Focus on SMEs: When to expand abroad and how to deal with legal and fiscal challenges in Romania

Newsroom 03/05/2016 | 12:46

Despite the sector posting steady development in the past few years, SMEs are still facing difficulties. Such firms are waiting for the local authorities to take measures to give them an impetus and encourage the entrepreneurial initiatives that could boost the local economy.

Ovidiu Posirca, Anda Sebesi

The 2015 Romanian Entrepreneurship Barometer – Entrepreneurs Talk, conducted by EY Romania, found that small and medium enterprises (SMEs) represent 99.6 percent of the total number of companies active in Romania, and represent 44 percent of the total gross added value registered in the local economy. The same study says that over 64 percent of the total number of companies active at the end of March 2015 were limited companies (SRL) that have one associate on average. In addition, 91.6 percent of limited companies are micro-enterprises having on average two employees, an average share capital of EUR 11,000 and an annual average turnover of EUR 47,000. Most of the limited companies have their registered office in Bucharest and Cluj county.

“SMEs don’t have their own ministry, but are included within the Ministry of Economy. If we look at what has happened in the past year, there is no new regulation regarding SMEs that would have passed from the government’s side. I hope the current government is more active and firm regarding the implementation of EU funds, because, aside from one type of regulation, the resources that the public sector gets through EU funds should reach entrepreneurs,” says Florin Jianu, president of the Association of Young Entrepreneurs in Romania (PTIR) and a former technocratic minister for SMEs. At present, there are two main EU-backed operational programs for SMEs: the Regional Operational Program and the Human Capital Operational Program, which are linked to the creation of new jobs, the hiring process and the setting up of new companies by entrepreneurs.

According to him, neither of these two programs has so far launched a component for entrepreneurs, which would involve putting the projects up for debate, developing them and setting deadlines. By the time all this is done and a program implemented, it could take until the end of the mandate of this government before the funds reach entrepreneurs or any contracts are signed. “I think this government is missing a huge opportunity, because it doesn’t take any political risks. I would have expected a more courageous approach from this cabinet,” says Jianu. “Having a perspective from both the public and private sector, I have seen that the public sector will not be able to achieve results without modernization. This is almost impossible because modernization means new, well functioning rules. Working with the same people, no matter how many times you ask them to change or pay them better, you will not obtain superior results.”

He said that there is a need for a transfer of competence from the private to the public sector. “I think the current government should have the courage to enforce new structures, to transfer over from frozen structures. We are missing a very favorable moment, because the next government will be political and will stay away from making structural reforms,” concludes Jianu of the PTIR.

According to Andrei Pitis, founder and CTO at Vector Watch, Romania is a growing market, both in terms of the number of entrepreneurs and of those who find local entrepreneurial projects attractive. He thinks that there is still a lot of room for growth and improvement in particular. “However, the market lacks a well established, easy to follow and rapid flow. I think that the legal, fiscal and judicial system continues to complicate and sometimes to hinder the growth of the business environment. There have been some regulations in the past few years meant to support the ongoing development of small and medium projects but we are still in the first phases of a significant stage of development and maturing,” says Pitis. In his opinion, however, there are still advantages. “To the utmost extent, Romanians are educated, have a friendly and open attitude and speak one or more foreign languages fluently, while good professionals can still be found at competitive wages for the external market.” According to him, IT, telecommunication and services remain the most attractive fields.

 

New wave of SMEs shaping society

Tourism is a sector that has growth potential, and the reduction of VAT to 9 percent has brought sharper growth and stronger investments. Jianu said the potential was not necessarily in tourism accommodation, because demand is not that high. Recreational facilities for tourists need massive development. “The potential is huge. Other growth areas are IT, agriculture, and education,” he says. The PTIR president added that SMEs need to be supported by the government to specialize in niche industries, with automotive and textiles being areas where such niches can be found. In his opinion, more and more young people of Generation Y have this entrepreneurial drive, “not necessarily entrepreneurial in the traditional sense, but also social entrepreneurship or done within the company.” He said the new generation of entrepreneurs will be more socially responsible, which will lead to the modernization of society.

 

SME checklist

Talking about SME strategy, Silviu Andrei Petran, co-founder at Materia, said during an event organized by EY Romania and Impact Hub this month that it is very important to start thinking about quality and not quantity. “This is something I have discovered from my start-up in the furniture industry. Although we have very good sales from exports, to the tune of millions of euros, all our exports are prefabricated products, things that are assembled elsewhere. We don’t add any value to the design or final product, where the profit is bigger. This applies to any kind of activity,” said Petran. “Materia recovers all the wood, from demolished buildings, for instance; we turn them into unique pieces of furniture for export. So our value add from such a product is 70 percent profit, 30 percent costs. If you take any chair that we export, and the chair is the most exported piece of furniture from Romania, the added value is insignificant.”

