The Malta Business Bureau is the EU business advisory office of the Malta Chamber of Commerce, Enterprise and Industry, and the Malta Hotels and Restaurants Association. According to several research studies conducted by the European Commission, access to credit is one of the main challenges encountered by all businesses in the EU irrespective of size, business sector and product market. Maltese enterprises are no exception. In this respect, the MBB has been on the forefront in prioritising the issue of access to finance locally, with the aim to enhance the ability of Maltese businesses to meet their financing needs whilst also allowing them to better understand the evolving EU policy on this subject. It was with this understanding in mind that the MBB in conjunction with Bank of Valletta have decided to undertake an assessment study, to identify market gaps in access to finance and the feasibility of new financing instruments in the EU addressing the credit needs of Maltese business. The study, which was carried out by Ernst & Young, is construed to assess the existing market gaps for Malta-based firms to obtain financing beyond the â&#x20AC;&#x153;traditionalâ&#x20AC;? bank loan facilities including overdrafts. This publication is a summary of the report. For a more detailed analysis I invite you to view the full report from the MBB website www.mbb.org.mt.
George Vella President Malta Business Bureau
Ernst & Young Limited Regional Business Centre Achille Ferris Street Msida MSD 1751, Malta Tel: +356 2134 2134 Fax: +356 2133 0280 Email: email@example.com Web: www.ey.com
12 April 2013 MBB Assessment Study - Market gaps in access to finance and the feasibility of new financing instruments in the EU addressing the credit needs of Maltese business
To the Malta Business Bureau, In accordance with the terms of our engagement agreement dated 29 November 2012, our work related to the provision of an Assessment Study on market gaps in access to finance and the feasibility of new financing instruments in the EU addressing the credit needs of Maltese businesses. The letter of engagement was signed following the submission of our proposal to the MBB in response to a public request issued by the MBB and further discussions with the MBB on the scope and nature of the Study.
We understand that the Study is required to inform the MBB, its members and interested parties of the potential local scope for additional financial instruments and initiatives addressing the finance gaps experienced by local businesses. This Study was addressed to the MBB with the above Purpose in mind. The MBB are authorised by us to use the Study and publicly disseminate the contents thereof to third parties, provided that this does not prejudice us, our clients, any of the participants in this Study and any third parties. To this end, we do not accept any third party liability.
This Study was prepared before the approval of the 2013 Malta Budget and the approval of the EU Budget for 2014-2020. We have relied on information provided to us through a survey with SMEs and various stakeholder meetings, and information that was publicly available before 15 March 2013.
We would like to thank the MBB, the Malta Chamber, MHRA, Bank of Valletta, Malta Enterprise, the Ministry for Finance, the Ministry for Resources and Rural Affairs, the Planning and Priorities Coordination Division, representatives of the agricultural and fisheries sector, financial services representatives, and respondents to the SME survey, for their valuable contribution and cooperation throughout the course of this Study.
Ernst & Young Limited Regional Business Centre Achille Ferris Street Msida 3
Contents Abbreviations and Glossary of terms ...................................................................................................... 5 Chapter 1 - Study background ................................................................................................................ 6 Chapter 2 – Maltese SMEs and access to finance................................................................................... 8 Chapter 3 – Survey results .................................................................................................................... 11 Chapter 4 – Financial instruments ........................................................................................................ 13 Chapter 5 – MBB Recommendations on access to finance .................................................................. 18 1.
Grant schemes .......................................................................................................................... 18
Financial instruments ................................................................................................................ 19
Greater role for local banks in an intermediary role ................................................................ 20
Investor readiness ..................................................................................................................... 21
Private sector equity funding .................................................................................................... 22
Other good practice examples .................................................................................................. 23
Chapter 6 - Concluding remarks ........................................................................................................... 25
Abbreviations and Glossary of terms Business Angels Developmentgrowth stage EC
Can be a firm/ affluent individual that provide capital for a business start-up, usually in exchange for convertible debt or ownership equity. By this stage, the firm would be fully functional and established. The business's focus is on maintaining loyal customers and strengthening both its product and market position. European Commission
European Investment Bank
European Investment Fund
Emerging- growth stage ERDF
In this stage a firm would start to register its first profits and the company would begin growing, as is reflected through the hiring of additional employees. European Regional Development Fund
European Social Fund
Factoring is offered within an agreement between the factor and a seller. Under this agreement, the factor purchases the sellerâ&#x20AC;&#x2122;s accounts receivable and assumes the responsibility for the debtorâ&#x20AC;&#x2122;s financial ability to pay. Many businesses factor their invoices to pay bills, take advantage of early payment discounts, increase sales and to fund their businessâ&#x20AC;&#x2122; growth. Instruments which provide equity/ risk capital, debt instruments (such as loans or guarantees to financial intermediaries), or a combination of both equity and debt A guarantee from a lending institution ensuring that the liabilities of a debtor will be met. In other words, if the debtor fails to settle a debt, the bank will cover it. Hence only in the case of default is money actually being spent. Joint European Resources for Micro to Medium Enterprises
Malta Chamber of Commerce, Enterprise and Industry
Malta Business Bureau
Mezzanine Finance is a collective term for hybrid forms of finance and has features of both debt and equity. The most common forms of mezzanine finance include the subordinated loan, participating loan, profit participation and convertible bonds. Multiannual Financial Framework 2014-2020
