions, which are becoming more complicated and protracted due to the economic changes in the corona crisis.
Our advice for use in practice on the necessity of equity investments in SMEs as a reaction to the corona crisis of April 3, 2020 remains valid. The KfW Quick Loan will facilitate the continuation and initiation of strategic partnerships and private equity investments in the SME sector in the short term and make numerous transactions possible in the first place. The Quick Loan and other debt offered by the government, however, will not replace equity investments, in particular the longer the corona crisis lasts.
For many companies that are not eligible to apply for the KfW Quick Loan, equity and mezzanine financing combined with a consolidation and subsequent growth concept will remain the key to finding the way out of the crisis.