REPUBLIC OF MACEDONIA
3. RECOMMENDED FINANCIAL INSTRUMENTS FOR THE SME SECTOR DEVELOPMENT
3.1. TYPES OF FINANCIAL INSTRUMENTS
Venture capital is in principle directed towards projects (clients), which have been assessed to having the capacity of achieving fast growth, high profit and a rather high IRR (Internal Rate of Return). The investment strategy, though flexible, depends on a number of criteria such as: type of industry, age of the company, size of the loan, geographic region
An access to venture capital is usually achieved in the following ways:
1. By recommendation (from a portfolio company).
2. By direct access or via.
3. By public presentation.
The process of project and/or applicant/client evaluation consists of:
1. Initial screening of applicant;
2. Due diligence: interviews, consulting analysis, recommendations, references;
3. Evaluation of applicant: IRR, age, financial history, liquidity, future development, perspectives;
4. Establishment of a frame work/structure for the deal, defining exit strategy, signing Conditional Term Sheet;
5. Signing of a JV (Joint Venture) contract and Contract of Mutual Agreement.
The brief presentation of venture capital managers currently operating in the territory is as follows:
IFC- SEF (International Finance Corporation - Small Enterprise Fund) Type of investment: Debt (long-term or medium term), Equity and Quasi- equity.
With reference to the track record projects financed up-to-date, the activity of IFC - SEF has obviously been aimed at funding large companies. The average investment size is USD 2.5 million or a maximum 40% of the project cost. The repayment period is usually 5-8 years and depends on the Funds exit strategy (buy back, public offering or third-party sale).
SEAF-Macedonia
SEAF-Macedonia is a venture capital fund promoting SME development in RM.
Basically, it is a commercial company affiliated with SEAF Washington D.C.
in addition to other contributing entities: USAID, EBRD, IFC and DEG (German Investment Fund). The Fund is an investing rather than lending institution. It acts as an active partner during the (agreed) period of ownership although it holds minority shares (25 - 49%). After 3 - 7 years SEAF seeks opportunities to sell its shares back to the partner or (with the partners consent) to a third party. SEAF Macedonia has been, so far, targeting medium sized companies, Venture Capital
(Local &
International)
Other
(Prospective) Assistance Mechanisms to SME
Development
with average investment ranging from USD 200.000 to 800.000. In some cases (not a practice though), SEAF invests in start-up companies as well.
However, such clients are selected from among reputable entrepreneurs, with good financial status and business performance in addition to their commitment to a venture.
Therefore, in practice, it is quite unlikely that micro and small firms would be given access to venture capital funds.
East European Food Fund (Jupiter Asset Management Ltd.)
The source of capital is EBRD and UK institutions. The type of investment is equity, with a variable period of return. The Fund invests in large food and beverages sector operations with investment size ranging from USD 2-7 million.
An average client from the SME sector will not be obviously in the target group of Jupiter Asset Management Ltd.
Micro-financing / Micro-lending (Micro - loan Programs)
Micro-landing schemes are usually managed through financial mediators who then offer loans to individual farmers, micro or small to medium-sized enterprises. These are aimed, in principle, for creation of new jobs. The terms and conditions for a credit approval are relative to the 4C criteria (Capital, Character, Capacity and Collateral).
In the case of Macedonia such schemes could be very useful in tourism sector as this industry is labor intensive and has rather ample opportunities for development (family businesses in particular), as well as for the employment of young professionals and women entrepreneurs.
• Leasing (Lease - A legal contract for occupancy or use of equipment, in return for money). Leasing is a common way to start and maintain a small business in a market economy, the key players are: lesser, lessee and the lending bank. Macedonia, due to lack of regulatory instruments and tradition, is still at the outset of this practice, but opportunities certainly lie ahead.
• Guarantees (The basic instrument that secures a creditors interest are:
mortgages, pledges and other instruments imposed by the lending bank).
Two investment guarantee agencies are currently operating in the RM:
(i) MIGA, member of the WB Group - political risk insurance in all sectors and (ii). OPIC dealing with political risk insurance, direct loans, loan guaranties and project finance.
• Investment Angels (An unconventional investment vehicle). In theory a potential investor may be approached in different ways: via the Internet, public announcements in media, courtesy of industry associations / chambers of commerce or via the so-called Angel Networks catering to specific industries. In real life Angels may just appear, but that is unlikely.
In the USA, for example, specific industries or specific communities (like Silicon Valley) offer ACE Network (Angel Capital Electronic Network) sponsored by the Small Business Association (SBA). It helps both entrepreneurs and small investors to find each other, and eventually
discuss business. It is original, informal way how to promote ideas and present them to the public and potential investors (angels). The most interesting fields are: IT, electronics, entertainment, show business etc.
• Chamber of Commerce. A good way of participating in the business community. In RM, however, both the Republican Chamber of Economy and Regional Chamber of Commerce are still reminiscent of the old socialist era. Although membership is compulsory for all duly registered companies (enforced by law) the Republican Chamber serves, traditionally, only large-size companies and mostly the ones that are still partly or fully owned by the state.
