Deep Pockets, Fast Growth

Domestic companies have identified financing as the second biggest challenge in their business operations immediately after finding new customers or entering new markets. You've undoubtedly heard the phrase: "Serbia's financial market is bank-centric." Bank centrality is a concept that denotes the superiority of banks as a traditional source, as well as the choice for financing domestic micro, small, and medium-sized enterprises (MSMEs), as opposed to other so-called alternative forms of financing. The term bank centrality can also be explained statistically. In Serbia, around 90% of all funding sources come from banks, 7% from the state treasury, and only about 3% from alternative sources. Banks in Serbia draw their power by not financing investment loans and nurturing risk aversion, operating with minimal risk in their portfolios. But why are these other sources of financing defined as alternatives? One gets the impression that they may be considered less important, attractive, or not as efficient or that they are supplementary in a "take what you can get" style. On the other hand, it is reasonable and logical to define them as alternatives, given their absolute dominance compared to banks as a source of financing. Thus, they represent an alternative to the primary financing of MSMEs in Serbia. Does this difference need to be so significant? Is there room for improvement, and are alternative sources of financing truly that alternative?

First and foremost, defining which financing models fall under the alternatives category is necessary. These include primarily funds: Venture Capital (VC), Private Equity (PE), mezzanine financing, securities (stocks and bonds), crowdfunding, leasing, factoring, etc. Some of these funding sources can be very significant and useful for MSMEs, and, most importantly, they are applicable in the Serbian market. However, not all alternative sources of financing are relevant in the domestic market. Some are partially applicable, such as crowdfunding, an exciting capital-raising concept with relatively decent returns (around 8% on average) on the purchased ticket. Still, its full potential in Serbia requires a more significant market or population or better promotion of the concept and its ultimate benefits to investors. What is certain is that crowdfunding is an ideal way to finance local endeavours, as it is significantly easier to present the importance of investing in a local project to one's immediate community. Unfortunately, selling shares has almost no applicability. The stock market, or the so-called stock exchange, has not been taken seriously in Serbia since its inception. Simply put, our business culture and economic system are oriented towards limited liability companies (LLCs) as the dominant method of company organization. Additionally, the model where individuals, natural persons, buy shares and thus finance the endeavours of domestic companies sounds like a good joke or a beautiful but unrealistic dream. We will unlikely witness this scenario in our country anytime soon.

But let's turn to the brighter side of the alternative scene in our country. First and foremost, there is no doubt that startups are the proper drivers of the world today. They are small, full of ideas, and adaptable to change. Such startups are ideal for funding through funds like VC. They operate with the logic of high risk-high return and obtain a particular, not large, ownership stake. In Serbia, there are currently around 300-400 startups, which is insufficient to be more visible to international VC funds where the most significant funds are raised. In 2020, VC funding raised a whopping $300 billion worldwide. The goal is to increase the number of domestic startups so that our market is recognized as a regional startup potential rather than just an outsourcing potential. How? It is necessary to foster synchronized growth of the entire ecosystem involving educational institutions, private companies, domestic funds, and hubs. The government also has a role to play, particularly in actively shifting the trend from outsourcing toward creating a conducive environment for startup development.

The other extreme is financing through PE (Private Equity) funds. As a rule, these funds get involved when a company is in a mature phase. The logic behind these funds is "buyout," meaning acquiring a secure and stable investment, improving the business, and then selling it (usually after five years), aiming for significant returns on investment (the average net internal rate of return is around 15%). In 2020, the worldwide value of all acquisitions (approximately 3,000 acquisitions) by PE funds was around $600 billion, which, for comparison, is about 12 times Serbia's GDP. Furthermore, by 2025, the total investment power of all PE funds is expected to reach $5.8 trillion, roughly four times Russia's GDP. There is, and will be, plenty of money in these funds, given the security that such funds bring along—demanding a high level of knowledge from portfolio managers, the acquisition of already stable companies and their development, as well as the ability to manage and control the acquired companies. PE funds have also made their way to Serbia, with examples like the sale of Bambi, Imlek, and Knjaz Miloš. Indeed, any domestic company would welcome them with open arms (additional capital, more significant investments, access to new markets, and keeping part of the profits in the country). However, for a company to become a target for PE funds, it must be stable with consistent and substantial income. This can be achieved by consolidating companies, especially if their businesses complement each other through the value chain.

Additionally, an exciting and applicable financing model in Serbia could be mezzanine financing, which is almost nonexistent in our market. Mezzanine financing is funded by an investment fund, which many domestic companies can also form. While the name may sound strange, or you may have never heard of this model, the logic behind it is clear. It benefits both companies and investors, considering the returns this financing model offers, which are significant (averaging around 12% to even 30%). It represents a hybrid financing model, combining debt (loan) and equity capital. What's advantageous about this financing method, which benefits capital seekers, is that it is a "cash flow-based financing" model, meaning mezzanine financing does not require collateral in the form of assets. Projected cash flows are sufficient, and ordinary shares can serve as security.

Issuing bonds to raise additional capital in Serbia's future could have a promising outlook. Some key advantages of this financing model compared to bank loans include risk dispersion due to raising relatively high amounts from various sources, longer maturity, and flexibility in negotiating coupon rates and nominal values.

We've all heard of leasing and factoring. They are almost taken for granted, yet at the same time, their potential is often underestimated or even overlooked. They are essential as alternative sources of financing in small markets where liquidity is a problem for many companies. The similarity with our market is evident, so let's use it. The advantages of both instruments lie in boosting current operations and working capital turnover, two essential aspects of micro and small business operations.

To emphasize the significance and discover the potential of alternative financing in Serbia, there's no need to look far. Germany is an example of a country with a highly developed alternative financing market for MSMEs. Some key options available to companies there are Venture Tech Growth Financing, which invests in innovative, fast-growing technology companies; KfH, which invests in companies oriented toward growth throughout the entire supply chain; and ERP Innovation Financing, which promotes digital transformations by supporting MSMEs.

To empower domestic micro and small enterprises and thereby strengthen the domestic economy, it is essential to overcome the financing problem, which primarily relates to the inaccessibility and inadequacy of many funding sources. Alternative sources of financing are not all that alternative after all. VC is one of the first choices for startups. Bonds can serve as a substitute for bank loans to a certain extent. Mezzanine financing can be incredibly interesting, especially when lacking traditional collateral is a significant challenge in obtaining bank loans. Factoring and leasing can expedite ongoing operations as substitutes for short-term bank loans, and attracting PE funds requires time. The synchronized progress of all ecosystem elements (business climate, economy, companies) is necessary. There is certainly room for growth in the alternative financial scene in Serbia, and it is more than welcome to fill that space. The best way to do so is through investments. As we've seen, there are deep pockets, and companies themselves will have to play a part in achieving rapid growth.