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Private Equity: Creating Value
Contains case studies of German companies which are financed with private equity.
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Private Equity Investor Brief
German Private Equity - an attractive asset class for institutional investors.
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BVK: MoRaKG no more than a first step
03. Juli 2008
In a survey carried out among BVK members, less than ten members indicated that they were prepared to investigate compliance with the WKBG. Among other reasons this is due to the fact that the intended tax transparency criteria are very restrictive and even tighter than the previously applicable administrative directive issued by the Federal Ministry of Finance. In addition, the introduction of the WKBG via the MoRaKG leads to legal fragmentation in the private equity market. Venture capital companies will be supervised by BaFin and capital investment companies (Unterehmensbeteiligungsgesellschaften, UBG) by the federal state ministries for economic affairs. In contrast to other countries, no supervision is planned for the majority of funds. The BVK suspects that the act’s rather restrictive requirements applying to the target companies of the capital investment companies will limit the desired positive effects on venture capital-based start-up financing. According to these requirements, target companies must be incorporated enterprises, based in the EU or the EEA, that may not exceed a maximum equity capital of € 20 million.
The amendment of the Equity Investment Company Act (Unterehmensbeteiligungsgesellschaftengesetz, UBGG) is not far-reaching enough to actually improve the financing terms for German SMEs. Although the changes represent a slight improvement for existing UBGs, they will not inspire more investment companies to choose this legal form. Hence, the equity capital situation in the SME segment is still less than perfect. However, it would be fatal to neglect the concerns of the small and medium-sized companies: The association Creditreform recently reported that one million German companies are facing massive financing bottlenecks and either receive loans at unfavourable conditions or no loans at all. The Basel II package is essentially responsible for this situation. As the banks, which must maintain more equity capital to secure their loans and apply tighter risk controls, are restricting their lending activities, their money is becoming substantially more expensive for the chronically undercapitalised German companies. Private equity could be the way out of this situation – provided there is sufficient private equity capital on offer in Germany. To set this trend in motion, the framework conditions that would lead to the establishment of more local private equity funds must be created. This would raise the level of investment in Germany and would benefit the economy as a whole: according to studies carried out by Deutsche Bank Research, a one-percent increase in venture capital investment in relation to the gross domestic product leads to a 0.44 percentage point increase in real economic growth. If German venture capital investment would catch up in relation to the economic power in Europe, economic growth in Germany would, statistically, increase by 0.25 percentage points.
Consequently, the BVK is campaigning for a uniform private equity law applicable to the entire sector that will make German investment companies competitive at the European level. This would require a uniform definition of fund transparency for tax purposes that is not more restrictive than the current administrative directive. In terms of turnover tax, funds must not incur higher costs than direct investments. Losses should not only be retainable by venture capital companies when target companies increase their capital; this regulation must be generally applicable to encourage growth among young companies and promote research and development. Furthermore, from a fiscal point of view, equity capital should not be at a disadvantage compared to debt capital. Unfortunately, this is largely the case after the 2008 enterprise tax reform. As a consequence of all these measures, the attractiveness of Germany as a location would increase significantly. The occurrence of tax deficits worth millions is extremely unlikely. On the contrary, due to the positive impulses emanating from the measures called for by the BVK, the tax revenue is likely to increase.
Today, the Bundestag passed the Law on the Modernisation of Framework Conditions for Venture Capital and Equity Investments (Gesetz zur Modernisierung der Rahmenbedingungen für Kapitalbeteiligungsgesellschaften, MoRaKG). With this law, the government intends to provide the venture capital sector with an internationally competitive legal framework.
The BVK welcomes this intention. However, the provisions under the new Venture Capital Investment Act (Gesetz für Wagniskapitalbeteiligungen, WKBG) are not strong enough to achieve an overall sustainable improvement of the framework conditions in the German private equity sector. The creation of a uniform private equity law for Germany, which the ruling parties had agreed upon in their coalition agreement, will not be implemented. As a consequence, large private equity funds will not be located in the German financial centre. Even medium-sized and smaller funds will increasingly look outside Germany. Since the MoRaKG will not have the desired broad impact even among the venture capital companies that are targeted by the WKBG and will thus not improve conditions in the German financial centre, the BVK hopes that the government will carry out a fundamental overhaul of the law in the near future.In a survey carried out among BVK members, less than ten members indicated that they were prepared to investigate compliance with the WKBG. Among other reasons this is due to the fact that the intended tax transparency criteria are very restrictive and even tighter than the previously applicable administrative directive issued by the Federal Ministry of Finance. In addition, the introduction of the WKBG via the MoRaKG leads to legal fragmentation in the private equity market. Venture capital companies will be supervised by BaFin and capital investment companies (Unterehmensbeteiligungsgesellschaften, UBG) by the federal state ministries for economic affairs. In contrast to other countries, no supervision is planned for the majority of funds. The BVK suspects that the act’s rather restrictive requirements applying to the target companies of the capital investment companies will limit the desired positive effects on venture capital-based start-up financing. According to these requirements, target companies must be incorporated enterprises, based in the EU or the EEA, that may not exceed a maximum equity capital of € 20 million.
The amendment of the Equity Investment Company Act (Unterehmensbeteiligungsgesellschaftengesetz, UBGG) is not far-reaching enough to actually improve the financing terms for German SMEs. Although the changes represent a slight improvement for existing UBGs, they will not inspire more investment companies to choose this legal form. Hence, the equity capital situation in the SME segment is still less than perfect. However, it would be fatal to neglect the concerns of the small and medium-sized companies: The association Creditreform recently reported that one million German companies are facing massive financing bottlenecks and either receive loans at unfavourable conditions or no loans at all. The Basel II package is essentially responsible for this situation. As the banks, which must maintain more equity capital to secure their loans and apply tighter risk controls, are restricting their lending activities, their money is becoming substantially more expensive for the chronically undercapitalised German companies. Private equity could be the way out of this situation – provided there is sufficient private equity capital on offer in Germany. To set this trend in motion, the framework conditions that would lead to the establishment of more local private equity funds must be created. This would raise the level of investment in Germany and would benefit the economy as a whole: according to studies carried out by Deutsche Bank Research, a one-percent increase in venture capital investment in relation to the gross domestic product leads to a 0.44 percentage point increase in real economic growth. If German venture capital investment would catch up in relation to the economic power in Europe, economic growth in Germany would, statistically, increase by 0.25 percentage points.
Consequently, the BVK is campaigning for a uniform private equity law applicable to the entire sector that will make German investment companies competitive at the European level. This would require a uniform definition of fund transparency for tax purposes that is not more restrictive than the current administrative directive. In terms of turnover tax, funds must not incur higher costs than direct investments. Losses should not only be retainable by venture capital companies when target companies increase their capital; this regulation must be generally applicable to encourage growth among young companies and promote research and development. Furthermore, from a fiscal point of view, equity capital should not be at a disadvantage compared to debt capital. Unfortunately, this is largely the case after the 2008 enterprise tax reform. As a consequence of all these measures, the attractiveness of Germany as a location would increase significantly. The occurrence of tax deficits worth millions is extremely unlikely. On the contrary, due to the positive impulses emanating from the measures called for by the BVK, the tax revenue is likely to increase.