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The EU has several tools at its discretion to support SMEs within the framework of the Eastern Partnership, with the latest addition being the Equity instrument, part of Access to Finance (A2F).

This instrument was piloted in Armenia, where the EU, with support from the EBRD, made a commitment of 10 million USD (€8.2 million) to the EU-Armenia SME Fund – a private equity fund managed by Amber Capital, which is mandated to pursue appropriate risk adjusted returns by investing in Armenian SMEs. In this way, EU funds are being managed by a professional asset manager for investments in the share capital of local SMEs to fund capital expenditures and expansion projects.

The Equity instrument is structured with two important investment enhancement mechanisms to help the fund manager raise additional funds from other investors.

Firstly, the EU is providing a first loss guarantee to other investors, meaning that in the case of underperformance other investors of the EU-Armenia SME Fund have a downside protection of up to 10 million USD (€ 8.2 million) before their capital is at risk.

Secondly, the EU does not participate in returns on its invested capital, meaning that the other investors receive the benefit of the returns on EU invested capital pro-rata to their commitments in the Fund.

These enhancements provided by the EU were instrumental to enticing other investors to join the Fund and thereby provide access to finance to Armenian SMEs.

1. Equity and debt as sources of capital

Why is access to institutional equity finance so important? Whilst bank finance is readily available in the Armenian market, very few SMEs are able to secure financing terms at attractive rates. Generally, the USD-denominated bank debt available to Armenian SMEs has interest rates of between 7% - 9% and a tenure of between one and three years. For local currency denominated debt the respective rates are c. 3% higher. In addition to the relatively high interest rate, the business is required to post significant amounts of collateral – from fixed assets all the way to personal guarantees by business owners. Whilst some companies are able to tap the capital markets and issue bonds at more attractive rates, these are usually larger entities from the financial sector with established corporate governance practices and audited financial statements – a pre-condition for listing any instrument on the local exchange.

The result is a significant debt overhang in the economy. Overleveraged SMEs are unable to attract more funding at affordable rates, which in turn stifles growth prospects and keeps the potential of the companies at artificially depressed levels. During times of economic downturn, many SMEs that have amassed a disproportionate amount of debt on the balance sheet face significant cash deficits to service the interest payments, bringing them to the brink of restructure or even bankruptcy.

Institutional equity finance provides a way out for SMEs that are facing the debt conundrum. The main advantages of equity financing have been proven time and time again and can be summarised as follows:

  • An equity investor becomes a partner in the business, sharing the risks and rewards with the existing shareholders.
  • With an equity investment there are no interest payments, so in times of underperformance the business does not have the pressure of additional cash outflows, which can instead be allocated to fund its operations.
  • The equity injection very often results in balance sheet optimisation and a better capital structure, which in turn reduces the risk profile of the company and helps to lower the cost of debt.
  • Institutional equity has significant elements of smart capital – i.e. the investor brings in not only fresh money, but also initiates knowledge transfer, experience sharing, and places a significant focus on financial literacy and corporate governance.
  • Institutional investors are increasingly focused on environmental and social governance (ESG), thus enhancing company valuations in the longer term by embedding sustainable practices and marketleading standards in the core of their operations.
  • Institutional equity investments help SMEs transform from a key-man organisation into corporates with appropriate internal controls, financial reporting, and governance standards, which in turn positions them for future capital market transactions through the listing of bonds and IPOs.
  • Last but certainly not least, equity capital is usually invested to grow the business and fund expansion projects, bringing the SME to a critical size to harvest important economies of scale.

There are numerous advantages to equity financing and private equity funds play a vital role in the development of local markets and corporate landscapes around the world. At the same time, the market needs to be ready to absorb equity capital. This requires a sufficient number of local companies to be at the right stage of development, which has a number of elements to it, such as:

  • Size:

Private equity funds generally operate lean structures and avoid making a large number of small investments due to the resources necessary for each investment, subsequent monitoring, and exits. Generally, a single fund with a critical size of at least 30 million USD (€ 24.7 million) would look to make between 10-15 investments, which implies an average ticket size of 2 million USD (€ 1.6 million) per investment. Since PE funds generally take minority investments, such a ticket size would mean that the company in question must already have reached a certain size prior to receiving an equity injection from an institutional player.

  • Financials:

Whilst SMEs generally do not produce audited accounts, good quality reliable management accounts are nevertheless required to prepare financial analyses, produce projections, and conduct a valuation exercise. Usually this goes hand-in-hand with the size and development stage of the company.

  • Culture:

SMEs are typically managed by original founders of the business, who may have a strong emotional connection to the company they created and do not adhere to the notion of corporate separate personality. In practice, before equity financing can take place, the owner of the business must not only be willing to welcome a new partner on board, but also adopt a new corporate culture and way of doing business, such as ceasing informal practices, minimising any cash transactions, bringing the books of the company into good order, etc.

2. The armenian experience

The EU’s Equity instrument has been utilised for the first time in Armenia through the EU-Armenia SME Fund, managed by Amber Capital, which launched in January 2020. The Fund itself is a single-country fund, focused on providing growth equity capital to Armenian SMEs. Given the fact that the country does not have a track record of institutional equity funds, the instrument created by the EU has played a crucial role in the fundraising process, as the single-country risk and the lack of track record have been partially offset with the first loss guarantee and return enhancement structural elements embedded in EU participation, thereby allowing the Fund to attract investments from domestic and international players.

EU-Armenia SME fund: value creation themes
  Balance sheet optimization Operational efficiency Expansion & Growth delivery Corporate Governance

Lack of equity funding in Armenia has led to excess corporate leverage, debt overhang and barrier for growth.

