What SMEs (and banks) are get­ting wrong

Miss­ing com­po­nents needed to build a sus­tain­able en­tre­pre­neur­ial ecosys­tem have be­gun to emerge

Arabian Business English - - FRONT PAGE - By Lubna Ham­dan

LAST YEAR SAW A RECORD num­ber of startup deals take place across the Mid­dle East and North Africa (MENA) – 366 deals amounted to $893m of to­tal in­vest­ment, ac­cord­ing to Mag­nitt’s an­nual MENA Ven­ture In­vest­ment Re­port. It also saw a record amount of to­tal fund­ing in regional star­tups, up 31 per­cent from 2017 when ex­clud­ing the $200m in funds raised by UAE-based ride-hail­ing app Ca­reem.

But the re­gion’s SME credit gap re­mains in ex­cess of $260bn. What are the miss­ing links to bridg­ing the fund­ing gap? Bank sup­port is one. In 2017, the Arab Mon­e­tary Fund (AMF) urged banks to help fill the 300 per­cent gap, with only one in five SMEs in the re­gion hav­ing ac­cess to a loan or line of credit.

Banks claim to be ‘at the front seat’ of ev­ery gov­ern­ment ini­tia­tive for SMEs. At the Ara­bian Busi­ness StartUp Acad­emy in De­cem­ber, Emi­rates NBD ex­ec­u­tive vice pres­i­dent Tariq Bin Hendi blames ex­ter­nal reg­u­la­tory el­e­ments for lim­it­ing fi­nan­cial in­sti­tu­tions in aid­ing SMEs.

“We are try­ing to do this, but you can’t avoid the ex­ter­nal reg­u­la­tory en­vi­ron­ment we have to deal with here from a dol­lar clear­ing per­spec­tive, which hin­ders a lot of reg­u­la­tors and banks from do­ing things,” he says.

“Bounced cheques, for ex­am­ple, are not a bank im­posed reg­u­la­tion. That is a reg­u­la­tor say­ing you have to do this, be­cause in the past, there has been a sub­stan­tial amount of fraud that came through this re­gion on the back of bounced cheques.”

Other banks, how­ever, have openly ad­mit­ted to be­ing hes­i­tant when it comes to SME lend­ing. At a con­fer­ence for the 2018 Shar­jah En­trepreneur­ship Fes­ti­val in Oc­to­ber, Na­jla Al Midfa, a board mem­ber at United Arab Bank, told Ara­bian Busi­ness she has seen banks “burnt” by SMEs in the re­gion.

“There is a huge credit gap there, and the gov­ern­ment is def­i­nitely fo­cus­ing on it. The cen­tral bank is talk­ing about more lend­ing to SMEs. But banks are hes­i­tant, so I think we’ll have to find that mid­dle ground where banks get com­fort­able with that,” she said.

In­sti­tu­tions such as Mashreq Bank in 2017 ar­gued that its SME loss rate stood too high at 20 per­cent.

But Al Midfa, who is also the CEO of Shar­jah En­trepreneur­ship Cen­tre (Sheraa), says the sec­tor would un­doubt­edly need more bank lend­ing to grow, es­pe­cially with SME bank lend­ing in the re­gion be­ing among the low­est in the world.

Bro­ken dreams?

Yet banks and in­vestors re­vealed an­other un­der­ly­ing is­sue.

“Peo­ple have ro­man­ti­cised en­trepreneur­ship too much,” says Bin Hendi.

“…Un­for­tu­nately, many of the con­ver­sa­tions I have with en­trepreneurs are about fads. Ev­ery­body wants to be­come a cup­cake en­tre­pre­neur at some point. From a rel­a­tive per­spec­tive, they say, ‘Ev­ery­one is mak­ing cup­cakes, but I’m go­ing to do it dif­fer­ently be­cause I’m go­ing to use a dif­fer­ent type of sugar in my ic­ing.’ From an absolute per­spec­tive, they’ve cre­ated nothing.”

Opin­ions di­verge

Fahim Al Qasimi, part­ner at cor­po­rate ad­vi­sory and in­vest­ment firm AQ&P, warns against ro­man­ti­cis­ing en­trepreneur­ship for “ev­ery per­son who thinks they will go to 12 startup events in three months and bump into [Wamda Cap­i­tal ex­ec­u­tive chairman] Fadi Ghan­dour and get $2.5m and start a busi­ness.”

