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THE DAR ES SALAAM STOCK EXCHANGE (DSE) ENTERPRISE GROWTH MARKET (EGM): The Financing Solution for SMEs TRAINING MODULES Table of Contents FOREWORD BY DSE CHAIRMAN ON ENTERPRISE GROWTH MARKET TRAINING MANUAL.............. ii ABBREVIATIONS AND ACRONYMS ................................................................................................................. iii MODULE 1: AN OVERVIEW OF SMEs IN TANZANIA ..................................................................................... 1 MODULE 2: BUSINESS LEGAL STRUCTURES................................................................................................... 7 MODULE 3: BUSINESS PLANNING AND EVALUATION................................................................................. 18 MODULE 4: FINANCIAL MANAGEMENT AND RECORDKEEPING.............................................................. 30 MODULE 5: CORPORATE GOVERNANCE AND COMPLIANCE.................................................................... 38 MODULE 6: FINANCING OPTIONS FOR SMEs............................................................................................... 52 MODULE 7: DSE’s ENTERPRISE GROWTH MARKET....................................................................................... 60 MODULE 8: LISTING REQUIREMENTS AND CONTINUOUS LISTING OBLIGATIONS............................. 68 LIST OF FIGURES Figure 1: Types of Companies........................................................................................................................ 9 Figure 2: Diagram of Relationships within Companies.............................................................................. 14 LIST OF TABLES Table 1: Categories of SMEs in Tanzania.................................................................................................... 2 Table 2: Key Features of Legal Business Entities in Tanzania ................................................................. 15 Table 3: Sample SWOT................................................................................................................................... 24 Table 4: Example of a Balance Sheet .......................................................................................................... 34 Table 5: Example of an Income Statement.................................................................................................. 35 Table 6: Example of a Cash Flow Statement.............................................................................................. 36 Table 7: Eligibility Conditions for Listing on the EGM............................................................................. 64 TRAINING MANUAL I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I i Foreword by DSE Chairman on Enterprise Growth Market Training Manual S mall and Medium Enterprises (SMEs) play a crucial role in employment creation and income generation and contribute substantially to development in Tanzania. SMEs have been established in both rural and urban settings to cover both farming and non-farming economic activities, thus, playing an important role in utilising and adding value to local resources. Indeed, SMEs’ development can be closely associated with a more equitable distribution of income and is thus an important factor in poverty alleviation and economic empowerment initiatives. Tanzania has many different policy initiatives that aim at developing the SME sector, but its full potential has yet to be tapped due to a number of constraints hampering its development. Financial literacy and access to finance are among the major constraints facing SMEs in Tanzania. According to the Micro, Small and Medium Enterprises (MSME) Survey Report of 2010, the two biggest challenges to growth in Tanzania are insufficient working capital and lack of access to financial markets. In the recent past, financial institutions and other stakeholders in the country’s financial markets have developed different solutions aimed at addressing these challenges, but they continue to hinder SME development. In an effort to address the financing challenge that faces Tanzanian SMEs, the Capital Markets and Securities Authority (CMSA) carried out a study that recommended introduction of a market segment at the Dar es Salaam Stock Exchange (DSE) that will cater to SMEs’ capital-raising needs. To implement this initiative, the DSE developed a Training Program to create public awareness and provide education on basic business and managerial skills, to ultimately create an environment conducive to attracting the capital essential for SMEs’ expansion and growth. Simply put, the purpose of this training is to enable SMEs to attract capital from potential investors. This publication contains eight training modules that will be delivered at different workshops aimed at medium-sized enterprises in the country. The training will be held throughout the whole country using a regional or zone approach. The training material is a revised version of earlier materials prepared by specialists or experts from academia, the business industry, and practitioners. The revised material takes into account new developments in Tanzania’s financial markets, particularly new developments in the capital markets and stock exchange operations. On behalf of the DSE Board, I wish to take this opportunity to express my sincere appreciation to: the project’s financiers – Financial Sector Deepening Trust (FSDT); the DSE management and staff; the CMSA; and the other experts involved. Their cooperation and dedication made this publication possible. Pius A. Maneno Chairman Dar es Salaam Stock Exchange August 2013 ii I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I TRAINING MANUAL Abbreviations and Acronyms BEST CIS CBT CGS CMSA CSR DSE EGM FSDT IFRS IPO IRR LDM MEMARTS MIMS MNC MSME NBAA NPV OECD OEM R&D SIDO SME SWOT TIC TRA TZS WACC Business Environment Strengthening for Tanzania Collective Investment Scheme Capital Budgeting Technique Credit Guarantee Scheme Capital Markets and Securities Authority Corporate Social Responsibility Dar es Salaam Stock Exchange Enterprise Growth Market Financial Sector Deepening Trust International Finance Reporting Standards Initial Public Offer Internal Rate of Return Licensed Dealing Member Memorandum and Articles of Association Main Investment Market Segment Multinational Corporations Micro, Small, and Medium Enterprises National Board of Accountants and Auditors Net Present Value Organisation for Economic Co-operation and Development Original Equipment Manufacturers Research and Development Small Industry Development Organization Small and Medium Enterprises Strengths, Weaknesses, Opportunities and Threats Tanzania Investment Centre Tanzania Revenue Authority Tanzania Shillings Weighted Average Cost of Capital TRAINING MANUAL I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I iii MODULE ONE I THE DAR ES SALAAM STOCK AN OVERVIEW OF SMEs IN TANZANIA 6 Module Outline MODULE OUTLINE (i)Introduction (ii) (iii) Purpose of the Module • To describe the importance of SMEs in Tanzania’s economy; • To present the position and role played by SMEs in the economy; and • To convey the importance of SMEs in the creation and distribution of wealth. Key Issues to be Addressed by the Module • Constraints facing SMEs and various interventions to address them; • Government policies on SMEs; • Financing opportunities available in the capital market; and • The role of the Dar es Salaam Stock Exchange (DSE) in providing investment opportunities. (iv)Methodology (v) • Presentations by capital market experts; • Practical examples/case studies of actual situations; • Interactions with entrepreneurs to share their experiences; and • Discussion of practical issues. Expected Outcome(s) • Entrepreneurs should understand various policy initiatives related to SMEs and their objectives in addressing the challenges faced by SMEs; • Entrepreneurs should be aware of available opportunities and solutions to constraints facing their businesses; and • Entrepreneurs should understand the available financing opportunities in the capital market and hence understand how to access the Enterprise Growth Market segment of the DSE. TRAINING MANUAL I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I 1 Module One 1.0 AN OVERVIEW OF SMEs IN TANZANIA 1.1Introduction 1.1.1 Definition of SMEs The term “SMEs” stands for Small and Medium Enterprises. The commonly used factors in defining the term are: total number of employees; total capital investment; and sales turnover. The Organisation for Economic Co-operation and Development (OECD) defines SMEs as non-subsidiary, independent firms that employ less than a given number of employees (between 250 and 500). As per the Small Industry Development Organization (SIDO) definition, SMEs in Tanzania are mostly formal undertakings engaging up to 100 employees, with a capital investment of up to TZS 800 million. To be listed on the Enterprise Growth Market (EGM) segment of the Dar es Salaam Stock Exchange (DSE), SMEs must have net assets (issued and paid up capital) of at least TZS 200 million. 1.1.2 Classification of SMEs For the purposes of the Tanzania’s SMEs Development Policy, SMEs are categorized as follows: Table 1: Categories of SMEs in Tanzania Category Employees Capital Investment in Machinery (TZS) Micro enterprise 1 – 4 Up to 5 million Small enterprise 5 – 49 Above 5 million to 200 million Medium enterprise 50 - 99 Above 200 million to 800 million Large enterprise 100+ Above 800 million 1.1.3 Attributes of SMEs SMEs possess a number of attributes that make them potential contributors to economic growth, including the following: • Compared to large enterprises, SMEs are usually more in number and therefore take up a larger share of the labour force. According to the MSME Survey Report of 2010, there are more than 3 million small businesses in Tanzania; • They are creators of employment opportunities. The MSME Survey Report shows that small businesses have over time employed more 5 million people; • They are a potential source of innovation, entrepreneurial talent, and export competitiveness; • Their existence increases competition and hence economic dynamism; and • Their support of entrepreneurial spirit and skills in diverse geographical areas 2 I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I TRAINING MANUAL contributes towards the reduction of economic disparities between urban and rural areas. 1.2 The Importance of SMEs in the Economy SMEs play a crucial role in employment creation and income generation in Tanzania. SMEs all over world and in Tanzania in particular can be easily established, since their requirements for seed capital, technology, and management are relatively minimal. SME development is closely associated with a more equitable distribution of income and is thus an important factor in poverty alleviation. At the same time, SMEs serve as a training ground for emerging entrepreneurs. 1.3 Policy Framework for SMEs in Tanzania In recognition of the importance of the private sector and SMEs in particular, the Government of Tanzania has put in place many supportive policies and programs. These are intended to create the necessary enabling environment for the private sector by addressing some of the key constraints it faces. Such policies and programs include, but are not limited to, the following: • Small and Medium Enterprise Development Policy The policy outlines priorities/strategies and improves the operations and competitiveness of existing SMEs while also helping to establish new ones. Its main mission is “to stimulate development and growth of SMEs’ activities through improved infrastructure, enhanced service provision, and creation of supportive legal and institutional framework so as to achieve competitiveness.” • National Microfinance Policy This policy’s overall objective is to provide a basis for the evolution of an efficient and effective micro-financial system in the country, and thus to provide a framework for ensuring coordinated interventions by the different players in the system. • Sustainable Industrial Development Policy This policy helps to create the overall framework for the country’s future industrial development (including SMEs). Furthermore, it provides for government support in enhancing SMEs’ capacities by improving the legal and regulatory framework and access to finance. • National Strategy for Growth and Reduction of Poverty This policy builds on interventions in the following areas: economic growth; reduction of income poverty; improvement of social life and wellbeing as well as governance and accountability; and addressing the challenges faced by the private sector (including SMEs) with respect to access to finance. The policy further outlines initiatives to improve the investment environment and provides for the government’s intention to support innovation, product development, and TRAINING MANUAL I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I 3 quality marketing strategies by local firms, including SMEs, to make them more competitive and enhance their capacity to respond to global marketing conditions. • Program on “Business Environment Strengthening for Tanzania” (BEST) This program aims at: achieving better regulation; improving commercial dispute resolution; strengthening the Tanzania Investment Centre (TIC); changing the culture of government; and empowering private sector advocacy. 1.4 Major Constraints to the Development of SMEs Three major constraints contribute to the underdevelopment of SMEs in developing countries, including Tanzania: • • • A non-supportive business environment; A lack of managerial and technical skills; and A lack of access to capital for growth. For the SME sector to grow in a sustainable manner, all three areas need to be addressed. However, this manual addresses only the third constraint: access to capital. This area has received relatively more attention than the other constraints faced by SMEs, but nevertheless remains a major constraint for the SME sector. So far, efforts to enhance access to finance by SMEs have focused mainly on commercial banks, microfinance institutions, and government/donor-funded programs. However, these funding sources have provided mostly short-term financing and, in some cases, have not been sustainable. Consequently, SMEs have not been able to obtain long-term funding for growth. There is, therefore, a need to identify additional sources of funds to provide long-term financing. 1.5 Financing Opportunities Available in the Capital Market As key stakeholders in the implementation of the government policy on SMEs, Tanzania’s capital market institutions have put in place an institutional framework to address the constraints to capital, management, and technical skills development. The capital market institutions’ intervention is intended to enable prospective qualified SMEs to enhance their business management capacities as well as to expose them to sustainable sources of finance. The Enterprise Growth Market (EGM) on the DSE A stock market is a vital part of economic development as it encourages savings, helps channel savings into productive investment, and encourages entrepreneurs to improve the efficiency of their investments. The introduction of the EGM segment on the DSE will serve founders and developers of enterprises by ensuring that capital is available to start or expand any project. 4 I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I TRAINING MANUAL Medium enterprises are the target group of the EGM. The selection of this target group is based on the following factors: • • • • Their size makes it possible for them to attain economies of scale and as such, they have the necessary absorptive capacity and can fully capitalize on the technology and technical assistance provided to them; They are potential sources of innovation; They have the growth potential to access funding through capital markets and thus can facilitate wealth creation through wider share ownership among Tanzanians; and As entities with listing potential, they have the potential to provide a demonstration effect and to bring about a multiplier effect. 