Thailand’s Proposed SME Board Falls Short of Market Needs

The SEC’s proposed SME board is unlikely to facilitate access to capital for startups that are most in need of funding, says Pongnut Thanaboonchai.

Startups are a new breed of businesses that aim to disrupt existing market ecosystems by introducing innovative products and/or services. Once they achieve economies of scale, i.e., breakthroughs, they can play a significant role in shaping a country’s economic prosperity. For this reason, countries have been racing to promote the growth of their startups.

Thailand has joined this group of countries, however, despite numerous government efforts, startups in the country have continued to lag behind those in the rest of the region. One of the primary reasons for this is a lack of access to capital.

Startups in need of capital by way of equity[1] have two options: merge with a conglomerate or go public in an IPO. Due to the high-touch nature of the IPO (particularly, the requirement for a positive EBIT), startups cannot easily list on the stock exchange. After all, they typically reinvest a sizable portion of their revenues in their business operations.

As a result, many startups are forced to rely on corporate buyouts as their only viable funding source. As mentioned in a previous article, the Thai SEC (Securities and Exchange Commission) is considering the possibility of establishing a new board dedicated to startups’ stocks – unofficially dubbed the “SME Board.”

Last month, the SEC published consultation documents outlining the criteria for startups seeking to list. While this initiative exemplifies the SEC’s broader goal of nurturing startups’ businesses, it falls short of addressing the issues underlying startups’ limited access to funding.

The SEC is overly protective of investors

When we examine the consultation documents, the majority of the requirements stem from the SEC’s stance on investor protection. While investor protection is critical, the SEC as a market regulator must weigh its obligation to safeguard investors against its objective of ensuring a prosperous and free market.

If the equilibrium is out of balance, it may work against the capital market. This is demonstrated by the SEC’s proposals on the eligibility requirements for startups themselves and the types of investors that can participate in the new board – imposing restrictions from both sides.

Startups’ side

The SEC requires startups to be public companies, which must have in place investor protection mechanisms which involve additional costs, more complicated governance structures, more comprehensive auditing and reporting requirements, and greater board diversity. Startups that are already cash-strapped and may struggle to meet these obligations.

Additionally, the SEC proposes that startups must be sufficiently large to be listed. Startups must either have a minimum annual revenue of THB 50 million (retail, service, or wholesale) or THB 100 million (manufacturing), or have been funded by a venture capital or private equity trust (i.e. post-series A startups).

Perhaps the SEC believes that the larger a company is, the safer the investment bet for investors. However, the underlying motivation for establishing the new board is to facilitate access to capital for startups that might not otherwise be able to raise funding. Requiring startups to be medium- to large-sized businesses or post-series A ventures contradicts this very notion. After all, why bother establishing an SME board if the SEC is not going to target startups most in need of capital?

Investors’ side

Along with the eligibility requirements for startups, the SEC plans to restrict the types of investors who can trade on the new board. As proposed, only professional investors, qualified investors, and affluent investors will be permitted to invest in startup stocks.

This means that retail investors, who account for 45 percent of total investors in Thailand, will not be permitted to trade on the SME board, which could have an adverse effect on liquidity. The SEC cites a “higher level of risk” as its reason for this proposal.

Lack of liquidity

Even if startups manage to navigate the restrictive eligibility criteria, they may find the lack of liquidity intimidating which might not warrant the listing effort and expense to begin with.

Liquidity is critical for any secondary market to thrive. Increased liquidity enables stockholders to sell their assets more quickly, resulting in a lower risk premium and increased value for the traded stocks. If the secondary market is illiquid, it may have a negative impact on the value of IPO transactions, discouraging companies from listing.

As previously stated, the SEC will restrict trading to only professional, qualified, and affluent investors. Additionally, the SEC is considering imposing obligations on intermediaries to verify that qualified and affluent investors possess sufficient investment knowledge and experience.

This, combined with the retail investor restriction, limits potential investors to private equity and venture capital funds. However, these two entities share a common investment strategy in that they acquire stocks and hold them for a period of five to ten years. This may cause startups to reconsider the value of listing, particularly if doing so would result in a decrease in their companies’ valuations in subsequent funding rounds.

A cascading effect

It is imperative that the SEC gets to this funding problem and gets it right. Limited exit options have the potential to have a cascading effect on the entire startup ecosystem. Startups generally seek to disrupt established businesses through the provision of innovative services and products. Having company mergers as the only viable exit route may jeopardise this attractive, if not defining, feature of startups.

As Mark Zuckerberg once said, “it’s better to buy than compete.” Large companies may acquire promising startups in order to limit competition, leaving startups that need funding with no choice. Second, the lack of exit opportunities shapes founders’ entrepreneurial mindsets. Ideally, founders should seek to innovate in order to alleviate market pain points. Why bother if their businesses are destined to become part of a corporate bureaucracy? Entrepreneurs may be dissuaded from market innovation in favor of products and services that merely attract larger corporations. In the end, it’s the entire ecosystem that suffers.

It is noteworthy, however, that having a liquid and functioning SME board presents just one solution to the multi-faceted difficulties embedded in Thailand’s startup ecosystem. Currently, the law governing private companies is not conducive to the nature of startups in terms of capital, governance structure and flexibility. In addition, private companies cannot easily affect debt to equity conversion, and face a difficult process when seeking to implement preferential shares schemes. These issues may also ward off potential investors, but are beyond the scope of this article.

The SEC should adopt a more consultative approach and launch a regulatory overhaul campaign to address the shortcomings of its proposed SME board in one go. A piecemeal regulatory approach is not an answer to this highly critical task.

[1] Negative balance sheets and a lack of tangible assets generally make it difficult for startups to obtain loans.

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