Small and medium-sized enterprises in Bulgaria

TABLE OF CONTENTS

INTRODUCTION

CHAPTER I: SME Sector in Bulgaria
1.1 Emergence and Early Development- Economic Overview (1990-2001)
1.2. Relative Importance for the National Economy
1.2.1. General Outlook
1.2.2. SME Economic Profile
1.2.3. Competitive Position
1.3. Recent Developments and Trends
1.4. Sectoral Barriers to Economic Growth

CHAPTER II: Financial Intermediaries in Bulgaria - Key Facilitator of SME Growth
2.1. Overview of the Bulgarian Banking Sector
2.2. Supply of Debt Capital
2.2.1 Types of Bank Loans in Bulgaria
2.2.2. Group I Banks in Bugaria - Role in SME Financing
2.3. Demand for Debt Capital
2.3.1 Debt Structure
2.4. Problems and Obstacles for Bulgarian SMEs in Obtaining Bank Loans
2.5. Suggestions for Improvement of Debt Accessibility for SMEs

CHAPTER III: Challenges and Future Outlook for SME Debt Financing
3.1. Alternative Sources of Finance - Project and Institutional
3.2. Trends in SME Debt Financing
3.3. Cost of Borrowing

CONCLUSION

BIBLIOGHRAPHY

LIST OF TABLES AND GRAPHS.

INTRODUCTION

In modern economic conditions, conducting business activity of any kind without availability of debt finance is improbable. The private sector in Bulgaria face the challenge of maintaining sufficient amount of capital to successfully satisfy both working and investment needs. Debt finance products offer an ideal way to satisfy those needs.

Small- and medium-sized enterprises are main employment generator and key economic growth factor. They play primarily role in forming both GDP and Value Added of the country. However, SMEs have experienced a vast amount of economic and social problems. Main problems groups can be brought down to:

- Inappropriate business environment for the development of SME (administrative, legal, poorly developed business consulting services and regional business centers etc.)
- Insufficient financial assistance

Since capital markets in Bulgaria are still underdeveloped and alternative sources of finance are hardly present, bank loans/credit lines along with supplier/customer debt prove to be a primary source of capital for small- and medium- sized enterprises. In a bank-based financial system like Bulgaria, banking system is a key factor of economic growth with a major role in productivity, investment levels, innovation and expectation of entrepreneurs.

All those factors explain the importance of the chosen topic on regional and national level. Purpose of this work is to create a comprehensive profile of the SME sector in Bulgaria; to pinpoint and analyze its problems toward access to external capital as well as to evaluate trends and challenges in SME debt finance.

Key question on which this work attempts to answer is:

What are the trends and challenges in the corporate debt financing sector?

In order to get there, specific tasks will need to be accomplished

- Creation of a comprehensive profile of the SME sector in Bulgaria and illustration of its growing importance for the national economy.
- Evaluation of the supply and demand for debt and determination of potential barriers to limited external finance access for SMEs
- Formulating and analyzing trends and challenges of corporate debt financing in Bulgaria

Chapter I focus on the economic importance of SME for the Bulgaria economy and therefore serve to present and evaluate the sector`s economic and financial performance and development. The summit of the chapter discusses barriers to SME growth and suggests ways to overcome them.

Chapter II deals with the banking system in Bulgaria and its role as facilitator of economic growth in particular. Current situation of the debt finance market is presented and specialized SME product portfolios of leading banks are outlined. Moreover, a variety of possible reasons for the limited access to SME finance are discussed, both from firms` and banks` perspective. Possible solutions are suggested.

Chapter III analyzes ongoing and potential trends in Bulgaria`s corporate debt financing. Sectoral challenges as well as cost of borrowing issues are evaluated. Several examples of alternative finance programs/projects are outlined.

The methodology and literature used in this bachelor thesis project imply use of statistical information from the National Statistical Institute (NSI), reports of ESTAT Sociological Agency prepared for the Ministry of Economics and Energy as well as sociological surveys prepared by Vitosha Research on the condition of SME.

Since there is no updated statistical data yet, parts of Chapter I is based on rather outdated info - end of 2004. National Statistical Institute is the only national organization for statistics on economical, political and social activities. Unfortunately, no recent data has been available.

Chapter II uses statistical data on banking system performance and lending performance in particular. Most recent information is obtained mainly from Bulgarian National Bank (BNB). Products of Group I banks are acquired directly from their respective websites.

Chapter III uses alternative debt financing sources from respective institutions’ websites. 3-month EURIBOR, ECB key lending rate, BNB key lending rate are obtained from ECB and BNB websites directly.

