Restructuring in SMEs: Cyprus

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Contents

Introduction

1

Relevance of different types of restructuring for SMEs

5

Drivers of restructuring

10

Distinctive characteristics of restructuring in SMEs

13

Main challenges and constraints facing SMEs in restructuring

14

Business support from public and private sources

16

Outcome of restructuring

18

Conclusions and policy issues

19

Bibliography

21

Introduction Small and medium-sized enterprises (SMEs) are the backbone of the Cyprus economy, representing 99.8% of all business and accounting for 83.2% of the nation’s jobs, mostly in activities such as tourism, financial services and real estate. Cyprus adopted the euro in 2004 and its GDP grew at well above the average EU rate up until 2008, when it was hit by the global financial crisis. SMEs have been badly hit by the banks’ retrenchment and there are widespread calls for a Loan Guarantee Scheme, in conjunction with tax incentives for smaller companies. There is also a lack of effective schemes to make SMEs more competitive.

Current economic and political contexts 1

Cyprus , a small island economy, is an interesting case for the investigation of entrepreneurial initiatives within SMEs (Hadjimanolis, 2008), including restructuring events. Cyprus was mainly an agricultural country until the time of its independence (1960). Light manufacturing industry (textiles, footwear and foodstuffs) developed quickly, mainly in the 1970s and 1980s. Tourism and other services also started to develop rapidly, especially after the 1980s (Dana, 2000). Today Cyprus has a market economy dominated by the service sector, which accounts for nearly four-fifths of GDP. The most important sectors of the country are tourism, financial services and real estate, exhibiting high growth rates over the past decade (IndexMundi, 2012). Data from the Cyprus Statistical Service (2012) show that financial, insurance and real estate activities contributed 20.5% of the country’s GDP in 2011, while trade, IT and tourism-related activities accounted for another 27.4% (Figure 1). Other services had a combined annual contribution of 32.6% of GDP (Cyprus Statistical Service, 2012). Figure 1: Distribution of gross domestic product, 2011

32.6% €mn 5,236.6

2.4% €mn 389.5

9.1% €mn 1,458.3

8.0% €mn 1,289.1

20.5% €mn 3,303.7

27.4% €mn 4,401.8

Agriculture, forestry and fishing Mining and quarrying, manufacturing; electricity, gas, steam and air conditionaing supply and water supply, sewage, waste management and remediation activities Construction Wholesale and retail trade; transportation and storage; accommocation and food service activities and information and communication Financial and insurance activities and real estate activities Other services

Source: Cyprus Statistical Service, 2012

1

The report refers only to the economy of the Cyprus government-controlled areas and does not therefore include the northern part of Cyprus.

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Restructuring in SMEs: Cyprus

Since 2004, Cyprus has been a European Union member, and in 2008 the country adopted the euro as its national currency. The country’s GDP grew at a rate well above the EU average between 1996 and 2008, recording an average annual growth rate of 3.7% (Cyprus Statistical Service, 2012). However, the country’s prosperity came under pressure in 2009 as a result of the global financial crisis. Initially, growth in the construction and tourism sectors slowed as a result of reduced foreign demand, which led to a contraction of the Cyprus economy by 1.8% in 2009 (IndexMundi, 2012). Despite signs of recovery during 2010 and 2011, the economy recorded growth rates of 1.1% and 0.5% respectively, well below the growth rates the country experienced prior to the crisis (Cyprus Statistical Service, 2012). However, the global financial distress not only had an adverse effect on the growth patterns of the Cyprus economy, but led also to an increasing budget deficit, which had reached 6.3% of GDP in 2011 compared to 5.3% in 2010, documenting a further violation of the EU’s budget deficit ceiling of 3%. In addition to this, the country’s public debt increased to 71.6% of GDP in 2011, from 61.5% in 2010 (eKathimerini, 2012). Despite the introduction of austerity measures and the government’s commitment to cutting the growing public sector payroll (which had grown from around €500 million in the early 1990s to €2.2 billion in 2010) and to reducing the country’s fiscal deficit to rates below 3%, the economy has yet to show signs of recovery. This is primarily due to the high reliance of the Cypriot banking system on the Greek economy, which led to a deterioration in their financial position due to their exposure to bad Greek debt (The National Herald, 2012a; 2012b; 2012c). Latest estimates by the International Monetary Fund (IMF) indicate that the Cyprus economy is due to shrink a further 1.2% during 2012 and will grow by 0.8% in 2013 (IMF, 2012a; 2012b). The country’s deteriorating financial position appears to be influencing the country’s competitiveness as a foreign direct investment location. According to the latest data provided by the Global Competitiveness Report for 2011/2012, Cyprus ranks 47th out of 142 countries, down from the island’s 34th place during 2009/2010 (Schwab, 2011). This downgrade reflects the country’s uncertain macroeconomic outlook. The prolonged macroeconomic crisis, the fiscal crisis across Europe and the ‘haircut’ of the Greek Government bonds has hit the Cyprus banks hard, the main source of external funding for SMEs. As a result of the erosion of the capital base of Cypriot banks, there is a serious liquidity shortage that is hampering the survival and growth strategies of the enterprising economy. This vicious circle has had a negative impact, especially on smaller firms that are notoriously characterised by a narrow equity base and over-dependence on short-term finance, mainly in the form of bank overdrafts and loans (Poutziouris, 2011). The retrenchment in the supply of bank credit and the increasing uncertainty about the business cycle has led to credit rationing. That is why all stakeholders are calling for government intervention in small enterprise credit markets in the form of a Loan Guarantee Scheme, in conjunction with tax incentives for equity injections in smaller companies (Poutziouris, 2011). In terms of enterprise policy, despite years of debate as to how to make SMEs more competitive, there has been a lack of effective schemes to promote the restructuring of smaller firms. Limited research has been directed to a prolific small business sector with a view to dealing with the chronic problems and challenges facing family-run micro enterprises.

