Asia is home to an estimated 271 million small- and medium-sized enterprises (SMEs) which accounts for 98 per cent of the companies operating in the region but with only 19 per cent of those currently receiving bank lending. This is because banks have a “one size fits all” mentality with regards to lending, with funding only available to companies that possess a strong credit rating and have tangible assets which banks can take as collateral; characteristics which SMEs do not tend to possess. 
Furthermore, Asian banks are inherently risk-averse and are eager to protect their credit ratings, therefore, they tend to not participate in the financing of investments that are perhaps wrongly perceived as “risky”. The implementation of Basel III has pushed banks to further strengthen their capital requirements which has in-turn moved financial institutions away from the SME lending space; instead concentrating on providing funds to large and/or investment grade companies.
Asia is also a diverse region of the world with varied legal and governmental structures further contributing to the reluctance of financial institutions to participate in cross-border SME financing, as firms look to expand beyond their domestic market. With a $2.7trn financing gap according to the International Finance Corporation, the growth of Asian SMEs is severely constrained.
SMEs in Asia are financed internally by shareholders until they reach a point where this is no longer a viable route to growth due to limited capital resources. At this point SMEs need to secure external financing from institutions in order to continue growing.
SMEs are also seeking business partners that understand the complexity of local markets in Asia and those that are able to offer value-added services that can fuel business expansion. These partners are unlikely to be found in banks due to the limited amount of resources available to provide the support needed to these firms.
This gap in lending therefore presents an opportunity for sophisticated investors, like Adamas Finance Asia for example, to step-in and secure preferential transaction terms. Because the market is significantly underserved, investors are spoilt for choice when considering these SME opportunities; giving them access to high growth companies in exciting end markets. Furthermore, SMEs are able to benefit from the extensive network the private financiers can facilitate with the intention of accelerating their growth plans.
The number of investment companies operating in the Asian SME sector which focus on smaller deals sizes remains relatively small. Private equity funds such as Blackstone and KKR typically invest hundreds of millions of dollars in a single transaction, which is far above the amount Asian SMEs are typically seeking to raise. This further reduces the pool of capital available to SMEs whilst increasing the number of potential investee companies for investment companies.
As Asia benefits from economic growth, the size of its middle class has been increasing and is expected to reach three billion people by 2030 according to the Organisation for Economic Co-operation and Development.
Asia’s middle class are demanding higher standards of living as their purchasing power increases, as such, this is driving the growth in industries including property, healthcare and food & beverage. The lack of financial institutions focusing on smaller investment into the Asian SME sector has also led to preferential transaction terms being obtained by participating operators. These preferential terms can be in the form of high paying interest rates and appropriate governance measures to monitor the performance of an investee company.
All in all, the Asian private SME market offers significant investment opportunities in a diverse and growing universe. However, investing in the sector requires lengthy experience and extensive due diligence meaning there are relatively few investment vehicles active in the space relative to the size of the market.
Suresh Withana is a co-founder and managing partner of Harmony Capital Investors, the investment manager of Adamas Finance Asia. The views expressed above are his own and should not be taken as investment advice.