II. SMEs´ Financial and Technological Investment Strategies

1. Relevance and metodology of the SME survey

2. SMEs and the manufacturing sector

3. SMEs and innovation

4. Survey Overview: Business and Corporate Characteristics of SMEs

5. Financial Strategy

6. Technology Strategy

1. Relevance and methodology of the SME survey

In knowledge-based economies, economic growth and high quality job creation depend upon successful technological innovation. SMEs (Small and Medium-sized Enterprises) attract considerable attention in the construction of EEC-EU policies. This can be explained by the quantitative importance of SMEs, as they make up the bulk of all enterprise, employ the largest number of staff in private firms and generate the greatest proportion of total turnover. Another important explanation is their characteristics. SMEs enjoy a very flexible organisational structure and represent an important source of high quality employment. However, faced with increasing difficulties in coming to terms with competitiveness in view of their lack of resources and limited access to capital for innovative projects, SMEs remain vulnerable.

This section presents some of the findings from the implementation of a survey conducted in Spain on the "Financial and Technological Investment Decisions of SMEs" which forms part of an EC project "Investing in Southern Europe". The standards and practical procedures for this survey have been designed to provide statistical descriptions of certain firms by asking a sample of SMEs a set of questions. The fieldwork collected information from around one hundred SMEs in three low and medium technologically intensive activities that make up the majority of manufacturing employment (that is, Food products & beverages NACE1 15, Textiles NACE1 17, Electrical engineering & apparatus n.e.c., and Radio, television, communication & equipment & apparatus NACE1 31-32). The survey followed the questionnaire proposed by the INTECH-UNU for fieldwork in three countries (Greece, Portugal and Spain). This questionnaire includes twenty-one questions on the Corporate, Financial and Technological Strategies of these firms.

The primary interest of this survey is not to analyse the characteristics of the samples per se. The main reason for collecting data about a sample is to reach a conclusion about a population. The sampling process was structured to reduce the normal variation, thereby producing a sample that is more likely to reflect the total population (size). We used a random sampling method based on stratified database for SMEs (10-499 employees) in the three manufacturing activities under consideration (Food products: 2,838 firms, Textiles: 1,285 firms, and Electrical: 1,069 firms). The total database (SABE) includes information about approximately 180,000 firms and 49,500 manufacturing firms (16,000 self-employed). This database covers 95 per cent of all the SMEs with over 10 employees and turnovers exceeding 100 million PTAs (euros 600,000), and is representative of these industries.

The sampling process was based on a random selection process of a database of firms. Once the firms were identified, the process was reinforced through business connections and regional Chambers of Commerce and Industry. The data source for the stratified samples was a database (SABE) with detailed financial, economical and institutional information. Considering that the sample is a small subset of a population representative of the whole population, the selection process was based on probability methods for choosing the SMEs.

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2. SMEs and the manufacturing sector

The enterprise is the basic unit for this survey and, in particular, the SME. There is no universally accepted definition of an SME; this is because employment, turnover and capitalisation vary among different industries. Additionally, any size definition that relates standard measures of size at a particular activity level may be relatively small or large in comparison to other industries. According to early critical contributions, SMEs must satisfy criteria related to markets, ownership and control. Another perspective on defining an SME attempts to identify those characteristics, other than size, which distinguish a small from a larger enterprise, which are: uncertainty, innovation and evolution. Although there is neither a simple nor a single definition of an SME there are certain features which are used to define them. The defining features of SMEs are the size of the labour force and turnover, while assets and equity are also used as criteria.

Broadly speaking, an SME is defined as an enterprise with fewer than 500 employees. In more detail, the SME consists of Small (10-99 employees) and Medium (100 to 259-499) sized enterprises. This definition excludes Micro (0-9 employees) and Large (250-500 or more employees) sized enterprises. This classification reflects the "breaking point" in SMEs, which has been identified in the literature. There exists certain consistency across different national statistical organisations about these criteria. The European Commission has also defined additional criteria which limits the percentage of shares which may be held by larger firms.