Malta Hotels and Restaurants Association
Planning & Priorities Coordination Department
Pre/ Seed Stage
This is the earliest stage of a business's life and includes activities such as transforming the initial idea into the development of a business plan, design of a prototype, and setting up the company Research & Development, and Innovation
Financial instruments Guarantee
RD&I Revolving instrument Seed Funding
SME Start up Stage VC
A fund from which loans are made for multiple SME projects. The fund gets its name from the frevolving aspect of loan repayment, where the central fund is replenished as individual projects pay back their loans, creating the opportunity to issue other loans to new projects. When an investor purchases part of a business as part of an early investment meant to support the business until it can generate cash of its own, or until it is ready for further investments. Seed money options include friends and family funding, angel funding and crowd funding (i.e. networking by individuals to pool their resources, usually via the internet, to finance an entity). This term can be applied to any finance raised at the outset of a new venture to allow for development. At this stage the risks involved in investment may be too high for venture capital investment. Small to Medium Enterprises The main focus of this stage turns towards introducing the product to the market. The company has just been formed, the product has been created, and it is being market tested and prepared for market entry. Venture Capital
Chapter 1 - Study background SMEs are the backbone of the Maltese economy. They employ about two-thirds of the private sector workforce, and contribute more than half of the country’s value added. This situation is similar to all countries in the EU, where SMEs provide an essential source of jobs, create entrepreneurial spirit and innovation, and foster competitiveness. Easier access to finance is needed for these enterprises to be continuously able to expand their operations and therefore generate additional jobs. One of the commonly identified main issues small businesses encounter is a financing gap where SMEs are unable to raise enough capital to support their business venture. There are multiple causes for such access to finance obstacles – with some being cyclical whilst others being of a more structural nature, such as the information asymmetry that inevitably exists between suppliers and demanders of funds. Maltese SMEs also experience this gap, and this scarcity in finance may actually be magnified due to the small size of the domestic market, and the lack of providers of risk capital and/ or lenders. Specifically, the inability of Malta’s SMEs to raise capital may stem from a number of reasons, including a non-existent venture capital market, limited presence of business angels, adverse collateral requirements and debt pricing. Malta’s small size also makes the capital market not economically viable for small ventures. As a result commercial banks remain the main (and in some sectors the only) source of finance despite not providing risk capital. Such retail banks are, however, unable to provide the full extent of support needed because they are fundamentally lenders not investors, and have to ensure that their depositors’ funds are adequately safeguarded. Within this context, the EU has always put SME assistance at the forefront of its agenda. With the new 2014-2020 Multiannual Financial Framework, the EU is pushing towards complementing grant funding with other forms of interventions, especially innovative financial instruments such as loans, equity and guarantees. Under the new common provisions covering all five EU funds, financial instruments are being advocated to support investments which are expected to be financially viable but which do not give rise to sufficient funding from market sources. These common provisions also take into consideration a combination of financial instruments and other forms of support, including grants. This shift is influenced by the contractionary fiscal policy being adopted by most Member States’ governments, as well as the experience to date with such instruments. In Malta, the JEREMIE loan guarantee product administered by Bank of Valletta is already a recognised success story, with assistance to about 450 SMEs through planned loans of up to €51m leveraged on the EIB’s €8.8m loan guarantee. This multiplier/ leverage effect is the main advantage of financial instruments, whereby risk coverage (in the case of loans and guarantees) or risk participations (in the case of equity) induce further investment, and whereby the repayments of capital or interest and proceeds of an investment can be reused in subsequent cycles. In addition, such instruments require less administrative controls compared to grants. 6
In Malta, the potential for various financial instruments (not only loan guarantees) needs to be further explored especially in view of Maltaâ&#x20AC;&#x2122;s shift from Objective 1 status to a non-assisted region, and the likely reduction in (total) available ERDF funding and co-financing rates (aid intensities). JEREMIEâ&#x20AC;&#x2122;s experience in Malta shows that, compared to grant schemes, the same number of enterprises can be assisted with a lower amount of resources, thus increasing efficiency and effectiveness of public funding. This Study explores the local potential for such financial instruments, as well as other non-traditional sources of finance such as private equity (seed capital, venture capital and business angels), mezzanine finance, microfinance and crowdfunding. This publication is an abridged version of the report on market gaps in access to finance, commissioned by the Malta Business Bureau and available on the MBB website on www.mbb.org.mt. The full report also includes a list of applicable references.
Chapter 2 – Maltese SMEs and access to finance To sustain the contribution provided by SMEs to the Maltese economy and enable them to achieve their growth potential, SMEs need to be assisted since they are known to often face significant difficulties in meeting their financing needs. Moreover, the smaller the business and the “younger” it is within its lifecycle, the more problematic it is to obtain the much needed credit lines. In Malta, the main sources of finance available to SMEs relate primarily to traditional sources such as bank overdrafts/ loans and trade credit, apart from personal savings and financing obtained from family or friends. Most companies are also eligible for assistance through national/ EU funds. To date it has been only the larger companies that have been able to deviate from the traditional sources of finance and tap the bond and equity markets, investor funds and informal venture capital/ private equity funds. Firm lifecycle Different firm lifecycle stages (as shown in the figure below) affect the level of access to finance and could be the difference between a firm expanding or not. The following list describes the main stages of the Maltese SMEs’ lifecycle and their related access to finance difficulties.