1.6Conclusion SMEs are considered among the key vehicles for wealth creation, with the potential to make a substantial contribution towards real economic growth depending on their growth orientation. In Tanzania, the full potential of SMEs sector has yet to be tapped due to the existence of a number of constraints (e.g., limited access to finance). The main focus of this module was to highlight the capital financing options currently available to SMEs in Tanzania, with emphasis on the role of capital markets. The module introduced the DSE’s EGM platform as one of the preferred long-term capital financing options for SMEs in Tanzania. TRAINING MANUAL I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I 5 BUSINESS LEGAL STRUCTURES Course Outline (i)Introduction (ii) Purpose of the Module • To help entrepreneurs understand the main forms of entities used in conducting business and the cost implications of each form of business; • To convey to entrepreneurs the comparative advantages of each form of business and to provide a comparative analysis of each; and • To enable entrepreneurs to make better, more informed choices of business legal structures (recognizing their importance in wealth creation and distribution). (iii) Key Issues to be Addressed by the Module • A comparative analysis of a variety of legal forms of business and what it takes to establish each form of business entity; • The factors that business persons need to take into account when choosing a legal structure and the post-establishment obligations of each form of business; and • The most appropriate legal structure for SMEs’ growth and sustainability. (iv)Methodology • • • • Presentations by consultants; Practical examples/case studies of actual situations; Participants’ experiences/interactions; and Discussion of practical issues. (v) Expected Outcome(s) • Entrepreneurs should understand the differences between the legal implications of a variety of business entities; • Entrepreneurs should be able to assess which form of legal structure will attract capital most easily (compared to other forms); • Entrepreneurs should be able to describe how limited liability companies make operational decisions; and • Entrepreneurs should understand the importance of the separation of powers between shareholders and management. TRAINING MANUAL I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I 7 Module Two 2.0 BUSINESS LEGAL STRUCTURES 2.1Introduction 2.1.1 What is a Business? A business is an enterprise or operation that produces commodities or renders services. It involves the performance of activities or functions such as buying, selling, and producing. These activities are conducted in a physical, political, and economic environment. The main motive for carrying out a business is profitmaking. 2.1.2 Types of Business Entities The entrepreneur or owner of a business can choose any formal manner in which he or she will operate the business. There are four main forms of legal entities by which business can be conducted: sole proprietorship, partnership, company (private, public, or listed), and commercial trust. The critical characteristics of each relate to: • • • • Ownership: Who owns the business? Control: Who runs and manages the business? Responsibility: Who is responsible for the business’s performance? Accountability: To whom is the leadership accountable for the business’s performance? • Liability: Who is liable for the business’s debts? • Taxation: Who pays the business’s taxes? 2.2 Considerations in Choosing the Form of Business Structure 2.2.1 Formality in Setting Up • A sole proprietorship can be established easily with no need to prepare any constitutive documents, as is the case with partnerships, companies, and commercial trusts. • A partnership: forming partnerships involve preparing agreements and filing constitutive documents to provide for the comprehensive treatment of all present and future aspects of the relationship. • A company: The Companies Act, 2002 imposes a number of formalities on the formation of a company, such that prescribed documents must be prepared and lodged with the Registrar of Companies. 8 I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I TRAINING MANUAL Figure 1: Types of Companies COMPANIES Private Company Ltd. (2 minimum shareholders: maximum 50 shareholders) Public Company Ltd. Shareholders (minimum 7, maximum - no limit) Public Company Ltd. - Listed on a Stock Exchange 2.2.2 Liability for Debts In sole proprietorships and most partnerships, sole proprietors and partners are fully liable for all the debts of the business. A partner has a right of contribution from his fellow partners but if they are unable to contribute, he is liable without limit. In limited partnerships, partners are liable up to the amount of authorized capital. The liability of a shareholder in a limited company is limited to paying the agreed price for his shares; usually this is paid in full at or within a short time after allotment by the company. A company provides the best cushion for liability to its owners compared to the other two forms of business organization. However, in certain circumstances (e.g., fraudulent or wrongful trading, personal guarantees, breach of duty to the company, and penalties under the Companies Act), directors are personally liable for what they have done or failed to do. 2.2.3 Raising Finance (i)Loans A lender extending a loan to any person will usually seek security for repayment of the loan. Companies, partnerships, and sole proprietorships can all create fixed charges over their assets as security. However, only a company is able to create a floating charge (for example, its stock-in-trade and future assets) as security for its borrowing and therefore a company has greater scope than a partnership or a sole proprietorship for raising loan finance. TRAINING MANUAL I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I 9 (ii)Capital A limited liability company that asks a person to introduce capital by becoming a shareholder has the benefit of being able to assure the investor of limited liability not offered by general partnership. It follows, therefore, that companies have a wider range of alternatives for raising capital than do partnerships and sole proprietorships. For example, only companies can access capital through capital markets; partnerships and sole proprietorships cannot. 2.2.4 Perpetual Life Legally, a company has a perpetual life unless stated otherwise in its constitution. A company is expected to survive the deaths of its shareholders. Although this is the legal position, experience has shown that many companies collapse immediately after the death of their founders. A partnership comes to an end with the death of one partner. The death of the sole proprietor also brings to an end the sole proprietorship. For continuity purposes, a company is the most appropriate vehicle for ensuring sustainability. 2.2.5 Management Structure A sole proprietorship is a “one-man-show.” As such, it is vulnerable to a number of shortcomings as stated above. A partnership is at liberty to organize itself in such a way that certain partners exercise management functions while others are only consulted on major issues. However, as far as an outsider is concerned, any partner may have apparent authority to act in management and may therefore bind the firm. In contrast, a company has a prescribed structure that facilitates the separation of management functions from capital investment in the company. Management functions are broadly exercised by the directors and relatively few functions are reserved for the shareholders in a general meeting. This arrangement provides the flexibility to hire competent persons both on the board and at the management level. 2.2.6 Tax Considerations Before deciding on the form of business vehicle to use, the tax relief available for each form is normally considered. There are many differences between the treatment of an unincorporated business (sole proprietorship or partnership) and that of a company and its directors and shareholders. Some favour the former while others favour the latter. Consideration is then given to the significant differences in treatment. 10 I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I TRAINING MANUAL 2.2.7 Disclosure of Information A company must make public a range of information about its affairs, its directors, and its shareholders by filing returns and documents with the Registrar of Companies or the stock exchange (in case of a listed company). This information includes audited accounts. Partnerships and sole proprietorships are entitled to maintain privacy in all their affairs, with the exception that, in the case of partnerships, the identity of all partners and an address for service of documents must be revealed. Investors prefer business organizations that are transparent; thus, companies are better at attracting investors on this score. 2.2.8 Statutory Obligations and Control Throughout its life, a company must comply with several statutory obligations regarding maintenance and filing of records and information. Examples include the completion of minutes of meetings and statutory registers and the filing of annual returns and audited accounts. These obligations call for administrative discipline and some expense. The Companies Act, 2002 also imposes controls and directives on certain activities, like dividend distribution to shareholders. 2.3 Control and Ownership of a Business Informed by the choice of entity, the fundamental issues of ownership and control influence all future strategic business decisions. 2.3.1 Non-Incorporated Businesses: Proprietorships and Partnerships In the case of sole proprietorships and partnerships, ownership and control are vested in the owners: • They own the business; • They run the business; • They enjoy the benefits of ownership; i.e., capital and wealth creation, as well as remuneration for running and managing the business; • They are personally responsible for the debts and liabilities of the business; • There is no separate legal entity; • There is no separation of ownership and control; • They may employ individual managers to run the business on their behalf; • They are responsible for paying taxes on all profits of the business; • They make all decisions affecting the business; and • They may be operated under the owners’ names or registered business names. 2.3.2 Incorporated Businesses: Companies An incorporated business is an entity that is a listed public company, a non-listed public company, or a private company. Incorporated businesses have ownership TRAINING MANUAL I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I 11 structures and control that reflect the essence of modern corporations and good corporate governance. In simple terms, the relationship between owner(s) and management is as follows: • The shareholders or members own the business; • The shareholders do not directly own the company, but appoint directors to manage and run the business on their behalf; • The directors are responsible to the company and accountable to the shareholders; • The directors are the agents of the shareholders; • The directors are trustees of the company; • Companies are separate legal entities from the shareholders; and • The assets of the business are owned by the company, not by the shareholders. 2.4 Decision Making in Companies 2.4.1 Shareholders’ Decisions (i) Shareholders are the owners of the company as they raise the money/capital to establish the company. Shareholders are responsible for making the following decisions: • Altering any aspect of the company’s constitution; • Appointing directors of the board; • Dismissing directors from the board; and • Condoning any breach of duty to the company by its directors. (ii)Shareholders’ decisions are normally made through resolutions in a prescribed percentage (e.g. 75%) or just a simple majority. 2.4.2 Directors’ Decision-Making Powers (i) Typically, directors are responsible for making the following decisions: • Entering into contracts (including sales and purchases, borrowing, contracts of employment); • Calling general meetings; • Taking legal proceedings in the company’s name; and • Approving transfers of shares (and the consequent changes in membership). (ii) Directors also have limited authority for the following decisions, in the sense that they must first seek approval from shareholders in a general meeting: • Issuing new shares in the company; • Entering into contracts with individual directors by which the company will buy from or sell to that director something of significant value; and 12 I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I TRAINING MANUAL • Awarding to individual directors service contracts of significant duration. iii) Directors’ decisions are made through resolutions passed on the basis of one vote per director and a simple majority suffices. The Board of Directors is generally allowed to delegate its decision making to one or more individual directors or committees. In all types of legal structures (listed public companies, non-listed public companies, and private companies), there are four principal role players (see Figure 2): • Shareholders/members/investors: Those who form(s) the company and provide(s) the start-up and risk capital; • The company itself: The separate legal business entity; • Directors: Agents of owners/members/investors; and • Management: Individual persons who run the company. TRAINING MANUAL I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I 13 OWNERSHIP Shareholders/ Members • Control over leadership • Voting Power Company Separate Legal Entity (with its own Rights, Responsibilities, Assets, LIabilities, Risk, Returns) independent of its shareholders Leadership DIRECTORS • Agents of the owners • Trustees of the Company • Control over Management • Leadership power • Focus on Strategy and Governance Management Executive Directors Top Management Middle Management Employees 14 I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I TRAINING MANUAL 1.0 Control over employees 2.0 Management power 3.0 Focus on operations, tactics and systems 2.5 Comparative Analysis of Various Business Entities Table 2 provides a comparison of the key features of the main legal business entities: Table 2: Key Features of Legal Business Entities in Tanzania S/No CRITERIA SOLE PROPRIETORSHIP PARTNERSHIP COMPANY COMMERCIAL TRUST 1. Formation Natural person Partnership begins trading Agreement Memorandum Trust Deed; and Articles of Certificate of Association; Incorporation Certificate of Incorporation 2. N/A On registration On registration Ceases when there is a membership change Perpetual succession unless stated otherwise Perpetual succession unless stated otherwise By agreement, change of partners or when a partners estate is sequestrated Deregistration or winding-up by dissolution/ liquidation Deregistration or winding-up by dissolution/ liquidation Incorporation N/A (Legal Personality) 3. Existence Ceases when the sole sole proprietor stops carrying on business 4. Termination Ceases when the sole proprietor stops carrying on business 5. Ownership of One natural person Natural or Business legal persons (2 to 20) Shareholders: Trustees on (a) Private (2 to 50) behalf of (b) Public (7 to beneficiaries unlimited) 6. Management The Sole proprietor Owned jointly by all partners The directors The Trustees 7. The partners The directors The Trustees Partners contribute (money, property or services) Issues shared captial of the shareholders Initial contribution by the settlor Shareholders Agreement & Articles of Association Trust Deed & Regulations Representation The Sole proprietor 8. Capital Own resources of contribution the proprietor (money/property) 9. Regulation N/A Partnership, (Agreements) agreement 10. Disposal or N/A As per Agreement As per