Start-ups Financing: Bangladesh Context
(Published in the Financial Express in 2018)
Dr. Shah Md Ahsan Habib
In Bangladesh, the financial system has been bank-based. Securities market started developing, however, market of Non-Bank Financial Institutions (NBFIs) are relatively recent development. In such a scenario, banks have been the single most important sources for both short term and long term funds for the entrepreneurs. However, banks generally handle known and proven clients; and commonly ask for collateral, guarantees from a company’s directors, considers past good performance, etc. to identify credit worthy entrepreneurs. Approaches of banks and NBFIs do not match with the capital/financing requirements and the growth of starts-ups. For addressing the need and capitalizing the true potentials of these entrepreneurships, it is mainly about understanding, owning, and financing potentially innovative business ideas.
In regard to BD, Venture Capital Financing institutions are primarily registered with RJSC as the limited companies under The Companies Act 1994. Subsequently, these companies are required to obtain separate registration from BSEC for establishing the fund as per the Bangladesh Securities and Exchange Commission (Alternative Investment) Rules, 2015. As per the rules, alternative investment funds must appoint fund managers and trustees. The aforementioned BSEC rules are applicable not only for the registration and regulation of alternative investment funds but also for fund managers and trustees of such funds.
All venture capital financing companies, particularly those who wish to enjoy government declared tax advantages and other benefits for such companies, must operate within the rules issued by BSEC. These Rules has been in force in Bangladesh since June 22, 2015. As of January 31, 2018, a total of 11 companies got registration as alternative investment fund under the aforementioned rules of BSEC. Though 11 companies got registration, a few are yet to start their operation in full swing. Three types of funds are given registration under this rules which are ‘private equity fund’, ‘venture capital fund’ and ‘impact fund’. Of these funds, venture capital fund” means an alternative investment fund which invests primarily in non-listed equity and equity linked securities of start-ups with less than 02 (two) years’ operational history or green field companies or emerging early-stage undertakings mainly involved in new products, services, technologies or intellectual property rights based activities or new business models. A venture capital fund under this rule shall be established for a specific period from 05 (five) to 15 (fifteen) years which shall be disclosed in the constitutive documents. Such funds can sale units to collect fund only from eligible investors and there are restrictions on investment from the fund too. Apart from Bangladesh Securities and Exchange Commission (Alternative Investment) Rules, 2015, Bangladesh Securities and Exchange Commission (Qualified Investor Offer by Small Capital Companies) Rules, 2016 have also been formulated for smoothening the exit route of venture capitalist firm. According to the new rules, companies with small capital (less than 30 crore) can also be listed in the capital market through IPO process. Other than these, Government of Bangladesh and Bangladesh Bank have certain circulars/arrangements to support and promote venture capital in the market. Considering the key challenge of the shortage of fund, Bangladesh Bank provision allowing BDT 200 crore by a commercial for venture investment is a remarkable one. However, the responses of bank are almost absent in this connection. Practically it is all about the collective initiatives of the stakeholders of venture capital financing in Bangladesh.
In the country, almost all the companies are relatively new and yet to start their business. Only one fund has registered so far and some funds are in the process of registration. A few companies have started venture financing from their own capital. As the companies are very much new in this arena, it is very difficult to measure their financial performance. Apart from these, several companies are also providing venture capital that is yet to be registered with BSEC. Practically, some of these companies have produced several success stories (for example, Popular Pharma by Brummer & Partners Asset Management); and have also proven workable environment for the venture funds in the country.
As a broad sector, SME is probably the biggest relevant area. Investment/financing demand supply gap is clearly apparent in the sector. As traditional bankers are relatively conservative to offer loans to SMEs, venture capitalists have huge opportunities to bridge this gap by way of provision of equities or loans or both and practice of the ‘participative management approach’ where venture capitalists can also reduce ‘information asymmetry and transactions costs of lending SMEs which are basically characterized by uncertainties. In several instances, in SMEs banks usually face problems in intermediating funds whereas venture capitalists do not feel so. It is to be mentioned here that venture capitalists not only supply finance to investee firms but also provide non-financial services, which a traditional bank can never offer. Institutionally, banks are in the lending business whereas venture capitalists are in a partnership business. It is argued in the introduction that most of the SMEs in Bangladesh also suffer from shortage of managerial skills, marketing skills, lack of standard products, communication skills and so on besides being overloaded with financial problems. So, venture capitalists have the opportunity to offer different non-financial services like strategic decision making, marketing, management, contracts and so on for the betterment of the firm.
In the context of Bangladesh, Banks and NBFIs, at the present mode of extending finance, are not interested to provide finance to Greenfield but high potentials firms considering high risk. As such, high potential Greenfield firms suffer much due to shortage of funds. Venture capitalists’ attempted to bridge this financing gap. However, due to shortage of fund from their own-source, venture capitalists are facing hardship. By investing in venture capital funds, there is opportunity for banks and NBFIs to be benefited in the long-run having some graduated clients suitable for financing. Though, banks and NBFIs are allowed to invest in alternative investment funds, as per BB guideline, we have only one instance at this stage. In Bangladesh, a large portion of the micro and small entrepreneurs are out of the banking services. Bangladesh Bank, as part of its financial inclusion program, is also motivating banks to include these unbanked groups under the fold of banking services. But banks are not interested to provide financing facility due to incomplete documentation, absence of collateral and other necessary information in several instances. Now this could be a great opportunity for the venture capitalist. So the micro and small entrepreneur willing to get the fund from the bank can be diverted to the venture funds/impact funds. Venture capitalist may nurture the entrepreneur, prepare necessary documents, provide managerial services and offer other assistance. Once the entrepreneur become successful banks/NBFIs may sanction adequate loan facility and thus might be as an exit route for the venture capital fund.
There is a common fear of the greater involvement of regulator in the development process of the financial segment like venture. It is to be mentioned here that policymakers and regulators generally acknowledge that venture capital funds should be exempted from the new stringent regulatory and reporting requirements; however, certain regulations must be in place to reduce systemic risk and promote the stability and efficiency of the markets. There must also be monitoring need and guideline to address high degree of information asymmetry between the fund managers, and the passive investors. Moreover, involvement of banks’ with such investment demands certain prudential requirements to ensure safety and trust issues. At the end, it is about a customized balancing regulatory and monitoring framework with sufficient incentive for the market players and investors to operate comfortably.