SME business environment Business population Cyprus is dominated by small and medium enterprises (SMEs). SMEs are the backbone of the country’s economy, representing 99.8% of all business and accounting for 83.2% of the nation’s jobs. While the proportion of SMEs in the total business population resembles the EU average, Cypriot SMEs contribute far more to total employment than the EU average and they also create more added value (European Commission, 2011).

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Restructuring in SMEs: Cyprus

Table 1: SMEs in Cyprus, 2010 Number of enterprises Cyprus

EU27

Employment Cyprus

Value added EU27

Cyprus

EU27

Number

Share

Share

Number

Share

Share

€bn

Share

Share

Micro

39,205

91.8%

92.1%

92,190

38.9%

29.8%

3

30%

21.6%

Small

2,921

6.8%

6.6%

56,666

23.9%

20.4%

2

24.3%

18.9%

483

1.1%

1.1%

48,049

20.3%

16.8%

2

20.7%

17.9%

SMEs

42,609

99.8%

99.8%

196,904

83.2%

66.9%

7

75%

58.4%

Large

79

0.2%

0.2%

39,868

16.8%

33.1%

2

25%

41.6%

Total

42,688

100%

100%

236,772

100%

100%

9

100%

100%

Medium

Source: European Commission, 2011

While other small economies exhibit high reliance on SMEs, what is interesting in the case of Cyprus, though, is that unlike other small economies, the actual size of SMEs is in line with the overall EU average. The average SME size in Cyprus is 4.6 employees, slightly higher than the EU average. This contrasts with SME size patterns in small markets, which are far below the EU average. Cyprus’ SMEs are, in fact, relatively sizeable given the smallness of the domestic market. A reason for this is the fact that a large percentage (40% compared to 31% in the EU) of SMEs have an international presence, primarily via exports (European Commission, 2011). Entrepreneurial environment Cypriots are engaged in entrepreneurial activities to a far higher degree than the average EU citizen. The percentage who started a business which is still active, or who are currently taking steps to start one, amounts to 32% in Cyprus, whereas the EU average is only 23%. Cypriots are also above the EU average in terms of their willingness to become an entrepreneur (37% as compared to 30%) (European Commission, 2011). One of the major drivers of entrepreneurship in the country is the preference for self-employment, which is the highest in the EU27 (66% of the adult population versus 45% for the EU). This type of entrepreneurship is driven by necessity, is embedded in Cypriot culture and is reinforced by the educational system. However, the share of entrepreneurs driven by opportunity is much lower in Cyprus than in the EU on average (49% versus 64%). This is important as opportunity-driven enterprises are found to be more profitable and sustainable than those started from necessity (European Commission, 2011). Between 2004 and 2009, Cyprus exhibited an average annual enterprise start-up rate of 4.2%, which was far below the EU average of 9.8% (Schror, 2009; Eurostat, 2012). However, the birth of new enterprises in the country is diminishing, exhibiting a 3.04% start-up rate in 2009, compared to the 5.92% and 7.14% during 2004 and 2005, respectively. Since the global recession was felt in Cyprus from 2009 onwards, the diminishing rates described in Figure 2 are due to the vibrant pre-crisis employment market.

© European Foundation for the Improvement of Living and Working Conditions, 2012

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Restructuring in SMEs: Cyprus

Figure 2: Percentage of newly created enterprises among existing companies 2004–2009 8 7.14 7 6 5.92 5 4

3.32

3.04

3.61

3 2

2.27

1 0 2004

2005

2006

2007

2008

2009

Source: Schror, 2009; Eurostat, 2012

A recent survey of the entrepreneurial economy in Cyprus (Poutziouris, 2010) identified that 90% of businesses, especially SMEs, are family-owned and managed. The survey identified that a small percentage of these firms (approximately 9%) reach the third generation of family owner-managers. Restructuring in SMEs Restructuring among SMEs has been a recent topic of public and policy debate in Cyprus. Although SMEs contribute greatly to the Cyprus economy, there has been an absence of any dedicated Small Enterprise Policy. The need for supporting SMEs became explicit after joining the European Union in 2004. EU accession brought along a number of schemes, assisting SMEs to expand their premises and technological base, internationalise activities, strengthen competitiveness, and appreciate research, training and information services. Despite this realignment in the policy towards SMEs and the presence of restructuring support, the whole support mechanism still remains fragmented across several ministries and organisations. Arguably, aside from political nepotism, in the name of industrial development, enterprise policies have always been biased towards large businesses.