Firms in Spain, including those in the manufacturing sector, are notably smaller than those of the European Union [EU] average. This characteristic of Spanish firms has historical roots since enterprises emerged as very small firms with close connections to family business (Comín & Martín Aceña 1996). In the 1995, Spanish firms represented 13 per cent of the total number of EU firms but only 9.8 per cent of employment. The average size of the Spanish firm was well below the EU average: while 4.6 people on average worked in a Spanish firm, the corresponding EU figure was 6.2 in 1995. In Spain, micro-firms - defined as those firms which have less than ten employees - accounted for 94.3 per cent of all firms and 65 per cent of employment, compared with 93 per cent and 32 per cent respectively in the EU. While firms with over 250 employees accounted for only 20 per cent in Spain, in the EU this figure was 34 per cent. In Spain's industrial sector 82.4 per cent of firms are micro-firms; 15.6 per cent have between 10 and 49 employees; 1.9 per cent have between 50 and 249 employees and only 0.2 per cent have over 250 employees. In order to draw a comparison with Europe, less than one third of industrial firms in Spain have more than 250 employees compared with 47.5 per cent in the EU average (EUROSTAT 1999).

Source: INE (2000).

According to empirical evidence, SMEs have had a more positive reaction than larger companies [LCs] towards employment. This has contributed to the creation of new jobs and the maintenance of employment. However, SMEs exhibit a higher incidence of death than LCs (the figure 50 per cent survival-rate after 5 years is fairly robust across the EU, 1999). These characteristics of the Spanish manufacturing sector are highly relevant to our analysis of financial and innovation strategies, in particular, with regard to the debate in the literature about the relationship between firm size and technology investment.

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When R&D intensity is considered as a measure of technological effort, the ratio is again higher in large than in SMEs firms. However, when the innovation intensity is considered, the relationship is not so clear, since the highest levels of innovation are in innovative SMEs. These figures reflect the lower level of intensity of technology, or the internal spending on R&D, performed by the SMEs. Both the low technology sectors considered (food & beverages and textiles) are examples of low internal R&D intensity, where other components of innovation represent 93.9 and 83 per cent of the innovation intensity. In fact, the intensities of innovation are similar in both low technology sectors than in electrical engineering (medium technology activity). This reflects that the R&D ratio is a poor indicator of the extent of innovation and that the relationship between R&D and innovation is not straightforward, in particular, for SMEs belonging to the low technology industries considered here.

In order to examine the industrial technological convergence that occurred in Spain, technology intensity (measured as R&D expenditure divided by output) can be contrasted to the EU levels during the period 1980-1995. This framework for comparison makes it possible to evaluate the extent to which the different manufacturing categories in Spain have caught up with EU levels. In general, manufacturing technology doubled relative to EU levels. This increase was as significant in high as in low technology industries such as textiles or food & beverages. The catch up was more accelerated after the EU accession than between 1991-95, and this indicates the immediate benefits of Spanish specialisation in the low intensity activities. Moreover, this trend proves the importance of low technology industries for an economy like Spain. These industries tend to be over-shadowed by the limelight put onto the "high-tech" enterprises of the "new economy".

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4. Survey Overview: Business and Corporate Characteristics of SMEs

The results of the survey on financial and technology investment decisions of the firm are organised into twenty-one tables and general findings are included in the Appendix. These tables correspond to the questions proposed by the UNU-INTECH and reveal three issues about the surveyed firms which are: business and corporate characteristics; financial strategy; and technological and innovation strategies.

The general characteristics of the surveyed firms in terms of size and age showed that they are typical SMEs with between 10 and 500 employees. The average number of employees was 93 for food firms, 118 for textile firms and 155 for electrical engineering firms, while the average age of the firm was between 34 and 56 years old. We found a representative number of firms in each range of the population.

The need to be competitive in the global economy has forced many enterprises to restructure via three main ways. Firstly, through management buy-outs (MBOs, which enable existing management to acquire a business); secondly, through management buy-ins (MBIs, which enable managers from outside to buy-in to a company), and thirdly, through strategic partnerships and alliances. Venture Capital investment has been an important sources of finance for these processes as much as the "start up" (investment in new and young, rapidly-growing, often technology-based companies). In most of the existing SMEs, restructuring requires investment for renovation as a way for innovation to adapt to the global competitive environment. The importance of restructuring was identified in 32.6 per cent of the firms surveyed: 26 per cent of Food firms (F), 30.3 per cent of Textile firms (T) and 41.4 per cent of Electrical engineering firms (E). These figures imply a certain correlation between restructuring for renovation and technology intensity among sectors.

