SME Exchange: Diversification in Kenyas Capital Markets

Mrs. Stella Kilonzo, MBS Chief Executive Capital Markets Authority

Coast Province Investment Conference 23RD November, 2011

PRESENTATION OUTLINE Capital Markets Agenda

SME Market Relevance

Establishment of a Growth Market Enterprise Segment Benefits of an SME Market

Opportunities from Public and Private Equity

Listing Requirements and Role of Nominate advisers Current Status

CAPITAL MARKETS AGENDA

Kenyas capital and financial markets have registered phenomenal growth and development in virtually all parameters. Various reforms initiated towards deepening of the market with particular emphasis on:

modernization of market infrastructure increased awareness enabling policy framework fiscal incentives developing new products such as the Growth Enterprise Market Segment (GEMS) at the Exchange for SMEs

SME DEFINED
In Kenya, the following definitions of the SME sector are applied: Micro Enterprises: Businesses employing 1-10 full time employees with annual sales turnover Kshs 5 million. Small Enterprises: Businesses employing 11-50 employees with annual sales turnover of between Kshs 5 million - Kshs 50 million. Medium Enterprises: Businesses employing not more than 100 workers with annual sales turnover of Kshs 1 billion.

THE CAPITAL-RAISING PROBLEMS FOR SMES

SMEs suffer from lack of access to appropriate funds (in term and cost) from both the money and capital markets. They suffer from:
Being regarded by creditors and investors as high-risk borrowers due to insufficient assets and low capitalization, vulnerability to market fluctuations and high mortality rates; Information asymmetry arising from their lack of accounting records, inadequate financial statements or business plans SMEs are less structured than large scale organizations and are usually dominated in terms of management style and other characteristics by the promoter. They are therefore perceived as higher risk. High administrative/transaction costs of lending or investing small amounts which do not make their financing a profitable business.

THE CAPITAL-RAISING PROBLEMS FOR SMES

SMEs cannot borrow significant funds from banks. Banks regard them as too risky and with too little collateral to support a loan.
Their owners are often already fully invested in the company, often having borrowed from family and friends as well. Trade creditors and suppliers might give them some leeway, but in time they too must be paid. Shares in a private company are not transferable, except under exceptional circumstances, which hardly conforms with an investors long-term desires. SME might already have a number of small shareholders; usually family, friends, and employees leaving them little for raising significant capital from new investors while staying below the 50 shareholder maximum. Consequently, raising capital while staying within the limits of private company status is a much too limited course for many SMEs.

MAIN INVESTMENT MARKET SEGMENT (MIMS) AND THE ALTERNATIVE INVESTMENT MARKET SEGMENT (AIMS).
Part A Requirement Criteria for MIMS Part B Criteria for AIMS

Size: Share Capital

Min. authorized issued and fully paid up share capital of Kshs. 50.0 million.
Immediately before the IPO should not be less than Kshs. 100.0 million. Profits after tax attributable to shareholders in at least 3 of the last 5 completed accounting periods prior to listing.

Min. authorized issued and fully paid up share capital of Kshs. 20.0 million.
Immediately before the IPO should not be less than Kshs. 20.0 million. Must have engaged in the same business for a min. of 2 years, 1 of which should reflect a profit with good growth potential.

Size: Net Assets

Track Record, profitability and future prospects

PERCEIVED DOWNSIDES
Perceived downsides especially for Medium Enterprises in these markets has been: Compliance Loss of control & ownership Reporting obligations Approval process EGM/ AGM Listing costs This could be addressed through the introduction of a Market that addresses these issues

ESTABLISHMENT OF A GROWTH MARKET ENTERPRISE

The Authority in conjunction with the Nairobi Securities Exchange (NSE) and the Central Depository and Settlement Corporation (CDSC) are jointly embarking on the establishment of an SME market at the exchange. To cater for Micro, Small and Medium Sized Enterprises (MSME) sectors which is one of the key drivers of Vision 2030, destined to play an effective role as an engine for economic growth, poverty eradication and unemployment.

SMEs are the main source of economic growth in developed and developing countries such as Kenya.
Responsible for about 80% of employment. Contributes about 40% to GDP.