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Relevance of different types of restructuring for SMEs Bankruptcy/closure 2

Bankruptcy/closure is a major type of restructuring being identified by the European Restructuring Monitor – ERM (2012) of the European Foundation for the Improvement of Living and Working Conditions (Eurofound). This restructuring dimension relates to the closure of an industrial site or when a company goes bankrupt for economic reasons. Data related to bankruptcies and closures of SMEs in Cyprus are scarce. The limited available data indicate that approximately 50% of newly formed SMEs fail three years after establishment (Christofides, 2008). Eurostat (2012) data provide a snapshot of enterprise closure rates in the country. Between 2005 and 2008 there was an average closure rate of 2.34%, which was well below the EU average of 8.5% for the same period (Figure 3). These data refer to the business population of the country as a whole. However, considering that 99.8% of businesses are SMEs (European Commission, 2011), this information would very much reflect the current situation with regard to the SME closure rate in Cyprus. Figure 3: Enterprise closure rate* in Cyprus, 2005–2008 (%) 3.5 3

3.06

2.5

2.38 2.2

2 1.71 1.5 1 0.5 0 2005

2006

2007

2008

*Refers to the percentage of businesses that discontinue their operations (Schror, 2009). Source: Eurostat, 2012

However, data are available up to 2008. Consequently, this restricts understanding of the situation during the economic crisis, which brought serious financial problems to many Cypriot SMEs, causing many of them to close. Data from the Cyprus Statistical Service (2012) show that the global crisis triggered a fall in growth in construction and tourism, the pillars of the Cyprus economy. Evidence shows that businesses in these key sectors face serious threats to their existence (Boukas and Ziakas, 2012), and it is therefore expected that the closure rates are soaring.

2

http://www.eurofound.europa.eu/emcc/erm/index.htm

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Restructuring in SMEs: Cyprus

Interestingly, enterprise closure rates are relatively low, due to the fact that some firms experiencing bankruptcies or closures are subsidiaries, spin-offs or satellite firms of established family business groups. Failure is stigmatised in Cypriot culture. Table 2, from the Registrar of Companies, offers trends in bankruptcies of people and liquidation of companies. It is difficult to reconcile this with the Eurostat projections as figures differ. According to estimates the business population in Cyprus is between 43,000 (European Commission, 2011) and 63,000 (local projections) across legal forms. So, based on the assumption that people are sole-proprietors or self-employed entrepreneurs, 2.58% is the bankruptcy rate for 2010, with 3.46% for 2009. Table 2: Bankruptcies and liquidations 1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

People

226

286

434

460

462

407

358

359

430

576

640

839

1,083 1,329

941

849

Firms

122

87

121

142

147

139

190

118

149

158

140

141

171

182

135

159

Note: The methodology used for the statistical data up to September 2010 was estimated in accordance to the date of issue of the court orders. From 1 October 2010 onwards, the date on which the court orders are received by the Official Receiver is used. Source: Registrar of Companies, Republic of Cyprus 2012

Mergers and acquisitions Mergers and acquisitions is another major restructuring event. This occurs when two companies merge or an acquisition of a company involves internal restructuring such as downsizing (European Restructuring Monitor – ERM, 2012). The literature on mergers and acquisitions is mostly concerned with large firms, ignoring the overall role of small and medium enterprises (Bullock et al., 2004; Weitzel and McCarthy, 2011). Acquisitions in the small business sector are relatively neglected because of the difficulties in identifying them and in obtaining data on their characteristics (Bullock et al., 2004). According to Weitzel and McCarthy (2011), since most SMEs are not publicly quoted, it becomes difficult to obtain reliable data on their mergers and acquisitions. Data on mergers and acquisitions, where Cypriot SMEs are involved, are scarce. Datamonitor (2012) offers general information on 339 acquisitions involving Cypriot firms which occurred between 2002 and 2012. Among these deals, 16% included full acquisitions (100%), 25% majority acquisitions, 54% minority acquisitions, and 5% asset purchase (see Figure 4).

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Restructuring in SMEs: Cyprus

Figure 4: Acquisitions by deal type, 2002–2012

5%

16%

25% 54%

100% acquisition

Majority acquisition

Minority acquisition

Asset purchase

Source: Datamonitor, 2012

Datamonitor offers also data relevant to the deal value of acquisitions. Figure 5 shows that acquisitions had generally a low deal value, which may reflect the fact that most acquisitions have been minority acquisitions. Another reason might be that most of these acquisitions involved smaller firms as targets, which may again justify the low deal value of these acquisitions. Some 40% of the acquisitions between 2002 and 2012 had a deal value between USD 1 million and USD 25 million (€807,241 – €20,180,494 as at July 2012), while the vast majority of these acquisitions (about 83%) had a deal value less than USD 200 million (€161,553,995). Figure 5: Acquisitions by deal value, 2002–2012 (USD millions)

4%

1%

4%

4%

3% 1%

40%

11%

13% 19%

1-25

26 - 50

51 - 100

101 - 200

201 - 300

301 - 400

401 - 500

501 - 1000

1001 - 5000

5001 - 10000

Source: Datamonitor, 2012

Figure 6 provides details regarding the industry within which these acquisitions took place. The majority of acquisitions that were captured by Datamonitor between 2002 and 2012, took place between companies in the energy and utilities sector (21%), followed by companies in the financial sector (17%), metals and mining (10%), industrial goods and machinery (9%), and construction and real estate (8%).