Tincuta Baltag, founder of Digital Kids, a project developed by Edusfera Association, says that entrepreneurs, at least at the beginning, have to deal with a lack of information regarding the application of fiscal legislation or financing sources.

Although the Romanian legal framework seems to be clearer to both local and international investors than it was, they still face significant legal challenges that affect their development or expansion in Romania. “For a foreign investor, for instance, it is very difficult, due to the legal framework, to invest in a Romanian start-up. A lot of the successful start-ups that left Romania have foreign investors, and those investors asked them, in all the cases I know of, to relocate. In practice, the large start-ups that are mentioned in the press are Romanian only because they have Romanian founders, but legally they are already working in other jurisdictions, the most common of them being Great Britain,” says Florin Grosu, co-founder of Traderion, an IT start-up. In his opinion, the regulators should work on the legal framework to make it attractive for an investor to back a limited company founded in Romania.

According to Jianu of the PTIR, companies in Romania are facing a “huge problem” trying to employ people with technical skills, such as mechanics or welders. He added that these people are going abroad where they are better paid. The PTIR head said the association has proposed the setting up of a private technical school in every county, with the help of EU funds, under a program called Romania Profesionala. He added that there are already some successful cases, but needs to be a critical mass. However, he mentions entrepreneurs in the tourism sector that have struggled to convince technical and economical schools to launch classes for tourism. Jianu said he would call for the complete privatization of the technical education system. At the same time, asked how his start-up is able to keep its programmers onboard, given the high demand in the market, Grosu said, “Equity. They become shareholders in the company. It’s the only way to face competition from giant companies because you are giving them the chance to work for something that is very challenging, and they own a part of it, which could become very big, in the not so distant future.” The start-up has ten employees.

“Our conversations, research and business life experiences show that the attraction of talent, restructuring and reorganization of the company to achieve an adaptable business model and business development and product/services diversification are important aspects on the agenda of entrepreneurs and their management teams. Additionally, we should not ignore the focus on improving cash flows, cost reductions and access to finance,” says Ionut Sas, director of tax consulting at PwC Romania and leader of the tax consulting team for private companies, family businesses and SMEs.

SMEs are already dealing with difficult access to finance, poor collection of receivables and the instability of the economic and political background, according to Daniel Pana, tax director at professional services firm KPMG Romania.

“Developing businesses face a tougher challenge in finding resources to expand and in fulfilling all the legal administrative and fiscal requirements related to their development,” Pana told BR. If a company is able to get over the domestic issues and is starting thinking about international expansion, it should prepare to face another set of challenges.

 

Minimum wage hike

According to Jianu of the PTIR, the minimum wage has to be raised, but to avoid an additional fiscal burden for entrepreneurs, this should be done by freezing social contributions at the same time. This is possible, either as state aid or through a change in the Fiscal Code. “Entrepreneurs would rather give the extra money to their employees, not pay half to the employees and the rest to the state.” He added that Spain had a similar program for job creation: the government capped the payment of social contributions at EUR 100 for companies that hired new people that were previously unemployed.

Main unsolved issues for SMEs

“There is still a lot of useless regulation that costs the entrepreneur a lot of time reporting and obtaining information, and a lot of simplification can be done here. Micro-enterprises in Romania have on average 2.3 employees, and when you have two employees, it’s hard to cover all these reporting requirements to the tax administration agency ANAF, to obtain documents,” says Jianu. He suggested that the extension of online reporting could be really helpful for companies, which, for instance, are looking to participate in public tenders and need a fiscal certificate.

“In the SMEs law there is a provision taken from from the Small Business Act, which says the state has to abstain from asking for information that it already has. So, in the next period a lot of effort has to be put into interconnecting various sources of information in the public sector – for instance for the fiscal certificate. There are a lot of good things in the new Fiscal Code, but there is also taxation on the social HQs which has to be revised and actually return to the previous provisions,” adds Jianu.

 

When to go abroad?

According to Pitis of Vector Watch, there is no appropriate time for international expansion. “In an economy based on consumption, a business plan that works locally can be applied to other markets too. I recommend that Romanian entrepreneurs think globally, because we live in a ‘dot com’ world, not in an exclusive ‘dot ro’ one. We can look at companies that succeed wherever and that can enter in any market. This globalization is often seen in software but there are also other niches that cannot be neglected, such as tourism or services. Once you have thought of a process that is tested and optimized, expansion in other markets is just a matter of time, resources and imagination,” he believes.

