By Andrea Silvello

In 2008, the “Big Crisis” hit hard the global economy. In the USA the GNP (Gross National Product)

decreased by roughly 1.2% in 2008, but then bounced back (delta GNP 2008-2015: +24%). In

Europe, and especially in Italy, things went differently: in 2008 Europe lost around 5.5% of GNP,

while Italy approximately 9%. In Italy, contrary to the USA, the GNP has continued to decrease

(delta GNP 2008-2015: -14%), stabilizing only in 2014. This is a critical situation for the European

and Italian economies, based on small and medium-sized enterprises (SMEs). In the Eurozone,

SMEs account for around 98% of the total number of enterprises, while in Italy the percentage is

even higher. This segment includes the majority of existing companies and a significant proportion

of the employees. In Italy, the share of SMEs is overwhelming: more than 99% of industrial

companies have less than 250 employees, and among them more than 80% are micro-enterprises

with less than 10 employees.

That being said, what are the most important differences between Italian SMEs compared to the

ones in the rest of the world?

Italy is known to be a relationship-based system country, more or less like all the civil law countries

in Europe; on the other hand, we have arm’s length system countries, like UK and USA, which are

common law countries. Although Italy has a relationship-based system, it also has an important

and characteristic peculiarity: its “industrial fabric”. Indeed Italy, more than other countries, has

based its economy on SMEs and, for this reason, we are going to focus on the three main

arguments we consider "key" to well understand the Italian specificities:

SMEs / Banks relationship

SMEs / Suppliers relationship

SMEs’ financial structure

Italy is going through a recessive cycle, economy-wise, as the majority of the other European

countries, but Italian SMEs appear to be unique in the international scenario. What makes them

different seems also to be the main reason why Italian SMEs appear weaker than their

international competitors in this difficult cycle: it has to do with their financial structure. We can sum

up these features in three key points:

More than 90% financial indebtedness hold by banks

High delays in suppliers’ payments

Low equity level

Looking at a sample of around 11.000 European SMEs, the framework outlined in the European

Central Bank (ECB) published studies, as shown in the graph below, is clear. The majority of

SMEs’ debt, included factoring and leasing, is hold by banks due to a limited access to capital

markets for SMEs and historical approach to face financial needs by access to new debt facilities.

The other form of financing and issuing of

equity is almost null. New forms of debt

financing have been developing during the

last years although, up until now, their impact

is overall negligible. Private Debt Funds are

developing their role to support SMEs to

finance their investments and long-term

development strategies. We consider it

realistic to imagine a long-term trend in which

the banks role will be more and more to focus

on working capital financing, letting Private

Debt Funds acquire market shares on

medium-long structural term financing. It is not

to be ruled out that, on the wake of this trend,

some commercial banks may strategically

decide to find new forms of agreements for

medium-long term operations with Private

Debt Funds.

It is not surprising to note that Italian SMEs are, compared to European small-medium firms, the

ones that have recurred more to the bank debt as a financing tool, even if the banks tend

increasingly to cut debt’s granting to SMEs due to their structural financial weakness.

Based on a study published by “EULER HERMES ECONOMIC RESEARCH” - a world-leading

provider of solutions for financial services - on Bloomberg data, Italy is the country, among the

15 most developed ones of the world, where the companies pay their suppliers more slowly.

Other Financial

Debts

7%

Equity

3%

Banks’ Debts

90%

Total form of Financing

100%

Percentage of form of financing

Compared to the rest of the world, in the majority of business sectors, the Italian firms have an

average of approximately 100 DSO (days sales outstanding): this is higher than all the other

countries (Russia, UK and USA have nearly half of DSO), as we can see from the picture below.

Another study of “CRIBIS D&B” – worldwide network of business and economic information -

reveals that, in the first quarter of 2015, only around 37% of Italian SMEs pays at maturity, around

17% pays the suppliers over 30 days (often synonymous with financial weakness or, even worst,

incapacity to respect obligations), while the majority of the SMEs pay with up to 30 days delay. In

Italy, this delay is historically considered something "physiological" and overall accepted. Suppliers

in the Italian market are a real financial source to leverage when treasury budget shows it is

needed.

Nowadays, the economic and financial crisis

has caused a double effect on the enterprises:

a great reduction in profits and, on the other

hand, the increase of non-performing loan

rates for banks, with the necessary

intervention of the ECB to adjust the minimum

capital requirements.