© European Foundation for the Improvement of Living and Working Conditions, 2012

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Restructuring in SMEs: Cyprus

Figure 6: Acquisitions by industry, 2002–2012 6%

9% 6%

8% 6%

10% 4%

21%

4% 9% 17%

Business and Consumer Services

Construction and Real Estate

Consumer Packaged Goods

Energy and Utilities

Financial Services

Industrial Goods and Machinery

Leisure and Arts

Media

Metals and Mining

Transport and Logistics

Other

Source: Datamonitor, 2012

Business expansion Business expansion is another restructuring activity. This involves a company extending its business activities via internal and external growth strategies which leads to hiring workers (European Restructuring Monitor – ERM, 2012). A number of growth ambitious firms have been pursuing integration strategies and horizontal strategies in order to consolidate their position in the local market. Primarily, it is part of a strategy to achieve operational efficiency and to diversify by extending their business model through developing their market and products. Traditionally, Cypriot entrepreneurs prefer business expansion via internal–organic growth strategies as opposed to external strategies such as mergers/acquisitions and joint ventures. Anecdotal evidence suggests that there are several reasons for this: n

Cypriot autonomist business culture;

n

intensified market competition which renders financial projections as too uncertain;

n

corporate valuations tend to be a conundrum – in the absence of up-to-date financial and management reporting;

n

family owner-managers prefer organic growth, as they are not keen on strategies that will lead to the erosion of family control.

Prior to the economic crisis, exporting and other internationalisation tactics was key to the growth strategies of SMEs. Exporting is the major means of international expansion of Cypriot SMEs, and is a critical factor in the development and long-term survival of many SMEs. Cyprus’ EU accession and the abolition of trade barriers, offered opportunities to Cypriot firms to achieve or strengthen their international position, through exports to EU markets. A study by Yamin, Sinkovics, and Hadjielias (2008) showed that EU accession contributed to an overall increase in the interest and willingness of the managers within the SME sector to initiate expansion via exports to the EU. Figure 7 depicts the

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Restructuring in SMEs: Cyprus

export performance of Cypriot firms between 2002 and 2011. While the value of exported goods and services reached €5,674 million in 2002, exports reached €7,699 million in 2011, an annual average increase of 3.9% between 2002 and 2011. Though this figure provides details on export activity of businesses as a whole, it becomes apparent that Cyprus’ EU accession brought along a boost in the exports of goods and services for its SMEs. Figure 7: Cyprus exports, 2002–2011 (€ millions) 10,000 7,863.0 8,000 6,000

7,303.3

7,058.4 5,674.1

7,667.5

6,089.8 6,611.4

6,883.0

7,699.0

5,541.2

4,000 2,000 0 2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

Source: Cyprus Statistical Service, 2012

Other types of restructuring The European Restructuring Monitor – ERM (2012) identifies another four major types of restructuring for which it was not possible to collect data specifically about Cypriot SMEs. These include: n

Relocation: When the activity stays within the same company, but is relocated within the same country.

n

Outsourcing: When the activity is subcontracted to another company within the same country.

n

Offshoring/delocalisation: When the activity is moved or outsourced outside the country’s borders.

n

Internal restructuring: When the company undertakes streamlining operations not linked to another type of restructuring.

The case studies outlined in this report offer empirical evidence that show these restructuring events occur, and are important for the growth and sustainable development of SMEs.

© European Foundation for the Improvement of Living and Working Conditions, 2012

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Drivers of restructuring Restructuring in SMEs appears to be influenced by a mixture of internal and external factors. Internal stimuli are those related to the key functional areas of the organisation, including: n

human resources,

n

finance;

n

research and development;

n

production;

n

marketing.

External stimuli include factors relating to both the domestic and foreign markets, such as: n

home and foreign government legislation and policy;

n

competition;

n

customers (Leonidou et al., 2007).

A number of studies have been made about the reasons for restructuring among Cyprus SMEs such as business expansion and internationalisation (Leonidou and Katsikeas, 1996; Leonidou, 1998; Yamin et al., 2008). Leonidou (1998) identified a mixture of internal and external factors stimulating Cypriot SMEs to export, including; n

the potential that a business has to achieve extra sales and profits from export operations;

n

the desire of the company to grow, especially when domestic opportunities are limited;

n

a special managerial interest in exports, perhaps due to an owner-manager or key decision-maker having contacts overseas;

n

the identification of specific market opportunities abroad;

n

the opportunity for achieving economies of scale from exports, which would not be possible if business was limited to a small domestic market.

A study by Yamin et al. (2007) revealed a number of factors that tend to drive expansion and entry of Cypriot SMEs into EU markets. These include (prioritised in terms of their importance): n

competitive pressures in domestic markets;

n

opportunities for extra sales/profits from expanding abroad;

n

corporate growth;

n

scale economies;

n

reduction of the risk associated with a high dependence from a single domestic market;

n

special managerial interest and vision for expanding abroad.

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Restructuring in SMEs: Cyprus

With respect to competition, the recent entry of retail mega-stores like Lidl, Carrefour and IKEA in the Cypriot market created further pressures on domestic SMEs. Since these large firms source large quantities of goods from Europe and beyond, they have the ability to offer cheaper foodstuffs and household products to consumers. As a result, many Cypriot SMEs turned to niche manufacturing with a focus on the middle to higher end of the market – often offering customised production and generous terms of credit, as part of the market mix. In their quest for survival and long-term sustainable growth, other small-scale producers had to streamline operations and outsource certain non-core functions such as distribution. More sizeable firms have pursued expansion across Cyprus, and internationalisation through exporting, for example, pharmaceutical products, food and beverages, electronics, recycled products, machinery and equipment, basic metals and chemical products; and through direct foreign investment in the Balkans and in the Middle East in order to overcome resource bottlenecks and access bigger market demand. The winners of industrial restructuring have been service-type manufacturing, for example: n

printers, with high-tech plants serving accountancy, law, banking, insurance and financial firms;

n

technician teams supporting service institutions (such as hospitals, schools, colleges);

n

trading firms dealing with cars and heavy construction equipment, air-conditioning and plumbing (triggered by the enlarged construction and property development sector, before the financial crisis).

