16 January 2017 / 0 Comments
Quasi-equity: A new financial structure for a new challenge
Quasi-equity investments provide an important tool for the EIB in delivering on the Investment Plan for Europe
The first puzzle: Companies want to reduce their carbon footprint, so they’d like to generate their own renewable energy. But space is at a premium in the business districts of big cities—you can’t put a wind farm outside Liverpool Street Station or a solar park in La Défense.
The second puzzle: Finance it.
If that sounds easy, it isn’t. EIB financiers spent years figuring out how to structure deals that would provide capital to innovative, new companies without making them focus more on repaying their debts than on growing the business.
Quasi-equity has been in the EIB toolbox a couple of years, but only in a small way. The arrival of the Investment Plan for Europe makes it a central part of the Bank’s plan to expand higher-risk investments in companies that previously wouldn’t have been eligible for EIB financing.
“We are starting to handle small, high-risk and incredibly innovative things,” says Adrian Kamenitzer, the Bank’s director of equity, new products and special transactions. “It means that the EIB has to change to fit these new kinds of deals, so that they can be done to their fullest potential.”
EFSI backs quasi-equity
The Investment Plan’s European Fund for Strategic Investments (EFSI) is intended to back financing for innovative companies. That’s because commercial banks tend to view them as untested and therefore too risky. Yet it’s important for Europe that new ideas get a chance to develop. Though this is a new area for the EIB, it fits the Bank’s historical role in filling market gaps.
The Bank refers to higher-risk deals as “special activities.” The Bank aims to boost special activities in 2017, as the procedures underlying quasi-equity deals and other new structures are streamlined. The Bank’s growth capital and innovation finance division already has 1 000 requests for financing from innovative companies and plans to do EUR 1 billion in such deals by mid-2018.
“It’s a very positive moment,” says Hristo Stoykov, the division’s head. “We’re working with new customers who wouldn’t have received a loan before from the EIB. We’re working with innovative companies. And it’s largely because of the quasi-equity product.”
How quasi-equity works
Quasi-equity is a product that’s unique in the market to EIB. It aims to fill the market gap that afflicts about 2 500 European companies of medium size, where the financing needed is between EUR 10 million to EUR 17 million. Here’s how it works:
The EIB makes a long-term loan to an innovative company. Steady repayment of the loan would drain the company’s coffers just when it needs to be investing in research and development. Alternatively, an equity investment would dilute the people who bore the risk of financing the early years of development.
So quasi-equity provides non-dilutive equity risk capital that is remunerated based on the company’s performance, just as an equity investment is.
The first quasi-equity deals
Developing this product took time. Stoykov and his colleagues across the EIB had to create new documentation and contracts, and to change relations between different directorates within the Bank. The Bank’s management approved an entirely new equity strategy for deals done under EFSI.
Some of the first quasi-equity deals illustrate the kind of company that needs this financing:
- Archos The French electronics company got EUR 12 million to develop a network for the “internet of things”
- Canatu A EUR 12 million deal to fund the Finnish company’s development of flexible screens
- Ultimaker EUR 15 million for R&D at a Dutch manufacturer of 3D printers
So far most quasi-equity deals were done under EIB programmes like InnovFin Mid Cap Growth Finance. Increasingly, quasi-equity will be an important factor in EFSI deals, which will also enable the Bank to increase the size of its investments, because of the EFSI guarantee.
First quasi-equity under EFSI
The first quasi-equity EFSI deal did get done in 2016, however, and in an area of Europe where the EIB has been prominent—Greece. And it wasn’t about connecting your fridge to the internet or designing a screen that could be woven onto your sleeve and fit to your arm. It was about sausages.
One of the biggest cold-cuts companies in Greece, Creta Farms spends five times as much as its peers on innovative ways to produce healthier meats and filed 20 patents in the last five years. The company’s inventiveness focuses on a complex, proprietary technology that allows the company to remove saturated animal fats from its meats and, instead, to inject extra virgin olive oil, which includes unsaturated fat. That makes the meats healthier because it lowers “bad” cholesterol, but it also keeps them tasty.
“When you eat these meats, you experience indulgence with less guilt,” says Konstantinos Frouzis, the chief executive of the Rethimno, Crete company. “It is indulgence with good health.”
Quasi-equity boost for Greece
The EUR 15 million Creta Farms quasi-equity deal backs the company’s further expansion in international markets, as well as R&D to introduce its “oliving” technology into the worldwide snack-food business.
“Investors have many doubts about Greece just now,” says Frouzis, “but this deal proves that Greek companies can be built on very solid foundations.”
Quasi-equity plans for 2017
Creta Farms was one of 23 quasi-equity deals completed in 2016. Stoykov expects to do 40 in 2017. EFSI will enable his team to increase the size of the deals to EUR 50 million—enough for it to back R&D at larger corporations too.
The Investment Plan’s EFSI aims to put EIB funds and an EU budget guarantee to work on deals that wouldn’t otherwise have been financed. The higher-risk nature of innovative companies and the equity-style payoff of these new deals give a clear answer to this question of “additionality.”
Stoykov notes that, of course, this means some of the quasi-equity loans won’t pay off. “If we picked only winners, everybody would have put their money into them,” he says. “From a policy point of view, these are great investments. That makes it worth the risk.”