Last week, in an opin­ion piece pre­dict­ing the year ahead, Ghan­dour said 2019 will be the ‘year of ex­its’ for Mid­dle East star­tups, when funds will re­turn money to in­vestors, en­cour­ag­ing new ones to be­lieve and in­vest more in the re­gion. Ghan­dour added that the $120m in­vest­ment by New York-based Gen­eral At­lantic in Prop­erty Fin­der and Ama­zon’s ac­qui­si­tion of Souq have proved to in­vestors that the MENA re­gion “is in­vestable”.

But Al Qasimi ar­gues oth­er­wise, claim- ing that many star­tups will “dis­ap­pear” in 2019.

“The fail­ure rate of star­tups glob­ally im­plies that a lot of en­trepreneurs will be seek­ing work in the near fu­ture and re­tail in­vestors will write off their sup­posed ‘nest-eggs,’” he wrote. “The claims of be­ing the ‘next big thing’ will be dis­pelled and… we will have a lot of very in­tel­li­gent peo­ple wind­ing down their star­tups to dis­ap­pear and ‘find them­selves and work out what to do next.’ I ar­gue that this will be the norm and the hand­ful of suc­cess­ful ex­its, the ex­cep­tion.”.

Miss­ing links

Al Qasimi at­tributes star­tups’ fail­ure rate on in­creas­ingly higher val­u­a­tions for early stage star­tups and a lack of po­ten­tial exit op­tions, urg­ing the en­tre­pre­neur­ial com­mu­nity to fo­cus on routes to profitabil­ity.

“I ap­pre­ci­ate the ar­gu­ment that Ven­ture Cap­i­tal firms (VC) tol­er­ate more risk, but in­vestors should be wary of in­creas­ingly higher val­u­a­tions for early stage com­pa­nies… As in­vestors in 2019 be­gin look­ing for re­turns, com­pa­nies will need to be­gin think­ing about long term fi­nan­cial vi­a­bil­ity or suf­fer the fate of wind­ing down when they can­not raise an­other round of in­vest­ment,” he says.

Yet Wamda Cap­i­tal man­ag­ing di­rec­tor Khaled Tal­houni be­lieves Al Qasimi’s as­sess­ment does not de­tract from the fact that the re­gion has one of the world’s largest credit gaps – re­gard­less of the ‘hype’ around en­trepreneur­ship.

“There is a sense that there is too much cap­i­tal in the re­gion flow­ing to high risk or tech star­tups. I un­der­stand where that feel­ing can come from, but it’s not born out of any ev­i­dence. The frac­tion of VC in­vest­ment in the re­gion as a per­cent­age of GDP is among the low­est in the world. There are great busi­nesses which should get ac­cess to debt but can’t be­cause they’re un­der five years old or can’t give a per­sonal guar­an­tee… Our prob­lem in the re­gion is the op­po­site. There is hype but we trail the rest of the world and we need to catch up,” he says.

One so­lu­tion? Small cap and medium cap ini­tial pub­lic of­fer­ings (IPOs), ac­cord­ing to Will Hut­son, co-founder and CEO of Dubai-based cre­ative agency LMTD.

“Longer term, we need ex­its and liq­uid­ity. A lot of peo­ple as­sume that

“Ev­ery­body wants to be­come a cup­cake en­tre­pre­neur at some point... From an absolute per­spec­tive, they’ve cre­ated nothing”

large cor­po­rate buy­ers come from Asia or North Amer­ica, but I don’t think there is a panacea in those ex­its. I think regional eq­uity mar­kets need small cap and medium cap IPOs. That is the so­lu­tion. Ja­pan, UK and Canada are great ex­am­ples of small cap mar­kets. This will en­cour­age regional de­vel­op­ment,” he says.

Keep the dirham in the room

A strong eq­uity mar­ket will al­low the re­gion to keep in­vest­ment and re­wards within its econ­omy as op­posed to for­eign own­ers, ac­cord­ing to Hut­son.

“We’re not build­ing these busi­nesses to be for­eign-owned,” he says.