Articles As per the Trust transfer ofDeed interests TRAINING MANUAL I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I 15 S/No CRITERIA SOLE PROPRIETORSHIP 11. Liability to Liable for all the creditors debts of the business 16 PARTNERSHIP Partners are jointly and severally liable for the partnership debts COMPANY COMMERCIAL TRUST Debts of the company are its shareholders Trustees are liable for all Trust debts 12. Audit No audit required No credit required requirements Audit requirements by independent auditors Audit requirements by independent auditors 13. Accounting N/A N/A requirments by law Specific accounting requirements -disclosure & record Specific accounting requirements -disclosure & records 14. Insolvency of Results in Results into business entity bankruptcy of the bankruptcy of owner the partners Does not lead to bankruptcy of the shareholders Does not lead into bankruptcy of the Trustees 15. Tax Entity Not separate - taxed in the hands of the proprietor (30%) Not a separate entity - partners partners taxed (30%) Separate tax entity (25% - 30%) Separate tax entity (30% or 10%) 16. Salaries to N/A - cash taken is owners drawings and not deductible Salary to an equity partner is an advance against partnership profits If a shareholder is employed, salary is deductible If a trustee is employed, salary is deductible For Salaried partner, it is just a business expenses I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I TRAINING MANUAL MODULE THREE BUSINESS PLANNING AND EVALUATION TRAINING MANUAL I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I 17 Course Outline (i)Introduction (ii) Purpose of the Module • To help entrepreneurs understand the importance of business planning in establishing new businesses and maintaining/expanding existing businesses; • To teach entrepreneurs how to develop excellent business plans for different business sizes; • To convey to entrepreneurs the importance of and need for excellent business plans for SMEs; and • To teach entrepreneurs how to develop business plans for SMEs that can be used to attract capital and/or business financing. (iii) Key Issues to be Addressed by the Module • Business planning and its importance in establishing new businesses and expanding existing businesses; • Business plan creation and how plans can used to attract capital and other available sources of business financing; and • The benefits to SMEs of business planning. (iv)Methodology • Presentations by consultants; • Practical examples/case studies of actual situations; and • Participants’ interactions/experiences and discussion of practical issues. (v) Expected Outcomes • Entrepreneurs should understand the importance of business planning in establishing and expanding businesses; • Entrepreneurs should understand what to include in a business plan and how, when, and why to prepare one; and • Entrepreneurs should understand how a well-written business plan can help SMEs attract capital and different sources of funding. 18 I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I TRAINING MANUAL Module Three 3.0 BUSINESS PLANNING 3.1Introduction A business plan is a very important tool for guiding new businesses to success. It allows entrepreneurs to test if a business idea is feasible and if, when put into use; it can be sustained in the foreseeable future. For a business idea to get off the ground, decisions about products, market, location, size, financing, infrastructure, etc. should be thoroughly examined in a business plan. The business planning process should be given adequate time to satisfactorily answer if the product(s) or service(s) to be offered: fills a gap in the market; provides something different from other businesses in the same industry; and will have a demand in the market that is greater than the current supply. 3.2 Why Prepare a Business Plan? Business planning gives entrepreneurs an opportunity to identify a target market, a product, and customers. It also helps entrepreneurs study the market to establish clear benefits for the customers who ultimately choose to deal with them. Among other things, a good business plan: • Serves as an opportunity to prepare a review of planned operations; • Provides further insights into the detailed working of the company; • Reveals strengths and weaknesses that may not be immediately apparent; • Signals to potential investors the business’s prospects and opportunities for the future; and • Is a document (required) to be presented to the CMSA for capital raising and listing to get regulatory approval. 3.3 Guide to Writing a Good Business Plan A business plan generally projects three to five years ahead and outlines the route the company intends to take to grow revenues. The plan should be reviewed regularly and changed when necessary to ensure that it (and the business) stays focused on the objectives. A good business plan will include, among other things, the following: 3.3.1 An Overview of the Business The business overview section should provide a high-level review of the business’s current position. Key historic milestones and information about the company should be clearly stated here. This section should help financiers, current and potential investors, and the public understand the position, goals, and future plans of the business and its unique proposition. TRAINING MANUAL I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I 19 A brief summary of the following items should be included in the business overview: • The nature of the business and when/how it was established, the industry, and the current market demand for the business’s product(s) or service(s); • The business philosophy and how its marketplace’s logistical needs will be served; • The current number of staff/outlets and the business’s geographic spread, acquisitions, mergers, and large contracts; • The specific and targeted consumers, organizations, or businesses the business serves or will serve; • The business’s main difference from competitors – i.e., its comparative advantages, such as better location, cheaper price, better service, and/or more efficient operations, and the key benefits to consumers; and • Where the business will be three to five years in the future and how this will be achieved. 3.3.2 The Nature of the Business This section describes exactly what the business sells or produces and how it is (will be) produced. It provides a brief overview of the services/products in terms of branding, special features, packaging, key supplies, and on-going service or product development. It highlights the benefits to potential and current customers and focuses on how the business’s particular product/service will fill a need for its target customers. The description of what is offered to customers should include: • A description of the product/service and life cycle; • Intellectual property rights held by the business; • The price and how it is determined (considering production costs, labour, and other overhead expenses); • The competitive operational advantage; • Research and development (R&D) activities; and • Key suppliers and special dealings with supplier/s, if any. 3.3.3 The Business Structure and Management The purpose of this section is to give stakeholders and investors assurance that the business structure and management team can deliver on the prospects and forecasts contained in the business plan. It provides information to regulatory bodies and the public on who does what in the business, the respective 20 I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I TRAINING MANUAL backgrounds of key employees, and evidence of their ability to manage the business and comply with laws and regulations. This section should include: • The business’s organizational and ownership structure; • Details about ownership of the business, profiles of the management team, and qualifications of Board of Directors members; • Other relevant elements such as trademarks, patents, and intellectual property that may need to be protected; • Other key information about legal agreements and senior staff and their involvement/responsibilities; and • The business’s exit strategy (if any). 3.3.4 Market Analysis The market analysis of the business plan should briefly outline what market the business’s product/service will serve and why. It should clearly illustrate the nature of the industry, using market knowledge and data from internal research or from external trusted sources like business magazines, government reports, and consumer surveys. The market analysis should include: • The state of the market – is it growing, declining, or segmented? • Analysis of who will buy the product or service and where the market is (will be) located; • Identification of current customers (if any) and their average buying volumes; • Information regarding positive/negative feedback from customer surveys; • Details of current large contracts and their prospects going forward; • The state of the industry and its outlook – the current size and historic and projected growth rate; • Information about the targeted market – distinguishing character, size of the primary market, how much market share can be gained, etc.; • Market influences such as seasonal price fluctuations or trends; • The price range: based on the target market, will it be high, low or in the middle? and • Barriers (e.g., regulatory restrictions, technology, personnel, cost), if any, that might restrict/hinder production/sales of planned services or products, and the window of opportunity to overcome them. TRAINING MANUAL I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I 21 3.3.5 Industry Overview The industry overview section should show how the industry is currently performing, present the market forecast going forward, and ascertain the opportunities available within the market forecast. 3.3.6 Competitive Analysis The competitive analysis should identify the business’s competition by product line, service, and market segment. The analysis should assess the following characteristics of the competitive landscape: • Market share – how the business’s products/services feature against the competition and an analysis of the business’s competitive edge; • The benefits of the business’s services/products to consumers; • A comparative analysis of the business’s pricing, promotion, and distribution strategies; • Evaluation of the importance of the target market to competitors; • Assessment of any indirect or secondary competitors who may enter the market and impact the business’s success; • An identification of competitors and how they are faring in the marketplace in comparison; • A description of how the business will position its product or service against competitors; and • Opportunities available based on the analysis. 3.3.7 Marketing and Sales Analysis Marketing is the process of creating and maintaining customers, as customers are the lifeblood of any business. This section describes how customers will find out about the business’s products or services, and should include: • Where, how, and when products/services will be promoted (e.g., shopping centre promotions, point of sale, viral marketing, billboard, loyalty schemes, etc.); • The types of printed materials, if any, that will be created; • The business’s website or online presence; • Details and cost of advertising, including print, online, TV, and radio; • Product/service launch plans; • How the success of the marketing strategy and various promotions will be measured; and • How pricing will encourage sales (e.g., selling in bulk). 22 I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I TRAINING MANUAL A good marketing analysis should include the following four strategies: • A marketing penetration strategy – how to enter, capture, gain, and maintain the market; • A growth strategy – an internal strategy for how to increase human resources, buy another business, or branch out, and how to differentiate and segment the market if necessary; • A channels of distribution strategy – how to physically move products/ services to consumers (choices for distribution channels could include original equipment manufacturers (OEMs), an internal sales force, distributors, or retailers); and • A communication strategy –how to reach customers (usually best achieved with a combination of promotions, advertising, public relations, personal selling, and printed materials such as brochures, catalogues, flyers, etc.). 3.3.8 SWOT Analysis A strategic SWOT (Strengths, Weaknesses, Opportunities, and Threats) analysis helps turn knowledge into strategy, which can then be turned into actions. It provides direction to the business and its marketing strategies. The SWOT analysis should be used to describe the business’s strengths and weaknesses and to develop strategies to help eliminate or mitigate them. Table 3 illustrates the generic elements of a SWOT: TRAINING MANUAL I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I 23 Table 3: Sample SWOT StrengthsWeaknesses Advantages the business can exploit, e.g. • good customer service • innovative edge • unique products Areas of the business that need to be acted on, e.g. • poor website • not enough staff training Opportunities Strategies to use strengths to address opportunities Strategies to reverse weakness to address opportunities Marketplace areas taht can be built on, e.g. • gaps in the market • competitor closure Ways to take advantage of business strengths, • promoting good customer service to attract competitor’s customer Ways to ensure weaknesses don’t hamper opportunities, e.g. • hire experienced trainer(s) to up skill staff • provide better customer service Threats Strategic to counter threats with strengths Strategies to fix vulnerabilities External issues that could affect Ways to use business Ways to address areas where the the success of the business, e.g. strengths so threats are where the business may be • decrease in consumer demand • launching new product • utilizing new technologies or • sudden increase in costs to revitalize consumer social media to reach potential demandcustomers 3.3.9 Financial Performance and Projection This section of the business plan should provide in detail the current financial position of the business (if any) and future projections of its financial position (and the basis used). It should include comments regarding key ratios such as: revenue growth, profit margins, and other major industry-specific ratios. The purpose is to highlight the positive factors that will enable the business to grow sustainably for the foreseeable future. It is important to include a short analysis of the business’s financial information – a ratio and trend analysis for all financial statements (both historical and prospective). Graphs of trend analyses (especially if they are positive) and pictures to make the business plan easy to read and understand should be included if possible. The business’s financial situation should be summarized with the following: • How the business will be financed (e.g., business loan, personal funds, or investment capital); • Costing, including start-up costs, salaries, and fixed overheads; 24 I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I TRAINING MANUAL • Financial projections, including how much is needed to break even, when the business is anticipated to make a profit, and any growth expectations; and • Financial statements (including income statements, balance sheet, current cash flow and projections, etc.) to validate the summary. 3.3.10 Action Plan The action plan should clearly explain how business plan objectives are to be achieved, and should be regularly reviewed and used to control decisions and actions taken. The action plan should list actions by key areas (such as Legal, Finance, Establishment, and Marketing). It should clearly state how key tasks will be done, by whom, and by when. If they are too detailed, they may become unworkable. 