Noble aims of LEAP for SMEs

THE announcement on the introduction of the Leading Entrepreneur Accelerator Platform (LEAP), which is expected to address the funding gap of small medium enterprises (SMEs), during KL Investors’ Week recently was lauded by SMEs.

On the surface, it offers an alternative form of equity financing to the conventional and asset-based model that is currently prevailing. Hence, one cannot help but welcome the noble objectives of LEAP as outlined by Bursa Malaysia.

However, many are still unsure if there would be differences in the policy guidelines and the reality upon implementation. On paper, the ACE market does not have a stringent profit requirement as well. The investment banker would normally discourage you if your company’s profit after tax (PAT) is not at least about RM4mil.

In LEAP’s case, there is no mention of profit requirements, and the clichéd reply is it would be up to the investors. The key success factor for LEAP is that it is supposed to be more market or investor driven. If the approved adviser has confidence in “sponsoring” the initial public offering (IPO) and there is sufficient interest from sophisticated investors, the listing could see the light of day.

All appears hunky-dory until we start looking at numbers. Recently, the million dollar question for interested SMEs would be the cost of the listing exercise. The professional fees that have been bandied around are between RM700,000 and RM800,000. Some have even quoted close to RM1mil.

Using some back-of-the-napkin calculations, fees of such astronomical proportions could derail the viability of the IPO on LEAP for SMEs. Let’s take an SME with a PAT of about RM1mil. Based on a price earnings (PE) multiple of five to six times, the valuation should be about RM5mil or RM6mil. Others may contend that a higher valuation is possible.

The issue is to be realistic and look at market accepted averages that can attract investors. There are outliers and unicorns such as Grab but are they the exceptions or the norm?

In the first round of financing, it is unlikely that the SME’s founders would want to lose majority control. Assume that the founding shareholders are prepared to dilute 30% of their equity, which translates into RM1.5mil to RM1.8mil. If the professional fees add up to RM750,000, this would be 40% to 50% of the total amount raised, leaving the company with net funds raised of only RM750,000.

When the professional fees take up almost half of the financing, the viability of the fund-raising exercise becomes suspect. One can argue that the valuation could be higher if the profits are larger, but do consider how many SMEs in their earlier stages of growth have PAT above RM1mil. SMEs that have surfaced PAT above RM2mil would probably be looking at an ACE listing over the next two years.

The objectives of LEAP as an alternative platform for SMEs to raise funds are indeed noble. Nevertheless, the key word in this equation is affordability. We must remember that the purpose of LEAP is to allow emerging and growing SMEs to raise funds from the capital market. LEAP is not meant for mature SMEs and valuation should not be the primary mantra.

How do we bring the professional fees down to a percentage that doesn’t exceed 20% of the amount raised? For a start, the increase in the number of approved advisers would hopefully create more competition and drive down pricing.

Another critical issue that distinguishes LEAP from the other platforms under Bursa is the restriction to sophisticated investors. As the regulatory authorities have recognised the higher risk profile of these emerging SMEs, they are confined to the more savvy investors.

Unlike the ACE and Main Board listings, retail investors are not in the equation. In such circumstances, the approved advisers need not carry out such extensive and in-depth due diligence.

There are a couple of reasons behind this suggestion. For emerging companies, the forecast and projections are subject to larger variances. That is why only sophisticated investors with higher risk appetites are allowed to invest.

Secondly, these sophisticated investors can determine the risks themselves. By having direct presentations to the sophisticated investors, the founders can explain their business plan and clarify the assumptions. The approved advisers only need to conduct some basic due diligence to check that the company exists and the entre- preneurs’ background, and some indicative checks on customers and suppliers. The audited accounts should be taken at face value.

The onus should be on the sophisticated investors to draw their own inferences on the forecast and projections. They are at liberty to question the entrepreneurs during the pitching sessions. With lesser information, asymmetry issues between the sophisticated investor and entrepreneur and the roles of the professionals can be reduced. This measure would inadvertently reduce the professional fees.

The summary to this proposal is that the key agents to this deal have sufficient information to make informed decisions. While there are savings in time and money on one hand, let us not take that away with overindulged due diligence. Sophisticated investors do not need such protection, and by lowering the professional fees, the viability of SMEs tapping funds from LEAP would be enhanced. Otherwise, the reality could end up being just a leap of faith for the SMEs.

SENG H. YEOH Penang