Financial Structures of Swiss SMEs in the manufacturing industry

Table of Content

Abstract

Acknowledgements

List of Tables and Figures

1. Introduction
1.1. Research Objectives
1.2. Structure of the Thesis
1.3. Research Question

2. LiteratureReview
2.1. Definition of SMEs
2.2. Growth stages and the impact of age and size of a company
2.3. Finance and Capital Structure of SMEs
2.3.1. Relevant Theories
2.3.2. Financial Instruments
2.4. Market Characteristics
2.4.1. SMESwitzerland
2.4.1.1. Employment and Industry Characteristics
2.4.1.2. Financial Structures
2.5. Conceptual Framework

3. Research Methodology
3.1. Research Question and Hypotheses
3.2. Research Design
3.3. Sampling Strategy
3.4. Data Collection
3.4.1. Quantitative Research (online survey)
3.4.2. Qualitative Research (interviews)
3.5. Data Analysis
3.5.1. Triangulation
3.6. Limitations and Critical Reflections
3.7. Researcher’s Role
3.8. Ethical Considerations

4. Outcomes
4.1. What is a typical financial structure of SMEs in Switzerland?
4.1.1. Summary
4.2. Does firm size affect SMEs’ financial decision making?
4.2.1. Summary
4.3. Does employment growth affect SMEs’ financial decision making?
4.3.1. Summary
4.4. How satisfied are SMEs with their financial structure? What would they improve and why?
4.4.1. Summary

5. Conclusion
5.1. Reflection on the Research Question
5.2. Other Findings
5.3. Contribution to Literature and Practice
5.4. Insights for Further Research

List of References

Appendices

Appendix 1 :SME by comparison

Appendix 2: SPSS Outcomes

Appendix 3: Theoretical Frameworks

Appendix 4: Interview guide for SMEs

Appendix 5: Interview guide for Experts (Banks)

Appendix 6: Interview guide for Experts (BAS)

Abstract

Purpose: The thesis aims to explore the different financial instruments used by Swiss SMEs in the manufacturing industry and factors that influence SMEs when making financial decisions. In this sense, growth, size, age and its impact on financial decision making are examined. Moreover, this research is trying to investigate how satisfied SMEs are with their financial instruments and bank loans in particular, which can also influence SMEs in making financial decisions.

Methodology: This research was realised using a mixed research approach. Qualitative data was collected by conducting 12 semi-structured interviews with SMEs and experts in the field. For collecting quantitative data an online survey was sent to 1’004 SMEs. All data was collected from companies located in the German speaking part of Switzerland.

Findings: Swiss SMEs in the manufacturing industry follow a clear strategy when it comes to financial decision making. In general, the examined enterprises want to act flexible, independent and are risk-averse. These characteristics are reflected when making financial decisions. With regard to family businesses independence is even more important. Therefore, SMEs focus on using financial instruments that perfectly fit to their strategy. The main instruments used are retained earnings, personal savings, bank loans and family and friends. Size and growth mostly does not have a strong impact. However, the outcomes of the online survey show that growth might have an impact on retained earnings. As most examined SMEs are equipped with a lot of equity these enterprises have no problems when asking for bank loans. The online survey and the conducted interviews further show that most SMEs are satisfied with the available financial instruments and bank loans in particular. This research also concludes that almost no financing dilemma exists. A finance gap is also nearly not existent.

Research Limitations: The small sample size with regard to the online survey and limited scope used in this research does not allow generalisation to the population. As SMEs often have a lack of time and are not willing to share financial information to externals it was difficult to find interview partners.

Keywords: SMEs, SME financing, financial instruments, bank relationship, financial structure.

Acknowledgements

This thesis is the result of a journey of efforts full of interesting findings and enriching discussions with very experienced professionals. They generously gave their time and ideas to allow this project to come to light.

Therefore, I especially want to thank all interviewees and online survey participants. Without their time and effort, I would not have been able to gain such deep insights into the examined topics.

Furthermore, I want to thank Professor Dr. Rolf Meyer for helping and guiding me through the whole project.

Last but not least, I am very thankful for all the proof-readers helping me to improve this paper (Anika Josef, Laura Bendig and Danielle Powell).

List of Tables and Figures

Table 1: Definitions of SMEs

Table 2: Instrument Characteristics

Table 3: Number of employees in different sectors - Switzerland (2012)

Table 4: Number of employees within the manufacturing industry

Table 5: SMEs financed by bank loans (2012)

Table 6: Participants’ List

Table 7: Coding Scheme

Table 8: Instruments by employment

Table 9: Employees/Instrument Crosstabulation

Table 10: Instruments bycompanyage

Table 11 : Interviewees’ market situation

Table 12: Growth and used instrument

Table 13: Employees/Bank loan satisfaction Crosstabulation

Table 14: Hypotheses

Table 15: Literature Review, China

Figure 1: SME growth (in %)

Figure 2: Sources of Finance

Figure 3: Comparison of employment rates (in %)

Figure 4: Received funding from banks and other money lenders (in %)

Figure 5: Conceptual Framework

Figure 6: Research Design

Figure 7: Employment and age characteristics

Figure 8: Interviewee Location

Figure 9: Which financial instrument(s) is your company using?

