Financial Regulation of SMEs PRESENTATIONAT IFAC Small and Medium Practices (SMP) Forum th October 2008 Abuja, Nigeria BY JAPHETH KATTO CEO, CAPITAL MARKETS AUTHORITY-UGANDA

Outline Definition of SMEs Importance SMEs & Capital Markets Regulatory challenges Way Forward

Definition of SMEs There is no universally agreed definition of Small & Medium Enterprises. Definitions range from those based on the number of employees to those based on business turnover and assets. Definitions vary from country to country depending on the size of the economy.

Definition of SMEs  World Bank’s Definition since 1976 SMEs are firms with fixed assets (excluding land) less than US$ 250,000 in value  UNIDO’s Definition for Developing Countries Large :firms with 100+ workers Medium :firms with workers Small :firms with workers Micro :firms with < 5 workers  UNIDO’s Definition for Industrialized Countries : Large :firms with 500+ workers Medium :firms with 100 – 499 workers Small :firms with ≤ 99 workers

Importance of SMEs SMEs make up over 90% of business units in the world and account for between 50% - 60% of total employment Innovations that have transformed this world were not born in the posh offices on Wall Street or the square mile (City of London) but in garages, and back offices of little known towns. E.g. Google Inc.

SMEs & Capital Markets  Regulation in the capital markets has traditionally focused on large and well established companies.  In the last decade regulation has tried to accommodate SMEs through the Alternative/Growth Markets.  However many of these markets are dodged by low levels of liquidity with the exception of Asia which has been the bastion of private equity investments in the last three years

Regulatory challenges Source: World Federation of Exchanges

Regulatory Challenges  Compliance with accounting standards – too complex: Few entrepreneurs have adhered to international accounting standards, expensive to hire qualified staff.  Only 38% of the small companies in Uganda employing less than 20 employees had their financial statements audited by an external auditor.  This number substantially increased to 72% when it came to the medium enterprises which employ more than 20 but less than 100 employees. Source: World Bank Productivity & Investment Climate Survey 2006

Regulatory challenges  Poor corporate governance practices. There is some unwillingness by owners, directors and managers of SMEs to subject themselves to a high degree of accountability to outsiders.  In most companies there is no separation between ownership and management.  A recent unpublished (2008) CMA survey of 100 private Companies in Uganda, revealed the following; Principal owners were also the Managing Directors in 46 of the 65 (71% ) of the companies which responded. The Managing Director was also chairman of the Board of Directors in 40 out of the 92 (43%) of the Companies that responded.

Regulatory challenges  Under developed capital markets- Venture and Private Equity funds are limited especially in developing and emerging markets  Cost benefit analysis-Compliance with regulations is costly.  A majority of SMEs end up sourcing financing not from capital markets but from family, microfinance, short-term bank loans and retained earnings

Sources of Investment Finance for Small Firms (1-19 Employees)-% Investment Finance refers to funds devoted to the Purchase of fixed assets, & other long- term investments.

Sources of Investment Finance for Small Firms ( Employees)-% Investment Finance refers to funds devoted to the Purchase of fixed assets, & other long- term investments.

Way Forward SME accounting standards SME audit: An alternative assurance service to the traditional audit. However it has to be relevant and cost effective. Corporate governance reforms. Legal & regulatory reforms. Mentoring: A notable example is the UK AIMS market where they have nominated advisors for SMEs wishing to raise funds in the capital markets SME Forums that would build networks and foster synergies between the different stakeholders with an interest in SME development

“Timing is what is fundamental here, at a young stage, the Small Medium Enterprises ( SMEs) collect funds from relatives and friends. As they grow, the angel investors come on board and eventually as they mature, venture capital and even initial public offers crown their financing” Shri V.K. Chopra, Chairman & Managing Director,Small Industries Development bank of India. Quote

References Kennedy & Hobohm,1999,Capacity Building for Private sector Development in Africa.Working paper 3,Vienna Peter Quartey Regulation, Competition and small and Medium Enterprises in developing Countries,Centre of regulation and Competition IDPM University of Manchester Working paper 10. Lutwama et al. (2008)Private Sector Opinions on Listing

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