All interpretations, evaluations, analysis are conducted based on personal view and judgment. Unfortunately, due to the specifics of the work, some of the book/internet sources are in Bulgarian exclusively.

CHAPTER I: SME sector in Bulgaria

1.1 Emergence and Early Development- Economic Overview (1990-2001)

The official regulation of Bulgaria’s private sector was initiated with the issue of “Directive 56”^[1]. The rules however, were insufficient and not clearly defined resulting in sporadic and rather unregulated initial stage of business development. Furthermore, it served to promote the inflow of capital of unclear origin and present opportunities for a number of illegal organizations to amass huge profits. As a result, the private sector in Bulgaria was growing at relatively low rates and the share of the “grey” economy was increasing.

The deficient private sector regulation and heavy financial crisis that followed hit the economy and led to hyperinflation. The process of privatization was abandoned and currency board was introduced, tying Bulgarian “Lev” to DM in an attempt to reduce inflation and stabilize the financial state of the economy. Interestingly enough, the crisis (1996-1999) did not hit the private SME sector, as the number of small- and medium sized enterprises did increase during the above mentioned period.

Table 1: Total number of Enterprises (absolute number)

Abbildung in dieser Leseprobe nicht enthalten

Source: NSI: www.nsi.bg

As the table indicates, the financial crisis did have negative consequences for the bigger enterprises, resulting in more than 20% decrease in the number of companies in that sector (partially being a result of privatization processes 1995-1999). Around 98% of all enterprises (private and public) in Bulgaria by the time were small or medium. The trend of shifting the focus from huge capital intensive businesses into smaller flexible business units persisted further after the process of privatization. Important governmental moves contributed to this size-shifting tendency of big public companies:

- The directive for restructuring and isolation of losing state-owned businesses
- Continuous trend of reengineering in unprofitable public companies

Furthermore, the government did pursue a national policy aimed at developing and sustaining the country’s SME private sector. The “National Strategy for Promoting Development of the SME Private Sector” was introduced in 1998. Milestones of the strategy were:

- Development of entrepreneurship and endorsement of fair competition
- Creation of new employment opportunities
- Training and improvement of managerial skills
- Enhancement of export activities in the SME sector
- Stimulate introduction of high-technology production facilities
- Promote investment (mainly FDI) in the SME sector

Milestones were to be achieved through:

- Simplification of administrative and normative directives in the SME sector
- Improvement of business environment and competitiveness of Bulgarian small and medium enterprises
- Help in the process of internationalization and specifically in SME’s economic activity within the EU
- Ensure better access to financing opportunities

Success of the strategy was limited in the shorter term and was strongly hindered by a series of financial and economic slow-downs. In general, small and medium enterprises in the country were slow to react to the rapidly changing national and international business environment and failed to take advantage of the scarce governmental/non-governmental stimuli. Chaotic business environment, limited access to funding, huge trade deficit (almost lack of export activities), countless bureaucratic obstacles and aged production facilities were characterizing the SME private sector in the late 90es.

However, a couple of possible developments were to be observed as well. Firstly, the continuous increase in FDI, mainly due to the privatization processes that took place in the second half of 1990es. Secondly the growing importance of SME sector in economy’s value added^[2]. As the table below illustrates, in 1999, the share of SME sector in the country’s value added extended to the still record 27.3% (some 50% on average in developed Western European economies), a positive note reflecting the increasing impact of the SME sector on the national economy.

Table 2: Size and ownership structure of enterprises (%)

Abbildung in dieser Leseprobe nicht enthalten

Source: NSI: www.nsi.bg

In summary, the emergence and early development of the SME private sector in Bulgaria was characterized by a handful of ups and downs. Along with the numerous obstacles, both internal and within the business environment, several positive signs were to be observed:

- Growing absolute number of small and medium enterprises
- Mounting sector contribution to the economy’s value added
- Increasing governmental attempts to promote and stimulate SME growth
- Formation of non-governmental organizations aimed at providing financial and technical assistance to the sector.

1.2. Relative Importance for the National Economy

According to the active legislation in Bulgaria, micro, small and medium enterprises are defined as described in the table below^[3]:

Abbildung in dieser Leseprobe nicht enthalten

In modern market driven societies, SME are a prime engine for economic development. Their strategic functions and capabilities can be defined as follows:

- Employment generator and contributor to more competitive business environment
- An important driver/tool for social and regional development
- A primary factor for “middle class” formation
- Small and medium enterprises possess flexibility and can respond quickly to changing market conditions
- SME sector serves as a fundamental platform for innovations, new technologies and is a favorable arena for development of entrepreneurial skills and strong corporate culture

This part of Chapter I focus on the relative importance of small- and medium-sized enterprises for the national economy as a whole. Additionally, recent sectoral developments and trends as well as problems and barriers to growth are discussed in order to create a comprehensive sectoral profile and lay a basis for analyzing the supply and demand of debt finance instruments for the SME segment (Chapter II).