Figure 1: Business Life Cycle
• The pre-seed and seed stage: since the product or service is still at an embryonic stage, the initial financing needs typically involve small amounts necessary to develop the initial product. In Malta, the initial seed financing would be sourced through the use of personal savings, where available, as well as funds from family and/ or friends. The founders can also tap certain start-up grant schemes, even though these schemes are generally available only for selected industries with higher growth/ value added potential. Commercial banks in Malta are unlikely to provide assistance at this stage since the risk is still high and the idea still uncertain. Likewise, there are no formal venture capital funds or other risk-based financial instruments which are currently targeted at seed companies in Malta. • Start-up stage: In Malta, apart from the initial seed funding, SMEs in the start-up phase might again be eligible for grant assistance designed for start-ups. Though less risky and uncertain than in the earlier seed stage, commercial banks in Malta might still deem SMEs in this start-up stage as “non-bankable clients”. By definition, start-ups have an above average risk profile – this is added to potentially low collateral coverage which renders them less attractive for credit granting by banks. The MicroCredit/ JEREMIE initiative was designed with the aim of filling this gap by providing a safety cushion for the commercial bank implementing the JEREMIE scheme in the form of an EIF-backed guarantee. As a result, the bank is more likely to extend loan financing to start-ups which it might not have done under normal commercial conditions. As a result, as at December 2012, around 40% of JEREMIE’s successful applicants had initiated operations within a period of less than 24 months. In terms of local private equity funding, there currently still exists a gap for start-ups in Malta as previous attempts to set up venture capital funds for technology-driven ideas have had limited success to date. Stakeholders consulted in this exercise have highlighted that the possible reasons for the previous limited success of these past venture capital initiatives could have included the low quality sales pitches by potential start-ups, lack of willingness to dilute ownership, potential past experiences of failed local mergers, entrepreneurs’ high expectations, administrative difficulties and the small size of Malta facilitating informal approaches to venture capital over the more formal ones. • Emerging-growth stage: Though the firm could be seeing its first profits at this stage, it is also probably also dealing with increased demand for its products/ services and new competition. Hence management may begin looking for a new round of funding should profits and the initial funds not be adequate when it comes to covering internal growth. In Malta, this need for additional funding might lead to the SME’s first attempt at securing bank financing through loans, potentially facilitated by local schemes providing soft loans or interest rate subsidy schemes from Malta Enterprise or guarantee-backed schemes such as the JEREMIE scheme. Certain sectors, such as enterprises engaged in manufacturing, industrial services, ICT, biotechnology, or in other innovative or high value adding operations, are better positioned to attract such financing. The Employment & Training Corporation has also administered a number of national/ EU funds addressed at training needs of local SMEs. While formal Malta-based private equity remains inexistent in this firm lifecycle stage,
informal venture capital might be successfully secured through local entrepreneurs and businessmen who are often seeking investment and further diversification opportunities. • Development-growth stage: In this stage the firm relies on profits and existing funds for finances, and may also rely on government/ EU schemes and banks for further financing. In Malta, with the availability of financial statements and customer demand/ contracts, such a firm is more likely to be able to prove its viability and attractiveness and secure further financing. This financing might also enable the firm to release its initial financial backers, including family and friends. At this stage, any informal investors would also start looking at an exit strategy. • Expansion-growth stage: Locally, the firm may share the cost of new projects by entering into joint ventures with other companies or directly from banks, but may also get funds from private investors (through informal approaches), partners, and licensing. A firm in this stage and with a potentially successful track record in its core product/ service might also be able to start looking at institutional investors. In Malta, organisations which pool large sums of money and invest those sums in securities, real property and other investment assets are the investment fund managers, insurance companies, pension schemes and banks’ investment arms. Some banks have also invested equity directly in local companies, even though this practice is not common locally due to local banks’ cautious approach to investment and lending, increasingly stringent regulatory capital adequacy requirements and the current financial and economic crisis. Only the largest local companies would be able to list their bonds or shares – generally the listing requirements and related costs are too exorbitant for SMEs. The figure below combines the above discussion related to the stage of SME development, enterprises’ revenues, various funding mechanisms, and related risks. Figure 2: SME development and funding instruments
Source: Ernst & Young (2012), Funding the future – access to finance for entrepreneurs in the G20
