Saudi SMEs look to sharia funding to balance cash flow

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• Firms turning to fintechs rather than banks to secure bridging loans
• Exempt offer sukuks gaining favour
• Democratising access to investing is crucial for long-term wealth creation

In Saudi Arabia, small to medium-sized companies are increasingly turning to sharia-compliant funding to raise money for their businesses.

But rather than borrow from banks, these SMEs instead rely on the kingdom’s nascent fintech sector to obtain bridging loans, invoice financing and other kinds of niche financial support.

“SMEs are underserved by the banking sector, so this is a way for them to access finance without selling equity and diluting themselves,” Mohammed Al Sehli, chief executive of Saudi’s Wethaq Capital, said. 

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Small companies often use crowdsourcing platforms to raise anything from $50,000 up to around $2.67 million, while private placements are the preferred route for raising more than that, said Al Sehli.

A private placement is a sale of shares or bonds to investors and institutions rather than publicly on an open stock market.

“Private placements require further disclosures and have proper legal counsels involved, so there is a more extensive work associated with that and the cost becomes higher,” Al Sehli added. 

“Some smaller companies just need, say, 5 to 10 million riyals ($1.34 million to $2.67 million) to get a project up and running or to run operations for a year, so it’s not worth the extra, up-front cost of doing a private placement. It’s better to go for an exempt offer sukuk.”

So-called exempt offer sukuks have been legal for several years but were little used due to the lack of supporting infrastructure to make them workable, said Al Sehli.

Then in 2018 the central bank and capital markets regulator amended their rules to begin issuing experimental permits – the so-called regulatory sandboxes where fintechs and other financial services innovators can develop new products.

“Exempt offerings have very light disclosures – that’s what they’re exempt from and, as such, makes them riskier,” said Al Sehli, whose company has a sandbox licence and provides and operates the market infrastructure for private placements as well as custody services for private securities.

First crowdsourcing platforms sold equity stakes in small companies and the success of these offerings led the regulator to also allow lending via the same medium. 

Retail investors tend to use crowdsourcing platforms, while institutional and wealthy individual investors participate more in private placements.

On crowdsourcing platforms, companies sell Murabaha or Mudaraba debt instruments, which are sharia-compliant. 

Private placements and exempt sukuk are bought, sold and managed entirely digitally although not through blockchain.

Fintech boom

Two sukuk-based crowdsourcing platforms are among the 29 fintech firms with sandbox  licences issued by the Saudi market regulator, according to its website. 

On Mudaraba Financial Company’s platform, participants can invest SAR 1,000 to 20,000 ($266 – 5,333) in each offer. Currently, five are available, with companies seeking to raise SAR 600,000 to 1.5 million, repaid over six months to five years. These offer returns on investment of 12.65 to 19 percent, while borrowers can raise up to SAR 10 million annually. 

Rival platform Sukuk Capital features Murabaha offerings from several companies seeking to raise up to SAR 20 million. Durations range from 17 to 72 months and promise returns of 9.4 – 82.9 percent. 

Sukuk Capital and Mudaraba Financial Co did not respond to requests for comment. 

The central bank, SAMA, on Monday said it had issued its own sandbox licences to two new companies specialising in debt-based crowdfunding. The duo – Forusand and Tameed – are in addition to about ten other SAMA-licensed crowdfunding platforms.

Riyadh-based Raqamyah, which did not respond to requests for comment, enables peer-to-peer investments in Murabaha instruments. Individual investors cannot invest more than SAR 50,000 in a particular offering.  

Raqamyah offers borrowers various types of financing up to SAR 7.5 million. These include term finance for 12 to 36 months to fund day-to-day operations and invoice financing to ease cash flow strains while awaiting payment from clients. 

Market reforms

Saudi Arabia in 2019 reduced the certificate denomination of a sukuk to SAR 1,000 from SAR 1 million previously, enabling individual investors to participate. 

“Fintech is proving to be a massive enabler in democratising access to investing,” said Khalid Howladar, head of credit/sukuk at DIFC-based boutique advisory R.J. Fleming & Co.

“This is crucial for long term wealth creation and financial inclusion as smaller retail investors have hitherto been denied access to such products that are going to become more important in a high inflation environment. 

“However, it’s important that risk tolerance and consumer protections are key considerations so that retailers fully understand the risks associated with what are relatively high risk and yield credit instruments.”

Al Sehli highlighted similar concerns, noting private placements were lower risk due to tougher disclosure rules that make them more expensive in terms of administration costs for borrowers. Yet this reduced risk also enables borrowers to pay lower rates of return to investors. 

“It’s a risk-reward situation. Like, how much do we pay in order to make this transaction attractive? If the transaction is $2 million or lower, it doesn’t make sense to spend $200,000 on lawyers to do a private placement,” Al Sehli said. 

Although Murabaha debt cannot be resold due to sharia rules, other kinds of sukuk offerings such as mudaraba can, so small minimum tranche sizes will also boost liquidity in the secondary market, said Al Sehli.

“This should add more depth to the markets in the longer term,” he said. “Exempt offers and private placements are investment banking activities, but investment banks don’t bother because it’s not worth it really for them to do a $2 million transaction – it’s effort versus reward.”

In 2019 there were around 10 exempt offer sukuk issued in Saudi Arabia while as of early December 2022 there had been around 30 that year, Al Sehli estimates. 

“In Saudi three to four years ago, you wouldn’t hear much about sukuk – no one was doing them except for very large players such as the government or institutions like Saudi Aramco – it was rare even for other listed companies,” Al Sehli said.

“A key reason was that companies had easy access to loans through banks, especially large entities, so why would you bother doing a sukuk? Now the situation is changing as lending becomes more complex.

“We’re in a discovery phase where issuances are increasing, but we’ve not had defaults as of today. Eventually, there will be some – it’s a natural progression. That will help price risk better in the long term.”