3.3.11 An Executive Summary The executive summary is often considered the most important section of a business plan. It briefly tells the reader where the company is, where it intends to go, and why the business idea will be successful. If the business is seeking financing, the executive summary is also a first opportunity to interest potential investors. As it highlights the strengths of the overall business plan, it should be the last section written (even though it usually appears first in a business plan document). Depending on the stage of the business, several key points to include in the executive summary are as follows: For an established business, the following information should be included: • The mission statement – a few sentences to a paragraph that explain what the business is all about; • Company information – a short statement that covers when the business was formed, the names of the founders and their roles, the number of employees, and the business’s location(s); • Growth highlights – examples of company growth, such as financial or market highlights (e.g., “increased sales, profit margins and market share year over year for x years”); graphs and charts can be helpful in this section; • A brief description of the business’s products/services; • Financial information – any information about the business’s current bank and investors, especially if financing is being sought; and • A summary of future plans – where the business is headed. TRAINING MANUAL I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I 25 The information in the executive summary should be covered in a concise fashion using clear language. This is the first (and sometimes only) part of the business plan that many people will read, so each word should count. A start-up or new business won’t have as much information as an established company. Thus, its executive summary should include: • A focus on the owner’s personal experience and background as well as the decisions that led to creation of the enterprise; • Clear demonstration of a thorough market analysis by including information about the identified need or gap in the target market, and how the business’s particular solutions can fill this; • A convincing argument that the business will succeed in its target market; and • An exposition of future plans (accompanied by financing options). 3.4 Investment Evaluation Running a business requires regular evaluation of the business. It is very important to know the current value of the business before making an investment or financing decision or changing products and production techniques. For investment decisions, business owners and managers must assess whether the alternative proposed investment will give the best return at minimum risk. Some of the tools commonly used for business or investment evaluation include: 3.4.1 Capital Budgeting Technique (CBT) This is the process by which a business determines whether projects such as building a new plant or investing in a long-term venture are worth pursuing. Oftentimes, a prospective project’s lifetime cash inflows and outflows are assessed to determine whether the returns generated meet a sufficient target benchmark. Also known as “investment appraisal,” CBT is the financial management technique used to analyse whether it is worthwhile to invest in certain types of fixed assets, as this type of investment can have a long-term effect on business affairs and often involves relatively large outlays. Ideally, businesses should pursue all projects and opportunities that enhance shareholder value. However, because the amount of capital available at any given time for new projects is limited, management can use CBT to determine which projects will yield the greatest return over an applicable period of time. 26 I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I TRAINING MANUAL 3.4.2 Net Present Value (NPV) The NPV is the difference between the present value of cash inflows and the present value of cash outflows. The NPV is used in capital budgeting to analyse the profitability of an investment or project. The NPV compares the value of an investment outlay (in money terms) today to the value of that same outlay of money in the future, taking inflation and returns into account. If the NPV of a prospective project is positive, it should be accepted. However, if the NPV is negative, the project should probably be rejected because cash flows will also be negative. If two or more projects are being considered, the one with the highest NPV should be selected. 3.4.3 Internal Rate of Return (IRR) The IRR is the discount rate often that makes the NPV of all cash flows from a particular project equal to zero. Generally speaking, the higher a project’s IRR, the more desirable it is to undertake the project. As such, the IRR can be used to rank several prospective projects considered by a firm. Assuming all other factors are equal among the various projects, the project with the highest IRR would probably be considered the best and undertaken first. The IRR is used to evaluate the attractiveness of a project or investment. If the IRR of a new project exceeds a company’s required rate of return, that project is desirable. If the IRR falls below the required rate of return, the project should be rejected. IRRs can also be compared against prevailing rates of return in the securities market. If a firm can’t find any projects with IRRs greater than the returns that can be generated in the financial markets, it may simply choose to invest its retained earnings in the market. 3.4.4 Weighted Average Cost of Capital (WACC) A company’s assets are financed by either debt or equity. The WACC is the average of the costs of these sources of financing, each of which is weighted by its respective use in the given situation. A firm’s WACC is the overall required return on the firm as a whole and, as such, it is often used internally by company directors to determine the economic feasibility of expansionary opportunities and mergers. It is the appropriate discount rate to use for cash flows with risk similar to that of the overall firm. 3.4.5 Payback Period The payback period is the length of time required to recover the cost of an TRAINING MANUAL I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I 27 investment. The payback period of a given investment or project is an important determinant of whether to undertake the position or project, as longer payback periods are typically not desirable for investment positions. There are two main problems with the payback period method: (i) it ignores any benefits that occur after the payback (i.e., it does not measure profitability); and (ii) it ignores the time value of money. Because of these reasons, other methods of capital budgeting, like the NPV, the IRR, or the discounted cash flow; are generally preferred. 3.5Conclusion Business planning is part of the long process of introducing a business into the market. It is a very important step in the overall process of establishing new or expanding existing businesses. A good business plan should: explain the business’s products or services; protect ideas (intellectual property); provide an understanding of the market; assess the business’s skills and ability to develop products/services; help in the design and completion of a working business prototype; develop a marketing and sales strategy, and explore the possibility and availability of better funding and financing options. In the end, a well-written business plan should turn a business concept or idea into a real business opportunity. 28 I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I TRAINING MANUAL MODULE FOUR FINANCIAL MANAGEMENT AND RECORD KEEPING TRAINING MANUAL I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I 29 Module Outline (i)Introduction (ii) Purpose of the Module • To help entrepreneurs understand the importance of financial management and recordkeeping for running their businesses efficiently; and • To help entrepreneurs understand and make use of the financial management and recordkeeping process. (iii) Key Issues to be Addressed by the Module • Key elements of financial management (financial planning, financial control, and decision making) and recordkeeping; and • How to implement the key elements of financial management and recordkeeping. (iv)Methodology • Presentations by consultants; • Practical examples/case studies of actual situations; • Interactions with entrepreneurs to share their experiences; and • Discussion of practical issues. (v) Expected Outcome(s) • Entrepreneurs should understand the different elements, processes, and importance of financial planning and recordkeeping; and • Entrepreneurs should be able to collect, process, safely store, and consequently make use of financial data to make decisions on all finance-related issues. 30 I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I TRAINING MANUAL Module Four 4.0 FINANCIAL MANAGEMENT AND RECORDKEEPING 4.1Introduction Financial management is the operational activity of a business that is responsible for obtaining and effectively and efficiently utilizing economic resource (funds) to accomplish the business’s objectives. It is the area of business management devoted to the judicious use of capital and careful selection of sources of capital to enable the business to reach its goals. Financial management therefore plays a vital role in business development (including that of SMEs) by enhancing competitiveness and the ability to withstand business risks. Standard financial management and proper recordkeeping systems can also help enterprises be financially flexible enough to readily fund investments when opportunities arise. 4.2 Importance of Financial Management Financial management is critical to business development because finance is the backbone of businesses. Sound financial management enables businesses to: • Improve profitability – with the help of strong financial control tools such as investment evaluation and cost management; • Increase the value of the firm – with strong performance, profitability and a better financial position, a higher asset position and valuation are achieved; and • Promote savings – as a result of (and/or in conjunction with) strong financial performance. 4.3 Financial Planning, Control, and Decision Making Financial planning, control, and decision making are the three key elements of financial management processes: 4.3.1 Financial Planning The financial planning process is used to determine the current financial status and current/future financial needs of businesses. This ensures that enough funding is available at the right time to meet the business’s needs. In the short term, funds may be needed to invest in equipment and stocks, pay employees, and pay for purchases made on credit. In the medium to long term, funding may be required for major production expansions or acquisitions. 4.3.2 Financial Control Financial control is an important tool that helps businesses measure and meet their objectives. Proper use and allocation of funds leads to improved TRAINING MANUAL I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I 31 operational efficiency, reduced capital costs, and increased value of the firm. Strong financial control measures should address whether: assets are being used efficiently; business assets are secure; and choices and decisions made are in the best interest of shareholders and in accordance with rules. 4.3.3 Financial Decision Making The interdependent nature of some business units (e.g., marketing, production, personnel) necessitates financial decisions to consider their different (and related/likewise) needs. Decisions on how, where, and when to invest, hire, pay dividends, raise wages, fund new programs, etc. should be thoroughly investigated before any conclusions are reached. 4.4 Importance of Recordkeeping and Accounting Information 4.4.1Recordkeeping One of the most fundamental components of achieving business success is keeping good financial records. The importance of keeping good financial records is always clear during tax filings, loan applications, monitoring of business performance, and the selling of business shares, as it is important to know where, when, and how the money is going. The minimum requirement of a good recordkeeping system is that it lists monies that come into the business’s possession and monies that leave its possession. 4.4.2 Accounting Information Accounting information is simply the data a business entity is able to make known to its users. Business entities require accounting data and related information to manage and control activities and their respective performances – productivity/profitability levels, differences between marginal liabilities and marginal assets, etc. A sound accounting system in an organization depends on the existence of a good recordkeeping system. Therefore, a business must have system(s) in place for monitoring and managing finances that is both comprehensive and easy to understand. Accounting information should help businesses: • Manage cash flow – to optimize cash flow; • Handle supplier queries – to avoid double/late payments; • Maintain accurate records of past and current activities; and 32 I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I TRAINING MANUAL • Forecast business activities – to make more informed decisions on whether the business has sufficient capital/funds to invest, produce, hire, or buy. 4.5 Management Accounting Management accounting is the use of information from bookkeeping and other records to determine how well the business is doing. Management accounting provides information on how monies came in and went out, what the business owns and what it owes, and how monies will come in and go out in the future. It also helps in: 4.5.1 Operational Control A business entity requires management accounting information to enable it to manage and control its finances and resources. This will also allow the business to measure, control, and improve its operational activities. 4.5.2 Performance Measuring The constant flow of accounting data relevant to income, purchases, investments and overhead is used as a tool to gauge actual performance for the year. It is also critical in creating the budget for the coming year. 4.5.3 Financing Decisions Accounting data are usually used to determine funding needs for the organization. Potential investors and lenders look at business assets and liabilities to determine if the target business is a safe investment. 4.5.4 Expansion Decisions When business entities work on their growth plans and try to make the right decisions to expand their profitability, they use accounting data to determine how much they can take on in liabilities and costs. 