Figure 10: Why are you using retained earnings as your financial instrument?

Figure 11 : Why are you using bank loans as your financial instrument?

Figure 12: Why are you using personal savings as your financial instrument?

Figure 13: Do you have a pecking order to get your business financed?

Figure 14: Did your companygrow in the past 12 months (employment growth)?

Figure 15: Do you consider growth, with regards to employmet growth, when deciding which financial instrument to choose?

Figure 16: Are you happy with the available bank loans?

Figure 17: How would you rate the accessibility to bank loans?

Figure 18: Did you always receive your demanded bank loan within the past 5 years?

Figure 19: In general, are you satisfied with the available instruments in order to finance your business?

Figure 20: Financing Alternatives

1. Introduction

The research area of small and medium sized enterprises (SMEs) is a wide field with high potential for conducting research, as SMEs are the key drivers of growth and development for developing and developed countries. In this context, SMEs have the potential to bring about transformational change, which has attracted the interest of researchers and academicians in the field (Kumar and Rao, 2015). However, compared to larger and publicly listed companies, research for younger and smaller companies have been under-researched, as noted by Zingales (2000):

“[ ] empirically emphasis on large companies has led us to ignore the rest of the universe: the young and small firms who do not have access to public markets.“

A current analysis of the University of St.Gallen and the consultancy for SMEs, the OBT AG (Fueglistaller, et.al., 2014), states that 99.8 per cent of the registered enterprises in Switzerland belong to the category of SMEs, whereas 92.3 per cent employ less than 10 employees, 6.3 per cent employ between 10 and 49 and 1.2 per cent employ between 50 to 249 employees.

Despite the fact that SMEs enhance economic growth, growth and development slows down due to difficulties in accessing finance. This is mainly related to SMEs’ limited resources and perceived risk by lenders (Harvie, Oum and Narjoko, 2010). However, investments in technologies, assets, new markets or diversification is required for growth and development (Kumar and Rao, 2015). Therefore, access to financial resources is the lifeblood of any company, enabling it to grow, and to generate more output and employment (Harvie, Oum and Narjoko, 2010).

Capital structure constitutes all the available sources of funds in the market. In order to make financial decisions, existing capital structure reflects the choices of a company in regards to accessible financial resources and the potential for making investements to push growth and development (Kumar and Rao, 2015).

In this research, all these issues will be addressed meaning that size, growth and age of SMEs and its impact on SMEs financial decision making will be explored. Furthermore, current capital structure of SMEs will be examined, as the financial instruments and capital structure for SMEs greatly differ to their large counterpart (Kasseeah, 2012).

1.1. Research Objectives

The purpose of this Master thesis is to explore the different financial instruments used by SMEs and what influences SMEs in their financial decision making. Likewise, this research tries to investigate whether smaller SMEs are using different financial instruments than larger SMEs. Another exploratory focus is set on growth and its impact on financial decision making. Moreover, this research is trying to investigate how satisfied SMEs are with their financial instruments and bank loans in particular, which can also influence SMEs in making financial decisions.

This research initially aimed to explore the Swiss and the Chinese market. As data from China could not be gathered on time, only the Swiss market will be explored by focusing on the German speaking part of Switzerland. The research for the Chinese market is still being conducted by the Harbin Institute of Technology (HIT) in China.

1.2. Structure of the Thesis

The thesis explores SMEs’ financing structures in the manufacturing industry by exploring the Swiss market. In doing so, this research will provide an overview of the existing literature in the field of SME financing, focusing on the relevant aspects for this research (chapter 2). In the subsequent chapter, methodology of data collection, sampling strategy, data analysis and the research design, as well as researcher’s role and some ethical issues, will be discussed. After this, chapter 4 will explore the outcomes of the research, divided into each sub-question. In this chapter the outcomes will also be compared with theories in chapter 2, followed by the conclusion that includes other findings, contribution to literature and practice and recommendations for further research.

1.3. Research Question

This research attempts to shed some light on SMEs’ financing structures. In doing so, a grand-tour question has been defined to guide the research. Finally, sub-questions that break the grand-tour question into individual parts support the process of answering the grand question.

Grand-tour question:

Which factors influence SMEs in their financial decision making?

Sub-questions:

1. What is a typical financial structure of SMEs in Switzerland?
2. Does firm size affect SMEs’ financial decision making?
3. Does employment growth affect SMEs’ financial decision making?
4. How satisfied are SMEs with their financial structure? What would they improve and why?