1.2.1. General Outlook

Small- and medium-sized enterprises are of major importance for the national economy. They play an important role for improving the competitiveness of the Bulgarian economy through mainly generating higher value added and employment. Significant is their function as a tool for regional development.

In summary, SME sector’s weight in the national economy is growing as are regional disproportions. The number of employed at small- and medium-sized companies is growing faster than the number of firms, hence “growing up” of SMEs is observed. Additionally, consolidation of enterprises in the sector is monitored resulting in size structure shift on one hand and further increase of regional discrepancies on the other. Furthermore micro enterprises are the dominant sub-sector employment generator irrespective of location and industrial sector. Micro enterprises however account for the lowest productivity per employee compared to small- and medium-sized companies and therefore the lowest value added. All in all, small- and medium-sized enterprises dominate each planning region in the country and remain prime engine of the Bulgarian economy.^[4]

1.2.2. SME Economic Profile

Next two parts analyze key economic and financial performance indicators of the SME sector in order to illustrate the growing importance of the sector for Bulgaria’s economy.

- Total number of private SME

The number of SME continued to rise further after 2002. In 2004, an increase of almost 18,000 (8.5%) was registered against 2001. SME’s relative share (absolute number) in the private sector grew steadily to about 99.7% in 2004, a value similar to that in developed Western European countries (>99%).

Table 3: Total number of private SMEs

Abbildung in dieser Leseprobe nicht enthalten

Source: NSI: www.nsi.bg

Micro-enterprises (1 to 9 persons employed). Major feature of Bulgaria’s private SME sector is the prevalence of micro enterprises. Total number of companies in this sub sector grew to 198 727 in 2004 recording a 5.5% (10 366) increase against 2001. Due to the size structure shift or in other words the “growing up” of enterprises however, the relative share of micro enterprises in the total number of private companies has declined by around 3% to 89.6% compared to 2001.

Small enterprises (10 to 49 persons employed)

Enterprises with 10 to 49 employed are the fastest growing segment in the Bulgarian economy. Their share in the private sector increased by 2.5% to 8.5 in 2004 compared to 2001. In absolute terms, registered private small enterprises in 2004 were 18, 855 against 12,183 in 2001, or an increase of 6672 companies (54.8%).

Medium-sized enterprises (50 to 249 persons employed)

Medium-sized enterprises represent the smallest subgroup segment within SME and account for about 1.6% of the total number of private enterprises. The “growing up” effect outlined later contributes to the 28.8% (up 800) increase in the number of medium sized enterprises in 2004 against 2001. That is, more likely small (10 to 49 employed) companies have grown than new medium sized firms have been established within the period of interest.

As far as absolute number of companies in the SME segment is concerned, Bulgaria proves to have similar private sector structure to developed economies- Europe-19 and USA. Representative and positive is the growth rate of small-sized enterprises as well as the fact that the number of employed in the sector in growing faster than the number of companies.

- Employment

In developed market economies, the role of private SME in generating employment is substantial. Therefore the sector is an important instrument for economic planning processes (both national and regional). Relevant policies in Bulgaria are targeted at increasing the relative share of SME in employment as a means to tackle high unemployment levels. Furthermore, in remote and utterly unattractive geographical areas, only small- and medium-sized enterprises are in the position to create work places.

Table 4: Number of employed in Bulgaria’s private sector

Abbildung in dieser Leseprobe nicht enthalten

Source: NSI: www.nsi.bg

The total number of employed in the private SME sector in 2004 was 1,180,406, representing a 23.69% increase against 2001. This data confirms conclusions that employment in the private sector is generated primarily by SME (around 78 %).

Graph 1

Abbildung in dieser Leseprobe nicht enthalten

Source: NSI: www.nsi.bg

Within the SME sector, leading employment creator in 2004 but with a continuously decreasing share was micro enterprises (38.81%) followed by small- and medium-sized companies (31.25% and 29.94% respectively). A trend of size structure shift is clear to observe where small-sized companies experience an increasing relative share in employment generation at the expense of micro enterprises. Medium-sized firms do not exhibit major fluctuations as far as share in employment is concerned. These changes in the structure of employment by size classes of enterprises also support the conclusion made earlier that in the period under review a process of “growing up” of enterprises (primarily micro- and small-sized) is observed.