There are a number of other reasons, primarily external, for restructuring within Cypriot SMEs. Key external factors include: n

shortages of skilled workers;

n

funding schemes;

n

tax incentives;

n

accession to the EU;

n

the global financial crisis.

In previous decades, due to a market shortage of indigenous multi-skilled technicians, a number of small manufacturing enterprises have downsized, outsourced and reconfigured their business models. The accession of Cyprus into the EU and the enlargement of the EU across Eastern Europe triggered the further reduction of traditional production sectors, such as farming and manufacturing, but also the growth in service sectors notably: n

tourism;

n

financial services;

n

transport;

n

trading (with service-type manufacturing, offering installation of apparatus and after sale service)

The second driver refers to funding schemes. According to the Cyprus Investment Promotion Agency (2012), since the EU accession in 2004, the Government has introduced certain schemes and incentives to finance the restructuring of traditional production sectors.

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Restructuring in SMEs: Cyprus

In 2011, the European Investment Fund signed guarantee agreements with the Bank of Cyprus, allowing the bank to provide up to €50 million of new loans to Cypriot micro and small enterprises (MSEs); €35 million of this was earmarked to support enterprises up to three years old. The guarantees are implemented under the Joint European Resources for Micro to Medium Enterprises initiative, co-financed from EU Structural Funds. This opportunity is hoped to benefit a broad range of SMEs across Cyprus. The bank has also been extending finance to enterprises with insufficient collateral, reducing loan interest rates and also providing terms for extended repayment and grace periods. The ‘relocation of micro-enterprises programme’ (those with up to 10 employees) began in 2009 and provides 10%–15% funding for manufacturing firms wanting to move to more suitable premises or acquire their own plants (Cyprus Ministry of Commerce, Industry and Tourism, 2009). Another support mechanism is the ‘2007 – 2013 scheme for the reinforcement of the competitiveness of SMEs’ which provides 25%–35% of funding and up to €200,000 to manufacturing SMEs that wish to expand their premises and production lines (Cyprus Ministry of Commerce, Industry and Tourism, 2007; 2010). In 2010, the Cyprus Government also introduced the Cyprus Productivity Centre employment scheme. This aimed to maintain and boost employment by offering grants to draw up and implement business plans to improve the competitiveness of enterprises and, as a result, improve the quality and duration of employment. At least 90 businesses were expected to benefit, which would maintain about 600 jobs and create 300 new jobs (European Commission, 2011). However, it is worth noting that public financial support from EU funds — regional as well as structural funds — are focused much less on SMEs in Cyprus when compared to the EU partners (European Commission, 2011). There are also tax incentives for investment in technological upgrading, and in research and development as this is central to building competitiveness. Accession to the EU is another driver for restructuring. As seen in Figure 7, Cyprus’ EU accession led to an expansion of exports among Cypriot businesses. Studies show the high motivation and willingness among Cypriot SMEs to become international players, by starting to export to EU markets. A study by Yamin et al. (2008) showed that the accession of Cyprus, plus the subsequent harmonisation of businesses with EU law motivated businesses to expand to EU markets. The global financial crisis also appears to have caused Cypriot SMEs to restructure. SMEs in key sectors such as the tourism industry face serious problems, for example, lack of liquidity due to late payments, poor access to bank finance, and very expensive loans that pose a risk to their overall survival and longevity (Boukas and Ziakas, 2012). Many SMEs chose to close; others have decided to retrench, streamline their operations, outsource non-core activities, or promote themselves as potential acquisition targets.

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Distinctive characteristics of restructuring in SMEs The majority of SMEs in Cyprus are pursuing internal growth strategies. This has, since the accession, mostly been by expanding into EU markets. Expansion abroad takes primarily place through new or strengthened export initiatives, which are generally unplanned and reflect the reaction of many SMEs towards both domestic competitive pressures and increasing costs due to the lack of necessary scale economies. Studies reveal that, in many cases, SMEs in Cyprus do not plan their expansion abroad but tend to react to stimuli such as unsolicited orders received from customers (Katsikeas, 1996; Yamin et al., 2008). Several of these SMEs tend to engage in sporadic, as opposed to regular, exporting (Katsikeas, 1996), which shows that for many SMEs, business expansion may not be part of a broader long-term strategy of the firm. The dominance of family firms means that mergers and acquisitions (that is, external growth) are not very common. This might be changing, though, due to the financial pressures that SMEs are facing. These pressures have turned a number of them into targets for potential acquisition from larger domestic firms or companies abroad interested in entering the Cypriot market. Again, such moves appear to be unplanned and reactive and seen as an alternative to business closure. Moreover, there is an extension to the poor bankability of Cypriot SMEs that exacerbates the finance gap. Given the proliferation of the family owner-managed business model, the family offers family assets as collateral for bank loans which helps it to access bank finance. Paradoxically, each family owner-director will then have a facility to draw money from the business and they appear as creditors to the firm. Thus in the current crisis, where bank lending is limited, profits are wiped out, family welfare is at stake as ownerdirectors with modest remuneration have to curtail borrowing from their own firms. This phenomenon epitomises the information asymmetries (that creates an empathy gap between financiers and entrepreneurs) and the moral hazard that sours the relation of banks and entrepreneurs which nowadays has a disastrous effect on SMEs looking to re-finance their loans. Traditional financial management principles are not applicable and, put simply, any restructuring effort is in jeopardy. Another feature specific to Cypriot micro-small enterprising sector is the absence of any work councils at the executive management level or on firms’ advisory boards. About two-thirds of firms in Cyprus have one employee. Micro and small enterprises are predominantly family owner-operated. Thus, the Cypriot micro-small enterprise sector is not unionised, as they often employ family, friends and associates. Even in the case of more sizeable enterprises where their employees are members of unions, works councils, trade unions or other employee representatives are rarely involved in discussions about restructuring (exceptions are the quasi-public organisations in the utilities sector). For the great majority of SMEs there is no separation between ownership and management control. The owners are managers and are represented on the board – in the case of family firms, they tend to be more closely held and there is no separation between family and business affairs. As the business draws resources from the family, it often extends solidarity to the family by offering jobs to family relatives. In addition to family executives, some non-related managers are sometimes involved in strategic planning. Restructuring of such closely-held enterprises is often therefore constrained by social and family implications. On a positive note, this means entrepreneurs do not jeopardise jobs, but this failure to pursue essential restructuring because of its traumatic short-term effects means they can lose out on long-term competitiveness and sustainability.