Chapter 3 – Survey results The following section presents the salient results obtained from the survey amongst 100 SME owners/ managers, covering different enterprise sizes (micro, small and medium), business lifecycle stages, and pre-selected economic sectors. The full results and related data tables are available on the MBB’s website (www.mbb.org.mt). While data on the size distribution of firms is available, the number of SMEs by economic sector is highly dependent on the correct industry classification. In terms of lifecycle, there are various definitions of firm lifecycle stages, and no national data on the lifecycle of the local SME population exists. Participants were randomly selected from the population of member firms in the MBB’s parent organizations, namely the Malta Chamber and the MHRA. The resulting distribution by size, lifecycle and sector was therefore reflective of the type of Malta Chamber and MHRA members. The survey excluded firms engaged in agriculture, fishing, aquaculture, public administration, social enterprises (including cooperatives) and NGOs. Additionally, in order to ensure inclusion of start-ups, the sample was supplemented with SMEs who had successfully applied and obtained funding through ME’s ERDF Small Start-up Grant Scheme. The key survey results are the following: • Most of the firms interviewed (56%) have a family/ entrepreneur ownership structure, while “oneowner” structure stands at 30%. Business associates were less popular with 13%. None of the interviewed firms are publicly listed, as is generally the local SME case • “Own financing” is the predominant current source of financing (89%), followed by “overdraft, credit line, or credit cards” (68%), trade credit (51%), bank loans (45%), and financing through family and friends (9%) • All medium-sized firms used bank loans (while average use of bank financing was 65%) • 72% of SMEs in the start-up phase are currently using “traditional” lending products such as loans and overdrafts when these are not necessarily the best solution for companies that are going through their stage of development • Loans were taken out mostly to finance fixed assets (c. 50%), refurbishment (c. 30%) and working capital (c. 18%) • Half of the respondents who took a loan in the last two years applied for an average (mid-point) amount of €0.5 million • Equity from other sources was the less frequent source of finance (4%), mainly due to lack of relevance to the firm/ unwillingness to dilute ownership
• Firms that are smaller in size and firms in the emerging growth stage generally find it more difficult to access finance • EU and national funds were used by 22% of respondents, mostly medium-sized companies • Only 10% of micro SMEs used EU grants - a divergence of 55% from the SME average (22%) • About 10% of applications for national/ EU grants were discontinued, mainly due to failure by the applicant to meet application requirements • Looking forward, SMEs were still mainly interested in future funding from national/ EU grants (c. 80%), while equity from other sources and public issues of own shares remained the least popular (21% and 7% respectively)
Chapter 4 – Financial instruments Most financial instruments can be classified as either loans or equity, while it is now also common to find hybrid type of instruments that combine elements of both debt and equity. These sources of finance can be obtained from private sector institutions and financial intermediaries, from government or through EU programmes, or any combination of these sources. The EC has been providing a balanced mix of flexible financial instruments under the 2007-2013 Programming Period with the aim of enabling public sector resources to be used in a more efficient way by drawing upon commercial practices and actors and by stimulating the participation of private sector capital. Examples include the High Growth and Innovative SME Facility, the Risk Sharing Finance Facility, the SME Guarantee Facility and the European Progress Microfinance Facility. Further information on these financial instruments is available in the full report accessible on the MBB website (www.mbb.org.mt). According to the EC, and as per the February 2013 European Council conclusions, innovative financial instruments should play an increasingly important role in the EU budget spending for the 2014-2020 MFF. Although the term “innovative financial instrument” is used by the EC to refer to interventions other than pure grant funding, the EC’s intention is not to replace grant funding with financial instruments as grants will still be necessary, but rather to complement grant funding with other forms of interventions in order to increase the volume of finance and the impact resulting from the EU budget intervention. These financial instruments are being advocated to support investments which are expected to be financially viable but which do not give rise to sufficient funding from market sources. This shift to financial instruments is influenced by the contractionary fiscal policy being adopted by most Member States governments, as well as the experience to date with such instruments. The increased adoption of these types of instruments is based on the following objectives:
• Pursuit of EU policy objectives: These instruments ensure there is necessary financing for areas of EU interest and thus assist in correcting market imperfections that give rise to insufficient funding in such areas. This is the case in areas which are perceived as too risky by the private sector. These instruments can also lead to important non-financial effects such as demonstration effects in the targeted markets, triggering wider application to other sectors. The consistent application and promotion of best practices through EU instruments may foster the development of certain markets, such as for instance the venture capital markets, and increase intermediary sophistication over time. These instruments also offer a higher degree of flexibility through the possibility of tailor-made support and delivery structures. In addition, the expertise of the EU and the financial institutions 13
responsible for the implementation of such financial instruments can be transferred to national, regional or local authorities.