4.6 Financial Statements Every business of any size will have assets and liabilities of varying forms and will incur numerous transactions in the course of even one week. These must be recorded for various reasons apart from maintaining corporate memory. They are best captured by the preparation of financial statements – the balance sheet, the income statement, and the cash flow statement: 4.6.1 The Balance Sheet The balance sheet is used to report on the financial position of the business to TRAINING MANUAL I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I 33 the owner and other stakeholders. It provides a good picture of the financial health of a business and is a tool used to evaluate a business’s liquidity. The difference between the assets (what a business owns) and liabilities (owes) is the net worth of the business (owner’s equity). Table 4 – Example of a Balance Sheet ASSETS LIABILITIES Current Assets Amounts Current Liabilities Cash Accounts Payable Accounts Receivable Wages Payable Inventory Interest Payable Temporary Investments Taxes Payable Supplies Unearned Revenue Other current Assets Other current Liabilities Total Current Assets Total Current Liabilities Fixed Assets Long-term Liabilities Land Bond Payable Building Notes Payable Machinery & Equipment Contingent Liabilities Furniture & Fixtures Loans Total Fixed Assets Total long-term liabilities Intangibles Owner’s Equity Market Research Common Stock Goodwill Retained Earnings Patents Capital Reserve Research & Development Other intangibles Total Intangibles Total Owner’s Equity TOTAL ASSETS LIABILITIES + EQUITY 34 I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I TRAINING MANUAL Amounts 4.6.2 The Income Statement The income statement is a summary of the financial performance of the business over time (monthly, quarterly, or annually). It reflects the past performance of the business and is the report most often used by owners to track how their business is performing. The net income (loss) is derived by subtracting expenses from revenues. Table 5 – Example of an Income Statement Income Statement for the year ended …… RevenueAmount Sales Revenue Interest Income Other Earned Revenues Total Revenue Expenditures Cost of goods sold Selling, general and administration expenses Research and Development expenses Interest Expenses Other Expenses Total Expenses Pre-tax Income (Revenue-Expenditures) - Income Tax Expenses Net Income 4.6.3 The Cash Flow Statement Because the income statement does not provide the cash position of the business, the cash flow statement is usually prepared to report inflows and outflows of cash. It describes the causes of changes in cash reported on the balance sheet from the end of last period to the end of the current period. Reported revenues do not always equal cash collected from sales because some sales may be on credit. Also, expenses reported may not be equal to the cash paid out. TRAINING MANUAL I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I 35 Table 6 – Example of a Cash Flow Statement Statement of Cash Flow for the year ended …… Cash flows from operating activities Cash collected from customers - Cash paid to suppliers and employees - Cash paid for interests - Cash paid for taxes Net cash flows from operating activities Cash flows from investing activities Cash collected from investments - Cash paid to purchase manufacturing equipment Net cash flows from investing activities Cash flows from financing activities Cash received from a bank loan - Cash paid for dividends Net cash flows from financing activities Net increase (decrease) in cash during the period Cash at the beginning of the period Cash at the end of the period Amount 4.7Conclusion Sound financial management skills and good recordkeeping of accounting information ultimately help businesses make more informed and better decisions in terms of investments, production, profit sharing and allocation, personnel, expansion, etc. The three financial management elements – financial planning, control, and decision making – can be achieved only with sound recordkeeping and use of accounting data and information. 36 I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I TRAINING MANUAL MODULE FIVE CORPORATE GOVERNANCE AND COMPLIANCE TRAINING MANUAL I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I 37 Course Outline (i)Introduction (ii) Purpose of the Module • To help entrepreneurs understand the genesis and importance of corporate governance in business entities (companies); • To explain to entrepreneurs the various stakeholders involved in companies’ operations (internal and external) and their divergent interests; • To convey to entrepreneurs the separation of powers between and functions of shareholders, Board of Directors members, and management; • To describe the corporate governance challenges facing SMEs and various approaches to address them; • To underscore the importance of compliance with laws in doing business; and • To present the obligations and rights established by various laws. (iii) Key Issues to be Addressed by the Module • Corporate governance and its importance in attracting capital; • The separation of powers and decision-making roles exclusively vested to shareholders, directors, and management and the manner in which they are exercised; • Ways to harmonize the conflicting interests of stakeholders for the better functioning of the company; • Basic laws that businesses must observe; • The rights, obligations, and compliance requirements imposed by each law; • The pros and cons of legal compliance; and • The consequences of non-compliance such as penalties (monetary/ imprisonment). (iv)Methodology • Presentations by consultants; • Practical examples/case studies of actual situations; and • Participants’ interactions/experiences and discussion of practical issues. (v) Expected Outcome(s) • Entrepreneurs should understand the importance of corporate governance in attracting capital; 38 I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I TRAINING MANUAL • Entrepreneurs should understand how the mandates for power and decision making are divided in companies; • Entrepreneurs should understand the advantages of opening up family businesses to other stakeholders; • Entrepreneurs should understand the benefits of complying with the laws and the consequences of non-compliance; • Entrepreneurs should understand the importance of registering their businesses, inventions, trademarks, and copy rights; and • Entrepreneurs should understand the legal interests protected by each law. TRAINING MANUAL I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I 39 Module Five 5.0 CORPORATE GOVERNANCE AND COMPLIANCE 5.1Introduction Companies are legal persons with special governance structures set up to serve and meet the interests and expectations of various stakeholders. Stakeholders can be grouped into two broad categories – internal and external stakeholders. Internal stakeholders include directors, employees, management, and shareholders. External stakeholders include customers, suppliers, contractors, environmentalists, governments, and other parties indirectly associated with the company. All of these stakeholders have different interests which must be reconciled for the prosperity and continuity of the company. Reconciliation can be achieved by the existence of corporate governance. 5.2 Definition of Corporate Governance Corporate governance refers to the systems by which corporations are directed, controlled, and held to account. Corporate governance involves systems that assist companies in improving their management, their board structures, and their procedures to make them more accountable to shareholders and other stakeholders. Issues such as financial reporting, transparency and auditing, remuneration of directors, separation of powers, and minority shareholders’ rights are included in these systems. Corporate governance covers the full suite of relationships between a company’s management, its board, and its stakeholders including, but not exclusively, shareholders. In the broader sense, a company is not responsible to shareholders alone. It is also responsible to other stakeholders such as society, its employees, the government, and the public at large. Corporate governance involves the following three organs: 5.2.1Shareholders • Decide on changes in Memorandum and Articles of Association of the company; • Decide on the capital structure of the company; • Approve dividends, annual financial statements, and the annual report; • Appoint auditors and directors of the company; and • Approve directors’ remunerations. 2 40 Cadbury (1992) defines corporate governance as the system by which companies are directed and controlled; see Sir Adrian Cadbury Report on UK corporate failures. I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I TRAINING MANUAL 5.2.2Directors • Approve the business plan; • Hire executive management; • Are responsible for preparation of financial statements and the annual report; and • Recommend the amount of dividend to be paid. 5.2.3Management • Implements the business plan; • Oversees day-to-day activities of the company; and • Hires low-level cadre management. 5.3 Why is Corporate Governance Needed? The need for corporate governance has evolved in the recent past due to the following factors: • Corporations are required (expected) to comply with legal requirements; • Corporations are required to be accountable to all stakeholders with whom they interact; • Corporations are expected to be sustainable institutions, viable and competitive in society, and able to survive the demise of their founders; • Well-managed corporations are well-positioned and able to attract finance from different investors from within the country and from outside, thus increasing investment, growth, and employment; • As corporations interact with society daily, they must account for the manner in which they serve society at large, despite their profit motives; and • The expectations of shareholders for transparency, protection of their rights, fair and equitable treatment, and maximization of their returns must be met. 5.4 Drivers of Corporate Governance The importance of corporate governance worldwide has increased due to: • Globalisation and economic integration throughout the world; • Increased pressure to conserve the environment; • Increased separation of the ownership and control of corporations; • More competitive global markets, which force corporations to look for more optimal means of enhancing shareholders’ value so as to attract investment funds from both local and international sources; and • Evidence that good corporate governance structures can lead to higher economic payoff. TRAINING MANUAL I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I 41 5.5 Principles of Corporate Governance According to the Organisation for Economic Co-operation and Development (OECD), the key principles of corporate governance deal with: • The rights of shareholders; • The equitable treatment of shareholders; • The role of stakeholders in corporate governance; • Disclosure and transparency; and • The responsibilities of the Board of Directors. 5.6 Corporate Governance: The Board of Directors The Board of Directors should fulfil certain key functions, including: • Reviewing and guiding corporate strategy, major plans of action, risk policy, annual budgets, and the business plan; setting performance objectives; monitoring implementation and corporate performance; and overseeing major capital expenditures, acquisitions, and divestitures; • Selecting, compensating, monitoring, and, when necessary, replacing key executives and overseeing succession planning; • Reviewing key executive and board remunerations and ensuring a formal and transparent board nomination process; • Monitoring and managing potential conflicts of interest between management, board members, and shareholders, including misuse of corporate assets and abuse in related party transactions; • Ensuring the integrity of the corporation’s accounting and financial reporting systems, including the independent audit, and ensuring that appropriate systems of control are in place, in particular, systems for monitoring risk, financial control, and compliance with the law; • Monitoring the effectiveness of the governance practices under which it operates and making changes as needed; • Overseeing the process of disclosure and communications; and • Exercising objective judgment on corporate affairs independent, in particular, of management. 5.6.1 Appointment of the Board of Directors Appointment of directors is a crucial exercise that should be done with care to optimize the functions of the board. The best practices demand that there should be formal and transparent appointment of directors to the board and all persons appointed or offering themselves for appointment as directors should disclose any potential area of conflict that may undermine their position or service as a director. 42 I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I TRAINING MANUAL To have an effective board, it is important to select appropriate members who will carry the company forward to the level desired by stakeholders. It is important to determine in advance the skills needed of members. The use of a nomination committee is recommended to interview applicants and recommend the best candidates. 5.6.2 Board Composition The “right” number of Board of Directors members depends on the company. An appropriate mix of age, gender, ethnicity, geographic spread, experience, and team roles should be maintained. The board should also have sufficient and diverse skills relevant to the industry, leadership, governance, technology, communication, and marketing to lead the company into value creation. Board members should have good common sense, business acumen, integrity, and the ability and willingness to learn, with additional special competencies as relevant. There must also be a balance of power through the use of executive, nonexecutive, and independent directors. An executive director is a director who is also a member of the management (executive) team. A non-executive director is not a member of the management team. An independent (outside) director is a director who, other than serving on the board, has no direct connections with the company. For a Board of Directors to be effective, it should have both executive and non-executive members (numbers will differ from one company to another). There are usually more non-executive members than executive members to ensure independence in the board’s decision-making process. 5.6.3Remunerations Remunerations of board members are usually set at prescribed rates and paid either annually, hourly, or per meeting. Remunerations should be sufficient to attract outstanding people. Remunerations should also take into consideration the legal responsibilities of directors and the workload required to direct the company. Remunerations are recommended to the board by a Remuneration Committee and approved by shareholders in the Annual General Meeting. 5.6.4 Making Boards More Effective At the beginning of each year, the board should collectively determine and agree on its role and functions in the context of the company’s needs, strategic thrust, competitiveness, and viability. The board should also determine, agree TRAINING MANUAL I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I 43 upon, and articulate the activities necessary for its operations and prioritise the timing of such activities. The board should ensure that the identified activities are consistent with statutory requirements and its calendar of meetings. 5.6.5 Committees of the Board The board should establish appropriate committees to facilitate the company’s operations. Examples include audit, remunerations, and risk management committees. 5.6.6 Board Evaluation Evaluation of the board should be seen as a positive process, an instrument for the improvement of the board’s functioning, and a healthy process meant to ensure effectiveness and achievement of corporate objectives. 5.7 Corporate Governance: Corporate Social Responsibility There is no universally accepted definition of Corporate Social Responsibility (CSR) in place at the moment. The U.S.-based network “Business for Social Responsibility” suggests that CSR implies “operating in a manner that meets or exceeds the ethical, legal, commercial and public expectations that society has of business.” The Commonwealth Association for Corporate Governance suggests that CSR is the distinctive contribution a company makes to the advancement of a society or alleviation of social concerns, usually through some form of investment in partnership with the community, which may include the government. On a global scale, corporations are increasingly taking into consideration the need to contribute to the society in which they operate, recognizing the role other stakeholders play in the very existence of companies. Companies spend some of their profits contributing to the social needs of the areas in which they operate. Sometimes called Corporate Social Investment, this can include supporting education, health care, water, and social activities. CSR generally encompasses the areas of: accountability; community economic development and involvement; the environment; and ethics and human rights. 