revenue-based or royalty-based sme risk finance nazeem martin managing director: business/partners...
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REVENUE-BASED OR ROYALTY-BASEDSME RISK FINANCE
Nazeem MartinManaging Director: BUSINESS/PARTNERS
28 October 2015
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AGENDA
1. The SME environment– Economic significance of SMEs– Factors that promote/impede SME formation & growth
2. Sources of SME finance3. Demystifying SME Risk Finance4. Royalty-based or Revenue-based SME finance
Challenges Benefits to SME/entrepreneur and financier
5. BUSINESS/PARTNERS?– Some milestones: Investing in SMEs
6. Questions / comments
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SME ENVIRONMENT
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THE SME ENVIRONMENT
THE ECONOMIC SIGNIFICANCE OF SMES• Starting and growing a business is not for the faint-hearted,
BUT– If successful, it could be financially rewarding– It’s one of the noblest of human endeavours
• Economic contribution– Account for more than 35% of most countries’ GDP– Entrepreneurial SMEs are innovative … bringing new
technologies, products and services– Create wealth and jobs, and contribute taxes for development &
social welfare programmes– Constitute > 90% of formalised businesses in most developing
countries
• Employment contribution– More than 50% of people in formal jobs are employed by SMEs– Annually, more than 60% of new jobs are created by SMEs
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The Entrepreneur
Integrity
Doing skills
Business Skills
Entrepreneurial Talent
somedeals
somedeals
Sensible financialinstitutions/financial productsfor RISK FINANCE
Tax Regime
Physical infrastructure:- Transport- Telecommunication- Energy- Information
FACTORS THAT PROMOTE OR IMPEDE SME GROWTH
INFRASTRUCTURE
GOVERNANCE
Socio-politicalstability,security
Absence ofcorruption
Legal rights enforceable:- rule of law- property rights- bankruptcy proceedings
Bureaucratic environment:- labour- fiscal predictability- exchange rate- inflation
SUCCESS OF SME’S DETERMINED BY “DRIVERS”
Big AgricultureBig Manufacturing Big Mining Major Tourism
Nodes of Transport Seats of Learning Seats of Bureaucracy
HUMAN CAPITALEducation system:- Basic-Tertiary
Training:-Including Mentorship
Stimulation of entrepreneurship:-Technology centres
Health
© Copyright Business Partners
FACTORS THAT PROMOTE OR IMPEDE SME GROWTH
• Finance is not the only challenge• Other (more difficult to solve) challenges include
…– Entrepreneur
• Business & management skills• Technical/industry knowledge and skills• Entrepreneurship• Integrity
– Business viability … based on a plausible business plan– Market size and access– Regulatory environment– Infrastructure
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SOURCES OF SME FINANCE
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SOURCES OF FUNDING
• “OWN” FUNDS– Savings– Retrenchment packages– Equity in Mortgages
• “OUTSIDE” FINANCE– Family– Friends– Seller– Investors– Banks & other lenders– Development finance
institutions
FINANCING OPTIONS:LOAN FINANCE VS. RISK FINANCE• Traditional Loan Financing:
– Up to 50% owner’s contribution– 1x collateral/security cover
• Risk Finance:– Limited/low own contribution– Less than 1x collateral cover– Viability based– Higher risk … higher returns to
investor
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DEMYSTIFYING
SME RISK FINANCE
HOW DO WE SOLVE THIS PROBLEM?
A competent person with good “doing” skills, business skills and much
entrepreneurship approaches a financier with a business plan to set up or buy a
viable pizza store — (requiring $100 000), but with little own contribution (say $10 000) and no further
security/collateral.
DEAL STRUCTURE 1
LOAN FINANCE
• Loan finance @ prime + … like a bank• But, banks usually require …– up to 50% own contribution ($50 000 in example)– security/collateral which covers their exposure at
least one times.• CONCLUSION: Our entrepreneur’s funding
requirement will probably not be solved by a traditional bank or lender
DEAL STRUCTURE 2
EQUITY FINANCE
• The financier/investor …– acknowledges $10 000 equity from
entrepreneur– invests $90 000 as equity– split shareholding as follows:• 10 - 20% for entrepreneur• 80 - 90% for investor
• Deal not tenable … entrepreneur will not act as owner
DEAL STRUCTURE 3
REVENUE-/ROYALTY-BASED FINANCE
• The financier/investor …– acknowledges $10 000 equity from entrepreneur– injects a $90 000 term loan at prime +, with LESS
THAN 100% collateral cover– obtains no shareholding (100% shareholding for
entrepreneur)– charges a royalty fee based on % of revenue (or
number of widgets sold, etc.)– obtains a return (IRR) commensurate with the risk
… and shares in the upside like an equity investor
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DEMYSTIFYING
SME RISK FINANCE
Various permutations of loan (interest-bearing debt), equity (shares) and
revenue- or royalty-based finance are possible.