Many poor economic and credit performances

have to do with the unfamiliarity of SMEs’

entrepreneurs with the basic rules of

corporate finance. In fact, the use of leverage

should be appropriate only when businesses

earn a lot and get a return on capital higher

than the net cost of borrowing: principles

regularly unknown or ignored in the years of

fat profits and “easy” credit.

These two effects are linked, because when businesses

I quarter Italian SMEs 2015

17%

37%

46%

Up to 30 days

By due date

Over 30 days

53 99

80

56

47

74

7766

66

USA

SAUDI

ARABIA

UK

ITALYTURKEY

BRASIL

RUSSIA

INDIA

CINA

decrease their Ebitda and profit margins, banks will

deteriorate their credit ratings. At the same time, those

same businesses will seek new financing from the same banks, but they will not be willing to grant

it (considering the increase of default rate on their credits portfolios and also the strict rules

introduced by central banks), or, in a better scenario, they will, but with increasing interest rates on

loans. This chain of events has simple consequences: first, companies will run on a low amount of

liquidity, and second, they will not generate enough cash flows to repay banks and suppliers,

worsening even more the overall economic framework.

All this facts, graphically summed up below, create a dangerous “loop” that in many cases will act

as the “kiss of death” to SMEs business.

We can note, as reported from the CERVED - ABI analysis, that the rate of Italian businesses in

financial distress has increased from 1.5% to 2.5% on average from 2007 to 2015. This is a result

coherent with the findings linking SMEs’ probability of default to their bank debt proportion; indeed,

the more SMEs contract bank obligations, the more they are inclined to default. This probability,

from 2007 to 2015, has increased from 1.7% to 3.5% on average. This obviously has reflected on

SMEs’ risk profile; as we can see from the chart below, the percentage of risky and vulnerable

enterprises has increased roughly by 4% from 2007 to 2014.

Worsening of economy

SMEs low liquidity

Banks don’t borrow

SMEs down rating by banks

Lowering SMEs’ margins

Need of new financing

Banks borrow with higher

interest rates

Not able to repay banks and

suppliers

17,7% 20,5%

35,7%

42,6%

36,9%

46,6%

Risky SMEs

Vulnerable SMEs

Solvent SMEs

2014

100%

2007

100%

+ 4%

Regarding the SMEs’ equity financial structure we can find out how much low equity they get.

As Simon Lewis - Chief Executive of the Association for Financial Markets in Europe - said in his

article published in The Telegraph in March 2015, there is more than one reason why Europe’s

economic recovery from the financial crisis has lagged so far behind the US. However, at the heart

of the European malaise is a shortage of equity capital for SMEs; this deficiency in Europe is a

major obstacle to growth, holding back entrepreneurialism and innovation.

This is a crucial difference compared to US SMEs, which have on average more equity than debt

and, doing so, do not depend so much on banks.

This over-reliance on debt is a peculiarity of the European economy and it is reflected in the

structure of its financial system.

In Italy, many enterprises should increase their equity levels, because their relationship with banks

would benefit primarily. This is a basic concept: if an entrepreneur does not believe in his business,

and is not willing to invest more equity, why should the banks do that?

The low equity level of Italian SMEs complicates their relationship with those who have to decide

whether to grant them a line of credit. According to Il Sole 24 Ore – the main Italian finance and

business newspaper -, using criteria equivalent to those of Basel 2, the Italian SMEs have on

average a BB credit rating and with equity levels around 10% of all financing sources, with a

financial leverage of approximately 90%. To improve credit rating just at BBB- grade, it would be

sufficient to raise equity levels to at least 25% (2.5 times of the current one) of the total invested

capital and stabilize their financial leverage between 60% and 75%.

Summing up: if Italian companies would increase their equity levels, consequently decreasing their

bank debt and strengthening their financial position, they would finally benefit from better credit

ratings and a lower cost of financing, creating a new virtuous circle between banks and

businesses. This would make the latter fit enough to face the current adverse economic

framework, and, in the end, provide them with stronger competitive weapons for the coming years.

Andrea Silvello is Founder and Managing Director of Business Support Spa, a Strategy Consulting &

Financial Advisory "boutique" which focuses on SME's in Italy.