The lack of a clear strategy, poor management and limited revenues are some of the things that put the brakes on SMEs that are looking to make a name for themselves in Romania and even expand abroad. Analysts say that sometimes, even the founders of SMEs block the development of companies without realizing it.

“From our experience, one of the main difficulties facing SMEs is the transition from a family company to a management one. This means moving from a company in which the founder is the ‘hero’ and solves everything at anytime, to a new structure in which a well-prepared management team handles the firm’s current activity,” Sorin Spiridon, manager at Ensight Management Consulting, told BR.

He says there are many reasons why such a transition is blocked. For instance, the company’s founders might not have realized that being a successful entrepreneur is not the same as being a good manager. In other cases, the founders tend to micromanage and miss the big picture. Some SMEs will also fail to develop because they don’t have efficient policies for retaining key staff and recruiting new talent, according to Spiridon.

“To approach a new market you need to have basic competences so you can differentiate yourself from the existing players. Moreover, when looking to attack a new market, firms should have a clear business model, effective management teams and procedures for repetitive tasks,” said Spiridon. He added that firms will fail in their international endeavors, and even locally, if one of these elements is not taken into account.

Elsewhere, there is an inevitable tipping point when every entrepreneur thinks of making his or her exit from the business they backed. But to do it successfully there is a need for a clear exit strategy and a list of potential buyers who might be interested in the firm.

“We have an exit strategy and we have in our mind the potential buyers. We have never approached them to sell; so far we have only talked with them so we could become partners and work together. The ideal buyers are large clients, large companies, but right now we are showing them what we can do and over two to five years of relationship, I think this discussion will also pop up,” said Grosu of the IT start-up Traderion.

Another feature of the local market is that there are few strong companies with Romanian capital. Mihaela Matei, entrepreneurship communication officer at EY Romania, the professional services firm, says there are only 138 companies with private Romanian capital that have a turnover above EUR 50 million, compared to 322 firms with foreign capital. In the EUR 10-50 million turnover band, there are around 1,300 companies with foreign capital and 1,000 with domestic capital.

“Maybe the penetration at regional level is not as visible and widespread as we would wish, but I would say that Romanian SMEs are present in the region, in the European Union or at global level, with examples in this sense. Looking at whether there is a good moment or not, it is quite difficult to assess as it depends on market conditions and/or the industry where SMEs are involved,” said Sas of PwC Romania. Research carried out by the Ministry of Development has shown that two thirds of start-ups cease their activity within a year, added Pana of KPMG Romania.

Financing remains a challenge

“Personal financing remains the main source, self-financing, followed by traditional financing from banks. There will also be some guarantee funds of loans through EU funds – an initiative for SMEs, as well as other instruments in the 2014-2020 period. I am a supporter of listings on the stock exchange, but in this area we need a culture and more time. Smaller companies generally stay away from listing on the stock exchange and they are not very comfortable with this subject,” says Jianu of PTIR.

He added that the success of companies in America is confirmed by floating, while this is not necessarily the case in Europe. “I would look at alternative financing models, for instance crowdfunding.” Jianu said there is a bill in Parliament that regulates crowdfunding, which was launched while he was in government. Crowdfunding involves breaking the banking monopoly, because if someone has a business idea and posts it on a crowdfunding platform, it can attract resources from other parties.

At present, the law prohibits such transactions. If a company wants to lend money to another company,it is not allowed do it. Only banks and other non-banking financial institutions have the right to do so. Another type of financing is through business angels. There is already a law, and some kind of support scheme (minimis – e.n) should have been added, but this has not yet happened.

Financing from EU funds remains a significant chance for Romania, but one not much capitalized upon. The Human Capital Operational Program has EUR 4 billion available, and the Regional Operational Program EUR 1 billion for SMEs, while there are significant options in the rural development programs.

 

Healthcare companies set SMEs as priorities…

SMEs already have dedicated products and services, with lenders prominent among the companies targeting them. Private healthcare providers and insurers also do so: the Regina Maria private healthcare network recently launched prevention and treatment packages aimed at SMEs, regardless of their number of employees. They also address lawyers, consultants and accountants. The SMEs range includes IMM Plus, IMM Optim and IMM Ultra, with all three products involving prevention services that can be customized with different medical options. “The SMEs sector is very active and there are many companies that post good growth and we want to support them. The reason behind this range is ‘People that build things need solid health.’ If we look at the medical packages market for companies, we will notice that its penetration is significantly lower for SMEs than multinationals. It is a segment with high potential,” says Fady Chreih, CEO at Regina Maria. He adds that SMEs requested such products even before Regina Maria had officially launched its dedicated range and the demand increased along with the development of the specific products. “There are regions in Romania where the penetration of medical packages is quite low, especially within SMEs. So it is a market that deserves to be increased and supported. Regina Maria intends to sell about 10,000 packages in the first year,” added Chreih.

