Dubai: Funding support is a subject that invariably comes up when talking about the region’s small businesses. It is still a struggle for start-ups to find the capital to launch and scale up.
In the past few years, banks in the UAE have publicised their lending activities to small and medium enterprises (SMEs). While bank credit to the sector has improved over the years, with some lenders and government institutions starting dedicated funds, it is still miniscule as a percentage of total loans. Loans to SMEs in the UAE and Saudi Arabia comprise less than five per cent of the total number of loans given in each of these countries, according to the Institute of International Finance (IIF). Compare this to an average of 20 per cent and 25 per cent in other emerging regions and advanced economies respectively. Only eight per cent of all bank lending in the Middle East is directed towards SMEs.
Without blaming the banks — after all, the economics of lending and regulation drive the rationale to lend to big corporations and family businesses — a leading academic believes that a series of initiatives from and for various players, including the entrepreneurs, would help generate funds for the small and medium private sector companies.
“If you are a bank manager, would you rather lend to a large corporate that you know and has a good credit standing or would you take the risk to lend an unknown entity that doesn’t even have financial records in proper order?” asks Florin Vasvari, a professor of accounting at London Business School. “The problem with SMEs is that sometimes while going through the due diligence process of assessing the credit risk of the entity, the cost is higher than the loan required.”
Also, the fact that the capital markets in the Middle East are still developing means large corporates, instead of going to the markets to get funding either by issuing equity or bonds, go to banks. So, there is not enough left for the smaller businesses, Vasvari says.
SMEs currently account for 92 per cent of the UAE’s total registered companies, 86 per cent of the workforce in the private sector, and 40 per cent of the country’s gross domestic product (GDP), according to the UAE Ministry of Economy. There have been funding initiatives from the government such as DubaiSME and Khalifa Fund as well as UAE banks and multinationals. But that is not enough, he says.
While government funds such as the $2 billion Khalifa Fund (Dh7.3 billion) are substantial by any standard, academic studies suggest that governments in general may not be the best entities to allocate capital.
Vasvari suggests an alternative approach. “A better approach would be to say that ‘we have this $2 billion fund. So, if you manage to get funding from a third party, from a [venture capital] or from some angel network, we will be matching that.’ For that the government should have some kind of an approved list of investors that follow best practices,” he says.
“There is some conflict of interest that has to be dealt with, but to some extent the government could try to outsource the investment process to people who do that on a daily basis because the allocation of capital will be more efficient.”
While the government’s initiatives through the likes of DubaiSME and Khalifa Fund are noteworthy, hassle-free paperwork and lower cost of doing business are aspects that should be looked into, he said. “So, if you want to go through some sort of funding scheme, [you should have] documents really set in stone and everybody knows them,” Vasvari says. “More of that could be done in the UAE and Saudi Arabia.”
Nasdaq Dubai’s plan to establish an SME Exchange and Qatar’s efforts at something similar are in the right direction. “GCC governments could do more to facilitate this,” he says, citing the example of China, whose Shenzhen Stock Exchange has launched two sub-boards. One is called the SME Board in 2004, specifically for SMEs, and the other called ChiNext in 2009 for even smaller ventures. Supported by these two sub-boards, SZSE had reached over $1.2 trillion in market capitalisation, one of the world’s largest, within which SME boards accounted for 40 per cent, and ChiNext 10 per cent of the whole market cap of SZSE. Chinese regulators, however, are trying to control the indiscriminate growth of listings.
“Of course not all [SMEs as in case of China] will be successful and investors may lose their money on small exchanges, but this is not unexpected given investments in smaller companies which are risky and have unproven business models,” Vasvari says.
The London-based academic, who has been a frequent visitor to the UAE for the past seven years and is also on the boards of two private equity funds, wants private equity investors to fill the funding gap. To make that happen, incentives should be provided, he says, while commending that the likes of Abraaj Capital and Gulf Capital are entering the SME sector despite the limited deal pipeline. Incentives might be in the form of lowering the cost of doing business, and clearer regulations.
The fact that even the bankruptcy regime is unclear does not help, he says. “If a company defaults on its payment it is difficult to take that company to court,” Vasvari says. “A private equity investor needs a clear regulatory environment. They invest in a company and they do so by using preferred type shares and if the company doesn’t do well, what can the courts do to recover the investments? This is where the legal system plays an important role. The DIFC has its own court and the English Law applies there, which makes a difference, but it is an expensive place to do business for a small private equity firm.”
An alternative funding source is large corporates. Companies such as etisalat and large family businesses could set up “corporate venture arms” to support the emerging high tech sector and get financial returns, he says.
“The good thing is that the big family offices that have been putting money into private equity typically abroad, outside the Gulf, have started to see this opportunity,” he says. “They are committing more money into local funds. But it will take a bit of time.”
The problem is on the receiving side too. One way to facilitate funding is to educate people, especially entrepreneurs, according to Vasvari. “You try to invest in people who don’t know how to put together a proper business plan and that’s a serious issue.”
Educating the entrepreneurs could address this issue.
“It would be useful if young entrepreneurs [are taught] how to put together a business plan, pitch their business, plan and strategise, or network with potential investors, and, of course, how to do their accounts and financial reporting.”