Therefore there is a grave need for the establishment of industry associations and perhaps a Chamber of Commerce catering to the SME sector in particular in order to address at least but not as last the following issues:
legal advice, mentor system for start-up entrepreneurs, alternative dispute- resolution, ethical behavior / good business practice, development of the angel-networks, small business information system etc. These activities should by all means be coordinated with the present mandate of the National Enterprise Promotion Agency, which is focused on assisting new entrepreneurs and start-up businesses.
A proposed inventory of other useful tools of SME finance promotion envisaged by the authors of this study is as follows:
• Training Programs.
• Regional SME Service Centers.
• Encouragement programs: national awards for successful SMEs, e.g.
Little Giant award.
• Financial Programs for SMEs: development fund, credit guarantee fund, venture capital and mutual guarantee funds.
• SME Consulting Programs: voluntary consultants program, professional advisory group, one-stop shop (SME problem solving center), task force for SMEs.
Authors Remark:
It should be noted in the context that WB Group set up in March 2000 a global SME department with IFC, MIGA in cooperation with representatives of the small business communities worldwide, all in order to promote a comprehensive and more efficient SME support program. The Program was initiated by the drafting of country maps, identification of priority needs and analysis of key development factors and constraints.
3.2. FEASIBILITY OF IMPLEMENTING NEW FINANCIAL INSTRUMENTS
Bearing in mind the constantly improving enabling environment and the gradual picking-up of the Macedonian economy the feasibility of SME Assistance
Programs
implementing new financial instruments becomes even more realistic.
However, a more substantial (foreign) support to the Macedonian economy is very much conditioned on the improvement of the overall political climate in the region, which is still quite volatile. The recently triggered Albanian insurgency from Kosovo into Macedonia hampers efforts to an increased presence of foreign capital in the country thus decreasing possibilities for a more substantial SME support and finance.
The ongoing reform of the banking sector is expected to significantly improve the operating environment. This will particularly foster SME finance promotion.
However, the lack of tradition in the funding of small businesses will for some time remain one of the more the significant constraints to SME finance promotion in addition to the customary reluctance of banks to deal with
small private players.
The growing presence of foreign donor entities is extremely helpful in boosting SME promotion and development. In the context, qualified business advisory services and finance counseling will be needed in order to bridge the increasing offer (of capital) and demand.
Although periodical surveys will have to be conducted in order to assessing the market, it is already obvious that the predominantly foreign capital inflows for SME finance can not meet the increasing requirements for fresh money by the growing SME sector which, realistically, already constitutes the backbone of the Macedonian economy. Therefore, a major shift in SME finance policy will be required in order to cope with present day challenges.
This should include not just a clear vision and strategy for sector promotion and development, but also a feasible strategy with the setting-up of specific targets and time frames for the realization of objectives.
4. CONCLUSIONS AND POLICY RECOMMENDATIONS
4.1. PROPOSED CHANGES IN CURRENT POLICY, LEGISLATION AND PROCEDURES
The list of proposals for viable changes and/or up-grade of the current SME promotion policy, legislation and procedures is as follows.
The following financial instruments intended to foster SME development should strongly be taken into consideration:
1. Risk Capital Facilities.
2. Transitional Joint Ventures.
3. Guarantee Facility Development.
Establishment of Clearing Banks, members of the National Clearing House network. The major role of the latter being settlement of payments between commercial banks, thus assisting SMEs in facilitating financial transactions and offsetting overdue liabilities and claims.
4. Enterprise Board: The EU Committee of Regions has endorsed the establishment of enterprise boards assigned to act as clearing points between public funding agencies, banks and individual entrepreneurs. In addition, the boards will have the authority to grant or reject loan applications.
In addition, the door should remain open to implementing other successful instruments in worldwide practice in SME finance promotion.
Possibilities should also be explored for the implementing of venture capital schemes as an additional tool (where applicable) for SME development.
However, one should note that venture capital is seldom used for the financing of start-up firms (in the USA only 6% of the venture capital is invested in start-up companies).
Transforming pension, social security or health care funds into venture capital funds intended for investment is an option. However, the latter may be a risky enterprise unless the state provides a security in addition to a package of efficient legal instruments to protect the pledged investment.
Policy measures should be addressed in particular to the following issues:
• Draft new legislation against corrupt business practices and promote good governance principles nation-wide.
• Up-grade existing legislature pertaining to public procurement and specifically with regard to spending for the health and defense sectors.
• Further promote reforms in the public administration. Also introduce meritocracy in recruitment for the public administration.
Venture Capital Schemes
Venture Capital Fund
Policy Measures
• Introduce anti-trust regulation based on modern business practice and promote free competition in order to counter oligarchy.
• Draft new regulation pertaining to the founding of independent industry associations and specifically re-draft the existing (obsolete) Law on the Chamber of Commerce of the Republic of Macedonia.