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
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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
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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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03
DEMYSTIFYING
SME RISK FINANCE
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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.
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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
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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
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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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04
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)
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SOME OF OUR MILESTONES
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$1,6 billionSME finance
596 388Job opportunities facilitated
70 506SME finance transactions
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INVESTMENTS APPROVED(US$ MILLION: $1 = ZAR10)
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 -
20,000,000
40,000,000
60,000,000
80,000,000
100,000,000
120,000,000
140,000,000
75,051,123
90,047,169
104,931,029 98,741,167
76,499,733
100,934,853 93,521,245
89,173,097
108,255,495
117,702,177
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INVESTMENTS APPROVED PER “PRODUCT”(US$ 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
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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
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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
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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