â&#x20AC;˘ Increasing efficiency and effectiveness of public resources: By pooling resources from various sources, financial instruments can catalyze investments for identified market gaps, achieve economies of scale and/ or minimize the risk of failure in areas where it would be difficult for individual Member States to achieve the required critical mass. In addition, such instruments require less administrative controls compared to grants. â&#x20AC;˘ Promoting enhanced performance and financial discipline: Well-designed innovative financial instruments can promote enhanced performance by setting appropriate success indicators suited to the achievement of public policy objectives in line with best practices. â&#x20AC;˘ Multiplier effect of the EU budget: The main advantage of financial instruments is their multiplier effect, whereby risk coverage (in the case of loans and guarantees) or risk participations (in the case of equity) induces further private sector investment in cases where investors would have not invested at all or invested less without the support from the EU budget. Such direct financial "leverage" or multiplier effect can be achieved through co-financing by international financial institutions such as the EIB or through the additional debt volumes banks and guarantee institutions are requested to provide to final beneficiaries. Furthermore, an additional multiplier effect is achieved during the lifetime of the innovative financial instrument if repayments of capital or interest and proceeds of an investment can be reused for the instrument. This "revolving" character of such instruments can considerably increase their reach, leading to a further indirect multiplier effect. After this period, repayments of the initial investment plus an eventual participation upside will flow back to the general budget, which also positively impacts the overall cost-efficiency of the intervention. The possibility of using the same funds several times through various revolving cycles contributes to the impact and sustainability of such revolving instruments. The impact of revolving funds can be many times greater than grant assistance, giving them a particular added value and relevance in times of budgetary constraints, as explained in the figure overleaf. These financial instruments are also seen as a way of encouraging a move away from public funding grant dependency. However, the EC has also commented that its intention is not to replace grant funding since this form of funding will still be necessary in a range of areas, but rather to blend such grants with financial instruments, such as loans from financial institutions.
Figure 3: Comparison of grants and revolving instruments
Support based on Grants
Tax Revenues Reallocat ion t o Funds Grant programmes
Target Project s
Target Project s
MONEY REMAINS IN CIRCULATION
MONEY IS LOST
These innovative financial instruments include mechanisms which provide equity/ risk capital, debt instruments such as loans or loan guarantees to intermediaries that provide financing to a large number of final recipients who have difficulties in accessing finance, or risk sharing instruments with financial institutions. Where appropriate, such EU support can be provided indirectly via dedicated investment vehicles, in particular where participation of private investors alongside public investors is being sought.
2014-2020 Multiannual Financial Framework In the new 2014-2020 MFF, the EU is pushing towards complementing grant funding with other forms of interventions, especially innovative financial instruments such as loans, equity and guarantees. Under the new common provisions covering all five EU funds, financial instruments are being advocated to support investments which are expected to be financially viable but which do not give rise to sufficient funding from market sources. These common provisions also take into consideration a combination of financial instruments and other forms of support, including grants, since these stimulate the design of well-tailored assistance schemes that meet the specific needs of Member States or regions.
In contrast to the 2007-2013 Programming Period, the rules proposed for 2014-2020 financial instruments are non-prescriptive in regards to sectors, beneficiaries, types of projects and activities that are to be supported. Member States and Managing Authorities may use financial instruments in relation to all thematic objectives covered by Operational Programmes and for all Funds, where it is efficient and effective to do so. One of the main shortcomings observed by the EC in the previous Programming Period was related to gap assessments. Financial instruments are a special category of spending and their successful design and implementation hinges on a correct assessment of market gaps and needs. The amended regulations stipulate that financial instruments should be designed on the basis of an ex ante assessment that has identified market failures or sub-optimal investment situations, respective investment needs, possible private sector participation and resulting added value of the financial instrument in question. Such an ex ante assessment should also avoid overlaps and inconsistencies between funding instruments implemented by different actors at different levels. The EC has already outlined a number of proposals for the inclusion of innovative financial instruments in the next MFF to be implemented through the EU equity and debt platforms. These include: • Investments in RD&I under Horizon 2020 – includes (a) a debt instrument providing loans to single beneficiaries for investment in RD&I, guarantees to financial intermediaries making loans to beneficiaries, combinations of loans and guarantees and/ or counter-guarantees for national or regional debt-financing schemes, and (b) an equity instrument that would (i) invest in technology transfer and intellectual property vehicles and in venture capital funds providing equity finance to early stage RD&I-intensive SMEs, and (ii) support investments in RD&I sectors by targeting thematically focused multi-country “funds-of-funds” with a broad investor base, including private institutional and strategic investors. • Competitiveness and SMEs – Two financial instruments to be funded by the Programme for the Competitiveness of Enterprises and SMEs 2014-2020 are being proposed: (a) an equity facility for growth-phase investment which will provide commercially oriented reimbursable equity financing primarily in the form of VC through financial intermediaries to SMEs; (b) a loan facility providing direct or other risk sharing arrangements with financial intermediaries to cover loans for SMEs and provide cross-border lending or multi-country lending with a high leverage effect. • Self-employment, micro-enterprises and social enterprises – financial instrument with an EU contribution to provide equity, debt, and risk sharing instruments to social investment funds and other financial intermediaries for financing social enterprises. • Infrastructure – Financial instruments under the Connecting Europe Facility for infrastructure are likely to include (a) a risk-sharing instrument covering loans and bonds to respond to the requirements of multiple financing models applied across the EU, the size and sector of projects and the stage of development of project finance and capital markets in general, and (b) an equity 16
instrument to complement the toolbox of infrastructure instruments with the objective of further developing EU-wide risk capital markets. • Education and culture – Guarantee facilities will be developed to contribute to the EU2020 objectives under the Creative Europe Programme, including a guarantee facility (possibly to be combined with another SME financing instrument) to incentivise financial intermediaries to extend loans to SMEs in the cultural and creative sectors, which include producers, music companies, video game developers, publishers and distributors whose assets are mostly intangible (such as intellectual property rights), often resulting in financial intermediaries perceiving these companies as too risky to finance. • Structural Funds – An increasing share of support under the Structural Funds will be delivered by means of financial instruments, in particular support to enterprises and other projects or investment activities that generate revenues, notably in the areas of climate change, environment, innovation, ICT and infrastructure. • European Social Fund – Member States and regions will also be encouraged to support financial instruments under the ESF.