The dimension of global competition is also noticeable in terms of market strategy. Although 41.8 per cent of the firms surveyed oriented their main products towards international markets (54 per cent E, 43.8 per cent Textile and 19.3 per cent F), both EU and international markets were more relevant for Electrical engineering firms and than for Textile or Food firms. This shows that international competition and restructuring is stronger in medium than in low technology firms that are investing in renovation.

The evaluation sought to predict the changes that will take place over the next few years in order to evaluate the prospects for SMEs in the face of global competition. Responses show that the EU and the rest of the international markets emerged as the most significant change for Electrical engineering and Textile firms. The main area of transformation is the international market that is associated with the globalisation process for the SMEs. An important area of market change is clearly Eastern Europe. These results are interesting because none of the firms quoted this market as an important one today but, in all sectors, Eastern Europe is considered as a growing source of change.

Investing in restructuring and innovation are a necessary condition for firm growth. This is considered a requirement to cope with international competitiveness. This contrasts with the lack of renovation that leads to the death of the firm and a declining economy. Some of the more relevant factors of growth in terms of firm organisation (management, labour, linkage with customers or suppliers and marketing), technological innovation (R&D, technology adaptation, engineering abilities), finance (access and cost of capital) or institutional (government assistance). The identified factors of growth show a common pattern of behaviour among industries and firm sizes. The main factors with values over the average have been: first, Linkage with customers: second, Management skills (both linked to firm organisation): third, R&D innovation capacity; fourth, ability to transfer technology; fifth, design & project engineering (all of them linked to technology innovation capacity). By contrast, we observed that: the cost of capital, access to finance and government assistance were considered by the firms as the least relevant factors to explain their growth. However, these financial factors were more important for Small firms (less than 100 employees) than for Medium sized ones. This reveals that finance is not a significant restriction in terms of the predominant reorganisation and technological strategies of the firms. However, finance is a much more important restriction for smaller firms.

Other results worth mentioning are the factors perceived as most important over the next 5 years. Since R&D innovation capacity has become the main factor, this reflects the importance that acquiring technological innovation has for the firms, among others related factors, such as the ability to transfer technology, and to design & project engineering.

Most scholars discuss growth strategy at the corporate level and at the business level (Johnson and Scholes 1997). De Wit and Meyer (1998) discuss corporate strategy as part of the strategic process and business level strategies are associated with Porter (1980 and 1996). We can take a view that, within a firm, there are five different types of strategies: Innovation, Technology, Production, Management and Human Resources. The first two are the most important in terms of this research. Innovation is concerned with the commercialisation of new products, process and services [PPS]. Technology is concerned with the search for the acquisition and the development of technologies that can be used in innovative PPS, as well as supporting the existing product process portfolio. Production is concerned with reducing product cost by lowering material contents, promoting easier manufacture or simplifying logistics. The type of innovation or technology strategy can be classified as being from radical to conservative. A radical strategy will disrupt the existing competencies in the industry creating new markets for new products. By contrast, a conservative strategy aims to maintain the current products in the present markets. Obviously, certain innovations reinforce existing competencies and linkages between producers and markets. In the middle, a regular strategy will improve the products entrenching the existing competencies in the markets, and a niche strategy will reinforce the competencies creating new markets.

• In terms of innovation all the three sectors follow conservative innovation strategies, but the strategies of Food and Electrical engineering firms differed from those of Textiles. The Textile industry follows typically a niche strategy that requires new products to maintain current markets. For Electrical engineering and Food firms it was observed that the relevant behaviour is a niche strategy that seeks new markets for existing products. In terms of size, medium enterprises are more active than small ones -adopting niche or regular as much as conservative strategies-. In all cases, it was clear that the firms do not follow radical innovation strategies.

• In terms of their technological strategies, all three sectors revealed more defensive strategies based on improving their own existing technology and accepting in second place the importance of developing new technologies. In fact, Electrical engineering medium sized firms give more importance to defensive than to offensive strategies. Finally, in all sectors, SMEs estimate that dependent (using technologies developed by others) and adaptive (adapting technologies developed by others) strategies were not the most adequate path of growth.