2. Literature Review

The following chapter introduces the reader to the current literature in the field of small and medium sized enterprises (SMEs), their financing structures and the specific market characteristics of Switzerland. The literature can be classified into four categories, called “Definition of SMEs”, “Growth stages and the impact of age and size of a company”, “Finance and capital structure of SMEs” and “Market characteristics” and are closely connected to the research questions. The discovered categories will be further elaborated in the following chapters.

2.1. Definition of SMEs

This sub-chapter is the starting point for conducting research, as the following definitions of the term SME will help to set delimitations for the study. To obtain a clear and current definition of the term, recent definitions by the Swiss Federal Statistical Office, the European Commission and the Industrial Policy Orderare used.

According to the European Commission, a small firm can be described as having revenues of maximum € 10mn, a firm value of maximum € 10mn and less than 50 employees. In comparison, a medium-sized firm has revenues of € 50mn or less, a firm value of € 43mn or less and between 50 and 250 employees (Verheugen, 2006).

The Industrial Policy Order 2010 defines a small enterprise as having a value of € 5mn to € 100mn and between 25 to 99 employees. Medium-sized enterprises are worth € 100mn to € 300mn and employ 100 to 250 workers (Experts for unified definition of SME with main focus on jobs, Anon., 2012).

The Swiss Federal Statistical Office (BfS, 2015) describes SMEs as having less than 250 employees and either revenues per year of maximum € 50mn or a maximum worth of Master of Science - International Management Jonas Josef € 43mn in the balance sheet. Within this definition, a small enterprise has less than 50 employees and revenues or value of less than € 10mn.

Table 1 gives a good overview of the mentioned definitions and shows that an unified definition of the term SME does not exist. However, as it is indispensable to set limits for the own research, only companies that have 25 to 250 employees will be examined for this study.

Table 1: Definitions of SMEs

Abbildung in dieser Leseprobe nicht enthalten

Source: Kasseeah, 2012, Experts for unified definition of SME with main focus on jobs, Anon., 2012, Verheugen, 2006 and BfS, 2015, own table.

2.2. Growth stages and the impact of age and size of a company

As this research is going to explore size and growth of a firm as important influencing factors when making financial decisions, this sub-chapter will discuss these aspects based on the theory. In addition, since the age of a firm correlates with growth and the size of enterprises, it will also be discussed as a key factor.

According to a study by Evans (1987) that examines firm growth of manufacturing firms, firm growth is found to decrease with firm age and firm size. Hence, one can assume that start-ups and SMEs in general have a higher potential for growth. Evans (1987) further mentions that growth can be measured by the number of assets, sales, or employment. However, the study focused on the number of employees in order to measure growth as asset data was not available. Other research papers such as Mitra and Abubakar (2010) or Romano, Tanewski and Smyrnois (2001) defined growth in the same way. Furthermore,

Romano, Tanewski and Smyrnois (2001) included the number of locations as one additional criteria of growth.

A recent study (SECO, 2013) examined the following growth rates of employment, revenues and profit in 2012, asking Swiss SMEs whether they grew in the past 12 months.

Figure 1 SME growth (in %)

Abbildung in dieser Leseprobe nicht enthalten

Source: SECO, 2013, own graph.

The graph shows that 14 per cent of the interviewed SMEs declined, 19 per cent grew and 66 per cent remained stable in regards to employment growth. One can see that SMEs’ number of employees mostly grew or remained stable.

Having a more detailed look at the growth stages one can classify three stages: The early stage, expansion stage and the later stage. During these stages financing can greatly differ (Gündel and Katzorke, 2007). Berger and Udell (1998) go one step further, saying that depending on the age, size and information availability of a firm, enterprises tend to use different sources of finance. In order to get a first overview, the three growth stages will be discussed in detail.

The early stage includes the foundation of a company and can be classified in seed­financing, start-up-financing and first-stage-financing. During the seed-financing only a first business idea exists. This rough idea must then be substantiated by doing market research and a refinement of the product. In the start-up-financing, the product slowly reaches maturity and a business plan is drawn. The need of financing increases during that stage. However, usually only the founders provide the young company with the needed money. After the start-up-financing is completed, the company enters the market in the so called first-stage-financing. As such, the product will be offered and services provided to customers (Gündel and Katzorke, 2007).

The second stage, the expansion stage, can be classified into two stages, namely the second-stage-financing, which contains growth of a company after the successful launch of the product or service where it is common that the break even will be reached, and the third- stage-financing, which is embossed by the exploration of new markets and the extension of the product-portfolio. During this phase, financing can occur by minority shareholding or mezzanine financing (Gündel and Katzorke, 2007).

In the later stage, the company is already well-established. Therefore, there are many opportunities to further develop the company such as going public, generating buy out strategies, or restructuring. Buy out can occur as Management buy-out (MBO) or Management buy-in (MBI). MBO describes the process of the acquisition of the company by the existing management, whereas during a MBI the company gets acquired externally. MBOs or MBIs are very convenient for an exit of the initial founder of the company or for succession planning (Gündel and Katzorke, 2007).

