Debt financing is what everybody is familiar with. It is
what you know as a loan. It may be short term or long term, or it may be
transactional. The institution I belong to---Small Business Corporation, a
government financial institution attached to the Philippines Department of
Trade and Industry provides loans for MSMEs. In fact loans make up much of its portfolio.
Loans are lent out with the intention of getting back the
principal amount plus the interest depending on how long the loan is to be repaid.
If the borrower is not given a grace period of about 6 months to a year at
most, the loan is immediately amortized or repaid; the principal plus interest which
is usually fixed and given at the onset of the loan.
The lender in most cases is does not participate in the
business; is not interested in owning it, but merely wants to get his money
back plus interest.
Debt is ideally used
only to finance the working capital requirements of business at most about 70
percent of it. Or short to medium term asset acquisition such as for machinery
and equipment.
For start ups, product development, or expansion of the
business, a more appropriate kind of financing is available.
We call it equity financing. In this article, I will talk
mostly about equity financing under SB Corp.’s Venture Capital and Enterprise
Incubation Program or SME-VIP.
First let’s start with the basic---- equity financing is not
a loan; it is an investment.
So unlike a loan, an investment is not to be repaid
immediately. The one providing the investment becomes part owner of the
enterprise, and shares of stocks are issued for the invested amount.
Second difference from a loan is that an investor expects
their investment to grow and given back over a period of several years many
times over their original amount of investment.
However, there is no specified rate of return, but has a
minimum rate of return without limits on the upside. Usually, there is no
specific time the investment has to be returned to the investor.
Finally, investors may get involve in the management of the
business as part of the deal of investing. Investors are often members of the
Board of Directors.
The good news is that aside from SB Corp.’s lending or loans
program, it now has a venture capital/equity financing program as an offshoot
of the passage of the revised Magna Carta for mSMEs or R.A. 9501, which
includes in our mandate, a venture capital fund.
What is SME-VIP?
The SME-VIP shall identify, select and nurture and develop
business ideas and early stage/start-up enterprises into competitive
businesses. A minimum objective is to create sustainable and viable enterprises
that are self-supporting and can already stand on their own.
Specifically, the SME-VIP will have the following
objectives:
- To provide equity and/or venture capital financing;
- To provide by itself or though its network of partners capacity building services; and
- To help provide through its network of partners access to production facilities, office spaces, equipment and machinery rentals, and marketing venues.
How does the SME-VIP
work?
The program concept starts with a business idea. This may be
a technology, a unique product or service that requires capital to start. Or
may have already started up but requires additional capital to grow further.
We take this pre-bankable business and let it undergo the
business incubation process. Business incubation is a business support process
designed to accelerate the successful development of start-up and fledgling
enterprises through an array of business support resources and services,
developed and orchestrated by SB Corp. management and offered both in the
incubator and through its network of contacts.
The enterprise that graduates from the incubator program is
expected to create jobs, improve the environment, commercialize indigenous
technology, improve local economies, and contribute to the general standard of
living of the country.
Critical to the definition of an incubator program is the provision
of capacity building such as management guidance, technical assistance, and
consulting tailored to fledgling and growing firms. The usual thinking is that
it is a requisite for incubators to provide physical locations and facilities
to its clients. However, about half of incubator programs serve “virtual”
enterprises. These are enterprises that are housed outside of incubator
facilities, most probably home based or with their own premises, but can
benefit from the services extended by incubators.
In this particular instance the SME-VIP shall provide
venture capital and equity financing, and capacity building services to
businesses enrolled in the program. The SME-VIP shall broker the package of
assistance needed by the enterprise be these in the form of financing or of
capacity building services. An enterprise incubator’s main goal is to produce
successful firms that will leave the program financially viable and
freestanding.
Five Stage
Implementation
The SME-VIP shall adopt a five-stage process in its
implementation to attain its set objectives and targets. The following
describes the general mode of operation of the SME-VIP:
This involves the scanning of the
environment for business ideas and early stage enterprises which may be the
subject of the incubation program. Various sources of such enterprises may be
the sub-borrowers of conduits financial institutions, inventors, SME borrowers
of SB Corporation, the academe, research institutions, government institutions
and their programs, Chambers of Commerce and Industries, Trade and Industry
Associations, Non-government Organizations and other VCs and private equity
funders. Those identified as potential investees/incubates are screened based
on a set of pre-qualification standards and subjected to a due diligence
process that they should pass.