ESTABLISHMENT OF A GROWTH MARKET ENTERPRISE

The market segment allows existing companies to diversify their ownership and introduce new investors and management capacity Founding owners have an opportunity to realize their investment through disposals to new investors (subject to restrictions) The market segment creates opportunities to facilitate the raising of long term, affordable, risk capital for SMEs. Maintains high levels of disclosure and transparency to secure investor interests The free float and number of shareholders after listing should facilitate liquidity.
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BENEFITS OF AN SME MARKET

Creates a market for shares of SMEs, broadening their shareholder base and potentially giving existing shareholders an exit route Obtains an objective market value for SMEs through market price discovery Aids EAC domiciled companies in raising their profiles with a view to expanding operations in Kenya and the rest of the East African Community Rewards and encourages employees of SME firms through the introduction of share incentive schemes.

OPPORTUNITIES FROM EQUITY FINANCING

Provides SMEs with equity financing opportunities to grow their business from expansion to acquisition. Equity Financing will lower the debt burden leading to lower financing costs and healthier balance sheet. Increased information availability provides immense opportunities for investors to identify and invest in good SME companies at early stages.

Helps unleash the valuation of companies and in the process create wealth for all the stakeholders.

OPPORTUNITIES FROM PRIVATE EQUITY

Initiating a dedicated exchange platform for SMEs will lead to diversification of resources of finance and help build a bridge between the SMEs, Private Equity and the Venture Capital by providing an exit route.
A key consideration of strategic investors into private companies will be the availability of a mechanism for effective exit within a 5 8 year investment cycle Transparent market price discovery and opportunities for sale to diversified investors instead of a single investors provides greater flexibility in exit timing

OPPORTUNITIES FOR PRIVATE EQUITY

Opportunities to invest in the fastest companies in East Africas largest economy. growing

Entry into the fastest growing sectors in the economy. Free movement from one segment to another as long as firm meets requirements.

Capital Market will help distribute risk more efficiently by transfer of risk to those who are best able to bear it.
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LISTING REQUIREMENTS
Exchange to carry responsibility for first line assessment and approval for listing by introduction
Financial Requirements- Paid up share Capital of Ksh. 10 million. Low minimum number of shares: 100,000 issued shares Free float of at least 15% of the issued shares to be available to ensure liquidity. Corporate Governance Requirements composition, audit and management accounts). (board

Continuing Reporting and Compliance Requirements

Supported by Nominated Advisor in ensuring compliance
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ROLE OF NOMINATED ADVISORS

A Nominated Advisor will be responsible to the Exchange for:
assessing the appropriateness of an applicant for GEMS listing

advising and guiding an SME company on its responsibilities under the GEMS Rules for Companies.

NOMADS will be subjected to vetting and registration by the exchange.

The Nominated Advisor's role is of particular importance to the successful operation of alternative market. A nominated advisor acts as a coordinator between the issuer and the exchange all the times and is responsible for ensuring compliance.

CONSIDERATIONS
Graduation to the main market to be made easy through: Streamlined Process Prescribed timelines by which the approving authority has to
respond to applications;

Ensuring that SMEs listed on SMEx are eligible investments for pension fund schemes and insurance companies. An educational program will be developed by the Capital Markets Authority, and the Securities Exchange on which the market segment is situated.
Research coverage provided by the NOMAD to boost the profile of the SMEx Existing incentives for the main market to be advanced to the SMEX market

EXISTING TAX INCENTIVES- FOR ISSUERS

to be advanced to the GEMS market

Tax amnesty on past omitted income for newly listed companies, provided they make full disclosure of assets and liabilities and undertake to pay all future taxes; Expenses related to issuing shares to the public fully tax deductible; Stamp Duty and VAT on transfer of listed securities exempted; Law amended to reduce listing fees by 50% (0.3% to 0.15%); Preferential corporate tax treatment for listed company from the usual 30% to as little as 20%for for the first five years after listing those who release to the public up to 40% of their shares through IPO; New and expanded share capital for companies approved for listing or already listed exempt from stamp duty;

Cost of rating made tax deductible in order to encourage credit rating;

CURRENT STATUS
Public exposure of the SME regulations closed on September 20, 2011. We are now in the process of incorporating stakeholders comments into the framework. Regulatory framework is subject to gazettement by the Minister. Launch is expected by June 2012.
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INVESTOR PARTICIPATION
Reviewing and assessing the disclosures in the Listing Statement to determine whether investment is attractive and meets their needs Purchase of listed shares on the GEMS segment

All listed securities are deposited in the central depository

Trading is on the Automated Trading System (ATS) Investors will need to open a CDS account to trade Companies in first instance to be listed by Introduction (not an IPO) Capital raising may be done post listing through rights and additional issues
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THANK YOU!