The different financial sources available within the different growth stages and important theories about capital structures will be discussed in the next chapter.

2.3. Finance and Capital Structure of SMEs

The following chapter connects the theories regarding growth stages of SMEs with the financing and capital structure theories. In doing so, chapter 2.3.1 describes the most important capital structure theories, whereas chapter 2.3.2 is focusing on the different financial instruments that are available for SMEs in order to build up a capital structure.

2.3.1. Relevant Theories

Capital structure between SMEs and larger enterprises greatly differ. Looking at different research papers, literature is frequently connected to the capital structure theory of Modigliani and Miller (1958), which assumes that the value of a company does not change by an alternative mix of capital structure. Therefore, an optimal leverage ratio does not exist. In other words, no matter which financing you choose, an optimal capital structure does not exist as cost of capital is constant, which implies that the advantage of cheaper debt is offset by higher cost of equity. Furthermore, the study argues that dividend policy does not affect a firm’s value, meaning that there is no optimal payout ratio. The theory further assumes that perfect market conditions exist, which implies that there are no taxes, default risk or agency costs involved (Pagano, 2005). Even though a perfect market condition, as suggested in this theory, does not exist, this model is a good starting point for research about capital structure. However, the study assumes that size does not affect a firms’ capital structure, yet studies like Bergerand Udell (1998), Romano, Tanewski and Smyrnois (2001) or Hutchinson (1995) suggest that links between size and capital structure exist.

Romano, Tanewski and Smyrnois (2001) report supplementary influence factors for SMEs in their financial decisions such as cultural, entrepreneurial, personal preferences and attitudes or the age and the size of the firm itself. The study of Berger and Udell (1998) replicates these assumptions, in saying that financial decision making is highly correlated with size and age of a firm, as well as information availability. When looking at figure 2, small and medium sized firms tend to use financing from business angels, short term loans, initial insider finance, venture capital or trade credits to finance their business. Large firms are more willing to go public by using public equity, commercial paper or public debt. However, the transition is fluent. Thus, also some medium sized firms are willing to go public. Berger and Udell (1998) further argue that information opacity is a key driver of financial growth and distinguishes small business finance from large business finance. Hence, informational imperfections are much more applicable to small businesses, as they typically do not have audited financial statements, many business assets, and have little repayment history. Outsiders often put considerable weight on the creditworthiness and reputation of the entrepreneur for such firms. This leads to a high deviation from the Modigliani and Miller (1958) theorem, as this theory assumes that decisions are based on full information availability.

Figure 2 Sources of Finance

Abbildung in dieser Leseprobe nicht enthalten

Another well-known theory regarding capital structure is Myers’ (1984) pecking order model. This model suggests that firms have a specific preference order for their financial choices. As such, a firm prefers inside finance to outside debt, short-term debt over long­term debt and outside debt over outside equity. The theory further mentions that information asymmetry between management and investors is the main reason for pecking order. Thus, information transparency has a major impact on corporate financing decisions. In case of a high information asymmetry and a low corporate information transparency, management prefers debt financing before using equity (Wang, et.al., 2011).

The literature of small and medium sized businesses refers to the concept of a “finance gap” in order to explain differences in the capital structures in comparison to large firms. The financial gap contains two components. First, smaller firms have a knowledge gap, which means that they are not aware of appropriate resources. Second, a supply gap exists, meaning that funds are either unavailable to smaller businesses or more frequently the cost of debt to small firms exceeds the cost of debt to large firms, which scares SMEs of borrowing from financial and associated institutions (Holmes and Kent, 1991). Ekanem and North (2009) tried to investigate whether a financing gap still exists. Their findings concluded that especially for manufacturing SMEs, start-ups and young firms, and businesses led by women and ethnic minority entrepreneurs, a financial gap is still existent.

Holmes and Kent (1991) categorise SMEs into two factors: First, those that have access to the public market and can issue equity, and second those that do not. Normally, SMEs do not have access to the public market, even though they are able to issue private equity. Therefore, SMEs would prefer debt instead of equity financing. Nonetheless, debt can be more expensive for SMEs, which leads to a dilemma (Holmes and Kent, 1991). Banking regulations, known as Basel III, can also have a negative global impact on the access to finance for SMEs. Basel III is a global regulatory standard on bank capital adequacy and liquidity and strengthens the bank capital requirements that have been introduced in the Basel II framework. Thus, it introduces new regulatory requirements regarding bank capital, liquidity and bank leverage. Especially small banks will not be able to lend as easily as before, because there is significant pressure in terms of calculating the risk of lending a loan. Hence, SMEs will be forced to go to large banks to obtain the capital needed. However, large banks do not want to take big risks. Therefore, the loans will certainly become very expensive and smaller firms will look for different sources, such as crowdfunding or money from family and friends (Roman and Rusu, 2012 and Moritz and Block, 2013).