Hut­son be­lieves regional own­er­ship is fun­da­men­tal as Mid­dle East own­ers will have the best in­ter­est for the growth of the en­tre­pre­neur­ial sec­tor.

“For ex­am­ple, for­eign own­er­ship in a pub­licly traded mar­ket won’t care about cre­at­ing jobs. The health of star­tups won’t be their pri­or­ity in the long term. They’ll care about re­turns,” he says.

Re­fer­ring to the Ama­zon ac­qui­si­tion of Souq.com, Hut­son says it would have been ideal to build the Dubai-based e-com­merce firm and grow it into a global player.

“When the In­ter­na­tional Mon­e­tary Fund (IMF) says that 58 per­cent of the GCC’s wealth sits out­side the re­gion, we have much big­ger fish to fry and need to cre­ate re­ally com­pelling op­por­tu­ni­ties here,” he says.

While for­eign ac­qui­si­tions of regional busi­nesses pro­vide short term cash flow, they lead to hav­ing a “com­peti­tor in our back­yard”, whereas re­tain­ing own­er­ship will “keep the dirhams in the room,” he says. “That way, you’ll cross in­vest and part­ner with the gov­ern­ment to be able to add more value to the GCC.”

Mid­dle East Ven­ture Part­ners (MEVP) CEO Walid Hanna says that while sell­ing to a global player val­i­dates the VC busi­ness model, the current mar­ket pro­vides more ben­e­fits to for­eign play­ers.

“Our part­ner [Mo­hamed Alab­bar], who is ex­posed to the re­tail space, went on the news say­ing that we en­cour­age all e-com­merce play­ers to have local 51 per­cent own­er­ship. Imag­ine you’re a re­tailer in this part of the world, and you own a fran­chise and you spend bil­lions to build brands lo­cally, but are then un­able to build much be­cause in­ter­na­tional play­ers are cut­ting costs and sell­ing your own prod­uct. This model is a bit un­fair,” he says.

“You spend bil­lions to build a brand then some­body else eats your cake,” he says.

But Tal­houni of Wamda begs to dif­fer, stat­ing that whether own­ers re­main local is be­side the point.

“What we need to fo­cus on is grow­ing local com­pa­nies. It doesn’t mat­ter who owns them in the end. Whether they exit lo­cally or glob­ally is a sep­a­rate point”

“We shouldn’t adopt this pro­tec­tion­ist, zero-sum men­tal­ity that either local com­pa­nies or some­one else is mak­ing money. If prof­its are ex­tracted else­where, that’s be­side the point be­cause we’re also free here to in­vest in pub­lic com­pa­nies on the New York Stock Ex­change or any other ex­change. What we need to fo­cus on is grow­ing local com­pa­nies. It doesn’t mat­ter who owns them in the end, and

whether they exit lo­cally or glob­ally is a sep­a­rate point,” he says.

The low hang­ing fruit, how­ever, is the at­trac­tive­ness of regional play­ers to global com­pa­nies.

Be­cause MENA-based com­pa­nies need to op­er­ate in mul­ti­ple mar­kets in or­der to scale, those who have fig­ured out how to op­er­ate in a com­pli­cated mar­ket find them­selves “in­cred­i­bly at­trac­tive” for global play­ers, ac­cord­ing to Tal­houni.

But there re­main many miss­ing pieces of the puz­zle in the re­gion’s world of en­trepreneur­ship. World class re­search uni­ver­si­ties, grand fi­nanc­ing, gov­ern­ment-backed re­search pro­grammes and tal­ent are a few.

The good news? We are now start­ing to see the miss­ing com­po­nents.

“For­eign own­er­ship in a pub­licly traded mar­ket won’t care about cre­at­ing jobs. The health of star­tups won’t be their pri­or­ity in the long term. They’ll care about re­turns”

A con­tin­u­ous chal­lenge for the re­gion’s star­tups is fund­ing

Khaled Tal­houni (far right), Wamda Cap­i­tal man­ag­ing di­rec­tor

Tariq Bin Hendi, Emi­rates NBD ex­ec­u­tive vice pres­i­dent

Will Hut­son, co-founder and CEO of Dubai-based cre­ative agency LMTD

Fahim Al Qasimi, part­ner at in­vest­ment firm AQ&P

Walid Hanna, CEO, Mid­dle East Ven­ture Part­ners

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