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GETTING A FAIR DEAL
COST OF RISK FINANCE
• Secure funds: Good collateral– Financier’s expected return (IRR) = prime +
• Less Secure funds: Equipment as collateral– Financier’s expected return (IRR) = prime + 2%
to 8%
• Funds @ risk: Unsecured– Financier’s expected return (IRR) = 25% to
35%
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CHALLENGES OF
REVENUE-/ROYALTY-BASED FINANCE
• Moral hazard: SME may under-report sales or revenue on which royalty is based– Need for a monitoring/tracking system – often costly & time consuming– Contracting as the less expensive option:
• “the higher of budgeted or actual revenue”• “payable for the period of the loan or until the loan has been repaid in full,
whichever period is the longer”
• A royalty, in the wrong hands, may be a very dangerous deal structuring instrument which could destroy businesses.– Because royalties strip cash out of a business, one must be mindful of
factors such as seasonality.– The rule is to structure royalties as payable when the cash is there.
• Even with cash royalties – risk financiers must remain patient capital investors
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BENEFITS OF
REVENUE-/ROYALTY-BASED FINANCE
• For the SME– An opportunity – to start/grow a business– Affordable finance (albeit more expensive than loan finance)– Retain 100% ownership – especially important for family-owned
businesses– Access to a risk sharing financier/investor with business acumen
and expertise– No single, large “exit” required
• For the Financier– A financing opportunity with a return (IRR) which is
commensurate with the risk– Regular payments (periodic contractual “exits”), rather than rely
on a large, undetermined exit only– Lower likelihood of entrepreneur managing the business to
reduce the exit of an equity investor – Deal structure could “guarantee” a minimum return plus upside.
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BUSINESS/PARTNERS?
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WHO IS BUSINESS/PARTNERS? • A specialist risk finance company providing …
– Funding (customised financial solutions), – business premises, and– technical assistance, sector knowledge & added-value
services
… only for SMEs (formal small and medium enterprises)… to have a positive development impact and make profits
• Established in 1981 … a sustainable track record of success in South Africa
• Expanded SME finance & TA business model into East Africa (Kenya, Rwanda and soon Uganda, etc.) and Southern Africa (Malawi, Namibia and Zambia)
SOME OF OUR MILESTONES
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$1,6 billionSME finance
596 388Job opportunities facilitated
70 506SME finance transactions
INVESTMENTS APPROVED(US$ MILLION: $1 = ZAR10)
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 -
20,000,000
40,000,000
60,000,000
80,000,000
100,000,000
120,000,000
140,000,000
75,051,123
90,047,169
104,931,029 98,741,167
76,499,733
100,934,853 93,521,245
89,173,097
108,255,495
117,702,177
INVESTMENTS APPROVED PER “PRODUCT”(US$ MILLION: $1 = ZAR10)
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 -
20,000,000
40,000,000
60,000,000
80,000,000
100,000,000
120,000,000
TF TFR TFRS TFS PFS PFEP PFR EI WOP
LEGENDDISBURSEMENTS BY PRODUCT TYPE
• TF Term Finance• TFR Term Finance with a Royalty• TFRS Term Finance with a Royalty and
Shareholding• TFS Term Finance with Shareholding• PFS Property Finance with Shareholding• PFEP Property Finance with Equity Participation• PFR Property Finance with a Royalty• EI Equity Investments
FY2011 FY2012 FY2013 FY2014 FY2015
TF 10186.18348 3029.49147 2367.20902 2654.32007 2026.1046
TFR 60605.59822 53003.92783 59068.05232 37479.25574 31497.84998
TFRS 9219.76349 13538.11945 1470.08709 1666.40657 1487.07381
TFS 0 4195.76149 9559.41954 718.15186 2092.5643
PFS 3324.24548 12509.2214 2174.76383 18595.12676 9790.30565
PFEP 0 1039.19375 0 0 0
PFR 0 0 0 0 0
EI 1508.36756 1106.82059 2491.43613 0 3116.10574
5,000
15,000
25,000
35,000
45,000
55,000
65,000
75,000
85,000
95,000
Bad debts written off per product type
FY2011 FY2012 FY2013 FY2014 FY2015
TF 0.120057570167492 0.0342615311404915 0.0306907728961518 0.0434328004522619 0.0405139858968794
TFR 0.714316689378981 0.59943912762227 0.765815001486913 0.613275337082732 0.62983098200939
TFRS 0.108667039456112 0.153107115736447 0.0190596219579945 0.0272675118743868 0.0297355266682474
TFS 0 0.0474512684294536 0.123937502621199 0.0117511624850129 0.0418429140028177
PFS 0.0391806053516196 0.141470963950066 0.0281957284909701 0.304273188105606 0.19576694363669
PFEP 0 0.011752589297315 0 0 0
PFR 0 0 0 0 0
EI 0.0177780956457961 0.0125174038239567 0.0323013725467713 0 0.0623096477859755
5.0%
15.0%
25.0%
35.0%
45.0%
55.0%
65.0%
75.0%
85.0%
95.0%
Bad debts written off per product type
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BUSINESS/PARTNERS’ HISTORY
NET CREDIT LOSSES
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THANK YOU / GRACIAS
QUESTIONS / PREGUNTAS?
WWW.BUSINESSPARTNERS.CO.ZATEL: +27 11 713 6600