Constrained: In Israel, SMB might as well stand for sado-masochistic business.
Smaller businesses are constrained, often mortally, by the high cost of capital and favoritism shown to big business. The tide may be turning, though. Photo by Dreamstime.com
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Elah Alkalay
Administrative burden on startups Photo by Elah Alkalay

Recently CNN's Market Watch ran a feature on boutique breweries in Israel, such as Alexander Beer.

The story is that after a few years, during which micro-brewing began to flourish, tax regulation was tweaked. That did it. As Ori Sagy, founder of Alexander, told CNN: when a tax increase doubles the price to consumers overnight, demand is bound to go down.

Between 2010 and 2013, micro-brewers had managed to grab almost 2% of the market, if not delivering a blow to the ruling beer duopoly – at least they were noticeable. But taxation is likely to remove even this dent.

Not all readers would shed a tear over reduced demand for alcohol. But the bad type of alcohol consumption won't exactly be dented by the change in tax, while small businesses producing higher-quality drinks will either collapse or remain a basement industry catering only to wealthier tourists and Israelis.

A month ago I attended a session of the MIT Forum which focused on early-stage angel investment and the development of small and medium technological businesses in Israel. This is what we are good at, right? It's the core of the "Start-Up Nation".

So I was surprised when one of the speakers half-joked that in Israel "SMB" actually stands for Sado-Maso Business. By which he meant, not joking at all – you have to be a masochist to get into small business in Israel, which for all its reputation as "Startup Nation," isn't friendly to small businesses at all.

It takes an angel

The problem starts with credit. One basic problem all SMBs share is the high cost of capital.

Israel has 400,000 small and medium businesses. These range from the small garage-based technology startup to the coffee house around the corner to local builders, and so on.

The reality is that if an SMB can provide collateral, it could borrow from the bank at interest of 8% to 11%. Without collateral, only angels can save the SMB's day.
Some 25% of all credit in Israel is allocated to SMBs. The remaining 75% goes to the biggest companies, which pay an average interest rate of 4%.

Thus a cruel cycle is perpetrated. SMBs are high-risk so only large banks, able to diversify their lending, will cater to them. As long as these big banks can charge the SMBs interest through the nose, barring market catastrophe – the banks become more profitable, and can be more competitive both in dealing with large-cap companies (and with the SMBs too).

The last 40 years have taught us that left to market forces, only big business will prevail in most sectors. There are very few private grocers, very few private bookshops, isolated pharmacies that do not belong to a national chain. And in the technology world, for every Wix that floats on Nasdaq, at least 50 startups are sold before they reach profitability.

It takes government intervention

Competitiveness is a fundamental requirement of efficient markets, but if only the strong prevail - the inbuilt mechanism of is that competitiveness is reduced.
The smaller the country is, the more harmful this internal market mechanism is, as there are less market niches in which new businesses can take root and solidify.

This is where government intervention becomes necessary. But in Israel, it seems the government's intervention had a negative effect, as with the boutique breweries.

In a 2008 survey by the OECD of the administrative burden on start-ups, Israel ranked between Turkey and Brazil – well below most of Western Europe and the U.S..
Much of the burden is due to poor coordination between central and local government; some is due to the lack of separation between religion and state; and high security requirements just add to the pile.

Yet looking at 2014 and beyond, we are optimistic for Israel's whiplashed SMBs.
Most regulators realize that regulation can suffocate. The term de-regulation has been heard over and over again over the last year. Also, new technologies promise to remove barriers for SMBs – cloud computing services and 3-D printing are two of the more obvious examples.

New management at the Tel Aviv Stock Exchange and an increase in trading volumes, alongside crowd funding - and the advent of new credit providers - might improve access to capital. Some of these platforms are in their infancy in Israel, but 2014 might be a year of rapid growth as both demand and supply seem to be ripe.

The bottom line is that Israel has a lot to gain from advancing and developing the SMB sector. It will improve competitiveness and consequently pricing and services in Israel; it will help reduce inequality and - last but not least - improve Israel's global access and competitiveness for the long run.

Elah Alkalay is VP Business Development at IBI Investment House and serves as a member of the Board of Directors of The New Israel Fund and of Ma'aleh, Elah is also chair and co-founder of "invest in you" a financial forum for Women.