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Main challenges and constraints facing SMEs in restructuring Evidence about the challenges and constraints SMEs face when restructuring in Cyprus is mainly associated with barriers to growth, internationalisation, and efforts to engage in mergers and acquisitions. Panikkos Poutziouris, in his 1993 report on the growth dynamics of small manufacturing firms in Cyprus, defined the evolutionary phases across the business life cycle of classic small firm growth constraints as ‘existence’, ‘survival’, ‘comfort’ and ‘growth’ . The following barriers to growth were found to be consistent across all stages of small firm development. Labour gap: The small-scale manufacturing sector traditionally fails to attract local people to fill jobs as multi-skilled technicians, because they have instead increasingly aspired to work in the services sector and in other white-collar posts in large companies, quasi-public and government departments. This has discouraged entrepreneurs from investing in new businesses and growth strategies. Even in the middle of today’s economic crisis with escalating levels of unemployment – especially amongst young university graduates – there is still a high dependence on foreign low-skilled labour that lacks both the charisma and enthusiasm to contribute towards the upgrading of local technological and innovation knowhow. A technology gap: Entrepreneurs are put off by the very high levels of investment needed to ensure a minimum presence in technologically advanced European markets. Limitations imposed by premises: Micro enterprises are particularly affected here; in rural areas, indeed, there are business activities that lack proper planning licences. Poor working capital productivity: This reflects the fact that companies are over-stocking imported raw materials and that producers, with purely local market orientation, are over diversifying. A finance gap: This is suggested both by the difficulty firms face in accessing loan capital and their under-developed use of equity capital. The former may reflect the poor equity base typically associated with the small family firm, the lack of an industrial banking sector or short-term thinking by the Cypriot financial system, whilst the latter is arguably best seen as reflecting concerns regarding the dilution of family influence as an equity base is developed. A high gearing ratio: Universally acceptable by the Cypriot family-business system highlights that the traditionally under-capitalised small business sector usually opts for bank loan financing using personal and familial guarantees. A shortage of working capital: this has been fuelled by excessive use of trade credit and seasonal trading patterns. Anecdotal evidence highlighted that new entrant and ‘struggling’ firms are pressurised to use the limited overdraft facility (or alternatively resort to expensive hire purchase finance) in order to fund their basic capital requirements, for example, second-hand machinery. Given the artisan culture of small business owners the basic principles of financial management are not respected. This is exemplified by their propensity to use loan facilities to meet working capital requirements, but occasionally their familial needs also.

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A number of studies provide empirical data on the barriers and major constraints that Cypriot SMEs face in their efforts to internationalise their activities. Leonidou (2004) offered a classification of such constrains into internal and external barriers. Internal barriers that small businesses are likely to face include: n

a limited availability of information to locate and analyse foreign markets;

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limitations and inefficiencies in human resources (such as lack of managerial time), production (lack of capacity), and shortage of working capital;

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limitations in developing new products for foreign markets;

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difficulties in pricing, distribution, logistics and promotional activities abroad.

External barriers (Leonidou, 2004) include: n

unfamiliarity with techniques/procedures, communication failures and slow collection of payments;

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lack of home government assistance or incentives for exporting, unfavourable home government rules and regulations;

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different foreign customer habits/attitudes;

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the existence of keen competition in foreign markets;

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poor, or deteriorating, economic conditions abroad, strict foreign country rules and regulations;

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tariff barriers, language differences.

More recent data show that perceptions of SME managers about these barriers are changing due to the accession of Cyprus to the EU. A study by Yamin et al. (2008) reveals that Cypriot SMEs are more inclined to initiate expansion via exports to the EU because they perceive an overall reduction in export barriers that were traditionally constraining their internationalisation. Poutziouris (1993, 1995), in turn, says SMEs’ efforts to engage in mergers and acquisitions have been restricted due to: n

a small domestic market;

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a poor resource base;

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thin and embryonic capital markets;

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a weak industrial and manufacturing tradition (the entrepreneurial aspirations of Cypriots are geared towards trade and services).

Several industrial development plans for scaling up Cypriot enterprises through mergers and acquisitions have failed. As a result, the industrial base has always been characterised by a proliferation of micro and small-scale enterprises, whose sub-optimal plants tend to be labour-intensive, focusing on the low technological production of consumer-goods, mostly for local and neighbouring ‘easy’ export markets.