• Although in all three sectors the X-efficiency factor is the dominant production strategy of growth, there are different secondary factors in each sector. In the case of Textile firms, using new material was the most relevant factor and, in the Electrical engineering and Food group, the most relevant factor was reducing labour costs. The evaluation of production strategies by size shows again that the most important criterion was X-efficiency followed by cutting labour costs for small firms and using new material for medium sized ones.

• Management practices are clearly dominated by total quality management. Meanwhile, management incentives through compensation received one of the lowest values. It is highly possible that this is associated with the debate about the Spanish business community which included criticism of "Fat Cats" and the Stock Options of certain privatised public enterprises.

Finally, human resource strategies show a similar pattern in the following order: continuous training, enhancing engineering capabilities, staff motivation and, finally, innovative compensation package.

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5. Financial Strategy

The financial strategy of SMEs is an issue that is widely and deeply analysed in this project as well as in other academic and institutional circles (Cobham 1999 FitzGerald 1997, OECD 1997). It is interesting to note that some of the hypotheses about the importance of self-generated resources and bank debts (short and long term) have been contrasted with the results of the sample of SMEs in the considered industries. Firms' own resources and bank debt represent the bulk of firms' resources and are more significant in small than in medium enterprises, where other resources such as bank equity, venture capital or business angels account for around 8 per cent of resources.

Firms' access to finance is a crucial element in the innovation process, particularly for smaller SMEs, so that the results of R&D can be translated into commercial outcomes. Investment in innovative SMEs generally involves: (1) an element of risk; (2) a long time-frame (a 3 to 7 year investment), (3) returns in the form of capital gains (rather than dividends) (4) a partnership with management. Venture capital is a specific type of finance provided by certain institutions that invest alongside management in young companies that are not quoted on the stock markets. Several financial institutions and scholars have overemphasised the importance of venture capital to support high-risk investment in SMEs. For a variety of reasons, it is very difficult for large companies to undertake high-risk innovation projects. These kinds of projects have a greater chance of success if they are undertaken in small technology-based firms (OECD 1996, 5). This idea was also supported by evidence that American technological revolutions, such as that of Silicon Valley, which have resulted in the transformation of industries, led by venture capital-backed firms. The venture capital market is small relative to other financial markets. However, its economic role is very significant because venture capitalists specialise in investing in high growth companies and high technology-based sectors. While venture capital in the United States has been oriented to technology-based sectors and consists of a range of investors, including pensions funds, insurance companies and private individuals, the continental European venture capital sector is younger, oriented to mainstream sectors and dominated by banks.

A second stage results when current sources of finance are compared to finance five years ago. In all considered industries, self-generated resources and short-term bank debt are the most relevant categories, and these figures imply a restriction to firms' growth. In general, the firms consider they depend less on their own resources and more on long-term debt. However, in each activity, the firms predict different changes in their financial strategies. In Electrical engineering firms the strategies will be mainly based on bank debt (short and long term), and in Textile firms, they will be increasingly dependent upon their own resources. Finally, despite its relatively low contribution, venture capital is a growing financial resource.

In terms of the accessibility of sources of finance quoted previously, we established a ranking which rates the importance of each item by the accessibility attributed by the firms. Self-generated resources are less restricted financial resources than short or long term bank debt in Food and Textile Firms but, in Electrical engineering firms, short-term debt is the easiest to access. In terms of size, small enterprises found it easier to access short-term bank finance than their own resources, while the medium ones were in the opposite situation. However, for both of them their resources own and short-term bank debt are the least restricted sources. Finally, venture capital is a more restricted source of finance. However, it is, in relative terms, as easy to access in terms of long-term bank debt is to self-generated funds.

As was noted in the first part of this report, innovation investment depends on firm decisions that are adopted within an institutional framework. For this purpose, the significance of other financial schemes has been evaluated by the answers provided (value 2 means necessary and 1 means help). The results of the Food and Textile firms show that investment grants are the most important category followed by tax credit and employment grants. For Electrical engineering firms, the tax credits category is the most significant, which is followed by investment and employment grants. In terms of firm size, tax credits are slightly more important than investment grants but, for medium enterprises, the latter category is more significant. The fourth relevant category is regional incentives. All these categories of financial support can be considered relevant for different outcomes and institutional strategies. Finally, of lesser importance, venture capital schemes are more frequent among Food and Textile firms and medium sized enterprises.