Chapter 5 – MBB Recommendations on access to finance The Malta Business Bureau would like to make the following recommendations aimed at improving access to finance for local SMEs.
1. Grant schemes The need to address the financing gap structures in Malta through grant assistance will remain, especially for those sectors / start-ups that have a high dependence/ necessity for such aid. The grant process should therefore be made as effective and efficient as possible. National/ EU-funded grant schemes will continue to remain a necessity for the local market. This is especially the case for firms lacking the necessary initial collateral (especially start-ups) looking to finance their initial stock and working capital. It is also needed for those local companies having a low capital base, as well as those firms operating in sectors whose sustainability is often a challenge (e.g. agriculture and fisheries). Moreover, due to the small size/ insularity of the Maltese Islands, grants are needed to finance internationalisation efforts that allow local firms to bridge this market gap (e.g. through export guarantee scheme).
There are various lessons learnt from the previous Programming Period. These include: • Greater access to EU funding – greater access and availability of funds is needed, especially for sectors such as tourism, digital gaming and the creative arts, and for projects related to energy efficiency, exporting, and commercialisation of prototypes. • Application process - open call system rather than time windows would speed up approval times and provide greater certainty to the market. The approval process itself needs to be streamlined and quickened. • Selection process – the selection process/ control mechanisms should make sure that distressed companies are not financed. • Disbursements - Faster refunding process is needed to decrease cash flow pressure on SMEs. Another option is the pre financing of projects, particularly for start-ups. This type of bridge loan is already provided by some local banks. Pre financing could also be linked with a bank guarantee to safeguard EU/ national funds.
2. Financial instruments The JEREMIE loan guarantee product introduced in Malta has proven to be a success story in terms of take-up, effectiveness and efficiency in the use of private/ public resources. There is therefore scope for more financial instruments, including loans and loan guarantees, equity guarantees, and engineering instruments combined with grants.
The high dependence on bank financing and the lack of risk capital financial instruments in Malta does not rule out any market scope for further financial instruments. The JEREMIE Malta product has managed to successfully provide the local market with a product that combines bank financing with a guarantee element. In line with a demand-driven approach that takes into account the heterogeneity of the local SME population, there is potential scope to: • extend the scope of current loan guarantee financial instrument – The success and take-up of the current JEREMIE loan guarantee instrument implemented in Malta suggests the need for further similar instruments – potentially increasing the guarantee and consequently the available funds, as well as extending the scope of such an instrument to include additional eligible sectors (e.g. agriculture and agri-processing firms, fisheries and aquaculture). The latter would be facilitated by the risk-pooling element of this type of instrument. • introduce loan-based financial instruments - Financial instruments based on a loan element could be introduced. In France, for example, a seed loan product was introduced, aimed at start-ups (less than 3 years since inception), or entrepreneurs with the duty to set up their SME in the next 6 months, with a planned direct leverage of a multiple of 2. The product entailed an interest-free loan of up to €100,000, without any personal guarantee required, and could be used to finance both the acquisition of assets and working capital. The risk sharing was split equally between the fund and the financial intermediaries administering it. • introduce equity-based financial instruments - Financial instruments based on an equity element could also be introduced through funded risk-sharing products (equity or equity guarantee). Again, in France an equity product aimed at SMEs with high growth potential was introduced. This product was based on a leverage ratio of 2, a maturity of 10 years, and co-investment amounts set at a maximum of €2.5 million over a period of 12 months. To date, the leverage achieved is equal to a multiple of 5, with the fund generating significant interest from the private market (included VC firms based outside the region). • blend facilities – Facilities that combine grants with financial instruments (e.g. equity/ loan / loan guarantee). For example, a facility could include grant funding, a financial instrument funding, and the remaining being financed directly by the SME. These hybrid instruments would capture the synergies between grant assistance and the revolving nature of financial instruments. Existing examples of such combinations include the Bulgarian Energy Efficiency for Competitive Industry Financing Facility and the Hungarian New Széchenyi Plan Combined Loan Guarantee. 19
Any new facility will be, however, subject to State Aid scrutiny (as both financial instruments and grants are subject to rules on State Aid) and impacts of any co-financing rates reductions following Malta’s change in status from an Objective 1 country to a non-assisted region. The administrative feasibility of this option would need to be analysed further given that State Aid may limit blending of grants with financial instruments, and might only allow for grants to be blended with loans priced on normal market-lending parameters. Additionally, the administrative cycle would need to be strengthened to include parallel selection processes (e.g. Managing Authority or Evaluation Committee as well as selection by participating bank). • adopt a multiple instrument approach – a multiple instrument approach of JEREMIE funds have been used in some countries/ regions. The French examples mentioned above are actually part of a multiple instrument approach comprising seed loan and equity products (both mentioned above) as well as a guarantee product (guarantee rate set at 80% to cover the first loss up to the cap rate, thus leading to a price reduction and reduced collateral requirements – this is similar to the JEREMIE scheme introduced in Malta). All these three JEREMIE-backed financial instruments have been utilised concurrently to assist the region in supporting SME innovation.