2.3.2. Financial Instruments

According to the literature, different financial instruments are available for SMEs. Regarding this thesis, the most common financial instruments will be briefly described in this sub-chapter in order to examine the research questions. In the field of accounting literature is talking about the liability part of the balance sheet. More precisely, the following financial instruments can be either categorized as debt, equity or a mixture of both.

Personal Savings/Own Savings-. Personal savings are usually the first place where entrepreneurs are looking for money. Thus, it is the most common source of equity capital for starting a business. Personal savings can be seen as private money an entrepreneur invests in the company (Kustner, 2014).

Family, Friends and Fools (FFF)-. After an entrepreneur’s personal savings are exploited, they typically turn to family, friends, and fools, which means getting money from people who like them or their project/company to finance their business. (Meyer, 2015). Like personal savings, money from family, friends and fools is typically utilised in the early stage in form of equity.

Business Angels. Business Angels are private investors who back emerging entrepreneurial companies, usually in the early stage, with their own money and support them with know-how and business contacts. Business Angels usually receive company­shares for their investment with the opportunity to sell them after a certain time (Exit) (Pechtl and Gloszat, 2010). Thus, money from business angels can be seen as equity. Enterprises benefit by receiving experiences, knowledge and competences from the business angel, but also by getting beneficial contacts in order to increase their existing network. However, as business angels want to get strongly involved in the business, the shared goals must match. Business angels are likely to invest in the early stage, as returns are expected, but also risks are high in the first years of a company (Gündel and Katzorke, 2007).

Venture Capital. Venture capital can occur in the form of investments from venture capital corporations or industrial investors. Venture capital corprations are specialised in providing seed capital or start-up financing for firms that are in the early stage of development (start-ups). Within the definition of the early stage, venture capital is mainly utilised during the first-stage-financing and less during seed-financing. They are typically organised as a limited partnership (Satyanarayana, 2005). It can be seen as a form of private equity. However, in comparison, venture capital is not frequently used in the later stage. Venture capital corporations are interested in young and innovative companies involving high risk, which is reflected in high expected returns. As such, companies are subjected to a rigorous selection process. Industrial investors are usually companies from the same industry or venture capital corporations that represent large enterprises from the same industry in order to extend the value chain or to increase the product range. Venture capital is commonly used by technology driven enterprises. Often, such a venture capital

corporation provides management advice and commands a network of consultancies, lawyers, banks and certified accountants (Gündel and Katzorke, 2007).

IPO: Initial public offering (IPO) defines the process of going public when a company raises capital by selling shares of its stock to the public for the first time. The financing appears in the form of equity (Kustner, 2014). Public offerings are mostly utilised in the later stage and commonly by larger or medium sized enterprises (Berger and Udell, 1998). The main reason why companies, especially smaller enterprises, do not go public is that they lose independence as the shareholders receive voting rights, which reduces their decision­making power. In addition, due diligence, the obligation to report and extensive effort of maintaining an investor-relationship, makes this financial instrument very complex, especially for smaller enterprises (Werner, 2006). According to accounting principles it can be treated as equity.

Private Equity: As public offerings are often not feasible or just not wanted by SMEs, some companies pay attention to private equity (Gündel and Katzorke, 2007). In doing so, private equity can occur in different forms of equity and equity-like capital. The most commonly known forms are buy-out funds, mezzanine financing, and venture capital. The capital is used to re-finance, acquire or further develop private companies (Knox, 2003). It can occur in different stages of a company. However, the expansion- and the later-stage are very attractive for private equity investors, as growing companies can guarantee high returns. Private equity investors can be institutional investors, such as banks, assurance companies, pension funds, and companies or private equity corporations. In the case of institutional investors, they often do not invest directly in the company but participate in an investment company. Banks also often offer mezzanine financing programs. Mezzanine capital is a form of capital whose risk is located between classical equity and debt, combining the advantages of equity and debt. As such, depending on the form, it is more like equity (equity mezzanine) or debt (debt mezzanine). It is commonly used for buy out transactions during the expansion phase or restructuring, but not in the early stage. In a narrower sense, it is equity with no voting rights and debt that cannot be treated prior to other debt in case of bankruptcy. Debt can also be seen as collateralised outside capital. It commonly exists in the form of silent partnerships, participation rights or option loans. Private equity corporations are usually more risk-averse than venture capital corporations. Thus, they rather support larger enterprises. In general, private equity is a financial instrument for companies in different stages that have a high growth potential (Gündel and Katzorke, 2007).

