Market Gaps on Access to Finance - Bank of Valletta

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Malta Business Bureau – <strong>Market</strong> gaps in access to finance April 2013 critical mass required by institutional investors to pool risk and provide financing to local SMEs is also difficult to reach, leading to reduced/ selective funding, if any at all. The case of state aid support and grants, even though it might be argued that it might distort competition, is even stronger in small countries such as Malta, given the high degree of economic openness and the need to be internationally price competitive. There may therefore be a case for considering state aid and continued provision of grants as permitting some form of level playing field due to Malta’s small size and insularity and their consequent impact on the cost of production 50 . Moreover, access to finance in the local SME market is nowadays even more challenging as local banks, despite not being exposed to peripheral country sovereign debt, have tightened their lending criteria. As a result many SMEs are finding it increasingly difficult to find access to finance to run and expand their businesses. 3.3 Traditional sources of finance 3.3.1 Loans This section provides further details on the these traditional sources which are currently available to local SMEs, including assistance from family or friends, the main forms of bank financing and other third party financing. In Malta bank financing is the most common and accessible source of external finance. With a sizeable number of players in the market, bank financing can range from short term assistance such as bank overdrafts, credit line or credit card overdrafts, to loans of a longer-term nature. Firms can tap this source subject to: Previous credit history Guarantees requested Track record and availability of a Business plan Availability of own capital and working capital Applicable interest rate/ fees Type of investment, that is, attractiveness/ riskiness of investment or sector. Other obstacles which banks often face when dealing with local SMEs relate to: Inadequate knowledge, experience and capacity of the SME Management to ensure good financial management Issues related to corporate governance/ succession planning issues Locally, banks often build a long-term client relationship with their SME clients, providing assistance at various stages and for various needs. Apart from bank loans, other traditional sources relate to loans from internal sources (family or friends) or external sources (other shareholders or related companies). 3.3.2 Trade credit and factoring Maltese SMEs also tend to utilise trade credit in their financing needs, thus reducing the need to go to a bank and use personal funds as collateral. It also allows the SME to establish business credit and hence have a better chance of getting a bank loan – the SME can also be seen as reserving the bank financing for capital improvements that will generate more returns. The cost of such financing relates to the forfeiture of cash discounts or the incurring of late penalties. Banks also use information on business credit to assess credit rating at the bank loan application process. 50 Briguglio and Buttigieg (2004), Competition constraints in small jurisdictions Page | 26
Malta Business Bureau – <strong>Market</strong> gaps in access to finance April 2013 A number of local firms are increasingly transferring their receivables to specialised financial institutions such as commercial banks and banks specialised in trade finance. Through factoring, SMEs are able to solve problems of late payment, collection and ease cash flow problems. As a result, local SMEs benefit from working capital financing, credit risk protection, accounts receivable book keeping and collection services. The 2013 Budget Speech referred to the development of a regulatory framework of factoring to facilitate the use of factoring as another means of liquidity for local SMEs 51 . 3.3.3 Leasing and hire-purchase In Malta, over the last few years leasing and hire purchase have become increasingly readily available for SMEs which use it to acquire most types of equipment, machinery, IT and vehicles. 3.4 Non-traditional sources of finance Although relatively non-existent in the local market, there are various other sources of finance which are currently utilised in other European countries. These include business angels, venture capital funds, mezzanine finance, and other sources of finance. These are being overviewed hereunder. 3.4.1 Business angels A business angel is generally an individual investor, usually with business experience, who provides capital for firms, especially in the start-up phase. They are an important source of equity for small firms with growth potential in their early stages of development, long before they become attractive for venture capital funds (discussed in the next sub-section) and bank lending. Business angels are usually interested in firms with potential for rapid growth operating in fields where they have experience, and usually prefer firms located close to their home or office. There are about 75,000 business angels in Europe 52 . Business angels are increasingly merging together into networks (such as the European Business Angel Network), private or semi-public organisations which help match up entrepreneurs and potential investors. At an EU level, the European Angels Fund, managed by the EIF, provides equity to the business angels and other non-institutional investors for the financing of innovative companies in the form of co-investments. It works together with business angels and helps them to increase their investment capacity by co-investing into innovative companies that are in the seed, early or growth stage 53 . In Malta, as discussed in Section 2.4.3 of this report, a Malta Business Angels Network was set up in 2003. This network was not taken forward for a number of reasons, including the quality of the sales pitches to the business angels by potential start-ups, lack of willingness to dilute ownership by founders, high expectations of entrepreneurs and the fact that Malta’s small size facilitates informal approaches to venture capital which did not require the usage of this formal business angels network. 3.4.2 Venture capital Venture capital is private equity which is provided, generally through a fund, to early-stage, highpotential, high risk, growth companies, especially start-ups. Venture capital funds operate by making returns through equity ownership in these companies. Typical venture capital sectors include 51 Ministry for Finance (2013), Budget Speech 2013 52 CSES (2012), Evaluation of EU Member States’ Business Angel <strong>Market</strong>s and Policies 53 European Investment Fund (2012), European Angels Fund Page | 27
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Market Gaps on Access to Finance - Bank of Valletta

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