The next step is to
institutionalize the enterprise based on the requirements of the SME-VIP. This involves the registration of the
enterprise as a corporation, its capital structuring, the preparation of its
business plan, the execution of all necessary documentation of the assistance
to be provided whether financing or capacity building in nature, its location
in an incubation center (only when needed) and the completion of all attendant
activities prior to its operation as an incubator enterprise.
At this stage, the enterprise
starts operating under the incubator program and starts enjoying the benefits
of such. VC or equity financing will be provided. Loans also whenever needed
are made accessible. Capacity building
in areas of management, marketing, or production; technical assistance in
product and business development, and consultancy and advisory services may
likewise be extended. This stage could last from a short one year to about
three years depending on the status of the enterprise upon joining and the
speed by which it can establish itself in the market and generate revenues.
- Commercialization
At this stage, the incubated
enterprise is spun off as a commercial going concern which means it shall
operate at the level of self-sustainability without further capital infusion,
grants or subsidies from outside parties or from the incubator. Exceptions
would be loans for working capital or capex for expansion, which are part of
the normal modes of financing by operating enterprises. This is the test for
the enterprise prior to its graduation from the program. At this stage, the
enterprise is expected to grow at a faster rate and generate sufficient
revenues to sustain its operations and generate profits. Once the enterprise
has proven itself to be sustainable for a period of about one to two years,
then it is ready to be graduated from the program.
- Graduation
The enterprise is released from the
program and proceeds to fulfill its growth potential. The residency for an
enterprise under the program is only for five years maximum.
Applying for the
program
First thing to do if you are interested in participating in
the SME-VIP is to write us a letter to formally signify your interest in the
program. As part of the letter, attach a 1-2 pager description of your business
model. This is a short description of your enterprise telling us about the
product or service and how it intends to make money, its competitive
advantages, and its socio-development impact or how it will benefit the
community.
After receiving your letter, we will schedule an interview
with you regarding your business. In the
interview we will get to know you better and clarify whatever concerns we have
about your business model.
The initial interview will tell us whether or not to endorse
the project. We will prequalify it and have it affirmed by our credit committee
for us to proceed with due diligence. At this stage, we will ask you to submit
a detailed business plan.
Then we examine the business plan and conduct due diligence
on you and your business. At this stage, we shall conduct credit investigation,
an audit/validation of the business plan, and a valuation of the enterprise.
After due diligence, we structure the deal. The deal
structure is the financial plan of business detailing the amount of investment,
the nature of the investment whether in common or preferred shares, or
convertible debt, the term of the investment, the ownership structure, the
projected rate of return, and exit plan.
Finally, we submit our recommendations to our Credit
Committee based on an investment risk rating tool that we use and the results
of our evaluation and deal structuring.
The Crecom either
approves or disapproves the deal.
Investment Risk
Rating
To evaluate our investees, we have developed a risk rating
tool for our investments and using this tool, we are able to assign investment
grades to our investees and identify, quantify, and mitigate the risks in a
particular project.
We call our investment risk rating tool LeADER Analysis
which is an acronym for the major parameters that we evaluate in rating the
risks. These parameters are: legal aspect of the business, the administration
aspect, the Doability of the business plan, the economic prospects and market
strategy and its return on investment.
As investee, you must pass the risk rating. Projects with 66-above
points or an equivalent investment grade B+ in our Investment Rating table
passes the evaluation. The highest investment grade is A+ and the lowest is C.
New Mode of Financing
for Filipino SMEs
Hopefully, after getting an overview of our SME-VIP, we hope
that you will now start to look at equity financing or investment as an
alternative mode of financing to loans. After about five years of investing in
SMEs our portfolio remains to be small hampered by our ability to find really
good opportunities in the SME sector.
However, we are proud to say that so far our batting average
is better than 50%---which also means that SMEs are good investees.
For those we have invested in, more than half of them have
been good deals. Examples of our deals are investees in cosmeceuticals, a mix
of cosmetics and pharmaceutical products, in an engineering firm in the telecom
industry, in a seaweed production and processing project, in a manufacturer of
movable walls and building acoustics, and a producer of personal care products
using essential oils.
Currently, we are doing due diligence on a food processing
start-up based in Bicol region that would retort Bicolano delicacies such as pinangat, laing, and bicol express for the consumer market.
SB Corp. has initially put up a Venture Capital/Equity Fund
of P 50 million pesos, and we are targeting to invest about P 15 million this
year. We have modest targets because we have a small fund. Nevertheless, we
look forward to be able to do some strategic deals in certain industries and
contribute to their development.
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