SME’s Booster Towards Financial Health — Part 1: Equity Financing
Small and medium-sized enterprises (SMEs) are a driving force in Southeast Asia’s (SEA) economic development. Across each country in the region, these businesses account for an average 97% of all enterprises, employ 69% of the total workforce, and contribute to 41% of the Gross Domestic Product (GDP).
Even though they play such a vital role in fuelling the economy’s growth, 51% of SMEs (equal to 36 million businesses) are underserved by financial institutions in SEA, resulting in a US$320 billion funding gap in terms of their financial needs which has yet to be filled. This became an even greater concern during the pandemic as sustaining their cashflow was the biggest challenge SMEs faced in order to keep their business afloat.
As SMEs look for ways to keep the lights on, 90% of SME owners used their own savings to fund their business needs, rather than looking for financing through traditional means. A study on Malaysian SMEs found that 64% of those who tried applying for bank loans during the country’s Recovery Movement Control Order between June to August 2020 ended up getting rejected.
GOVERNMENT CONTRIBUTIONS IN FILLING THE FINANCIAL GAP
Governments across the region have launched many initiatives to help bridge this financial gap for SMEs. Enterprise Singapore, a government agency, worked with financial institutions to approve USD 13 billion worth of loans for 21,000 enterprises amid the pandemic, representing 8% of all SMEs in the country. Thailand’s Central Bank granted USD 4 billion worth of loans to financial institutions, which in turn supported 73,000 SMEs out of the total 3 million in the country. The Malaysian Ministry of Finance approved a USD 3 billion soft loan scheme which would benefit more than 2% of Malaysian SMEs.
Even though governments are launching initiatives to provide financial support, most businesses remain unattended to as there are only a handful of SMEs that the government can reach through these schemes. This led to more than half of owners expressing that they will likely explore alternative financing options within the next 3 years.
In this two-part article, we will explore a few common equity and debt financing options to help bridge the gap for SMEs.
EQUITY CROWDFUNDING
Equity crowdfunding (ECF) is a form of financing that allows SMEs to raise capital by offering equity in their business to the public. As this is a highly regulated space, businesses would work with a licensed ECF provider who facilitates the fundraising campaign to ensure the compliance and safety of all parties involved.
ECF provides individual investors the opportunity to partake in the share offering of private companies and become a shareholder (or indirect shareholder through nominee arrangement) by investing in the overall fundraising amount. In order to start a campaign, business owners must first decide how much capital they want to raise and determine the valuation of their businesses.
Current Landscape
Global market size for equity crowdfunding financing is expected to grow by USD 196 billion between 2021 to 2025. Asia will be the biggest contributor, attributing to 62% of the total growth, due to factors such as increasing demand from investors. On top of that, regulators across SEA have made efforts to increase ECF adoption among SMEs. The Malaysian government allocated USD 12 million in 2020 and USD 19 million in 2021 for grants to encourage SMEs to raise capital through ECF (and Peer-to-Peer, which we will delve deeper in the next article). The result — 2020 saw a 199% increase in total capital raised from 2019, reaching USD 30 million in one year. First half of 2021 experienced a 151% jump compared to the whole of 2020, with the total amount raised hitting USD 75 million.
Indonesia’s Financial Service Authority (OJK) first introduced ECF rules back in 2018 with only 3 platforms permitted to operate by the end of the following year. When the pandemic hit, new regulations were released which expanded the type of businesses allowed to raise capital through this form of financing. In addition, more licenses were handed out increasing the number of ECF providers to 7. This helped to develop the ECF market in the country as the funds raised in 2021 reached USD 25 million by November, a 90% increase since the start of the year.
Other countries in SEA have more recently opened up to this form of financing with Philippines approving the country’s first ECF platform earlier in 2021, as they look to support underserved SMEs. Vietnam are also looking to develop an ECF platform as their Prime Minister announced plans to boost the development of SMEs in the country.
VENTURE CAPITAL
This form of financing commonly consists of direct investment by institutional investors, known as Venture Capital (VC). These investors focus on high growth SMEs in industries with promising exit opportunities and returns potential. Each VC will have its own strategies in terms of industry it invests in, investment size and stage of financing round (e.g. early stage, growth stage, late stage). SMEs of high growth nature can opt for VC investment as a financing option. In SEA, most VC funds started out to be tech-focused, however, we are seeing more funds gearing towards high growth non-tech companies as investment focus.
Current Landscape
Global VC investments have been on the rise, as it is on track to hit an all-time high with total amount invested reaching USD 580 billion in 2021 which is nearly 50% more than the previous year. SEA’s VC investments are still relatively small compared the rest of the world, reaching USD 4.4 billion in 2021H1 across this region. The number of deals completed in SEA reached a record high of 393 in 2021H1 which was 20% higher than the same period in the previous year showing good signs of growth.
VCs play an important role as their investments into businesses not only help them grow but spur a country’s economic growth, job opportunities, and innovation. Governments across the region recognise this value and want to stimulate more opportunities for businesses to raise capital through this form of financing. An initiative called ‘Dana Penjana Nasional’ was launched by the Malaysian government in 2020 — a USD 142 million matching grant into VCs investing in local SMEs. More recently, the Indonesian president announced plans to launch a new VC which will be backed by state-owned enterprises to focus on SMEs with Indonesian founders in the country. In SEA as a whole, total VC investment has grown substantially with USD 52 billion being invested in the past 10 years and out of that USD 8.2 billion was from 2020 alone.
An example of VC financing success is Indonesia’s Gojek which started off as a small business in 2010, connecting consumers and motorcycle taxis through their call centre. The company then experienced accelerated growth as they began to raise funds from VCs across multiple rounds, reaching a USD 1.3 billion valuation 6 years from launching. They later merged with another VC-backed business, Tokopedia, to form one of the largest tech-companies in Indonesia contributing 2% of the country’s USD 1 trillion GDP.
There may be a consensus that VCs only invest in technology companies, that is not always the case. Technology companies most commonly have qualities that enables scalability which meets VCs’ investment parameters. Kopi Kenangan started as a single brick & mortar store grew rapidly with the financial support they received from VCs. The business secured their first round of funding just one year of launching, raising USD 8 million from Alpha JWC Ventures. Needing to further fuel their growth, they later received an additional USD 129 million in financing from other VCs which helped them expand to more than 500 stores in just 4 years after launching.
In our next article, we will explore the different types of debt financing available for SMEs.
This article is prepared and co-authored by Kevin Rozario of kipleX and was originally published on e27.
