Innovation in Financing SMEs: An Opportunity for SMPs
While generalizations regarding small- and medium-sized entities (SMEs)—across countries, regions, industry, size, and so on—are hard to make, research, including IFAC’s, suggests that SMEs find accessing finance a significant challenge today, just as it was a decade ago. Yet what has changed considerably over the last 10 years is the variety of financing options, which presents a smorgasbord of alternatives to what was once limited largely to bank financing.
While most SMEs are interested in tapping these alternative sources, research indicates that this market will only realize its potential if the accountancy profession—especially accountants employed by or providing services to SMEs—familiarizes itself with the options. It is both a challenge and an opportunity for small- and medium-sized accounting practices (SMPs): they often help SMEs gain access to financing—identifying suitable options, as well as preparing, presenting, and providing assurance on financial and other information for prospective financiers. If SMPs can become experts in these alternatives, they can play a key role helping SMEs navigate them and gain access to financing. But that’s not all: SMPs can also play a role in creating similar sources in their own jurisdictions and shaping the appropriate supportive regulatory environment.
In this article I review the current global state of SME access to finance—especially in relation to tightened credit resulting from the global financial crisis—take a closer look at some of the new options, and invite readers to share examples of innovative sources of finance for SMEs that have gained traction in their countries.
Raising capital has always been one of the greatest challenges for the growth and sustainability of SMEs. The International Finance Corporation estimates that the total unmet need for credit by SMEs globally ranges from US$2.1tn to US$2.6tn and, of the six countries reviewed, new bank lending to SMEs declined by 47 percent since pre-crisis peaks.
IFAC research corroborates the extent of this challenge. The results of the latest IFAC Global SMP Survey of over 5,000 SMPs indicate that difficulty accessing finance ranks as a major challenge for SMEs, albeit one eclipsed by rising costs and economic uncertainty. The majority of respondents (87%) reported that at least some of their SME clients seeking financing experienced difficulty in 2014.
Conditions vary greatly from country to country; the Organisation for Economic Co-operation and Development (OECD)’s recently-issued annual Financing SMEs and Entrepreneurs: An OECD Scoreboard reveals access to finance remains problematic in many countries.
SMP Micro Poll on Innovation in SME Finance
The economic implications of this credit gap are huge, since SMEs constitute the vast majority of entities globally, as the Association of Chartered Certified Accountants (ACCA) among others testifies. Equally important are the social impacts. In many, if not most, jurisdictions SMEs employ the majority of workers in the private sector, and SMEs tend to be a channel to employment for many disadvantaged and minority groups, as well as female and young workers.
Largely thanks to disruptive technologies, a profusion of innovations is democratizing access to capital, especially for SMEs, and making them less reliant on traditional bank financing. Alternative mechanisms such as crowdfunding, seed and angel funding, value chain finance, and venture capital are changing the landscape and quickly evolving to become significant sources of financing for SMEs. SMEs can now look elsewhere if the banks turn them down as the Economist recently reported. ACCA has summarized many of these innovations in its paper, Innovations in Access to Finance for SMEs.
Crowdfunding, in particular, has been making headlines. The Economist reported that crowdfunding platforms raised US$16.2bn last year. Meanwhile, a study by the World Bank predicts crowdfunding will be a disruptive global influence—as a game changer for Islamic finance, a means of empowering women, a way to finance youth entrepreneurship and employment in the Middle East, and as a truly global, borderless financing platform.
Growth is highest in Asia, propelling the region past Europe to become the second-largest crowdfunding region after North America. The World Bank estimates that the market for crowdfunding will reach US$96bn in 2025, with China accounting for over half that figure.
The examples at the end of this article illustrate some of the most innovative financing options for SMEs.
Critical to the success and sustainability of innovations in SME financing is the willingness of governments and large financial institutions to embrace them and enable the necessary regulatory reforms to support the growth of SMEs and entrepreneurs around the world. Regulation demands a balance between consumer and investor protection and capital formation. Accountants can also play a role here, by helping shape the appropriate policy and regulatory frameworks and leading the debate around workable, innovative financing mechanisms
Unfortunately, as the Financial Times reported, the regulatory response remains slow, especially in Asia, which is characterized by bank-centric financial systems that present greater obstacles for SMEs than larger firms. The APEC Business Advisory Council, in its report entitled APEC Framework for Innovative SMME Financing Mechanisms, calls on economic leaders and governments from the Asia Pacific region to provide an enabling regulatory framework and environment that can support a diverse range of financial institutions and products. The report acknowledges that governments need to play a key role and recommends they consider a variety of measures, including the provision of tax credits and seed funds, as a stimulus in the development of a vibrant SME financing ecosystem.