Considering that the main external financial supplier of firms is the bank, it is crucial to examine what determines the bank's lending decision from the firms' perspective. These criteria have been widely defined and include business performance, guarantees, other requirements, managerial capacity and commitment to the bank. The firms considered that the bank's decision to lend was mainly based on guarantees and performance criteria, such as: appraisal of borrower's assets, financial ratios of borrowing, centralised credit review and collateral. At the same time, three seemingly irrelevant factors emerged: previously approved subsidies, documentation requirements and managerial expertise. The importance of the relationship between the firm and the bank is quite relevant for small enterprises, which are more dependent upon this financial resource as it was pointed out before.

One of the most relevant sets of questions in accordance with the aim of this research was the relationship between innovation, technological investment and financial facilities. As is usual we have carried out the research at the sectoral and size level. We have also looked for different financial resources but, unfortunately, few of the firms surveyed answered the sets of questions related to venture capitalists, because most of the SMEs do not participate in these markets.

The results by sectors show that the traditional financial investment approach was observed only in Food firms. In this case, traditional tangible investments (machinery and equipment, and buildings: MB) are easier to finance than innovations in products or process (PP). In turn, both of these are easier to finance than technology purchase, development or adoption (PDA). The least easy are intangible technology and innovation in services. While in Electrical engineering firms all the technology investments (PDA) are easier to finance than traditional tangible investment (MB), both of them are easier to finance than innovation investment in product, process or services (PPS). Again, intangible technology is the hardest to finance. In the case of Textiles, innovation in process and services and all the technology investments (PDA) are easier to finance than traditional tangible investments (MB). In general, innovation in process seems easier to finance than innovation in products or services. Considering that the finance of traditional tangible investments (MB) is at least as hard as the finance of technology and innovation investment categories, we should point out that there are no significant restrictions to finance innovation or technology investment.

Financing innovation and technology investment (Banks)

The results in terms of size do not contradict the point just made however, for the small enterprises, traditional tangible investments (MB) are easier to finance than other innovation and technology investments, except process innovation. The results for the medium enterprises confirm that all the technology investments are easier to finance than traditional ones (MB) and there are not significant differences among investment categories. Finally, the results for the small enterprises, and the fact that intangible technology is the hardest to finance, confirm a problem of financial guarantees.

Considering SMEs dependence upon financial resources from banks (Table 30) and the value given to the records between them for the lending decision (Table 30), it is clear that an important record of the financial strategy is the age of the relationship between firm and bank. In all sectors and size of firms, the relationship with the main bank has been stable. On average, it has lasted over 20 years (this figure represents 4.5 times the average age of the firms). The average age of the relationship between firms and banks is not directly related to the size or the age of the firm (from 15.3 years in the medium sized Electrical engineering enterprises to 26.2 years and a 1.4 ratio of the medium Textile enterprises). The firms considered that this relationship would have favourable effects on the availability of credit, interest rates, finance from other banks and non loan costs, however, the commitment to the main bank could also have negative effects, in particular on non-loan costs and interest rates.

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6. Technology Strategy

A first step in the evaluation of the technological investment programmes conducted by the firms was to define the sort of activities (innovation in products or process, inputs such as human resources or energy, or regulation standards) and the impact of technology policy (public funding) in the projects.

When assessing the technology programme undertaken by firms according to sector, the principal activities developed by the firms were: quality assurance, product development and design, manufacturing process set-up, human resources training and export promotion. These innovative programmes on process, products, human resources and markets received proportionally higher financial support from the EU or national or regional governments. Public support to product or market promotion or computer aided activities (CAD/CAE/CAM) encouraged the investment decision in Textile and Electrical engineering firms. Similar results can be seen in electronic data interchange, communications, local area networks (LAN) in Food firms; computer aided design, engineering and manufacturing in Textile firms and automation robotic and computer control in Food and Textile firms. In terms of size there were no significant differences in the proportion of developed programmes, although the small enterprises developed proportionally more investment projects in electronic data interchange, communications, local area networks (LAN) and automation, robotic and computer control.

The technological investment decisions of the firms are conditioned (restricted or encouraged) by the available external and internal sources of information about technological innovation projects and programmes.