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Business support from public and private sources Business support from both public and private sources resulted from the needs of many SMEs to restructure in order to secure their competitiveness and longevity. Accountants and bankers have created special units that are targeting SMEs and offering relevant advice and support on ways of restructuring such as mergers and acquisitions, and business expansion. The government has also developed programmes to help SMEs in this area. The Human Resources Development Authority (HRDA), for example, developed special training programmes (often involving consultancy) and consultancy-based initiatives where experts can help entrepreneurs with business plans. However, there are still a substantial number of businesses that do not value external support. As a result, many SMEs tend to fail in their attempts to restructure since they tend to rely on advice from internal sources that have not usually got the necessary expertise to deal with restructuring. An example of this is described in one of the case studies with this report. Further, the reactive manner with which restructuring is often treated makes many businesses seek support only when needed and at a point where owners or managers have no other viable options. This shows that SMEs maintain a rather reactive, as opposed to a proactive, stance towards restructuring support that, in turn, limits the efforts of those trying to help SMEs secure their long-term survival through proper and effective business restructuring. The Government policy for SMEs is more or less in line with the European Charter for Small Enterprises and has the following basic objectives: n

introduce a simplified legal, regulatory and procedural framework for the function of SMEs;

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improve the monetary and financial environment;

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assist SMEs to internationalise their activities, taking into account the European perspective of Cyprus;

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strengthen the competitiveness of SMEs;

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improve the access of SMEs to research, technological upgrading, training and information services.

According to Hadjimanolis (2008), the first SME-related support schemes, in Cyprus, in the late 1980s, sought inter-firm cooperation (especially in sectorally-based collaborations in production or marketing) in order to strengthen their competitiveness. Despite some isolated successes, the overall results were rather disappointing. More recently, the government has put at the centre of its 2008–2010 Framework for National Reform: n

the establishment of the Loan Guarantee Facility to improve the access of the existing and new SMEs to credit, with the provision of guarantees for bank loans, mainly to small enterprises;

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the aim of encouraging SMEs to participate in the Competitiveness and Innovation Framework Programme 2007–2013, as well as other relevant schemes for the same period, co-funded by European Structural funds, for example the scheme for the enhancement of SMEs’ competitiveness in the manufacturing sector.

As a result of the recession, other funding schemes, for example lending under the Joint European Resources for Micro to Medium Enterprises scheme, became available but it is not enough to make a noticeable impact on the operations of small and medium enterprises in Cyprus. During 2010 a number of financial schemes under the headings of ‘female entrepreneurship’, ‘technological upgrade’, ‘youth entrepreneurship’, ‘agricultural and manufacturing investments’ were also launched (European Commission, 2011).

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Apart from the government, there are several other bodies engaged in the support of SMEs. For example the Cyprus Employers and Industrialists Federation (CEIF) implementing the programme ‘Utilisation of the Investors in People Standard in the Cypriot enterprises and organisations’ which has a €1 million budget cofinanced by the European Social Fund. This programme concerns, amongst others, the implementation of the Investors in People (IIP) international standard in Cypriot SMEs. The project revolves around the cooperation between enterprises and specialised consultants. The services and processes are selected by the organisation ‘Investors in People — UK’ and 80% of the cost of advisory support is paid by the CEIF to the consultants. The main objective of this programme is helping SMEs to improve their competitiveness and performance through effective human resources management and development (European Commission, 2011). The HRDA annually supports a series of training programmes, often delivered by the Cyprus Chamber of Commerce and Industry, CIIM Business School and other organisations. Many of these management training schemes focus on the improvement of entrepreneurial skills within SMEs. An example is a business development programme designed and delivered by the HRDA for owners/managers of small firms who wanted to grow their businesses. Those participating get guidance by consultants on strategic planning and on how to prepare a business plan. Some programmes gave entrepreneurs the opportunity to visit successful firms in other European countries (Hadjimanolis, 2008). SMEs can also access support from various banks, which have dedicated centres and services for this. An example is the Cyprus Development Bank’s Centre for SMEs which provides tailored financial packages including (CDB Bank, 2012): n

medium and long-term loans with flexible repayment schedules, including a grace period;

n

venture Loans (medium to long-term loans with a grace period) generally offered to start-ups and which have gradually escalating repayments to match the company’s cash flow;

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current accounts and overdrafts which anticipate short-term requirements and working capital needs;

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letters of credit and guarantees to facilitate trading requirements.

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Outcomes of restructuring The outcomes of the restructuring effort can be evaluated at enterprise level, meso-micro level and macro level.

Enterprise level With the expansion of some enterprises, the business has outgrown the founding team and thus opportunities emerge to change the workforce (‘recruit-retain-reward’) as part of rejuvenating the enterprise. Creative destruction can bring about essentially new dynamic ventures that outsmart firms that fail to change and rejuvenate due to inertia and introvert culture. Entrepreneurs have embraced innovation – the narrow resource base of Cypriot SMEs coupled with the thin capital markets and embryonic network of business angels puts the focus on open innovation via partnerships and integration strategies. For example, outsourcing and streamlining in order to sustain competitiveness provided a boost for the logistics industry.