5.8 Corporate Governance: Strategic Management for Value Creation The corporation’s strategy is a combination of competitive moves and approaches to compete successfully, please customers, and achieve organizational objectives. A business’s sole purpose is to create value and wealth for its owners (primarily), shareholders, and stakeholders at large (secondarily). Corporate executives can create 44 I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I TRAINING MANUAL value for stakeholders by selecting the most appropriate field in which to operate and by utilizing their assets in the most effective way. The strategic management process involves a clear definition and implementation of the following: • The mission, or the overriding purpose of the firm. Whatever the firm states to the public implies maximizing value primarily to the shareholders and other stakeholders; • The objectives of the firm, or targets the firm establishes for the attainment of its mission. Objectives are selected for their impact in achieving value creation and are the means of evaluating progress towards fulfilment of the corporate mission; • The strategy, or the selection of markets in which to operate and how to compete. This can be done by pursuing a cost advantage or product differentiation to remain competitive in the market; and • The tactics, or the implementation of the best (available) operating policies to secure the chosen competitive advantage. 5.9 A Case for Corporate Governance in SMEs Good corporate governance by SMEs will facilitate a clear separation between owners and managers of SMEs. It will also influence transparency, separation of personal and business activities, and better governance of SMEs, hence contributing to wealth creation. Proper procedures and good governance will enhance SMEs’ ability to access funding through capital markets, as good governance is a prerequisite for entry into capital markets. 5.10 Corporate Governance: Transforming Family Businesses into Corporations Family-owned firms have great potential for transforming the economy if they open up to other stakeholders. Opening up companies to other stakeholders will facilitate the entry of investors who seek to maximize returns, and in the process will facilitate wealth creation for all stakeholders. Successful multinational corporations (MNC) such as SONY, Michelin, Microsoft, TATA, and others started as family businesses. Opening them up brought in new skills and talents, which revolutionized them to become today’s MNC. 5.10.1 Position of Major Shareholders (and/or Founders) Founder shareholders in SMEs consider themselves owners, and hence they have an upper hand in major decisions of the company. Instituting corporate governance will mean delegating some of the roles performed by major shareholders to the Board of Directors and attendees of the General TRAINING MANUAL I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I 45 Meeting. Such decisions include appointment of senior staff, alteration of the Memorandum and Articles of Association (MEMARTS), and dividend decisions. These members should realize that the moment the company goes public, they will no longer have the final say in many decisions. SMEs need to appreciate that establishing a formal organizational structure will result in the rest of the members’ involvement, as represented by the Board of Directors, in the decision-making process of the company. 5.10.2 Outside Investors’ Expectations Investors wishing to participate in an SME’s ownership will want to see changes in the ownership structure that conform to the best corporate governance practices. These changes include the following: • A significant reduction of family ownership by inviting outside investors though a public offer of securities; • Greater involvement of the non-executive directors in the management of the SME; • Establishment of committees for good corporate governance; • Disclosure of financial statements in compliance with the law – this includes publication of financial statements in the press; and • Listing on the stock exchange – to facilitate a fair and transparent price discovery mechanism. 5.11 The Legal Compliance of SMEs Simply put, laws are a set of rules that regulate relations between people and groups of people in a society. General compliance with the law is thus a necessary pre-condition for orderly existence in any society. In business, it is perhaps even more necessary to comply with relevant laws. Such compliance ensures that the business legally exists, that it enters into relationships that are legally recognized and enforceable, and that the business is generally run in accordance with the law. Compliance with the law ensures an orderly manner of doing business and that no act or omission runs the risk of being rendered invalid due to a legal problem. The following is a selection of some of the laws currently relevant in the day-to-day management of SMEs in Tanzania: 5.11.1 Companies Act (2002) Upon registration, a company acquires an independent legal existence regulated 46 I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I TRAINING MANUAL by the law, which imposes certain requirements with which the company and its officials must comply. These include: • • • • A The filing of annual returns, which consist of all the relevant particulars of the company, including information on shareholding, directorship, debentures, and other charges; The filing of audited accounts; The filing of any changes in the particulars of the company, such as change in the name of the company, its aims and objectives, the Board of Directors, the nominal share capital, the classes of shares, address of registered office, debentures and other charges in relation to the company, appointment of receivers, managers, and administrative officers, and winding up proceedings; and Payment of various taxes to the central and local government. company (and its officers) that does not comply with the above and other requirements may be penalized by way of payment of monetary penalties, and sometimes even by criminal action. Compliance will give credibility to the company, make it more creditworthy when such status is at issue, and will generally render the company in good standing both in business and social circles. 5.11.2 Contract Law Companies are required to comply with the terms and conditions of the contracts to which they are a party. If the legal requirements are not complied with, the contract becomes either void or voidable, depending on the legal consequences of the specific failure. It is thus important to ensure that any agreement entered is legally enforceable by complying with all requirements of the law. There may be a need to consult a lawyer beforehand to ensure that the business acts within the law. 5.11.3 Labour Law Any sizeable business is conducted with the aid of persons who are not owners of the business but who are instead workers paid wages for their services. Labour law governs the relations between the business (as employer) and its workers (as employees). It also creates a procedure for dealing with labour disputes and their settlement, and matters of pensions and other benefits for employees. A positive labour relation is an important aspect in an enterprise of any type, SMEs being no exception TRAINING MANUAL I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I 47 5.11.4 Licencing Law Doing business entails compliance with licensing laws. Depending on the nature of the business, the law sets down particular requirements. These are primarily under the Business Licensing Act, Cap 208. The law prohibits the conduct of business without a licence. Every license issued is for a particular business and at a particular place, unless there is a “principal place of business,” whereupon a subsidiary licence will be issued, or where no fee is prescribed in relation to the business. Licensing authorities have the power to close the premises of a business operating without a licence, and in doing so, an authority may request the assistance of a police officer or other authorised agent. 5.11.5 Land Law Land law (otherwise known as “the law of real property”) is one of the most important branches of law in any country. The main land legislation in Tanzania is the Land Act, Cap 113. It is the basic law in relation to land in Tanzania other than village land, and it governs the management of land and the settlement of land disputes and related matters. The other main legislation, the Village Land Act, Cap 114, deals with the management and administration of land in villages. Every enterprise business has a location. For that reason, it must either own its land or property or rent it or part of it from an owner. Thus, the business enterprise will either be a landlord or a tenant. Land law determines this relationship. To raise capital, a business may need some form of security to act as collateral. Mortgages in land are the most common form of security. Land law provides for the creation, registration, and enforcement of such arrangements. 5.11.6 Intellectual Property Law Under the Patents Registration Act, Cap 217, a patents register of patentable inventions is maintained at the office of the Registrar of Patents. An invention is a solution to a specific problem in the field of technology and may relate to a product or process. An invention is patentable if it is new, involves an inventive step, and is industrially applicable. The right to a patent belongs to the inventor. The Copyrights and Neighbouring Rights Act, Cap 218 is another relevant branch of the law on intellectual property. Patents law provides protection for inventors so that their inventions can be used commercially. An enterprise may only use a patent upon agreement with its owner. The inventor may agree to let a manufacturer use his patents and 48 I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I TRAINING MANUAL may even assign his rights under it to the enterprise. Trade and service marks are another type of intellectual property. The law gives entrepreneurs the opportunity to register their trade and service marks to protect their markets and reputations with respect to the quality of their products. A prudent manufacturer should make full use of this law by registering his trade and service marks. At the same time, it is pertinent to avoid using other people’s marks, as this may result in disputes and litigation with potentially adverse consequences. 5.11.7 Insurance Law In business, it is advisable to have a form of protection against risk. Insurance laws provide the mechanism to such protection by setting out rules governing insurance contracts between insurers and the insured. Fire insurance, theft and burglary insurance, motor vehicle insurance, and workmen’s compensation are among the risks relevant to businesses that can be covered. 5.11.8 Law of Succession The law of succession refers to transmission of the rights and obligations of a deceased person to his heirs. Succession also signifies the estate and debts left by a person after his death, whether the value of his property exceeds his debts or vice versa or whether he has left only debts without property. Succession not only includes the rights and obligations of the deceased as they exist at the time of his death, but all that accrues after opening of the succession. Finally, succession signifies the right by which an heir can take possession of the estate of the deceased, such as it may be. The law has thus devised a set of rules providing for substantive rights to cater to the rights of successors of estates. Some business enterprises die with their owners. Companies, on the other hand, survive the death of their shareholders. While the assets of sole proprietorships or partnerships are inheritable, those of companies are not; only their shares can be inherited. 5.12Conclusion The framework for good governance exists in Tanzania in all aspects. The legal and operating systems to foster good governance have been established and are working. The burden is on SMEs to improve their governance structures to tap into the huge, unexploited capital market potential in Tanzania. An SME should be able to survive the demise of its founders. This can only be achieved with the existence of good corporate TRAINING MANUAL I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I 49 governance, effective management information systems, a corporate management structure, and limited intervention in corporate operations by family members. Employment of corporate executives will help eliminate family intervention and enhance good governance. Family businesses that adopt the highest standards of corporate governance, modern management and technology, and performancefocused strategies will survive globalization and will attract international capital and contribute to wealth creation. This module shed some light on the legal regimes governing SMEs to give entrepreneurs an opportunity to weigh and consider the advantages and disadvantages of compliance and non-compliance and thus to inculcate them with the right attitude towards legal compliance. 50 I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I TRAINING MANUAL MODULE SIX FINANCING OPTIONS FOR SMEs TRAINING MANUAL I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I 51 Course Outline (i)Introduction (ii) Purpose of the Module • To help entrepreneurs understand different financing sources for SMEs and their attendant characteristics; • To describe the costs associated with each source of capital; • To convey to entrepreneurs the factors normally considered by investors (including venture capitalists); and • To help entrepreneurs understand the importance of gearing in any capital invested (debt versus equity) and the consequences of poor gearing. (iii) Key Issues to be Addressed by the Module • Sources, characteristics, costs, and access to capital financing; • Financial planning to secure additional working capital or capital expenditure; and • Ways for SMEs in Tanzania to access these sources of finance and to identify the best sources of capital for wealth creation and distribution. (iv)Methodology • Presentations by consultants; • Practical examples/case studies of actual situations; • Discussion of practical issues; and • Participants’ experiences/interactions. (v) Expected Outcome(s) • Entrepreneurs should be able to determine which source of capital finance best fits them according to the size and level of their business; and • Entrepreneurs should understand how to access finance through capital markets, including knowing when to do so, how long it will take, who to involve, and specifically what steps to take. 52 I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I TRAINING MANUAL Module Six 6.0 FINANCING OPTIONS FOR SMEs 6.1Introduction As a business moves beyond the start-up phase, the entrepreneur’s focus has to change. Identifying opportunities for growth and sustainability must become a priority for managers/owners. It is important that they keep looking for ways to develop and promote the business’s growth. Failure to do so will allow competitors to grow and take the entity’s market share, which could seriously weaken its position. Sound financial planning is the foundation of any growth strategy. This process entails establishing how much investment will be required and when and identifying possible sources of funding. One of the major hurdles to business expansion faced by SMEs in Tanzania, and indeed all over the world, is securing financing – be it to fund additional working capital or capital expenditure. The most common sources of finance available to SMEs in Tanzania are examined next. 6.2 Different Sources of Finance Available to SMEs 6.2.1 Owners’ Personal Savings In most cases, this is the first point of call whenever a business requires an additional cash infusion. Owners’ funding may take the form of a loan or an additional equity contribution from shareholders/directors. The main distinction between the two is that it is expected that the loan will be repaid by the business at a future date. Not only is this a cheaper source of funding (no interest), but it is also an indication of personal commitment to the venture on the part of entrepreneur(s). In practice, however, this option may be severely limited, as the entrepreneur may have already invested a substantial portion of personal resources in the business. 