Crowdfunding: Crowdfunding is a rather new financing method that involves an open call on the internet, usually through specific platforms (Hemer, 2011). In comparison to classical investments through venture capital, crowdfunding is tapping the crowd instead of specialised investors (Lambert and Schwienbacher, 2010). It usually occurs in the early stage, or more precisely, the seed and start-up phase. It can occur in different forms such as a simple donation model, reward model, lending model or an equity model (Moritz and Block, 2013). The donation-model works like an ordinary donation. It is an altruistic form of help by the investors. In doing so, the fund-seeker does not have any obligation to give something back for the funds he received (Hemer, 2011). The reward-based model can be separated into crowd-sponsoring and pre-selling/-ordering (Moritz and Block, 2013). Pre­selling means that investors want to invest if they want to help to produce something to get a promised return, which can be the delivery of an early version of the product or service, such as a book, film, music album or a software. In case of crowd-sponsoring the founder is obligated to give a reward in the form of a service like PR or marketing for the sponsor (Hemer, 2011 ). Crowd-lending is a model, where the rewards are normally the interest and the payback after the lending period (Hemer, 2011 ). Equity crowdfunding defines a model, where investors get shares of the company and/or profit sharing arrangements (World Bank, 2013). Therefore, depending on the model, crowdfunding can appear as equity or debt.

Bonds: Bonds are basically loans, made by investors to companies. Like loans, companies pay interest on the bonds during their term, and pay back the original amount at the end. They are rated according to the financial strength of the issuer. The safest corporate bonds are called investment-grade bonds. Bonds are rated by rating agencies like Standard & Poor’s, Moody’s or Fitch according to their risk and credit-worthiness. Bonds that have a higher risk and higher returns are calledyunk bonds or high-yield bonds. Another opportunity to invest in bonds are government bonds. Depending on the financial strength of a country, government bonds can be nearly risk free or very risky. Bonds in general can act as good portfolio diversifier for investors, as they tend to perform differently from shares. In case of Standard & Poor’s investment grade bonds are rated BBB or above (Bonds: What are corporate bonds?, Anon., 2008). The rating scales of Standard & Poor’s and Moody’s often serves as a guide for medium sized rating agencies, ranging from AAA or Aaa, for enterprises having a very good creditworthiness and low risk to C or D for enterprises whose creditworthiness is very bad, which also leads to high risks for investors (Schneck, 2008). Bondholders face three major risks. First, the chance that the bond’s issuer may fail to make the promised payment, a so called default risk. Second, inflation risk, which means that investors cannot be sure of what the real value of payments will be, and thirdly, interest rate Master of Science - International Management Jonas Josef risk that arises from a bond-holder’s investment horizon, which may be shorter than the maturity date of the bond (Cecchetti and Schoenholtz, 2015). Bonds belong to the category of external debt.

Bank loans (commercial banks and other financial institutions): The essence of debt is that you promise to make fixed payments in the future (interest payments and repaying principal). Bank loans as well as bonds belong to the category of external debt (Damodaran, 2010). In general, a good way to classify debt is to distinguish between short-term and long­term debt. As such, bank loans or bonds with a longer maturity tend to have lower annually payments than short-term loans/bonds. However, the maturity is longer and interest rates can change over the lifetime, which increases the risk of rising interest rates depending on the characteristics of the loan or bond. Thus, such debts can have fixed interest payments (FRM = fixed rate mortgages) or variable interest rates (ARM = adjustable rate mortgages). In the case of a FRM, interest rates are specified over a specific period or for the whole lifetime. ARMs are usually bound on a reference figure, such as the LIBOR (London Inter Bank Offered Rate) or EURIBOR (European Interbank Offered Rate) (Fetzer, et.al., 2009). Such loans can be granted by commercial banks, but also by other financial institutions. Other financial institutions that do not belong to traditional commercial banks, but have similarfunctions, can be mortgage companies, insurance companies or credit unions (Zibel, 2015).

Retained earnings: According to Damodaran (2010), a financing hierarchy exists in order to make financial decisions. Therefore, firms usually use internal funds as their first option before sourcing external equity and debt. Retained earnings belong to the category of internal funds, using the generated cash flows to finance the business rather than distributing it to shareholders as dividends (Casey and Godbout, 2010). Looking back to the different growth stages of a company, this sort of financing can occur when a company is entering the market during the first-stage-financing or later in the expansion and later stage (Gündel and Katzorke, 2007).

Awards: In terms of start-ups and SMEs, awards reward companies for their business ideas. In Switzerland, platforms such as swiss-startups-awards.ch, startup.ch or VentureKick award start-ups for good business ideas. Start-ups can pitch their idea in front of a committee and the winners get awards ranging from CHF 1’000 to CHF 100’000 or higher.It is mostly used during the early stage of a company (Meyer, 2015, Swiss start-ups awards, 2015 and start-up award, 2015).

Besides the mentioned financing sources, recent research (Tavan, 2013) has been exploring alternative sources to finance a business, such as Asset Backed Securities (ABS), covered bonds or an equivalent to the German “Mittelstands Bond”, which returns attractive yields of 7 per cent to 9 per cent.