Enterprises’ growing up is also confirmed by the changes in their average size measured by the number of employed persons per company. This approach integrates the number of SME outlined earlier and the number of employed at private small- and medium-sized enterprises in order to illustrate the real growth in terms of employment generation. In 2004, the average number of employed at a private SME is 5.3, which is by 17% (0.8 in absolute terms) more than the 4.5 in 2001. Within the SME sector, the size of an average micro enterprise in 2004 is around 2.3 people (2.0 in 2001). A small-sized enterprise in 2004 has 19.6 employed on average against 19.5 in 2001, whereas a private middle-sized Bulgarian company has on average around 98.9 employed , recording a decrease of 2.9 in absolute value against 2001 (101.8).

- Contribution to GVA and GDP of the Economy

A positive development is the accelerating increase in the contribution of private small- and medium-sized companies to the country’s value added and gross domestic product. Undoubtedly, large public and private enterprises hold the higher share in GDP and VA contribution because of higher productivity and more adequate capital equipment and production facilities. Restricted access to finance for SME result in inability to finance R&D activities and ultimately harms innovation capacity, lowering value added of output.

Table 5: Private SME contribution to VA and GDP (%)

Abbildung in dieser Leseprobe nicht enthalten

Source: NSI: www.nsi.bg

Value added created by private small- and medium - sized enterprises in 2004 amounted to BGN 7,367m or 58.4% of the value added created by the whole private sector. As table 5 illustrates, large enterprises have the highest share in value added - 41.6%. Looking at SME subclasses, a correlation between size class and contribution to value added is clear to observe. In 2004 medium - sized companies have highest share in value added - 9% against 7.5% for small - sized and 5.7% for micro enterprises. However, small enterprises exhibit the highest growing share in value added in the period 2001-2004 (3%), whereas for the period under review, private medium- sized and micro companies achieve 2.6% and 1.4% increase respectively.

Contribution of small - and medium-sized enterprises to the gross domestic product was 19.2% in 2004, a 5.7% increase compared to 2001. Similar with contribution to value added, size class is the key determinant toward a bigger share in GDP contribution. Large enterprises have the highest share in 2004 - 13.7% and growing. Within the private SME class, medium-sized enterprises account for 7.8% contribution to GDP, small - sized and micro companies for 6.5% and 4.9% respectively.^[5]

1.2.3. Competitive Position

- Profitability

Understandably, profitability is a crucial factor for sustainability of business operations. It is true that, the smaller the size of enterprises, the lower their gross operating rate and subsequently the lower their profitability. Accordingly, SME profitability can be assessed, with micro enterprises being least profitable, followed by small- and then medium-sized companies. Generally, the gross operating rate of SMEs (5%) is twice as low as GOR of large enterprises (10%). Reports illustrate that, apart from gross operating rate, higher profit per person characterizes large enterprises compared to SME.

- Turnover

The total turnover generated by SME in 2004 amounted to around BGN 64.9 billion, a 69% increase against 2001. Looking at subclasses, no substantial differences can be acknowledged with private small - sized enterprises having generated slightly higher total turnover than medium - sized and micro companies. Unsurprisingly, large enterprises do have the highest share in turnover generation within the private sector - little above 27%.

Table 6: Turnover of private enterprises in the population surveyed, BGN ’000

Abbildung in dieser Leseprobe nicht enthalten

Source: NSI: www.nsi.bg

Considering the close turnover generation values, interesting is to analyze turnover per individual size class so that a better understanding is gained of the private SME sector profitability. The average turnover per SME (total number of SME/ generated turnover) in 2004 was BGN 293,000, which is about 150 times lower than that of an average large enterprise (43,460,000). A medium-sized enterprise in 2004 generated turnover of BGN 5,882,000, an almost BGN 900,000 increase against previous year. Turnover per small-sized and micro company in 2004 was BGN 1,180,000 and BGN 98,000 respectively. Apparently, biggest sub class dispersion in terms of turnover generation exists between micro and small-sized enterprises, with the latter generating more than 10 times the turnover of micro enterprises.

- Efficiency

Efficiency is a critical factor for corporate competitiveness. It serves to illustrate how competent is the usage of human and fixed-tangible resources. As credibility of available personnel costs data is questionable, share of fixed-tangible assets in generating turnover will be used as a means of analyzing efficiency.

