KfW Research: Why small and medium-sized enterprises are not investing

• Coronavirus crisis is further exacerbating structural investment weakness: SMEs are losing ground
• Business expectations and volume of own funds influence investment appetite
• Capital expenditure strongly linked to business owner: high average age reduces investment propensity

For years Germany’s enterprises have been investing too little, particularly small and medium-sized enterprises. Now the coronavirus crisis has even intensified the trend towards a structural investment weakness in the SME sector that has been visible for some time. According to the KfW SME Panel, their new investment in 2020 fell by around EUR 14 billion or 7% to EUR 173 billion in total. At the same time, SMEs’ capital expenditure has steadily lost importance for overall investment activity in the German business sector. While they still represented 49% of all business investment in 2008, they have since lost 7 percentage points, dropping to just 42% in 2020. In a new study, KfW Research analysed the reasons SMEs provide for their reluctance to invest. When a business holds pessimistic expectations about turnover and profit and has limited own funds, its investment appetite falls more steeply than expected. But investment propensity in the SME sector is also very closely linked to the business owner.

A close look at the ranking of conditions that have to be met for an SME to make an investment decision shows that the company’s financial buffer plays a role for 54% of all small and medium-sized enterprises. The business owners’ experience ranks second (36%). Thus, an SME’s propensity to invest is often not so much characterised by whether the investment forms part of an overall strategic plan but, in general, is closely tied to the business owners themselves. Demographic change is having a severe impact here, with measurable negative consequences for investment activity. The propensity to invest declines substantially with the age of business owners. When they have reached a high age, many investments simply take too long to pay off, so they tend to shy away from the financial obligation. This is particularly true of investments that are rather extensive but make the business more competitive. In figures, this reads as follows: Over a long-term average (2004-2020) roughly 57% of younger business owners below the age of 40 invest in their business, but that share drops to only 36% of older business owners over the age of 60. Besides, younger business owners invest a larger proportion of their total investment volume in capacity expansion (50% vs. 20%) and are more likely to have positive net investment (38% vs. 22%) as well as a significantly higher investment intensity (investment volume per employee averages EUR 9,200 vs. EUR 7,600).

A look at the rapid ageing process among SME owners reveals the growing relevance of this aspect. The average age of an SME owner is currently 52.8 years. That average age increased by three years in the past ten years and even by eight years since 2002. At the time, just 20% of owners were 55 years old or older. Today it is already 50%, or one in two.

“SME owners’ propensity to invest drops sharply with advancing age – both the investment volume and the inclination to invest in capacity expansions decrease. Along with the rapidly rising average age of business owners, this pattern severely hampers investment”, said Dr Fritzi Köhler-Geib, Chief Economist of KfW. “The average age of SME owners has increased by eight years since 2002. In many cases succession is imminent as well, and that also reduces the propensity to invest.”

The aspect of succession coupled with the relatively high age of business owners literally undermines any appetite for investment. The closer the time of the planned succession or sale approaches, the less likely it is for investment projects to be carried out. If the succession is planned to take place in the next five years, the willingness to invest averages around 41%. But if the planned succession is more than five years away, the willingness to invest averages 56% – a significantly higher rate. A look at the succession figures shows what a difference this makes: In 2020 alone, some 260,000 SME owners were planning to transfer or sell their business within two years.

Last but not least, limited growth ambitions also act as a barrier to investment (43% of businesses). Many small and medium-sized enterprises have functioning, often locally established business models and rate business continuity more important than expansion. Generating their own income from self-employment is their top priority. Capacity expansion strategies that involve additional investment (such as venturing abroad or hiring staff) tend to be rare in these cases.

The current study can be downloaded from: www.kfw.de/fokus

The database:

The current analysis by KfW Research is based on an evaluation of the KfW SME Panel 2021 and various waves from previous years. The KfW SME Panel is an annual survey of small and medium-sized enterprises in Germany with an annual turnover of not more than EUR 500 million. With a database of up to 15,000 companies a year, the KfW SME Panel is the only representative survey of the German SME sector, making it the most important source of data on issues relevant to the SME sector. A total of 11,400 SMEs took part in the current survey wave between February and June 2021.