Issue link: https://maltatoday.uberflip.com/i/531627
maltatoday, WEDNESDAY, 24 JUNE 2015 13 Business Today I n most cases, when an entre- preneur has an idea and wants to build it into a business, he/ she meets barriers to get the right financing. The traditional way to start a business is by establishing a company and applying for a bank loan. In order for a bank to accept your risk you first have to provide a lot of information on your creditworthiness and the viability of project. This usually means a long, bureaucratic risk assessment process, which if successful may end up in signing a contract with a lot of covenants and pledges, e.g. property or pledged securities. This is acceptable practice, if you want to open a coffee shop in a good location, the shop itself will be the pledge and the profit will cover the loan instalments and the interests. But, for example, an innovative start-up firm usually does not necessarily need to own a property at the outset (one is reminded of the modest start-up by Microsoft in Silicon Valley), it just rents an office, and wants seed finance to meet recruiting and other services. It goes without saying that in Malta we never grasped the concept of "Think Same First", suggested by the EU when it transposed the Small Business Act in 2012 – political leaders then preferred announcing mega projects employing massive capital because it looks better on the front pages of the tabloids. A more innovative business means a riskier business, which makes it more difficult and more expensive to obtain bank finance. That's where the inceptive capital of start-ups comes from – what they call the 4Fs – founders, family, friends and fools. But if you dream big, you need bigger investments than the 4Fs can usually offer and that means venture capital – business angels could be a better financing idea. Venture capital in Malta never took ground albeit it was always patronised by political promises in every budget speech ever since joining the EU. This is a unique form of financing, a kind of private equity for early stage start-ups. Venture capitalists don't require pledges like property; what they are interested in is the high potential growth because in exchange for investment they take shares in the company, and thus they can earn a significant return if the company is a success. That's why their contribution often includes access to their valuable network, as well as managerial and technical expertise. For the same reason they usually want to take part in decision making, which indicates that the entrepreneur loses some independence. Although it doesn't definitely mean a bad thing, it makes a good relationship between the start-up and the venture capital really important. It's like a partnership, the goal is the same for both of them: success in the business. Unlike the banks, venture capital firms don't get a pledge to cover the loss if the company fails, they really expose themselves to the company's performance. That's why they expect a high return on their investment. The main form of venture capital's return is sale of their shares to another owner or another investor or to the public: the exit of the venture capital can also be the listing of the financed company on a stock exchange. The exit usually happens within 3-7 years. Between 4Fs and venture capital there are the start-up incubators and business angels: they offer smaller investments for shares as well. They usually help entrepreneurs to develop their projects to the next level through providing the seed capital and the inceptive support before the venture capital fund can get on board, if further investment is required. Some of the venture capital firms are specialised within an industry, a country, or a region, but most of them, like business angels, are open for any interesting start-up. For instance recently we could match one of our international clients and a Middle Eastern angel investor. In order to qualify for venture capital applicants need to prove that you will be able to grow and provide the return as the investors are expecting. To convince the investors and or bankers you are required to have a marketable idea, to be well-documented, sustainable and ideally able to demonstrate a strong recovery over the pay-back period. In the context of the development of a robust business plan, PKF Malta can assist, as well as further assist in facilitating access to alternative sources of finance. It is imperative to articulate an effective business plan to impress investors that you have more than just a great idea, to show that you are 100 percent sure that your idea will work profitably in the market in reality, that you know your future customers well, your future competitors in detail etc. The business plan usually includes a marketing plan and a financial plan which is projected into three- year financial statements. Nobody expects that the projected results are fully realised but it shows that you've estimated the customer base, the expenses, the revenue, the market share you can achieve, etc. It is true that start-ups then shy away from compiling numerical analysis which require a lot of research and/ or experience about the market and most will not have acquired knowledge in fields like marketing, finance as well as accounting, thus it is challenging for most of the start- ups to perform all the analysis and construct the business plan properly by themselves. These are all areas that a good service provider can spearhead for your venture. Quoting a particular case where PKF has been successful in assisting a start-up we may recount how an active actor in disruptive technology, was searching for funding. Taking into consideration how this industry is highly risky they were rejected when applying from a commercial bank. The founder and CEO of this firm is an experienced entrepreneur, they already had a business plan at our first meeting but they needed an objective observer to look through it, to find the mistakes in the projections and to make suggestions to fix the suboptimal points. The mistakes were remedied by taking a finance expert approach, which has positioned them far better to find a venture capitalist who will invest in their company and whom they could work with. Of course venture capital could be an available financing source for established companies' early stage projects as well. Another example is a reputable company in the retail industry that desires to expand abroad. For this they have launched a separate entity which would be responsible for the overseas business and as can be expected local banks are not too keen to take overseas risks. PKF assisted them to secure an alternative financing source, by first assisting in the preparation of the business plan for the new markets, because even though the applicants do have a lot of experience about the domestic market they are not sufficiently familiar with the new markets and don't have the capacity to do all the research by themselves. Maybe these cases could show that it pays for entrepreneurs to build up courage when faced with the hurdle to find alternative financing sources. In Malta's case it is no surprise that upwards of 70 percent of SMEs are dependent on bank loans while the European average is lower than 60 percent, according to a Survey on the access to finance of enterprises (SAFE). Access to finance is one of the most important issues highlighted by domestic firms in the latest survey. Compared with the previous period, the percentage of domestic firms that mentioned access to finance as their most pressing problem has increased from 4.7 percent in 2011 to 11.5 percent in 2014. This, however, remains below the EU average of 14 percent.[1]. Just imagine how many local firms could expand, armed with bright ideas having the support of an equity partner with a pre-defined exit clause if venture capital takes root. As always, the Small Business Act may talk big but in reality more needs to be done to help SMEs grow up the slippery slopes of the proverbial nursery. The writer is a research assistant in PKF Malta, an audit and business advisory firm info@pkfmalta.com Margit Vago Why do SMEs struggle so much to access finance?