What is new in this crisis? — Interview with Alexander Sator, Managing Director and Founder of 1NCE

Interviews

4th May 2020

In our latest entry into our blog series “What is new in this crisis?” our own Julian Riebartsch sat down with Angel Investor Alexander P. Sator. They talk about Alexanders experiences from past crisis, how he views the current crisis and the opportunities he sees for entrepreneurs going forward.

Q -Alexander, your history with btov goes back to the years 2004/2005 when you got to know btov in two respects. You had just successfully merged your laser company with an English competitor and had gone public on the AIM in London. In turn, you were looking for new investment opportunities as a private investor and decided to invest through btov. You also introduced btov to 4G at that time, as you had just founded the company 4G Systems specializing in End User Terminal Equipment for UMTS, i.e. UMTS Surf Sticks. This can be regarded as the precursor of today’s Internet of Things concept with a different technology. btov, however, did not invest and you had to experience the kind of pressure Chinese companies are capable of putting on a market segment. In 2007, the year before the real estate crisis, you purchased a company for IoT modules together with a Dax 30 corporate (let’s call it Corp), a Private Equity firm and also btov on a smaller scale.

How did you experience the real estate crisis in 2008 with your former company? How did the investors react to the crisis?
AS -Before 4G Systems went bankrupt it purchased its core technology from a wireless modules department of another German Dax company that developed the basic technology for surf sticks and were the market leader in this field. Corp intended to address this market and wanted to provide it with connectivity as every module sold also includes a mobile phone contract and, consequently, a recurring revenue. In 2007, we bought this department with me as lead in a carve-out in an intensive bidding process. We had a significant equity stake, the rest was financed by a debt investor (let’s call him X), and others. The company was very healthy, sales were at 250M Euro, and we had an EBIT level of about 15%. I was Chairman of the Supervisory Board and supported the company on the management level as well. Then came 2008 — Lehman. At the beginning we were not sure whether this crisis would have any impact on us at all. But the crisis shook our customer base. Various customers especially in the automotive sector started to cancel call-offs and urged us to stop deliveries. As a result sales fell by around 50% within two months. Beyond that all financing covenants were torn, especially those of the debt investor. The debt investor estimated the crisis as being only temporary and saw his chance to take over the company at a very cheap price via a dept-equity swap. And still — after a hard battle in bankruptcy and a distress sale to a large digital security company (we’ll call it SecCo) — we managed to save a significant portion of our equity.
Q -How could this predicament come about and how did you manage to avert the worst case scenario? What are the lessons you learned from this crisis?
AS -Although our company had around 35M Euro cash in its account the termination of the financing forced the management to file for bankruptcy. This led to a forced situation, an effect that X was not averse to as it seemed obvious that the company was healthy and the crisis’ negative effect would be short-lived. Furthermore, the shareholder base was too complex to react in a reasonable way. Apart from X we primarily had a PE fund and Corp with us. The former was massively pushed up against the wall by the crisis and as a result defaulted capital calls. Corp was inert — a typical corporate at the time. I was able to convince Corp to place a counteroffer in the insolvency proceedings together with me in order to raise the price of the fire sale. The asset was so interesting that fortunately, a bidding dispute crystallized between two other competitors of our company. One of them was SecCo who ended up acquiring the company. This resulted in a sale price that was below our original one but not nearly as bad as many had expected. In the end we were lucky with the insolvency proceedings. Without an insolvency administrator who showed personal interest and enforced the principle to grant the best economical outcome of exploitation right (“Bestverwertung”), we would have had a worse outcome.
One of the lessons learned from this situation is that you have to be extremely careful who you get involved with. You be sure of your investors intentions. Secondly, it is crucial to act quickly and consistently in a similar crisis. In case of doubt, you should try to guide a healthy and substantial company through insolvency and attempt to establish a new set-up with the banks. Banks can be quite helpful in this context and can support the former owner to get back on the horse. Of course, one should try to avoid a similar situation in the first place as it requires the owners and the management’s undivided attention. During these extreme circumstances a regular day-to-day business becomes impossible. If you run your business efficiently and properly, you manage to overcome a crisis quite well. Companies with sufficient reserves can easily survive 1 to 2 years of crisis without the support of banks. On the other hand, companies with a smaller financial reserve will not be able to last longer than a maximum of 3 to 6 months and will certainly have a higher risk of getting into a situation similar to ours.

The lasting effects of these problems in various industries will be great.