6.2.2 Bank Loans Bank loans remain the most commonly used source of credit for most SMEs. Bank borrowing has the following common features: • The borrower is expected to have a banking relationship with a lender; • There is a contractual repayment date; • There is payment of a specified rate of interest; and • The debt may be “unsecured” or “secured” on the assets of the business. In the event of default, the lender has the right to sell these assets to redeem the debt. TRAINING MANUAL I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I 53 Bank lending may be in the form of: (i) Bank Overdraft An overdraft simply allows a business to spend over the balance on its bank current account. The facility is available for a specific time period, after which it has to be repaid or renegotiated and rolled over. Technically, banks have the right to call in an overdraft at any point in time. Generally, the rate of interest on overdraft accounts is much higher than for equivalent sums borrowed on fixed loans. (ii) Trade Finance This particular facility is common with agricultural exports and crop finance. Banks facilitate trade finance through the use of collateral managers, who verify that the money advanced is used to purchase the intended crops during the harvest season when the prices are low and to subsequently sell them during the off-season when prices are high. Trade finance is also used for pre-financing of export commodities with confirmed orders from reputable importers. The exporter is facilitated to purchase the export crop and repay the bank once the importer has received and fully paid for the commodity. The collateral management company manages the entire transaction chain, ensuring that the borrower purchases the crop and exports it and that the lending bank is paid from the export proceeds. (iii) Term Loans Banks tend to provide term debt only to solid, creditworthy companies. By nature of their business, banks generally have not adequately supported SMEs’ medium- to long-term capital needs due to several factors, including: • Stringent collateral requirements and high interest rates; • Lack of innovative and well-structured facilities to meet the unique demands of some of SME activities, e.g., agriculture; • Overdependence on (short-term sources) customer deposits for lending by commercial banks, which reduces their appetite for long-term lending; and • The view by some that Tanzania is still a relatively risky lending environment, and one likely to intensify the risk of long term lending. 6.2.3 Government’s SMEs’ Credit Guarantee Scheme The objective of Tanzania’s SMEs’ Credit Guarantee Scheme (SME-CGS) is to 54 I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I TRAINING MANUAL facilitate access to credit by SMEs. The arrangement is in line with the National Policy on SMEs Development, which is geared towards the promotion and support of SMEs in Tanzania. Specifically, the SME-CGS aims at providing credit guarantees to participating financial institutions relating to short- and medium-term financing, as well as cooperating with various stakeholders in promoting SMEs in the area of entrepreneurial skills. 6.2.4 Asset Leasing Paying cash up front to purchase equipment can be a significant drain on businesses’ working capital. Leasing an asset, however, gives businesses access to assets without having to pay for them up front. Asset leasing is an agreement used to finance the use of equipment or assets. A financing company or bank (“lessor”) makes an investment in equipment for the benefit of its customer (“lessee”) with expectations to recover the full cost of its investment in the asset through regular rental payments. Payments are calculated in a manner that enables the finance company to recover the full cost of its investment in the asset, plus a margin of profit or interest. Leasing offers various advantages over other means of financing. The most important ones suitable for SMEs are: • No collateral requirements – collateral/security is seldom required in leasing because the leased asset serves as security for the finance advanced. The lessor retains legal ownership over the asset, and in the event of default, the lessor can repossess the equipment; • Leasing allows technological advancement and therefore offers a way to modernize production and develop small businesses; and • Low transaction cost – a lease can be concluded more quickly and simply than a bank loan. The lessor is usually only interested in determining the ability of the leased goods to generate sufficient cash flow to pay monthly rentals throughout the lease term. 6.2.5 Venture Capital Funds Venture capital is another source of finance for SMEs facing expansion funding constraints. Venture capital funds primarily collaborate with entrepreneurs by providing high-risk equity financing for business opportunities that can be profitably harvested eventually. Venture capital has been described as “the maternity ward and incubation center” for wealth creation. Unlike banks, TRAINING MANUAL I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I 55 venture capitalists are not passive providers of capital but active coaches for the entrepreneurs with whom they partner. Venture capital firms seek to add value in several ways, by: • Identifying and evaluating business opportunities, including management, entry, or growth strategies; • Monitoring and coaching company management; • Providing technical and strategic input; • Attracting additional capital, directors, management, suppliers, and other key stakeholders and resources; • Participating actively in managing companies; and • Assisting in the development of new products or services. Venture capital firms usually seek a high return on their investments to compensate for the various associated risks. Factors considered requirements by venture capitalists before they invest in any venture include: • • • • • • Significant growth potential of the business; Sustainability on a long-term basis; Good and well-researched business plans; Strong management teams; Length of investment to recoup profit; and Existence of an exit mechanism (e.g., an Initial Public Offer (IPO), merger, or acquisition). To the venture capitalist, the success of an investment is contingent upon being able to profitably divest from (or harvest) the investment at a future date. Possible exit mechanisms include sale of the shares to the entrepreneur, an over-the-counter sale to a third party, an IPO, and liquidation. The availability of a proper, clear exit route, such as an IPO through the DSE, therefore becomes an added attraction for venture capital financing. 6.2.6 Capital Markets The capital market is the medium through which a company can obtain its supply of long-term investment funds. The capital market is an economic market, not a physical market, as it is fixed neither in time nor place. It merely represents the aggregate activity of investors (all organizations and individuals with surplus funds to invest) and issuers (all with available use for those funds 56 I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I TRAINING MANUAL and the ability to pay the necessary rate of return to investors). A company can raise fresh capital from the market, provided it meets the requirements set out by the CMSA, by offering its shares to the general public. This is usually done through an IPO, whereby the issuer company, with the assistance of an investment advisor, compiles a prospectus; the prospectus gives full details of the shares to be offered, background information about the company and its business prospects, and what it intends to do with the funds to be raised. In exchange for the funds they subscribe to the company, investors receive a title of part ownership in the issuing company in form of a share certificate. These shares are then “listed” and traded on the DSE. To facilitate increased access to the capital market by SMEs, the DSE launched a second market segment specifically designed to cater to and meet SMEs’ capital financing needs. This segment is known as the Enterprise Growth Market (EGM). The DSE’s EGM is discussed more in Module 7. It is hoped that the EGM will become a nursing ground for SMEs, which can eventually move on to the main segment of the DSE. In the context of a prospective issuer, the perceived benefits of the EGM are that: • Companies that cannot meet the listing criteria of the main segment of the DSE will be able to list on the second segment (the EGM); • Companies will have a less expensive way of raising capital than obtaining term finance from banks; • Investors will have a greater choice of securities in which to invest; • It fits nicely with the government’s objectives of supporting SMEs; stronger SMEs will contribute to employment creation and, in the longer term, will generate increased tax revenues for the government; and • The EGM will serve as a logical exit route for venture capital investments in SMEs. 6.3 Capital Structure and Financial Gearing “Gearing,” or leverage, is a term used to describe the relationship between the debt capital and equity capital applied to finance the operations of a business. Gearing is sometimes expressed as a ratio of debt:equity (e.g., 40:60), or alternatively as debt as a percentage of the total funding (e.g., 40/ 40+60 = 40%). Gearing is said to be high when there is a large proportion of debt in the capital structure of a company and low when the equity interest comprises a large proportion of the capital. The more TRAINING MANUAL I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I 57 highly geared a company becomes, therefore, the greater the chance that a poor year’s trading performance will result in a default on its debt service obligations, with dire consequences. Businesses are usually advised to keep a low gearing ratio (low in debts) because debts involve a contractual commitment on the part of a borrower to pay interest and repay capital on the due date. Nonpayment of debt interest is a serious matter in that the majority of commercial loan agreements give lenders the right to use legal procedures to recover the debt. On the other hand, if a company fails to pay a dividend on equity, all that is likely to happen is that its share price will decline as disgruntled investors sell their shares. However, this is not likely to threaten the immediate survival of the business. 6.4Conclusion Given the above scenario, it is important that SMEs strive to ensure that a significant proportion of the entity’s finance is provided by shareholders, who are the legal owners of the business. This can be achieved through inviting venture capital equity participation or through the capital market. Moreover, the existence of a sizeable fund of permanent capital invested in the business will increase the confidence of lenders, whereas overdependence on debt finance might not only be seen as sign of weakness, but also as a potential threat to the future sustainability of the business. 58 I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I TRAINING MANUAL MODULE SEVEN DSE’s ENTERPRISE GROWTH MARKET (EGM) TRAINING MANUAL I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I 59 Course Outline (i)Introduction (ii) Purpose of the Module • To help entrepreneurs understand the position and role of capital markets in the financial system and the economy; • To convey to entrepreneurs the role the stock exchange plays in capital raising; and • To describe to entrepreneurs what it takes to go public and eventually obtain a listing in the DSE’s Enterprise Growth Market (EGM) segment. (iii) Key Issues to be Addressed by the Module • The importance, role, and position of capital markets and financial systems in the economy; • The functions and roles of a stock exchange in relation to capital raising; and • Basic requirements for raising capital through capital markets and listing at the DSE. (iv)Methodology • Presentations by consultants; • Practical examples/case studies of actual situations; and • Participants’ interactions/experiences and discussion of practical issues. (v) Expected Outcome(s) • Entrepreneurs should understand the importance of raising capital through capital markets; • Entrepreneurs should know what their business should do to access capital through capital markets; • Entrepreneurs should know how to undertake the process for going public and getting listed on the DSE; and • Entrepreneurs should understand the incentives available to issuers as well as investors in capital markets. 60 I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I TRAINING MANUAL Module Seven 7.0 DSE’s ENTERPRISE GROWTH MARKET 7.1Introduction It is universally accepted that no modern economy can flourish without the backing of a strong, efficient financial system. Such a system plays the role of intermediation by facilitating the movement of funds from savers (surplus spending units) to users (deficit spending units), thereby increasing the efficiency of economic resource allocation and deployment. In an effort to modernize and develop Tanzania’s capital markets, the Capital Markets and Securities Authority (CMSA) carried out a study in 2006 on the appropriate market structure for Tanzania. The study identified the need to change the existing structure to align it with the then existing economic functions and activities of the country (dominated by SMEs) as well as to facilitate the implementation of national policies aimed at empowering Tanzanians. Before the study, the DSE had one market segment that served established (i.e., medium to large) companies in the country – the Main Investment Market Segment (MIMS). The study recommended creation of a second segment – the Enterprise Growth Market (EGM) – to help SMEs mobilize funds to meet their capital needs through the DSE. 7.2 Functions of a Stock Exchange 7.2.1 Facilitates Raising of Capital for Enterprises A stock exchange facilitates companies to sell new shares/bonds at better prices (than prices randomly offered by buyers in informal and unorganized markets), which consequently lowers the cost of capital to such companies and improves their chances of increasing operating profits. 7.2.2 Provides a Market for Listed Securities It enables those wishing to join or leave listed companies to do so. A stock exchange therefore provides liquidity by way of providing a continuous market for securities, whereby securities are exchanged for cash. 7.2.3 Facilitates Price Discovery A stock exchange’s pricing mechanism ensures that buyers and sellers can do so at a price determined by demand and supply forces. Neither the exchange TRAINING MANUAL I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I 61 nor brokers determine the prices of securities traded on the stock exchange. 7.2.4 Facilitates Transparency Disclosure requirements put in place by the DSE require listed companies to promptly disclose all price-sensitive information so that investors may make informed decisions. This is achieved at two levels: (i) at the initial offering period, when companies have to meet listing requirements relating to offering documents; and (ii) through continuous listing obligations. In this context, the DSE becomes an information clearing point between listed companies and investors (an information hub). 7.2.5 Facilitates Privatization and Wider Ownership of Resources The DSE has facilitated and continues to facilitate the privatization of parastatals hitherto under the control of the government whose shares have been sold by the government through the DSE. 7.2.6 Creates Wealth Via Investments in Listed Securities Shares listed on the DSE have performed very well, with rates of return above the inflation rate, when compared with rates earned on bank deposits. Shares are not passive stores of value like bank deposits. While shares do increase in value over time if/when their prices go up, bank deposits do not increase in size during the lock-in period. 