Table 7: Efficiency of SME (FTA/Turnover in %)

Abbildung in dieser Leseprobe nicht enthalten

Source: NSI: www.nsi.bg

Generally, the higher the ratio, the more efficiently FTA are used and the higher importance they have in generating turnover. As the table illustrates, efficiency in SME sector stands at 24.40% and has continually increased since 2001. Sub-sect oral values indicate improving efficiency within the micro and small-sized enterprises and stagnation within the medium-sized companies. Understandably, large capital intensive businesses have higher share in private sector efficiency, as they mostly generate turnover through capital intensive production goods. Micro and small-sized enterprises achieved highest growth in efficiency for the period 2001-2004 (around 7% and 5.2%). Substantial growth in terms of turnover (Table 7) as well as increased investment in FTA (Table 8) serves to confirm the “growing up” trend discussed earlier in the text.

- FTA (fixed tangible assets)

Value of fixed tangible assets is presented as a platform for assessing efficiency as well as a rough illustration of the yearly need for capital (to be discussed in chapter II) in terms of FTA investments.

Table 8: Fixed Tangible Assets, BGN ‘000

Abbildung in dieser Leseprobe nicht enthalten

Source: NSI: www.nsi.bg

Total value of FTA in the small- and medium-sized enterprises accounted to about BGN 15.8 billion in 2004 compared to roughly BGN 8.1 billion in 2001. In relative terms, 93.13% and 87.31% is the increase in value of FTA within the SME and large enterprise sectors respectively (2001-2004), underlining significant private sector growth in the period under review.

Clearly the share of FTA between subclasses depends on the size of enterprises. Within SME, medium-sized enterprises have the highest share of fixed tangible assets - 36.19% closely followed by small-sized companies- 34.71% and micro firms - 29.34%. However, in terms of FTA growth within the period of interest (2001-2004), small- and micro-sized enterprises have achieved triple digit results (115.1% and 112.9% respectively) whereas medium-sized companies have registered 64.84% increase in fixed tangible assets value.

In order to assess the sub-class “capital endowment”, value of fixed tangible assets per enterprise is calculated.

Table 9: “Capital Endowment” - FTA per enterprise, BGN

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Sub-class differences in capital endowment are substantial and further growing. In 2004, an average medium-sized enterprise holds about BGN 1.600 million in fixed tangible assets, which is roughly six times the capital endowment of a small- sized enterprise (BGN 289,060) and 69 times that of a micro firm (BGN 23,350). A small-sized company in 2004 had around twelve times the capital equipment of a micro enterprise. Within the period 2001- 2004, capital endowment of a micro enterprise increased by 103.88%, whereas the FTA value for an average small- and a medium-sized company grew by 37.61% and 27.94% respectively.

- FIA (fixed intangible assets)

Value of fixed intangible assets is important indicator of the innovative capacity and the ability to create and protect intellectual rights. A statistical analysis of FIA can only be performed for enterprises with double entry accounting. According to NSI, just about 35% of private enterprises in Bulgaria do prepare financial statements. Hence representatively of results is relatively low and fails to create a detailed image of the private sector’s intellectual capacity.

The value of balance sheet reported fixed intangible assets within the private sector was roughly BGN 1.25 billion, a decrease of BGN 0.65 billion (5.06%) compared to the year before. Decrease in value of FIA was especially evident within the SME sector and in particular- medium-sized and micro enterprises, which drop off 20% and 40% respectively underlining ongoing sectoral problems with regard to innovation capacity and intellectual property (to be outlined later in this chapter). Although FIA share of small-sized enterprises within the SME sector has increased, they remain the sub segment with the second lowest subsectoral value (26.42%), behind micro and in front of medium-sized companies ( 50.85% and 22.63 respectively).

Table 10: Fixed Intangible Assets, BGN ‘000

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- Investment in SME

Level of investment in small- and medium-sized enterprises has direct bearing on their competitiveness and opportunities for economic growth. As already outlined, investment in capital equipment is a crucial factor especially for manufacturing enterprises. Hence, medium-sized companies are the most “capital endowed” due to their notably higher need for capital. However, small-sized and especially micro firms do account for faster growth of investment in FTA (more than 100% each since 2001.

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^[1] Law on SME - “Darjaven vestnik, 4th edition, 13th of January 1989”

^[2] Anywhere in this work, the term value added for enterprises refers to value added at factor cost

^[3] Law on SME in Bulgaria “Darjaven Vestnik, 64th edition, 23 th of August 2004“

^[4] Statistical data in this part of Chapter I is obtained entirely from he National Statistical Institute (NSI) due to lack of alternative data sources

^[5] Statistical data in this part of Chapter I is obtained entirely from he National Statistical Institute (NSI) due to lack of alternative data sources