SMEs are a driving force in SEA’s economic development. Across each country in the region, these businesses account for an average of 97 per cent of all enterprises, employ 69 per cent of the total workforce, and contribute to 41 per cent of the Gross Domestic Product (GDP).
Even though they play such a vital role in fuelling the economy’s growth, 51 per cent 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 cash flow was the biggest challenge SMEs faced to keep their business afloat.
As SMEs look for ways to keep the lights on, 90 per cent of SME owners use their savings to fund their business needs rather than to look for financing through traditional means.
A study on Malaysian SMEs found that 64 per cent 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 filling in the 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 US$13 billion worth of loans for 21,000 enterprises amid the pandemic, representing eight per cent of all SMEs in the country.
Thailand’s Central Bank granted US$4 billion worth of loans to financial institutions, which supported 73,000 SMEs out of the total 3 million in the country. The Malaysian Ministry of Finance approved a US$3 billion soft loan scheme which would benefit more than two per cent of Malaysian SMEs.
Even though governments are launching initiatives to provide financial support, most businesses remain unattended as there is 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 three years.
In this two-part article, we will explore a few common equities and debt financing options to help bridge the gap for SMEs.
Also Read: Digital transformation for SMEs, Part 3: Data analytics in the enterprise
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, companies 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 with 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.
To start a campaign, business owners must first decide how much capital they want to raise and determine the valuation of their businesses.
| Benefits |
Drawbacks |
- Access to the pool of individual and institutional investors on the ECF platform
- Greater control over the terms of the deal (e.g. how much equity to sell)
- Less dilution for business owners compared to other equity financing options
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- SMEs can only receive the raised capital if the final amount meets the target at the end of the campaign
- Have to make available business information such as financials and business plans publicly so that investors can make an informed decision
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The global market size for equity crowdfunding financing is expected to grow by US$196 billion between 2021 to 2025. Asia will be the biggest contributor, attributing to 62 per cent of the total growth, due to increasing demand from investors.
On top of that, regulators across SEA have increased ECF adoption among SMEs. The Malaysian government allocated US$12 million in 2020 and US$19 million in 2021 for grants to encourage SMEs to raise capital through ECF (and Peer-to-Peer, which we will delve deeper into the next article).
The result – 2020 saw a 199 per cent increase in total capital raised from 2019, reaching US$30 million in one year. The first half of 2021 experienced a 151 per cent jump compared to the whole of 2020, with the total amount raised hitting US$75 million.
Indonesia’s Financial Service Authority (OJK) first introduced ECF rules back in 2018, with only three platforms permitted to operate by the end of the following year.
New regulations were released when the pandemic hit, 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 US$25 million by November, a 90 per cent increase since the start of the year.
Other countries in SEA have more recently opened up to this form of financing, with the Philippines approving the country’s first ECF platform earlier in 2021 as they look to support underserved SMEs.
Also Read: Digital transformation for SMEs, Part 2: Understanding its maturity cycle
Vietnam is also looking to develop an ECF platform as its 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 return potential.
Each VC will have its strategies in terms of the industry it invests in, investment size and stage of financing round (e.g. early stage, growth stage, late-stage). SMEs of high growth can opt for VC investment as a financing option.
In SEA, most VC funds started to be tech-focused. However, we are seeing more funds gearing towards high growth non-tech companies as an investment focus.
| Benefits |
Drawbacks |
- SMEs can potentially raise more significant amounts of capital through VC than ECF.
- Existing VC investors may help with future fundraising rounds
- Access to VC’s business network and community
- Potential expertise contribution and portfolio collaboration from VCs
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- Process of fundraising from VCs may be lengthy depending on the fund’s profile and the number of investors involved in around
- Greater dilution for business owners with the possibility of losing majority control after multiple fundraising rounds
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Global VC investments have been on the rise, as it is on track to hit an all-time high, with the total amount invested reaching US$580 billion in 2021, which is nearly 50 per cent more than the previous year.
SEA’s VC investments are still relatively small compared to the rest of the world, reaching US$4.4 billion in 2021 across this region. The number of deals completed in SEA reached a record high of 393 in 2021, which was 20 per cent 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.
Also Read: Is omnichannel commerce a fairy tale for SMEs in Singapore?
The Malaysian government launched an initiative called ‘Dana Penjana Nasional’ in 2020 – a US$142 million matching grant into VCs investing in local SMEs. More recently, the Indonesian president announced plans to launch a new VC, 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 US$52 billion being invested in the past 10 years and out of that, US$8.2 billion was from 2020 alone.
An example of VC financing success is Indonesia’s Gojek which started 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 US$1.3 billion valuations six years from launching. They later merged with another VC-backed business,
Tokopedia, to form one of the largest tech companies in Indonesia, contributes two per cent of the country’s US$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 enable scalability, which meets VCs’ investment parameters.
Kopi Kenangan started as a single brick and mortar store grew rapidly with the financial support they received from VCs. The business secured its 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 US$129 million in financing from other VCs, which helped them expand to more than 500 stores in just four years after launching.
Our next article will explore the different types of debt financing available for SMEs.
This article is co-authored by Kevin Rozario of kipleX.
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The post SMEs’ booster towards financial health (Part 1): Equity financing appeared first on e27.