Although some manufacturing activities have direct links with the scientific community, the links with technology innovation are not always important. However, co-operation and networking between scientific, technical and other business institutions and agents are of increasing importance in many industries. The EU Innovation Surveys (1997 and 1999) found that trade fairs, conferences, publications, customers and other firms were the main sources of external knowledge in countries like Italy, Germany and France. Equipment suppliers and consultants were also of great importance to the acquisition of technology. Networking and co-operation are increasingly formalised as external knowledge and cost sharing. Both are becoming as important as innovation network since they help to diffuse technology. The growing importance of these activities is linked to the difficulties of incorporating new technologies and this secondary innovation network supplements the existing knowledge base of universities, research centres and technology transfer institutes (De Hertog & Bilderbeek 1998).

The main external information sources for the acquisition of technologies were trade fairs and national and international suppliers, accounting for around 20 per cent each in all industries. Other important sources were publications, national technical consultants, and business associations; these made up more than three-quarters of the total. Finally, only a few firms considered the co-operation of technological institutions, other firms or joint venture partners relevant for their technological decisions although this result was slightly higher in Electrical engineering than in Textile or Food (with lower technology intensity).

Technology investment decisions are promoted by the information available. However, there are other reasons that drive the firms to select an innovative tangible investment. Among the factors that have been proposed, investment is determined by compatibility with the existent equipment and after sale support services. Other important selection criteria are supplier's reliability and durability. The second and third categories show the importance of services in the acquisition of tangible capital goods embodied in R&D. In all kinds of sectors and firm sizes some of the conventional factors for the investment - such as price, familiarity or relocation - do not seem as important as technical characteristics or additional services.

Table 34 Embodied Technology Investment Selection

The main internal sources of innovation in products, process and services are: customers and R&D units, followed by production and marketing units, management, competitors and suppliers. The results are ambiguous for the project and engineering unit, which are very important for the Electrical engineering firms and small firms while they are irrelevant for the Food firms. Finally, the least relevant sources for innovations are associated firms, patents, licenses & trademarks and government programmes. This indicates clearly that the technological investment decision is the result of business and corporate strategies (linked to customers, R&D, production and marketing units more than the transmission of exogenous information, such as competitors, suppliers, affiliated firms, patents or government).

In the analysis of technological innovation it is important to consider the factors that promote the process as much as those that restrain it. The obstacles can be classified as technical (operative disruptions, unsuitable hard or software), financial (lack of internal or external resources), commercial (lack of demand or customer reply), human resources, services or institutional. It has been observed that the main obstacles were commercial (uncertain or insufficient demand and, for Electrical engineering firms, lack of reply from customers), technical (especially operative disruption), lack of human resources skills and internal financial resources and the fear that new technologies will disrupt current operations. Interestingly, some of the factors were not considered a serious obstacle to invest in new technology. First, the lack of institutional technological support or co-operation from universities or government research organisations. Firms considered in some cases that this was as a lack of technology transfer or communication. Second, the cost of private consultants. Third, the "uncertainty" that new technology will not be cost effective, and this is associated with the financial risk. Fourth, the lack of financial external resources (banks or venture capital).

Another interesting aspect of this survey is connected to the chronology of the technology investment process. In this evaluation, we have codified and weighed the answers by "phases I-III" and distributed the frequencies in the last three columns of each sample, which result is a mapping of the process.

During the first stage, most firms (39.4 per cent in Food firms, 43.7 in Textile firms and 48 per cent in Electrical engineering firms) take a general investment decision and between 12.5 and 22 per cent take a specific investment decision in the same phase. However, Food firms take fewer investment decisions during the first stage (52 per 100) than the Electrical engineering firms (70 per cent). Additionally, it is interesting to note that one fifth of SMEs take a general financing agreement during the first phase but, in this case, the proportion of firms was 30.5 per cent for Food, 28.3 for Textile and 23 for Electrical engineering. There is, therefore, an inverse relationship between the firms that take investment decisions and those that take financial decisions in Food, Textile and Electrical engineering.

The second phase is still dominated by investment decisions, in particular, by specific decisions. During this phase, the specific financing agreement and the applications for institutional support increase drastically. In the final phase, there are still specific investment decisions and, in the Food and Textile sectors specific bank agreements. In both cases, in the final phase, the applications for EU, national, or regional support peak.

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