Meso-micro level Business Associations and enterprise agencies, often in cooperation with academic institutions, are tailoring initiatives and programmes for growing SMEs. For example, in recent years, there have been innovation awards such as the Cyprus entrepreneurship competition–business plan competition, awards to honour growth champions, and prizes for the best wineries. The university sector has been promoting SMEs via forums and centres for entrepreneurship, case books with entrepreneurial success stories, family business academies, and other research initiatives. Following the restructuring of the winery industry – abandoning of the mass production of average quality wine – there is a network of independent wineries that promote their business model in cooperation with the Cyprus Tourism Organisation). The ‘Slow Food’ Movement is emerging to promote the artisan and organic culinary cuisine, where artisan firms engage in regional clustering and outsourcing, for example Anogyra with its tradition of making honey pies. With specialisation in niche sectors, for example, ethnic and local foods, organics and heritage businesses, there are more strategies building on inter-firm cooperation; and their products are often branded with Protected Geographical Indication (PGI).

Macro level The Cyprus economy heavily depends on external factors to fuel the growth of its service sector, for example, tourism, professional services (financial services, law, accountancy, shipping management). With the growth of the service economy, new white-collar jobs have been created which are suitable for the many university graduates. The tax regime is business friendly; doing business in Cyprus is easier compared with other EU partners. There is a trend for the conglomeration of groups of companies into holding structures which will explore relocation strategies in order to maximise tax efficiency.

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Conclusions and policy issues Given the prolonged economic crisis and the sharp retrenchment in credit markets, especially in the form of bank lending, it is of paramount importance to address the finance gap with an action plan to support smaller firms. Here are four essential pillars: n

a loan guarantee scheme to offer collateral for bank loans to viable firms;

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an equity investment scheme to encourage investment in the equity base of small firms with innovation capability and growth potential;

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changing the tax regime to respect the funding philosophy of small business owner-managers;

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promoting a code of governance for smaller, privately held firms – with special provision for family firms.

Constraints and difficulties Macro level The integration of Cyprus into the European Union has had a positive impact on enterprise policy. The challenge remaining is the corporate, legal and taxation policy which is very universalistic and fails to respect the idiosyncratic dynamics of smaller businesses. Cyprus lacks specific sectoral reports that relate to the industrial classification of firms being studied. This is understandable, given the fact that Cyprus is a small island economy and research suffers from samples being so small. Proper investigation and reporting is needed to ensure a more effective policy making that will improve strategic planning and restructuring processes at the micro and enterprise level. Meso-micro level Restructuring, triggered by the transformation of the industrial base, has itself sparked increased specialisation of enterprises, and more outsourcing. In certain sectors there has been horizontal integration strategies, for example, franchising and networks in the trade and restaurant sectors. There is a complex structure of enterprise support associations and agencies that are competing to help SMEs. These include: n

POVEK – Association of Professional Craftsmen and Shopkeepers;

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chambers of commerce and industry;

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Association of Employers and Industrialists;

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the newly established Federation of Small Enterprises.

There is scope for the formation of a Small Business Council which will represent all these organisations and their members with a view to lobbying more effectively for an enterprise policy which will also address the barriers to the restructuring process. Enterprise level The transition of enterprises to the next generation of management stimulates a more open, participative management culture, which is more conducive to effective strategic planning and restructuring processes driven by market opportunity. However, ownership and control which remain in the hands of a family hierarchy can constrain the adoption of best governance. At the enterprise level, the great majority of the founding owner-managers are reluctant to provide financial data, for example, on sales turnover, and profitability, even to loyal non-family managers. Understandably, this is symptomatic of why strategic planning cannot always guarantee an effective restructuring process. There is scope for regulations and measures that can help transform the entrepreneurial culture at the enterprise level which will also stimulate open growth strategies such as mergers and acquisitions and horizontal partnerships.

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Restructuring in SMEs: Cyprus

Enterprise policy Policy makers are rich in rhetoric, but less effective at implementation. The establishment of an SME promotion council (MCIT, 2004) announced in 2004, has still not materialised. Local policy makers have developed an over-dependence on the European Union Directorate for Enterprise and Industry. However, it is imperative to tailor certain support schemes to specific segments of the Cypriot SME economy based on scale of operations, sectoral dynamics or ownership regime. Some training programmes have been imported from European Union pooling firms which have from 5 to 249 employees; surely there is scope for more segmentation in order to achieve better results. Finally from an enterprise policy perspective, officials must abandon their universalistic approach – camouflaged under the broad SME banner – and dedicate more resources to better diagnose the evolutionary problems and challenges confronting the self-employed, and micro, small and medium firms. One current example which shows the failure of policy makers to tailor policies to help entrepreneurs and small businesses is the way retained profits are taxed. This impacts hugely on the firm’s finance structures. There has been, for nearly 10 years, a tax on ‘deemed dividends’ which discourages SMEs from retaining profits central to their survival and growth. If enterprises do not pay dividends for two years, 70% of their profits is deemed as a proxy for the dividend policy and is taxed at 17.5%. Naturally, this encourages enterprises to pay out profits as dividends – which somehow are not later invested in the equity base by the ownermanagers. This has led to the erosion of the equity base of SMEs and increased dependence on external debt financing – which, in the current crisis, with the poor access to bank loans due to the credit crunch is more difficult for SMEs as they are over-geared. Of course, it is also necessary to consider the unique issues facing special groups such as small, high technology firms, firms which rely on exporting, and multi-generational family firms. There is a need for effective support schemes tailored to the idiosyncratic Cypriot family business culture, with the problems and growth constraints that it entails. This is vital if smaller family business entrepreneurs are to survive in the short term and realise their growth potential in the long term.

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Panikkos Poutziouris and Elias Hadjielias, UCLan Cyprus University, and Milena Marinova, Zateons and Associates

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