ABS: Usually, Asset Backed Securities are triple-A rated and have a high level of subordination as well as the ability to withstand great losses. Even if the issuer goes bankrupt, the loan portfolio can be transferred to another servicer. Therefore, the investor is usually in no danger of losing his or her principal (Zuckerman, 1997). In case of SMEs, Asset Backed Securities could bundle SME loans and sell their risk on the capital markets (Tavan, 2013). Thus, it could be a transparent and effective tool to enhance security for investors by giving them access to underlying cash flow assets and cheaper funding costs for issuers. However, SMEs could fear what they do not understand. Furthermore, it played a negative, but substantial role during the financial crisis (Bollen, 2014). Nevertheless, such bundled portfolios could be very attractive for investors, as it grants them diversification (Tavan, 2013).

Covered Bonds: Covered bonds are long-term debt securities that are secured by specific assets of the issuer of the bond. Similar to the benefits of ABS, covered bonds can access low cost capital market funding with low risk to their investors. Investors have an unsecured claim against the issuer for the insufficiency to repay principal and interest on the covered bonds. The main difference between ABS and covered bonds is the fact that assets remain on the balance sheet of the issuer for accounting purposes and to give investors greater protection in case of issuer’s bankruptcy (Schwarcz, 2011).

German Mittelstands Bond: The so called “Mittelstands bond” has been issuing bonds ranging from € 25mn to € 225mn, for the past few years. This bond promises attractive yields. Hence, institutional investors hold 60 per cent to 75 per cent of these bonds. In some cases, banks are not even involved at all, as is the case in Stuttgart, where the BondM platform enables mid-cap companies and SMEs to issue bonds and sell them directly to retail investors with costs kept to a minimum. This could lead to a change in the bank-firm relationship, as banks would be more engaged in value-added services (Tavan, 2013).

To finish this sub-chapter, and to have a breakdown of chapter 2.2 and 2.3, the following table gives a good overview of the discussed financial instruments. Equity and debt can be separated whether or not they come from external or internal sources. Each instrument has Master of Science - International Management Jonas Josef its place in the life cycle of a company as displayed in the growth stages. The instruments can be roughly grouped into the following noted below, though one has to consider that exceptions exist and that this table is not binding.

Table 2: Instrument Characteristics

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2.4. Market Characteristics

In this chapter, the Swiss market will be described in respect to employment and industry characteristics, as well as common financial structures for SMEs. The following graph is comparing employment structures between different countries to get a first overview in an international context.

Figure 3 Comparison of employment rates (in %)

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Source: Fueglistaller, et.al., 2014.

As the graph shows, SMEs are having a major impact on employment except in the US and UK, where large enterprises have a stronger impact and employ around 50 per cent or even more of the jobholders. Nevertheless, considering figure 3, one can say that SMEs are playing a significant role in regards to employment even in an international context. Going more into depth, the following sub-chapter narrows this context down by looking at the Swiss market.

2.4.1. SME Switzerland

When looking at figure 3, one can say that Switzerland is dependent on their small and medium sized enterprises. Hence, Swiss SMEs enhance growth and heavily provide employment opportunities. The fact that the Swiss GDP increased by 1.2 per cent each year on average within the years 2008 to 2013 also indicates that SMEs grew analogically (Castiglioni, et.al., 2014). The characteristics regarding employment and financing of such enterprises in the manufacturing industry will be further elaborated in the following sub­chapters.

2.4.1.1. Employment and Industry Characteristics

According to Fueglistaller, et.al. (2014), more than 2/3 of all employees worked forSMEs in 2012. The Swiss Federal Statistical Office confirms the results by saying that in 2014, 61 per cent of all companies employed less than 9 employees, 27 per cent employed 10 to 49 workers and 9 per cent employed 50-249 employees. Thus, only 3 per cent of all employees in Switzerland are working for large enterprises that employ more than 250 workers (Statista, 2015). With regards to the industry, it is slightly different. Looking at table 3, 70 per cent of all employees within the industry are working for small and medium sized enterprises, whereas 30 per cent are working for large enterprises. However, the numbers differ depending on the sector, especially when comparing enterprises that employ 0-9 employees. In addition, structures differ in several cantons. The canton Basel-Stadt, for instance, has a higher portion of services and shows larger enterprises on average in comparison to other cantons. Whereas enterprises within the pharma industry employ 153 employees per company, companies within the service sector, such as laundry, hairdresser or beauty salon, employ 1.3 employees per company (Fueglistaller, et.al., 2014).

Table 3: Number of employees in different sectors - Switzerland (2012)

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Source: Fueglistaller, et.al., 2014, own table.

Comparing the results from table 3 with figures from the same research, but in the previous year (2013), the portion of large enterprises slightly decreased (30.1% in 2011), whereas enterprises that employ 50-250 (25.9%) and 10-49 (25.9%) employees increased (Fueglistaller, et.al., 2013a).