3. Greater role for local banks in an intermediary role Bank lending is the main source of SME financing in Malta and will remain crucial for local firms. It needs to be made more accessible and facilitated, and the role of banks within the whole spectrum of SME financing needs to be strengthened. However, this does not rule out supporting alternatives to bank lending. Survey results and discussions with key stakeholders indicate that loan finance is and will remain one of the most widely used instruments for local SME development. Regulatory and financial measures should therefore be aimed at reinforcing debt finance for local SME growth. Additionally, greater involvement by banks in the whole funding process is often advocated – given their specialist knowledge, banks have a significant role to play in various aspects, including information and education campaigns, proposal evaluation and selection, and monitoring. Any financing of the resultant additional administrative burden where this is considered unfair would also need to be taken into consideration. The majority of Member States have decided to manage EU funds directly or through state agencies. As advocated through the Vienna Initiative, however, commercial banks can play a crucial role in further increasing national absorption of EU funds. Banks and other private financial actors could contribute to leverage EU grant funds through their knowledge of local sectors and ongoing search for innovative entrepreneurial concepts and financial instruments. Banks can also provide prefinancing (in anticipation of the disbursement of the EU grants) and co-financing (especially where not all expenditure related to a project is eligible), thereby leveraging grants available. Banks are also 20
in a position to assist in project selection/ evaluation and eventual monitoring, especially in the local context where the commercial banking model is based on strong relationship banking. Best practice examples in channelling funds to SMEs include the intermediary role adopted by Italian commercial banks, the setting up of profit-oriented companies in Hungary, and the involvement of banks in the design of new EU co-financed programmes in Latvia and Poland. At the same time, issues related to the potential discrepancy between bankable projects and public-interest projects need to be taken into consideration. Locally, feedback obtained on both the Micro Guarantee and MicroCredit schemes further reinforce the call for greater bank involvement at an early stage of the funding process. In the former scheme, some SMEs expressed their disappointment at their bank application being rejected despite having a Letter of Intent from ME. On the other hand, in the latter scheme, the bank was the first recipient of applications and any decisions were based on the bank’s creditworthiness assessment. The Kordin Business Incubation Centre is another local example of the important support role of banks. The centre has provided financial consultancy to start-ups in collaboration with a local bank, through three full-time advisors and a part-time advisor appointed by the bank. This was in addition to the assistance provided by ME business mentors and officials to help start-ups to assess their needs, financing requirements and draw up a business plan.
4. Investor readiness Local entrepreneurs’ needs might be met through bank financing, and this could be the main reason why alternatives are not being widely sought. Lack of awareness on the availability, process and advantages of alternative sources might be another reason. Entrepreneurs require further investor readiness training programmes.
Such programmes would tackle: • Optimal use of overdraft and loans, and related cash management (e.g. factoring, stocking) • Optimal mix of debt and equity • Business planning • Understanding project viability and formal appraisal techniques An investor readiness programme carried out locally by ME had a successful take-up and there is interest in repeating this programme. In addition, local banks have also carried education seminars for investors. Apart from the owners, another important player for various local micro firms is the 21
external accountant, who generally takes over various tasks in those firms not employing such a professional on a full-time basis. These accountants need to be made aware of the different funding options/ schemes available for SMEs, so as to be in a position to advise their respective clients. The financial institution implementing the JEREMIE scheme in Malta adopted this approach when providing a tailor-made presentation and training on JEREMIE for accountants.
5. Private sector equity funding Malta lacks any equity funding alternatives. Previous attempts at creating a market for venture capital have been unsuccessful. Understanding the reasons for these outcomes is key to future attempts at re-launching such schemes. Banks’ risk appetite might not provide adequate financing for particular ventures as at the end of the day a bank is in the business of lending, not investing. This provides further scope for equity funding from non-bank sources. There are various options that can represent a complementary option to bank lending, rather than a competing alternative. These options can be supported through the involvement of international financial institutions, local banks and other new financial players, as well as financial intermediaries that provide business advice to local SME. In the case of venture capital, various past attempts have been partly successful. Reasons for the limited success of these VC initiatives are various, and based on stakeholder consultation relate to low quality sales pitches by potential start-ups, lack of willingness to dilute ownership, potential past experiences of failed local mergers, high expectations of entrepreneurs, administrative difficulties and the fact that our small size facilitates informal approaches to venture capital. Hence, any attempt to re-launch such schemes needs to kick off from understanding and tackling these issues. For instance, when investors are unwilling to dilute ownership, exit strategies might be contemplated which provide for a buy-back clause that allows the recipient to re-purchase their own shares after a stipulated period of time or on achievement of certain financial targets. Where critical mass is the main stumbling block, such funding mechanisms might not necessarily be through Malta-based funds. Alternatively, any Malta-based fund might also provide investment for non-Maltese companies, so as to ensure the attainment of the critical mass required to balance the portfolio’s risk. Mezzanine finance should also receive more attention in the overall SME financing strategy. This could represent an important financing source because it is relevant for: • many SME owners who do not consider giving up ownership (fully or in part) to be attractive • companies who are unable to obtain debt financing due to their low equity ratio.