Lack of company management expertise has led to inefficient business practices and underperformance in terms of return on capital employed.

Relatively low level penetration of Armenian corporations into regional markets, despite favourable trade regimes.

Underdeveloped corporate culture resulted in a lack of effective performance monitoring and reporting processes.


Capital restructuring, removal of debt overhang, reduction of cost of debt and reposition SMEs for growth.

Potential to enhance the target companies’ profitability by providing management access to the relevant know-how and incentivizing the delivery on performance.

Target companies to transition from “national champions” to “regional champions” through regionally focused growth strategy, taking advantage of new international economic partnerships.

Corporate reorganization to define a clear business plan and introduce effective performance monitoring, reducing the risk of mussing targets. Creation of a board of directors and a financial reporting unit with CFO proposed by Amber Capital.

On the investment front, the Fund focuses on deploying capital in key sectors of the economy, employing a combination of top-down and bottom-up analysis and investing in national champions which operate in growing and attractive sectors. Notwithstanding a challenging 2020, the Fund has already successfully deployed capital, with the first investment in the renewables sector at a deal size of ~ 3 million USD (€ 2.4 million). This investment is part of the Fund’s renewables strategy, which aims to build a critical size portfolio of clean energy assets, bolstered with high standards of environmental and social governance, transparent financial reporting, and western-style corporate governance, so as to either list the company on the local market or exit to potential industrial buyers.

In other segments of the economy, the Fund is currently pursuing a number of opportunities in its key sectors of interest, including high-tech agriculture, manufacturing, tourism, healthcare, and textiles. The investment team at the Fund have identified a large number of investment opportunities in the Armenian market where they are looking to implement the Fund’s investment thesis by optimising the balance sheet, de-leveraging and improving cost of capital, diversifying the funding sources of SMEs, and providing capital to allow SMEs to expand their business.

The ultimate goal of the Fund is to transform its pipeline of “national champions” into a collection of “regional champions”, equipped with best standards of governance, financial literacy, strategic vision, and the means necessary to implement it.

The emergence of similar funds is extremely important for all economies, and even more so for smaller economies such as Armenia. Following the COVID-19 pandemic, the necessity of making capital available to SMEs is even more pressing, as the contracting economies are putting pressure on margins and resulting in cash deficits, which, in most cases, SMEs are unable to fund through local banks. At the same time, the Fund’s involvement acts as an important catalyst for the development of local capital markets, by introducing the pre-requisites of listing fixed income and equity instruments such as audited financial accounts and guiding SMEs toward the benefits of listing.

This smart capital angle, brought forth by the Fund, has other benefits as well, including close cooperation with the EU and international financial institutions on such matters as technical assistance and grant programmes aimed at strengthening the SME sector. For example, one of the Fund’s pipeline companies is currently a beneficiary of a technical assistance programme from a leading IFI, helping the company to enhance its marketing efforts, improve financial governance, and develop a business strategy – all key elements in the development of SMEs. The Fund targets similar programmes to be implemented in other portfolio companies, making a systematic shift to higher standards.

As one would expect, the introduction of a similar instrument in the market also presents challenges. During the one year of operations of the Fund, several themes have been identified:

  • Understanding the instrument

SMEs in general have a lack of knowledge of different sources of capital, as the main type of funding they are familiar with is bank debt. The Armenian experience shows once again that institutional equity investors need to spend significant time and resources educating the owners of SMEs and future portfolio companies about the benefits of equity capital, how it differs from debt, and how the two sources of funding can complement each other to create long-term sustainable value.

  • Resistance to change

The introduction of an institutional equity partner brings many positive changes. However, those who have founded and developed a business across many years have a natural reaction to push back against initially unfamiliar concepts, such as the inclusion of new partners in the decision-making process, financial reporting requirements, the creation of a Board of Directors, overall increased accountability, and the costs that the implementation of sound internal control systems and corporate governance would entail. The investment team found that SMEs often take a short-term perspective on value creation and hesitate to invest in projects that do not yield immediate results.

Again, the investment team has had to engage in a significant amount of educational activities, at times supplemented by technical assistance from IFIs, helping company owners to view the cash outflows as an investment, rather than an expense. On this point, while each individual case is different, it usually helps to highlight that the ultimate exit from the company will be significantly enhanced and facilitated if these mechanisms are already in place – there will be more buyers for the asset and the asset will attract a higher valuation. Exit-oriented SME owners are more easily convinced to change the way of doing business if there are case studies from local or international markets showcasing the benefits of transforming their businesses from key-man organisations to largerscale corporates.

  • Valuation

Given the early stage development of private equity in Armenia, with a limited amount of transactions, acquirers of assets usually face a significant bid-ask spread with sellers of company shares. Considerable time is therefore spent on educating SME owners about different valuation methodologies, assumptions, and analysis that underlie the Fund’s financial models.

In this instance, third party valuators are of limited help, because the main drivers of the bid/ask spread lie between the very bullish projections developed by SME owners and the more conservative approach adopted by the investment team. There have been instances where an otherwise acceptable deal with a company that ticked all the other boxes has not progressed due to the valuation spread. However, in many instances, the investment team has been able to overcome this challenge by bridging the difference through the use of such tools as earnout structures and setting of key performance indicators.

In the end, the numerous challenges notwithstanding, the EU Equity instrument has played a key role in the establishment and fundraising of the first institutional private equity fund in Armenia, which in turn is currently deploying capital in SMEs, diversifying sources of funding, elevating SMEs into the next stage of their lifecycle, and paving the way for increased capital market activity.

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