7.3 Benefits of the EGM 7.3.1 Benefits to Issuers • The EGM helps companies that cannot access capital markets through MIMS to do so fairly and conveniently; • Enterprises can obtain needed capital for expansion; • The financing options available to companies are expanded; • Enterprises wishing to raise capital after being listed on the EGM know the price at which new shares will be issued; • The EGM has a built-in system that assists potential listing companies with planning and managing the company from the time the idea of running the company is conceived to its actualization; and • Valuation of shares is simplified, as there is a price discovery of these shares. 7.3.2 Benefits to Investors 62 I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I TRAINING MANUAL • • • 7.3.3 Investors have a wider choice of companies in which to invest their funds; Investors in EGM companies are able to unlock their investment values when market prices go up; and Investors are in a position to use EGM company shares as collateral against bank loans, as the worth of such shares is known. Benefits to the Economy • The EGM facilitates more transparency and accountability to listed companies and enhances the accountability of corporate leaders of the companies listed on EGM, which in turn fosters stability and growth; • The EGM facilitates formalization of the informal business sector, as upon listing, these companies become formally recognized in the financial system and are consequently able to access funding through capital markets; • The EGM enables more efficient tax collection, as EGM-listed companies’ business activities are usually immediately recognized and formalized, such that these companies can be easily identified for the purpose of tax collection; and • More employment is created as a result of expanded operations; as EGMlisted companies access capital through capital markets and expand their operations, they will increase employment both directly and indirectly. 7.4 EGM: Fiscal Incentives The government has deliberately provided several incentives to encourage active participation in capital markets by issuers and investors. 7.4.1 Incentives for Issuers • Reduced corporate tax from 30% to 25% for a period of three years where the issuer has issued at least 35% of the issued shares held by the public. The reduced rate is applicable for five years, starting from the listing date; and • Tax deductibility of all IPO costs for the purposes of income tax determination. All IPO costs are accepted by the Tanzania Revenue Authority (TRA) as acceptable expenses used in the generation of income and profits, and therefore are taken into consideration when determining profit for tax purposes. 7.4.2 Incentives for Investors • Zero capital gain tax, as opposed to 10% for unlisted companies; TRAINING MANUAL I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I 63 • • • • • Zero stamp duty on transactions executed at the DSE, compared to 6% for unlisted companies; Withholding tax of 5% on dividend income, as opposed to 10% for unlisted companies; Zero withholding tax on interest income from listed bonds whose maturities are three years and above; Exemption of withholding tax on income accruing to fidelity funds maintained by the DSE for investor protection; and Tax exemption for income received by Collective Investment Scheme (CIS) investors. 7.5 Eligibility Conditions for the EGM Table 7 identifies the eligibility conditions for companies applying to issue and list shares on the EGM: Table 7: Eligibility Conditions for Listing on the EGM 64 S/NO CRITERIA ENTERPRISE GROWTH MARKET SEGMENT 1 Track record of existence None. But if the applicant has no track record, has to show that funds are required to support a project which has been fully researched with indicated costs. 2 Profitability Track record None 3 Issued and paid-up capital 200 million 4 Incorporation Status Issuers must be incorporated in Tanzania as public companies or else where the companies’ law is in conformity with the law of Tanzania (for cross-listing companies). 5 The company shall have at least 50% of its net assets Net Tangible Assets situated within Tanzania. 6 Issuer Type Growth companies of all sizes. 7 Method of offering new Public offering, underwriting, private placement or issue of shares combination of all. 8 Business Operations Detailed profile of planned operations including the following: 5 years business plan and independent technical feasibility report for companies with less than 12 months of operating history. 9 Public shareholding spread At least 20% of its shares must be held by public 10 Minimum number of At least 100 shareholders shareholders upon listing I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I TRAINING MANUAL S/NO CRITERIA 11 Period moratorium ENTERPRISE GROWTH MARKET SEGMENT If the Issuer has less than three years track record, promoters to be locked-in for up to 3 years. 12 Utilization process of Disclose the estimated amount of the proceeds from proceeds the offer (net of the expenses of the offer) broken down into each principal intended use. If the anticipated proceeds will not be sufficient to fund all of the intended uses, disclose the amount and sources of other funds needed. Where specific uses are not known for any portion of the proceeds, disclose the general uses for which the proceeds are proposed to be applied. State the minium amount which, in the reasonable opinion of the directors of the relevant corporation, must be raised by the offer. 13 Nominated Advisors Must have a Nominated Advisor at all time of listing. 14. Directors and Management Suitable senior management with relevant experience of one year prior to listing. 15. Must be IFRS compliant and must have been audited by Financial Statements authorized auditor. 16. Auditors Registered by NBAA 17. Same Management No need. Emphasis should be on competence of the Management team. 18. Issuers must have audit Committee as per CMSA Audit Committees guidelines on Corporate Governance 19. Directors of the Issuer to give opinion on adequacy of Working capital adequacy working capital for at least 12 months. 20. Certificate of comfort Issuers to obtain comfort letters from institutions from relevant regulators regulating their operations. 21. Articles and Memorandum They must provide for public issuance of securities of Association as well as protection of minority shareholders, transferability of shares, borrowing powers of directors, corporate governance principles. 22. At least one third of the board members must be non- Composition of board of Directors executive directors. 23. Prospectus approved by Prospectus to be approved by the Authority a regulator TRAINING MANUAL I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I 65 S/NO CRITERIA ENTERPRISE GROWTH MARKET SEGMENT 24. Compliance to other All applicants to undertake to comply with other Corporate Governance corporate governance principle as per CMSA guidelines Issues for corporate governance as improved from time to time. 25. Issuer to disclose clear dividend policy. Clear dividend policy 26.Publication in the Press Applicants to prepare Abridged Prospectuses. 7.6Conclusion This module introduced the EGM segment of the DSE to entrepreneurs. It showed them the importance and benefits of mobilizing capital through the DSE and explained the whole process of going public and eventually getting listed on the DSE. It should be clearly stated here that this market calls for sophisticated investors who can assess the market and make informed decisions about the companies in which they invest. Those who cannot carry out the necessary assessment should consult investment advisors before investing in EGM-listed companies. 66 I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I TRAINING MANUAL MODULE EIGHT LISTING REQUIREMENTS AND CONTINUOUS LISTING OBLIGATIONS TRAINING MANUAL I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I 67 Course Outline (i)Introduction (ii) Purpose of the Module • To help entrepreneurs understand the functions and roles of the DSE in relation to capital raising (issuing) and listing; • To convey to entrepreneurs the initial issuing and listing procedures and requirements of the DSE; and • To enable entrepreneurs to understand the continuous listing procedures and obligations of the DSE’s EGM segment. (iii) Key Issues to be Addressed by the Module • Functions of a stock exchange – for and during issuing and listing; • The processes of raising capital (issuing) and listing using capital markets; and • Continuous listing obligations of the DSE. (iv)Methodology • Presentations by consultants; • Practical examples/case studies of actual situations; • Participants’ interactions/experiences; and • Discussion of practical issues. (v) Expected Outcome(s) • Entrepreneurs should understand the importance of raising capital through capital markets; • Entrepreneurs should understand the process and requirements of capital raising (and listing) through a stock exchange; • Entrepreneurs should know the continuous listing obligations of listed companies at the DSE; and • Entrepreneurs should know how to comply with the capital raising and listing requirements of the DSE. 68 I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I TRAINING MANUAL Module Eight 8.0 LISTING REQUIREMENTS AND CONTINUOUS LISTING OBLIGATIONS 8.1Introduction The DSE Listing Rules for the EGMs are less onerous compared to those for the Main Market segment in order to enable small and start-up companies to raise capital through the capital markets and list their shares at the Stock Exchange. An issuer who has met the initial issuing and listing eligibility conditions must: • Appoint a team of consultants to prepare the company for public issue of securities and the listing of these securities on the stock exchange; • Appoint a Nominated Advisor, who will nurture the company from the time the idea of raising capital arises; • Retain a Nominated Advisor to advise the company throughout its listed life on the EGM; • Submit to the CMSA and DSE an application for a Nominated Adviser for approval by both institutions; and • Prepare a prospectus for the purpose of public offer and listing as required by CMSA Prospectus Regulations. Approval of this prospectus will then allow the issuer to start selling securities to the public. 8.2 Listing Requirements: The Nominated Advisor 8.2.1 Roles and Responsibilities A Nominated Advisor acts as a consultant to companies that may have bright business ideas but lack capital and management capacity. The Nominated Advisor operates on the EGM because some companies listed there are new ventures. The Advisor guides the company on all initial listing requirements, preparation of the prospectus, and compliance with the continuous listing requirements. Companies wishing to obtain a listing on the EGM will not be permitted to list if they have not appointed a Nominated Advisor. The appointment is mandatory for the listing to be approved. 8.2.2 Conditions for Appointment as a Nominated Advisor The Nominated Advisor stays with a company for its entire listing life unless the company is de-listed or graduates to the main market. Individuals and firms wishing to be appointed as a Nominated Advisor must: • Be incorporated as a public company under the Companies Act; • Have enough professionals who are licensed by the CMSA; TRAINING MANUAL I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I 69 • • Have adequate capital as prescribed by the CMSA; and Have professional indemnity insurance. 8.3 Listing Requirements: The Initial Public Offering (IPO) Process A private company intending to go public must: (i) Make a presentation of the proposal to its Board of Directors: The IPO process begins with management making a presentation to the Board of Directors, complete with business plan and financial projections, proposing that the company enter the public market. (ii) Obtain approval of the proposal: If the board approves the proposal to go public, the proposal should be forwarded to the company’s General Meeting to secure shareholders’ approval. Once approved at the General Meeting, the company’s books and records should be reviewed for the past five years and financial statements restated, if necessary, to adhere to International Finance Reporting Standards (IFRS) to be certified. (iii) Select a team of advisors: The private company may already have one or more members of the IPO team serving it on a regular basis (e.g., accounting firm, auditing firm, law firm, and an investment bank/advisor). However, the company may need to either review existing relationships or establish new ones that will serve the company throughout the IPO process. Formalization of the relationship with advisors through appointment letters and agreement on fees will follow after appointments. After the IPO advisors are appointed, an IPO schedule or timetable of events can be prepared. 8.4 DSE Listing Requirements The rules lay down the procedure to be followed by applicants for listing. This includes: obtaining approval from the CMSA, naming a Nominated Advisor; obtaining sponsorship by a Licensed Dealing Member (LDM) of the exchange by submitting an application in the prescribed form; and satisfying documentary requirements (confirmation of being duly constituted as a public company from the legal advisor, confirmation of compliance from sponsor, 10 copies of the prospectus, 10 copies of audited accounts, 10 copies of applicant’s constitutive documents, details of existing and intended distribution of ordinary shares, etc.). 8.5 Continuous Listing Obligations The issuers’ continuing obligations are essential for maintaining an orderly market in securities and ensuring that all users of the market have simultaneous access to the 70 I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I TRAINING MANUAL same information. Continuing obligations of issuers cover the following: • • • General obligations of disclosure; Disclosure of periodic financial information; and Miscellaneous provisions. Every issuer shall comply with the continuing listing obligations prescribed by the CMSA and DSE rules. Every issuer must also retain a Nominated Advisor to advise the company throughout its listed life on EGM. An issuer shall, as soon as possible but not later than 24 hours, release an announcement giving details of: • • Circumstances or events that have or are likely to have a material effect on the financial results, the financial position, or cash flow of the issuer and/or information necessary to enable holders of the issuer’s listed securities and the public to make informed decisions on the issuer’s performance and operations; and New developments which impact the issuer’s operations, trading, and financial performance or any information whatsoever considered by the issuer to be price sensitive or that could lead to material movements in the prices of its listed securities. Lastly, an issuer shall submit to the DSE and the CMSA any material price-sensitive information and shall publish a cautionary announcement as soon as possible after it is in possession of such information, if at any time the necessary degree of confidentiality of such information cannot be maintained, or if the issuer suspects that confidentiality has or may have been breached. 8.6Conclusion This module illustrated to entrepreneurs the whole process of accessing long-term capital through capital markets. It explained the process and key requirements for any company that intends to float securities for public subscription. Furthermore, the process and available alternatives through which long-term funds for investments are raised were explained. TRAINING MANUAL I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I 71 72 I THE DAR ES SALAAM STOCK EXCHANGE (DSE) I TRAINING MANUAL