Targeting SMEs: A growth opportunity for software companies
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Small and medium-sized enterprises (SMEs) play a major role in European economy. France, Germany, Poland, Spain, and UK’s national funding agencies report that 88% of SMEs record stable or increasing revenue growth [1]. The reason behind this performance is strong positioning and high competitiveness of European SMEs on national and international markets.
However, SMEs must adapt to the recent technological developments to remain highly competitive and to stay as the backbone of the European economy. A large portion of SMEs are already utilizing various digital applications, e-invoicing solutions, cloud computing, and collaboration software, but there are still opportunities for further digitalization. The relatively new segments such as big data and AI are expected to experience a rapid growth in the near future. 54% of observed SMEs in France, Germany, Poland, Spain, and the UK claim that they see further investments in digital infrastructure as a key to remain competitive in the future [1]. SMEs’ necessity to digitalize further presents new opportunities for software providers.
SMEs are facing several challenges with the implementation of digital applications in their businesses. From a cloud computing perspective, the major challenge is security. SMEs can have trouble with the lack of control over their IT systems when using public clouds to store their data. There is also lack of understanding of the infrastructure and costs linked to using cloud computing services [2], as well as scarcity of qualified IT personnel. Cyber security education for employees makes additional investments inevitable [1], which increases the lock-in effect of the software companies.
Collaborating with professional providers is a reliable way to implement cloud services. They offer expertise in IT infrastructure & cyber security and protect their applications accordingly. Internal company data can also be protected with utilizing hybrid cloud solutions, where sensitive data can be stored in a private cloud and corporate applications can be operated in the public cloud. This approach protects the sensitive company data even when the cloud application is attacked. Additionally, cloud services can save costs, time, and resources in comparison to one-off investments in the IT infrastructure. Companies benefit from scalable data storage and secure, location-independent access to their data with digital applications and cloud computing services.
Businesses are not tied to their offices anymore and it is possible to work from anywhere with the help of cloud services.
Software companies need effective strategies in order to win customers in the SME segment. As shown in the Figure 1, SMEs have already implemented several new digital solutions. Electronic invoicing and collaboration software are widely used with a share of about 60% each. More complex technologies like AI and big data are less often used by SMEs while one third of SMEs are planning to experiment with these technologies in the future. SMEs’ interest in implementing more complex digital solutions in their businesses results in a growth opportunity for software providers by targeting SMEs.
What is a feasible strategy for software companies to improve their presence in the SME segment? Shifting existing marketing activities to SMEs, maybe even to build a new qualified sales team to focus on SMEs possible approaches. Another option is to acquire companies with existing SME clients to avoid building a new sales team from scratch and save up from the ramp-up time.
The transition to a SaaS model results in an effective combination of service and the software product. This makes the “package” affordable and (cost-) controllable for SMEs, while the software provider can shift its sales profile more towards recurring revenues. The result of the transition is a scalable and flexible product which immediately becomes much more attractive for SMEs.
Classical financing solutions are senior debt and equity. Both solutions have their advantages and disadvantages for financing growth strategies. With senior debt, companies have to start with repayments in early phases of growth plans which pressures management to have an eye on liquidity instead of focusing on growth. On the other hand, equity investments will require dilution or sale of existing shares to a third party, which will limit the upside gains.
Shortcomings of both financing options can be overcome by using new and alternative financing solutions such as mezzanine. Especially when companies consider growth, buy and build, or investments in sales and marketing teams, a mezzanine loan allows companies to grow their businesses without capital repayments in early phases of the investment. This helps management to focus on their growth strategy instead of worrying about liquidity.
Regarding buy & build strategies, mezzanine is also interesting in combination with a bank loan. Bank loans are the cheapest way of financing these transactions because banks require repayments and collateral. Adding a subordinated financing instrument, such as a mezzanine loan, to the mixture provides shareholders the optimum leverage in the financing structure.
From a shareholder perspective, mezzanine gives an option to finance growth without giving away a large part of the upside gains. In individual cases, there are also hybrid structures where mezzanine financiers provide a loan in combination with a small minority shareholding. In all cases, using a mezzanine loan is an interesting way to finance growth and acquisition strategies where the entrepreneurs can keep the majority of the shares.
A mezzanine loan is a strong financing solution to support shifting the business model to a SaaS model. A mezzanine loan provides liquidity in advance, which is supplemented by a grace period. It is subordinated to senior instruments per example bank loans and bears entrepreneurial risk. The provided liquidity remains within the company and can be used to transform the business model.
Mezzanine is a mixture of both worlds, which makes it a flexible financing solution for organic growth and buy & build strategies. With elements such as a grace period, subordinated characteristics and covenant light financing, mezzanine is a strong addition to senior debt and equity solutions to fuel growth and transition phases.
Do you want to know more about this topic and mezzanine financing, feel free to contact us!
Fabian Kühn: fabian@pridecapital.de; +49 221 42914255
Baran Atmaca: baran@pridecapital.de; +49 221 42914256
Laurens Asselbergs: laurens@pride.nl; +31 20 427 4242
[1] Abel-Koch, J., Al Obaido, L., El Kasmi, S., Fernández Acevedo, M., Morin, L., Topczewska, A. (2019), Going digital – The challenges facing European SMEs -European SME survey 2019, KfW Research.
[2] Assante, D., Castro, M., Hamburg, I., Martin S. (2016), The Use of Cloud Computing in SMEs, Procedia Computer Science 83, pp. 1207 – 1212.
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