KSA عربي
KSA عربي
Global عربي
SMEs typically find it challenging to obtain financing in Saudi Arabia and SMEs lucky enough to obtain loans under acceptable terms must still put-up valuable collateral.
While providing collateral is a mainstay of banking and lending the fear of potentially losing a valuable asset drives SMEs away from traditional finance.
That said, SMEs in KSA looking for collateral-free financing have several avenues that they can turn to.
Financing as whole in Saudi Arabia strictly abides by Shariah law, thus banning the use of interest-bearing credit, excessive speculation, and haram activities.
That said, many Islamic financing contracts do come with clauses that require collateral, such as Tawaruq and Mudarabah. Some that typically don’t include:
- Mudarabah: A profit-sharing agreement whereby the lender enters into a partnership with a borrower for a project or business, and then distribute the profits from the project based on agreed upon terms.
- Musharakah: The lender and the borrower enter into a partnership and share in the profit and losses. In a Diminishing Musharakah, the borrower (who isn’t required to enter into the arrangement with any financial capital) tends to buy the lender’s stake in the project over time.
Read more about: Musharakah vs. Standard partnership agreement
One of the most common forms of collateral-free financing is selling ownership stakes in the company.
For SMEs looking to grow into startups and then full-fledged companies, that would mean looking for angel investors, VCs and other institutions in the startup ecosystem such as incubators and accelerators.
Financing from these institutions usually comes in the form of investment, with no loans involved and no collateral. As investors, these institutions also provide connections, mentorship and other resources to help nascent businesses grow and succeed.
The primary disadvantage of this form of funding is that it is dilutive, requiring founders to give up an ownership stake in the.
Furthermore, the startup ecosystem is geared towards businesses looking to scale up and grow into startups and large businesses. SMEs that can’t scale will find it difficult to tap into this ecosystem.
Read more about: Angel Investing: A Guide to Investing in Early-Stage Venture
Crowdfunding allows businesses to raise funding for a project from a large group of people through online platforms. This type of funding comes in a variety of forms, including:
· - Soliciting donations from those eager to help the business.
· - Obtaining funding in exchange for rewards and benefits offered by the business.
· - Offering ownership stakes or profit-sharing schemes for those who invest.
· - Borrowing through peer-to-peer lending, whereby the business borrows from a large pool of individual lenders at an agreed upon rate or a fixed rate offered by the platform.
Whether it is peer-to-peer lending or other forms of crowdsourcing, collateral is typically not required. However, by its nature, this form of collateral-free financing opens the business up to public scrutiny, so any obligations offered by the business must be met.
Read more about: What are the different types Crowdfunding Platforms in Saudi Arabia?
Microfinance institutions provide SMEs with small loans. These institutions provide credit to businesses who have been traditionally shut out of the finance sector
Apart from requiring no collateral, these institutions typically forego other requirements demanded by banks, including extensive business records.
That said, the loan sizes are very small and may be unable to meet the needs of businesses looking for extensive funding. Also, some of these institutions provide funding at higher interest rates.
Read more about: Microfinance in Saudi Arabia
In Saudi Arabia, several banks provide credit card financing, allowing customers to access funds up to a certain limit without requiring any collateral.
These credit card financing options usually follow shariah compliant structures and may include installment-based repayment plans or cash withdrawals.
These typically use the following Islamic contracts but without the collateral typically used in these types of financing structures:
· - Murabaha: A financing arrangement whereby the lender purchases an asset and then sells it to the borrower at a mark-up or cost-plus profit.
· - Tawaruq: Similar to a Murabaha with the added step of then reselling the asset to obtain the desired liquidity.
Banks that provide this service include: Al Rajhi Bank, Riyad Bank, and the Saudi National Bank.
This form of funding sees suppliers provide SMEs with goods on credit and receive their payments at a later date – usually after the business has managed to sell off a portion of its inventory.
This is a very common form of financing, especially for typical mom and pop stores, with much of their inventory having been secured through this.
However, defaults can be costly, as suppliers may cut off the business if they fail to pay for their product and may force them into litigation.
Similar to trade credit financing, some companies provide SMEs with installment-based financing for purchases such as electronics, furniture and appliances, and equipment without requiring collateral.
The repayment terms are often structured over a fixed term, often with a mark-up but without interest. This allows SMEs to spread their financing for capital goods over time without risking assets.
This is a form of financing sees businesses borrow in exchange for a percentage of their gross revenues.
This form of funding provides businesses without access to the banking sector with collateral-free credit that is solely contingent on their ability to secure revenues, allowing entrepreneurs to focus on their topline growth.
This model aligns the priorities of the borrowers and the lenders as both benefit from the business achieving revenue growth.
That said, this type of financing is available solely to revenue-generating businesses, which is very difficult for newly-founded businesses.
This model typically shouldn’t be considered by businesses looking for long-term loans, as they may prove to be very expensive in a high interest rate environment.
Read more about: Are installments Halal?
Qard hassan is a type of loan in Islamic finance that comes without profit, interest and usually is collateral-free. These type of loans – where the borrower is usually only on the hook for the principal – is typically offered as a form of charity or social funding.
This type of financing is typically used to fund personal needs, emergency assistance or in support of entrepreneurs and SMEs.
Qard hassan in Saudi Arabia is usually provided in the context of charity or government-backed programs.
Among the most notable providers are
- The Saudi Social Development Bank
- The Sulaiman Bin Abdel Aziz Al Rajhi Foundation
- The King Khaled Foundation.
Read more about: Al Qard al Hasan (benevolent loan)- All You Need to Know
Unlike private-sector lenders who provide financing to SMEs with the motivation of profit, government-backed programs by government-backed institutions are designed to provide loans at favorable terms and grants to SMEs as a means of national economic development with the mandate of helping SMEs succeed.
These include programs through the Saudi SME General Authority (Monsh’at) and the Saudi Industrial Development Fund and its Kafala program, which provide financing for a variety of projects at a variety of sizes that range from startup scale to industrial scale companies, often without requiring collateral.
The main downside to these types of programs is they’re competitiveness, with a limited number of SMEs benefiting from them.
Disclamer:
This post is for educational purposes only, and does not constitute investment advice or a solicitation to take any financial action. It should not be relied upon when making investment or financing decisions.