The European Commission is currently undertaking a substantial project to build a Capital Markets Union, with a primary sub-theme of addressing the regulatory impediments that have made it hard for SMEs to raise finance in Europe.
We Would Like to Hear from You
We are keen to hear of other innovative approaches to SME financing and encourage you to share them in the comments below. Through sharing such experiences and knowledge, we believe that the accountancy profession can play a major role in improving access to finance. A future article will feature these approaches suggested by readers.
Kickstarter is a global crowdfunding platform based in the United States, whose mission is to help bring creative projects to life. Kickstarter has reportedly received more than US$1.5bn in pledges from 7.8 million backers to fund 200,000 creative projects, making it the world’s largest online crowdfunding platform.
People who back Kickstarter projects are offered tangible rewards and one-of-a-kind experiences in exchange for their pledges. Project creators choose a deadline and a minimum funding goal. If the goal is not met by the deadline, no funds are collected. Money pledged by donors is collected using Amazon Payments. The platform is open to backers from anywhere in the world and to creators from the US, UK, Canada, Australia, New Zealand, the Netherlands, Denmark, Ireland, Norway, and Sweden.
Kickstarter applies a 5% fee on the total amount of the funds raised. Their payments processor applies an additional 3–5% fee. Unlike many forums for fundraising or investment, Kickstarter claims no ownership over the projects and the work they produce. The web pages of projects launched on the site are permanently archived and accessible to the public. After funding is completed, projects and uploaded media cannot be edited or removed from the site.
There is no guarantee that people who post projects on Kickstarter will deliver on their projects, use the money to implement their projects, or that the completed projects will meet backers' expectations. Kickstarter advises backers to use their own judgment on supporting a project. They also warn project leaders that they could be liable for legal damages from backers for failure to deliver on promises. Projects might also fail even after successful fundraising when creators underestimate the total costs required or technical difficulties to be overcome.
Pozible is an Australian crowdfunding platform focused on fundraising for creative projects. The platform has raised almost US$28m for around 8,500 projects and claims to have “the highest success rate of any major platform” at 56%.
Similar to Kickstarter, Pozible bases its fee structure on the total funds raised, with a 5% fee for funds raised up to US$100,000 and a decreasing scale to 3% for projects worth $500,000 or more. There are a wide variety of transaction methods available, including Bitcoin, in addition to more traditional methods.
The same caveats as outlined above apply, with a funding agreement clearly pointing out that liability attached to projects in all aspects rests with the project creators.
Zhao Cai Bao (China)3
Zhao Cai Bao is the finance arm of Alibaba. Set up in April 2014, the platform lets small businesses and individuals borrow directly from investors.
The platform allows small businesses and individuals to borrow from a maximum of 200 investors after a financial institution has guaranteed the loan and made sure the money will be paid back. Zhao Cai Bao has listed about 11,000 products. The annualized return on a loan for a period of six to 12 months is at least 5.5 percent, according to the company’s website.
Zhao Cai Bao works with more than 40 financial institutions to help guarantee the credit: individual investors are not expected to be able to evaluate the risks in the financial products, so it is up to these financial institutions to determine the risks. The average loan size has been about 70,000 yuan (US$11,300). While there is no cap on how much an individual can invest, the minimum threshold usually depends on the loan size divided by the maximum 200-investor limit.
Zhao Cai Bao plans to create a marketplace for 1 trillion yuan (US$163 billion) in loans, within as early as two years, as the e-commerce group encourages more Chinese to borrow and lend. Alibaba has indicated that the financial arm could conduct its own public offering in the future, and the implied equity value would be at least US$25 billion, according to a filing with the US Securities and Exchange Commission.
 “Kickstarter,” Wikipedia, last modified May 8, 2015, http://en.wikipedia.org/wiki/Kickstarter.
 “About Pozible,” Pozible, http://www.pozible.com/about.
 Lulu Yilun Chen, “Alibaba Arm to Create $163 Billion Loans Marketplace,” Bloomberg, September 23, 2014, http://www.bloomberg.com/news/articles/2014-09-23/alibaba-arm-aims-to-create-163-billion-loans-marketplace.