Having a closer look at the manufacturing industry, enterprises are usually larger than those from the service and agricultural sector. Moreover, 16 per cent of all SMEs in Switzerland are acting in the industry, or more precisely, in the manufacturing industry and employ 30.5 per cent of the jobholders of all SMEs (Fueglistaller, et.al., 2014). Looking at the growth rates, 23 per cent of industrial SMEs are growing, whereas 57 per cent remain constant and 18 per cent declined, in regards of employment growth (SECO, 2013¹ ).

Table 4: Number of employees within the manufacturing industry

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Source: Fueglistaller, et.al., 2014, Fueglistaller, et.al., 2013a and Fueglistaller, et.al., 2013b, own table.

Within the manufacturing industry one can distinguish between different segements, namely metal industry, electrical industry/watches, furniture/wood processing, mechanical engineering/vehicle manufacturing, food industry, paper/printing industry, plastics industry, textil goods/clothing, pharma, chemicals industry and other industry. Recent research (Schlegel, et.al., 2014)from the Economic Research of Credit Suisse and the Swiss Federal Statistical Office found out that the main fraction of SMEs within the industry belongs to other industries (~15% Credit Suisse and ~18% SFSO), the metal industry (~15% Credit Suisse and ~20% SFSO) and furniture/wood processing (~12% Credit Suisse and ~25% SFSO). The chemical and pharma industry has the lowest fraction with less than 3 per cent.

2.4.1.2. Financial Structures

As already mentioned, financial structures differ between SMEs and large enterprises. A recent study (SECO, 2013) mentions that 35 per cent of Swiss SMEs that employ 10 to 249 employees are financed by loans from banks, as shown in table 5. 65 per cent are financed by equity, such as private savings or other external capital, which is common, especially for small enterprises.

Table 5: SMEs financed by bank loans (2012)

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Source: SECO, 2013, own table.

When asking SMEs about the conditions required to get financed, 50% said that conditions became worse due to cost of financing, credit line and the required warranties. This is a main issue for SMEs, as smaller firms often involve higher risk and therefore have to prove their creditworthiness. Thus, they have to demonstrate more securities. Even then, costs of financing are often higher as they are for larger enterprises (SECO, 2013).

Within the manufacturing industry, 51 per cent of SMEs are financed by loans from banks. Moreover, 80 per cent of SMEs in the German part of Switzerland received the demanded loan when looking at figure 4. 9 per cent received their loan at least partially, and 4 per cent got rejected when asking for funding. In comparison, only 38 per cent in Tessin and 70 per cent in West Switzerland fully received the demanded loan. This concludes that differences even within Switzerland exist. The main part of the funding, shown in figure 4, was generated by banks (around 80% in 2009 and 2010). Nevertheless, the portion generated by banks decreased in 2012 (63%). This is justified by the increased use of other money lenders, such as private lender, especially from family and friends (SECO, 2013).

Figure 4 Received funding from banks and other money lenders (in %)

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In case SMEs do not receive the demanded loan, other opportunities exist in order to get funded. According to the Swiss KMU portal (2015a), around 40 SMEs in Switzerland are publicly listed on the stock exchange in Bern, which is focused on issuing stocks and obligations to SMEs.

Some enterprises that did not receive their demanded funding also had to cut their investments. According to SECO (2013), 47 per cent of the interviewed SMEs were struggling with that issue, whereas 53 per cent did not reduce their investments in 2012. The numbers in the previous years (2010 and 2009) remained nearly constant, but generally SMEs do not go public.

2.5. Conceptual Framework

SME financing is one of the most under-researched areas of corporate finance. A conceptual framework becomes imperative in times of rapid growth as financial needs and options change with size and age of a firm. In doing so, the framework is useful in guiding the research and includes demand side and supply side determinants of SME financing (Kumar and Rao, 2015). Therefore, the constructed framework gives an overview of the examined literature discussed in the previous chapter and connects the research question to the theory. The framework also connects the literature review with the subsequent chapter of methodology of research and the outcomes.

In order to develop a conceptional framework, the frameworks of Harvie, Oum and Narjoko (2010) and Kumar and Rao (2015) were utilised, as both were used for conducting recent research in the field of SME financing (Appendix 3). Whereas Kumar and Rao (2015) highlighted the importance of growth, age and size of a company as some of the main characteristics when accessing financing, Kumar and Rao (2015) included additional factors. Nevertheless, both approaches include many factors that do not contribute to this research. Therefore, a new framework was developed to get a clear overview of this report. The first column (Antecedents) is separated in two parts, whereas the dark blue part on the bottom was not examined in the literature review chapter. In this sense, the focus lies on size, age, growth and the specific market characteristics of Switzerland. Based on these factors, investors, SMEs and banks have different preferences. Therefore, capital structure and bank-client relationship might change, which influences SMEs on which financial instrument to choose. The sub-questions are placed below each frame to show their belonging, illustrated in orange circles.

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