… as do insurers

Allianz-Tiriac has posted an increase of 20 percent for non-car insurance and doubled its number of health insurance policies for SMEs in the past two years. According to representatives of the insurer, almost all of its products for companies address SMEs too, but there are also some especially for such customers. There are two alternatives: fixed packages and flexible and modular ones that enable customers to customize them according to their needs and profile risk. “At the end of 2015, more than half of the total number of active polices closed by companies at Allianz Tiriac were taken out by SMEs,” say the insurer’s representatives. According to them, the majority of the SMEs (about 75 percent) that took out insurance policies in the past two years at Allianz-Tiriac come from fields such as distribution, services, production and construction.

New Fiscal Code offers impetus, but unpredictable legislation lingers

The new Fiscal Code rolled out this year offers some advantages for micro-enterprises, but the owners of SMEs are still dealing with cumbersome procedures and the lack of predictability in legislation, which remains a key issue for the local business environment.

Romania still lacks a fiscal framework that specifically addresses the SME sector, even though it generates most of the jobs in the country, according to analysts. Locally, SMEs represent 99.6 percent of the total number of companies active in Romania, compared with 99.8 percent in the European Union, according to a report by the European Commission, the executive arm of the EU, which was published in 2015.

“The provisions in the Fiscal Code have a ‘global applicability,’ so large companies, multinationals and SMEs benefit to the same extent from these provisions. So, without fiscal provisions targeting only one sector, which is important for any mature economy, we can say the current fiscal framework is not that prepared to offer too many tax advantages for small and medium enterprises,” Razvan Graure, partner at Musat & Asociatii – Consultanta Fiscala, told BR.

He acknowledges, however, that SMEs have simplified reporting criteria for their accounting data and need to submit fewer forms to the tax authorities than large companies.

The further simplification of legislation is something that smaller companies with fewer employees desperately need, according to Florin Jianu, president of the Association of Young Entrepreneurs in Romania (PTIR). The National Council of Private SMEs in Romania (CNIPMMR) agrees that this sector needs a further reduction in the tax burden. Entrepreneurs in Romania have to make three times more fiscal payments per year than the EU average, namely 39 (locally), according to a report put out in 2014 by the World Bank.

“Looking at SMEs and how a tax system could further facilitate their sustainability, simplification measures in terms of compliance, tax returns and payments would be of great help, combined with general support and assistance for SMEs’ tax affairs. In addition, access to state aid/EU funds or other financing aid will need to be simplified and made available to SMEs on a timely basis,” says Sas, of PwC Romania.

Getting less taxing

Microenterprises are getting more fiscal room for development as of this year, thanks to some key provisions in the Fiscal Code. They get different tax rates depending on the number of employees, from 1 percent to 3 percent. A transitory regime is available to encourage start-up micro enterprises at 1 percent for the first two years of activity.

“These changes in the tax rates, based on the number of employees, encourage the employment market, as SMEs are a good source of new jobs,” Anca Sucala, managing partner at Roedl & Partner Romania, the professional services firm, told BR. According to Pana of KPMG, the reduction of VAT to 20 percent should incentivize companies, including SMEs, while investors would benefit from cutting dividend tax from 16 percent to 5 percent.

Furthermore, the threshold for applying the micro-enterprise tax regime has been increased to EUR 100,000, allowing more companies to benefit from the special treatment. Sucala warned, however, that not all the changes were favorable; for instance, the new taxation regime for buildings with mixed use combines the residential and non-residential tax rates.

“Many SMEs are in this situation, so the property tax hike increases the fiscal burden, which in turn reduces the activity of SMEs, while some could even stop operating. This means jobs lost and less tax collected for the state budget,” said Sucala.

Florin Gherghel, head of the tax department at Noerr Finance Tax, noted that SMEs are also grappling with the approach of tax inspectors, who might levy extra charges following controls. He added that a growing number of companies are challenging the conclusions of tax inspectors in court. According to Graure of Musat & Asociatii – Consultanta Fiscala, the reversed taxation mechanism for VAT payments and the further reduction of labor taxes are some of the measures that could offer a “breath of fresh air” to SMEs.

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