Q -What is the conclusion that younger companies can draw from this experience?
AS -I advise young companies to look for financing partners who have a positive attitude towards you. There are “sociable” VCs who are very founder-friendly but there are others who are extremely difficult. It is very useful to find out what kind of experience other companies have with various VCs. In Germany, there are many VCs that are considered less aggressive, therefore much more founder-friendly. Caution is advised with many American VCs because their aggressiveness is severe in every aspect. They are much more progressive in the valuations of financing rounds but they will also exploit their advantage without mercy and optimize their situation to the utter limit. The current crisis will once again show which VCs are sustainably interested in the companies and whether they believe in their success because there will be follow-up of financing needs. Others will say: “I dealt with this issue once but I’d rather not do it again”.
Q -How is the Corona crisis different from others like the dotcom or housing crisis before it?
AS -I didn’t really experience the dotcom crisis because I was running a laser company at the time which was not affected at all. We continued to grow just as we had in previous years. The housing crisis was a pure financial crisis which lead to a relatively short shock in the financing situation, in the interbank market and the likes. What we are now being confronted with is a crisis in the real economy. The effects are tangible and some sectors will have great difficulty in recovering. During the previous financial crisis no sector was really affected in the real economy. There were effects, for example, in the automotive industry and in the financing of vehicles. However, this could be partially bridged with central bank money. Moreover, the crisis passed relatively quickly. There was a rat tail of problems but they were manageable because the real economy was working. The situation now is quite different. I own a manufacturing service provider, among other things. One of our customers — a large aircraft manufacturer — has frozen a substantial part of the production. Consequently, he no longer wants our components. We would have no way of manufacturing them anyway because the goods no longer arrive from China. The supply chain is broken. The factories in China are slowly starting production again, but only in parts. This is affecting all industries. As our company has enough substance we can make up for some of the lost time through increased productivity and double shifts after the crisis. Hotels, however, cannot increase occupancy rates to over 100%. In restaurants people will not eat more after the crisis than they ate before. The lasting effects of these problems in various industries will be great.
Q -A real economic crisis seems worse than a pure financial crisis to me. What measures did you take in your companies?
AS -One of the keys to survival is to react quickly. In all my companies we immediately implemented measures to the maximum extent possible. We introduced short-time work, postponed investments and did everything possible to minimize overall costs. Everything that is not absolutely necessary was postponed to a future date. We have stabilized operations but only to the extent that is absolutely necessary. This helps us to hold out for as long as we want, if necessary.
Q -How much financial help can entrepreneurs hope for from official bodies like KfW?
AS -The KfW funds in Germany are well-intentioned but they do not arrive “down there”. On the one hand, banks are afraid to take more risk on the books, even if they are only liable for 10% of the loans. In other words, they are very cautious allocating KfW funds. On the other hand, KfW’s requirements, especially in the startup environment, are disastrous in my view. It does not take into account the fact that most startups could never meet the necessary financing criteria. Only a few startups have been profitable in the last three years. On top the Economic Stabilization Fund (“WSF”) targets startups with a system- relevant function or those with a valuation of at least EUR 50M — we do not have many of these in Germany. Moreover, the WSF is still not available. The BMWi does not provide a contact person and there are no practical guidelines. Startups get into financial distress very quickly if funds are not available in time. There is a risk that only a moderate part of the 2 billion package agreed by the government and other KfW funds will be allocated effectively. What is indeed flowing are the small subsidies: 9,000 to 15,000 Euros from the federal and state governments. That can help very small companies, i.e. early startups, hairdressers, bakeries and the likes. For somewhat larger companies the situation looks much worse.

In my opinion, managers should immediately reduce their salaries at least by the same amount as the salaries of their employees.

Q -How would the allocation of loans have to change in order for these programs to have more positive impact on smaller companies in Germany?
AS -There would have to be a better understanding of the company itself. Would it be viable in a normal economic situation, is its business model valid? If these points are given, the allocation should be simplified. Of course, it must be avoided to support zombie companies that actually exist in large quantities. Here the business model must be scrutinized. But there are also companies where the business model is clear and definitively functioning but where the figures of the last three years are nowhere near enough to demonstrate financial service capability. And this is where the current allocation of funds fails. In order to repay a loan of 2 to 3 months’ sales with an interest rate of 3% in 5 years, you have to deliver a high EBIT. This is completely excessive.
Q -What sensible measures should startups take besides saving costs and introducing short-time work?
AS -In my opinion, managers should immediately reduce their salaries at least by the same amount as the salaries of their employees. Both the employees and the financing partners should see that the management personally supports the savings measures. In addition companies should talk to their creditors and try to extend their payment terms. They should defer their investments and reduce the number of consultants. And it is imperative to talk to your investors about the current situation.
Q -What opportunities do you see for entrepreneurs in this crisis? How should entrepreneurs behave in relation to VCs that offer “adapted” deals?
AS -One of the obvious opportunities is digitalization. That has become quite evident in this crisis. The best example is the heyday of video conferencing systems. A provider like Zoom was not prepared for such an onslaught. Therefore there were and still are justified security concerns. But it works very well nonetheless and in this respect many new and exciting possibilities are emerging. Another opportunity that was experimented by force now is the flexibilization of working hours. This is more than just an opportunity, it is a paradigm shift. Many smaller companies are learning that home office works well and can also be very efficient. “Nine to five” in the office is no longer necessary if the technologies work. This is an opportunity for the working world, especially for the motivation of employees. Hyperscalers in the USA have long since completed this paradigm shift — and so can startups here. Give people more freedom, they will thank you for it and be more motivated. Digitization will support this idea and digitization partners will, of course, benefit from it. With my company 1NCE I am sitting in the sweet spot because we support the IT of businesses globally. In addition, we ourselves have been preparing Home Office for a long time and were able to switch to it right away. Our productivity has actually increased as a result. Personal meetings are always necessary but otherwise Home Office works. Lastly, this crisis helps us to understand and to develop new business models. Even business models that are currently hit hard by the crisis will have a chance to re-establish themselves.
Q -There are some startups whose customer base is temporarily disappearing or where the implementation of the products at the customers’ sites can no longer be carried out. What should such companies focus on?
AS -There are two things that companies can easily do: Stay close to your customers and take care of them. Be completely customer-centric and show support where you can. On the other hand, use the time gained to further develop your product. This, however, must be considered with cost saving in mind. Forcefully ramping up the development department now is certainly risky but it also has the potential to make the company look much better after the crisis compared to competitors who were stalling. You should only do this if you have a clear perspective though and the funding to support it. Startups with rather thin financing better stay very close to the customer in order to understand what they can do better and how to adapt the product accordingly.
Q -Is there something you learned as a private investor and would like to share with the btov community?
AS -Every crisis also offers opportunities, it is extremely important to show courage. Take advantage of the opportunities and try out what is feasible. Under no circumstances bury your head in the sand. The worst thing you could ever do in this crises. The situation we are experiencing at the moment is historically unique and we have to adapt to be successful in meeting the challenge.

Thank you very much for sharing your experiences with us and our readers, Alexander.

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