Macro-Economic Environment in MENA
The USD 2.9 trillion GDP MENA economy has witnessed momentous volatility over the last decade given its high dependence to oil revenues, including the financial crisis of 2008 and the Arab Spring in 2010-11. The region strong macro demographics, including a young population with a median age of 28 years old, an expected GDP growth of 3.3% by 2020, a strong consumption of c. 65% of GDP per capita and an internet penetration of 65%, are strong economic development highlights. The road to recovery is underway and the importance on the contributions by SMEs cannot be emphasized enough. While in developed economics SMEs drive up to 45 percent of employment and up to 33 percent of GDP, in MENA markets the contribution is reduced to only 20 percent.
The Funding Gap in the SME market
SME growth and financing in MENA is restricted by the lack of an empowering environment. Developing regulations, lending capacity and availability are roadblocks to the growth of SMEs market. A recent World Bank survey of over 130 MENA banks shows that only 8% of lending goes to SMEs across MENA, and even less in GCC countries at 2%. This is substantially lower when compared to the middle-income countries lending average of 18% and high-income countries average of 22%, as per International Finance Corporation publicly available data. Mezzanine funding, a sub-ordinate lending option, offers the perfect solution to provide capital to these mid-sized organizations.
What is Mezzanine Lending
Mezzanine lending is a model that takes the best of both debt and equity and is essentially a mixed form (hybrid) of financing. The triple component return structure of cash interest, payment in kind (PIK) and warrants offers a lot of flexibility from a structuring perspective to both borrower and lender. Being subordinated debt, it entitles the lender to a lesser claim on the borrower’s assets though it can come at a higher cost of capital than conventional debt. The ability to raise funds without fear of dilution of control is an added value for most businesses along with reduced risk. Mezzanine funding can be used as growth capital for organic initiatives such as new product introduction and capital-intensive projects. It can also suitably aid refinancing, recapitalization, acquisitions and buyouts. Mezzanine lenders typically look for companies with consistent earnings, growth potential, and free cash flows as a lending covenants along with select ratios such as net debt to EBITDA, and interest to CFO coverage among others.
Why Mezzanine is Important for Business Owners
The MENA region has a high concentration of SMEs and family owned business who sometimes find it hard to avail financing from conventional banks due to lack of collateral or asset backing and lack of private investor interest due to transaction size. In addition, in most of the consumer oriented sectors, SMEs who operate an asset light business model are not suited for debt financing, even if the cost of debt is in the high teens interest rate. Mezzanine financing is a non-dilutive funding option, hence the ownership along with management control is maintained by the existing shareholders. The other benefit of using mezzanine financing is the optimization of the company’s capital structure aimed at boosting return on equity, return on assets and absolute profits. Based on Millennial Capital research, the average SME can release up to 70% of available cash using mezzanine and debt financing which can be distributed as shareholder dividends.
The opinions contained in this article are of Andreea Danila, Founder & Managing Director of Millennial Capital Ltd.