Companies with mezzanine capital are often able to obtain additional and more attractive bank loans, since the mezzanine finance is subordinated to all other types of loans.
6. Other good practice examples The applicability/ relevance of other sources of finance to the local market can be considered. For instance, win-win loans, the role of credit mediation and co-operative banking, and the increasing importance of public-private partnership structures could provide relief to local SMEs’ access to finance issues.
• Win-win loans - in Belgium it is possible for friends and family members of starter entrepreneurs to receive a tax benefit if they extend a loan to the business for a period of eight years. Initially this scheme only applied to start-ups, but it has been extended to all SMEs, who can gain access to a maximum of €100,000. This loan has worked extremely well in Flanders, helping small businesses who need risk capital but cannot get a bank loan. Since 2006 this measure has assisted about 3,000 SMEs with a total of €98 million. This scheme is in principle similar to the Maltese Micro Invest scheme, but the tax credits would be available not only for the businesses themselves, but also for the individual/ household providers of finance. The 2013 Budget Speech also announced the B.START initiative, giving a reduction in tax up to a maximum of €30,000 on capital investment in new enterprise approved by ME. • Credit mediation: Given SMEs find it hard to obtain the necessary funding from traditional sources, Belgium and France appointed a “credit mediator” to intervene to ease difficulties and help enterprises obtain bank funding. This mediator acts as a “final referee” by reviewing loan requests by SMEs and indicating how the request should be treated. In the case of France, between November 2008 and February 2009, the rate of successful mediation within 15 days was 66%, while the main cause of referral to the mediator was the need for short-term credit (69% of referrals). • Setting up a framework for PPPs: a number of Member States have utilised PPPs in which special purpose vehicles are funded through both Structural Funds and commercial banks. Such frameworks for PPPs need to be developed to attract this potential private lending into a wider range of sectors eligible for EU funds. • Development of a co-operative bank: In 2010, the European Parliament stated that the European economy needed a sound network of regional and local banks like cooperative banks, since they had a positive impact on GDP growth in most countries, and their internal deposit guarantee schemes could withstand the shocks of a crisis. The latter is mainly due to very tight bottom-up control mechanisms, leading to highly conservative investment decision-making. Co-operative banks are a 23
popular concept in Italy which mitigate credit-rationing to certain market segments, particularly SMEs. Some banks are consumer co-operatives, others are worker co-operatives. In Malta, this concept has been recently referred to in local fora, addressing the possibility of developing such a bank locally, either through groups like cooperatives setting up a bank, a local institution converting to this model, or a local institution establishing such a subsidiary. • Credit guarantees: In many countries, credit guarantees are emerging as a strong lever to address declining bank credit. In order to address the gap between expectations for bank credit and the willingness of banks to finance small enterprise, there is significant potential for public credit guarantees of subsidies. Indeed, all mature economies have established publicly funded guarantee schemes for SMEs. These schemes not only provide a direct financing guarantee to the borrower, but also help to share information, advice and monitoring, to foster the interaction between banks and SMEs. • Alternative markets: The success of several junior stock markets, such as the London Stock Exchange’s Alternative Investment Market, illustrates that having such an alternative source of liquidity for small size companies could potentially also be replicated locally as a way of fostering local companies’ expansion. An alternative capital market was also set up in Malta in 1999 to create a secondary market on which companies without an established track record, and/ or those that would otherwise not qualify for a listing on the Official List of the Malta Stock Exchange could offer equity or bond participation to potential investors – this could be a potential attractive source of financing for many local SMEs.
Chapter 6 - Concluding remarks The objectives of this MBB report are to analyse the existing market gaps that hinder the opportunity for local SMEs in Malta to access finance, and the feasibility of new EU financing instruments addressing the credit needs of Maltese business on the basis of experience with the JEREMIE programme in Malta. A number of recommendations have been put forward to assist the process leading to the identification of new/ amended financial assistance mechanisms for SMEs, as well as improve take up rates whilst lessening (as far as possible) the administrative burden on applicants. The results of this exercise show that although a range of assistance programmes and initiatives already exist for Maltese SMEs, there are nonetheless a number of Maltese SMEs (in certain firm lifecycle stages and sectors in particular) that require access to a broader range of support than what they already have had access to. As highlighted in the recommendations section of this report, any future financial instruments could be potentially based on either already existing initiatives (in Malta or in other EU Member states) or on any of the new ones which are being contemplated for the 2014-2020 MFF. Concurrently, the various public and private stakeholders consulted throughout the assignment, as well as a number of individual companies participating in the survey, highlighted the need for public information and awareness raising initiatives to complement other previously held information activities and hence assist take up rates of any new financial instrument. Ultimately the aim of this MBB report is to provide a snapshot of the current situation which can be used by both the local SME community and their representatives as well as in the ongoing national and international discussions leading up to the determination of Maltaâ&#x20AC;&#x2122;s priority areas and related initiatives within the 2014-2020 MFF, especially those targeting Maltaâ&#x20AC;&#x2122;s SMEs and business community.