SME financing needs from management’s perspective

Small and medium enterprises (SMEs) have been getting a lot of attention in the past few years. Government initiatives such as the Khalifa Fund and Dubai SME 100 complement private initiatives seeking to provide financing for these SMEs. Everyone agrees that SMEs form an important part of the economy. Everyone also agrees that supporting SMEs is challenging. That is the sum total of what people agree on with regard to SMEs.

In an earlier article this column referenced research showing that SME contribution to UAE GDP is about 60% and that loans to SMEs represent only 4% of total outstanding loans. Information on equity financing of SMEs is not as easily obtainable but discussions with various private equity players in the region would indicate that the equity side of the story is worse than the debt side.

As everyone rushes to support the SME sector with financing, be it debt or equity, an essential first step seems to be missing. Has anyone asked these SMEs what it is that they want?

Assuming that SMEs follow pure capitalistic reasoning might not be the right starting point. These companies are usually owned and managed by a family and it should not be surprising that their perspective would be different from a company with shareholders separate from management. Downside risks for SMEs are double: if things go wrong then they lose their assets and their jobs. The whole family becomes unemployed.

The other issue with the predominantly family facet of SME shareholding is that there are non-financial attachments to the company, employees and customers. Investors and lenders applying a pure financial lens to the business will find themselves in wild disagreement with the shareholder/manager family.

Some of the issues have a particularly UAE slant to them. For example, studies on financing SMEs in more developed markets are often not applicable to SMEs in the UAE. The first issue is that the economy of the UAE is far smaller than, say, the USA. SMEs in the USA will be much larger and therefore it is more effective for them to build out the administrative and operational infrastructure needed to have detailed documentation on financials, legal, processes and procedures, corporate governance and the many other non-revenue generating business facets that make it easier to get funding.

Even when compared to SMEs in smaller economies, corporate tax calculation and reporting requirements force those SMEs to invest in detailed documentation management. There is no such incentive for SMEs in the UAE and they prefer to focus more on direct revenue generating business.

Another unique feature of business in the UAE is that SMEs are owned predominantly by expatriates, which is the inverse of most other markets. Furthermore, the expatriates owning SMEs in other markets usually have the opportunity to become citizens or permanent residents of their host country. This affects UAE SMEs in two ways. First, banks find it easier to lend to someone who has strong legal roots in the country. Second, if an expat SME shareholder looks to equity financing they will want a full exit, something that PE firms will normally baulk at as they expect the shareholder to continue with his management role.

There are also issues of whether there is a common understanding on the role of financing in business. A classically educated financier from Wharton, with their tough exams and detailed case studies, staying up late into the night polishing their presentations, might argue that leverage is good and that it is easy to compute the optimal leverage ratio for any given business. An experientially educated SME owner, with their late-paying customers and their suppliers’ inflexible payment terms, staying up late at night worrying if they will have enough money to pay the rent, might humbly disagree.

Understanding the SME sector in the UAE, or any emerging market really, takes far more than reviewing summary studies from developed markets. The bad news is that anyone seeking to invest in SMEs, via equity or credit, is going to work hard at it (and no, hiring a consultant to do it will just cost you money and get you a pretty presentation). The good news is that if you figure it out, you will have a natural monopoly.

This article was originally published in The National.

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