Crisis Management
The facts are dramatic, both in terms of the numbers and the values involved: Between 2000 and 2003, the number of insolvencies per year in Germany rose some by some 47%, from 28.2k to 41.5k. In 1993, there were 15.1k insolvencies. According to the BDIU (Bundesverband Deutscher Inkasso-Unternehmen e. V.), some 650,000 employees will lose their jobs through insolvencies in 2003, causing an estimated macro - economic loss of € 50 Billion. Bank lending to companies declined by 2.4% in 2001, according to a study by the KFW (Kreditanstalt für Wiederaufbau), lending by private banks by 16%. The events are unprecedented, the values enormous and the names of the companies involved are becoming more prominent.
The explanations for business failure vary in detail from case to case, but my view is that this phenomenon is taking on a dynamic of it's own as an instrument of structural change in the German economy, and that ever more companies will fall victim to it.
The decline that ultimately ends in closure or insolvency typically starts with managerial problems, otherwise the companies don't become fragile in the first place. More often than not, these problems have been around for some years, in some cases even for a decade or more. The next module in the decline is often a mismatch between the strategy and the economic environment, leading to planning deviations, considerable operational problems and a squeeze in liquidity. With the benefit of hindsight, there are usually on or two key decisions where things went badly wrong. Next, the investors and lenders begin to ponder whether is a good idea to throw good money after bad and, given the crisis of venture capital and the banking sector sooner or later conclude not to inject further cash. At this point a frantic search for alternative investors is usually in full swing, but hopes to close a deal in time tend to be crushed. For reasons I will explain below, the logic of investors to wait until after the insolvency has occurred before investing in a fragile company is simply too compelling.
So you get insolvencies, both primary and secondary. The latter are those that occur because suppliers do not get paid or because businesses were excessively dependent on doing business with the insolvent primary company. This in turn creates the need to write off major investments, loans and suppliers credits. This in turn makes the players in the market more restrictive, putting the next wave of fragile companies on the radar screen of the insolvency administrators.
There exist a lively debate on whether investors and banks are too restrictive now, or whether they were too lenient in the past. The internet and telecom bubbles are often cited as an indication that they were too lenient, blinded by the prospect of high profits in an exceptionally short time. In the late 1990s and in early 2000 it was all about "land grabbing" and being the first to establish a business model, regardless of cost. My view is that long before the global hype, banks and institutional investors in Germany were less critical than they ought to have been. The tolerance for poor management, structural problems and politically motivated interference is declining, and rightly so. What we are seeing is a normalization of investment and lending practices by international comparison (USA & UK), not an irrational swing to overly restrictive policies. That means that a backlog of unresolved structural problems haunts Germany and its companies, and that there is no alternative to tackling the change process. Those who wait for better times do so at the risk of their own extinction.
Why is there such a lack of progress? Well, Germany has some nasty legal inhibitors to change, making a pretty standard restructuring program a highly risky business for the inexperienced. Add to this an army of lawyers more concerned about pointing out risks than what to do about them, and you have some apparently insurmountable barriers to solving serious structural problems in the economy. While this may offer a partial explanation as to why many companies delay change, the other was the tolerance of this by investors and lenders in the past.
An alternative to restructuring from within might be the sale of the business, but companies investing in ongoing operations typically end up with more than they bargained for: rigid structures and past liabilities. The new company inherits all employment conditions and all existing liabilities, and the staff is often protected from dismissal for a whole year.
Compare this to investing after an insolvency: Past financial and legal liabilities for pensions, redundancy protection related to years of service, warranty, taxes, environment or any other risks are a matter for the administrator to handle, making the due diligence process relatively simple and the investment outcome predictable. Equity investors, holders of stocks and bonds, lenders and creditors need to write off most or all of their exposure. The business can be split up, restructured, relocated prior to closing the deal, and the staff numbers required can be adjusted to the needs of the new investor. While the latter is not completely risk free, as social criteria may apply in some cases, there is no comparison to the complexity of a pre- insolvency investment. Add to this that the brand, inventories, machines and buildings tend to be sold at massive discounts, and you have the reason why investing in fragile companies in Germany is going out of fashion fast.
