SMME funding challenge, a perennial South African headache
Sisa Ntshona
Whilst access to funding by entrepreneurs is generally an uphill struggle worldwide, given South African government’s and private sector’s acknowledgement of the key role of SMME in moving the growth of the country’s economy on an upward trajectory, one would assume that entrepreneurs have never had it better. According to the National Development Plan (NDP) SMMEs will become more prominent and generate the majority of jobs created. They will be stimulated by procurement opportunities from the private and public sectors, access to debt and equity finance, a simplified regulatory environment and support services.
Add the ubiquity of development finance institutions (DFI) to the NDP, you would be forgiven for thinking South Africa is an SMME owner’s nirvana, especially for the previously disenfranchised black majority. The list of the country’s FDIs include the Industrial Development Corporation (IDC), the Development Bank of Southern Africa (DBSA), National Empowerment Fund (NEF) and Small Enterprise Finance Agency (SEFA), and a whole host of some eight provincial entities like the Limpopo Development Agency, Khula Finance in Kwazulu Natal, which means bar the Western Cape every province has a provincial FDI. As if that was not enough some of the metros are replicating this model at a local level, a case in point being the Tshwane Enterprise Development Agency and the Johannesburg Development Agency.
The proliferation of DFI and other initiatives notwithstanding, the reality is that the majority of black owned SMMEs are still finding it difficult to access funding and support from these agencies, commercial banks and enterprise development funds set up by large corporations for a whole host of reasons.
The enterprise development funds should ideally be one of the major drivers of SMMEs financing and support, largely because large corporations are required by law to contribute towards enterprise development, however the reality is that enterprise development initiatives have largely proven to be ineffectual. Properly implemented, enterprise development would be a much better and a sustainable solution, because entrepreneurs would have easier access to the market place and benefit from the expertise and mentoring from these corporations.
Even though South Africa has one of the most advanced and sophisticated banking systems in the world, the commercial banks have failed to come to the party in so far funding SMMEs is concerned, funding only 10% of start-ups. This in large part due to the fact that banks are traditionally conservative institutions, more concerned with the protection of the interests of their depositors. Similarly they have to comply with the South African Reserve Bank’s regulatory framework in order to ensure there is proper mitigation against a run on the banks. Given their aversion to risk, the reality is that banks are ultimately more geared towards providing funding to small enterprises that have reached a certain level of maturity, ultimately without a strong asset base to serve as collateral banks are unlikely to extend their facilities to start ups. This automatically rules out the majority of black people who in the main do not have the requisite collateral to satisfy the requirements of the commercial banks.
This lack of access to funding is further compounded by the fact that, statistics indicate that 90% of new businesses will fail within the first three years of being operational.
In response to this market failure, the government created a myriad of DFIs with the express mandate of stimulating economic growth. Their obligation notwithstanding, these DFIs have been found wanting because they have adopted the same commercial approach implemented by the commercial banks. Which is why these institutions routinely fail to disburse the funds they have been allocated by government to their constituencies.
The bleak outlook aside, there is hope, provided that entrepreneurs start boxing clever, and apply some ingenuity in their funding application processes by amongst others gaining an understanding of which funding is required for the stage the business is in, because the funding requirements of a start-up and those of a running concern are different, consequently the possible financiers for each phase of the business are different. However, the reality is that the average SMME operator is not educated enough to appreciate some of these nuances, which means they are automatically placed at a disadvantage when they are engaged in conversation with the funders.
For instance manufacturing is an equipment driven and asset heavy industry, accordingly the most likely funder for such a venture is an asset financier. On the other hand the ICT sector and other types of consultancy businesses do not require any capital expenditure funding or CAPEX because it is a space driven by intellectual capital, and therefore most of the capital required is to pay for the expertise in the form of salaries.
Having said that, one of the major shortcomings of entrepreneurs is a singular focus on finance, without taking the time to gain a thorough understanding of what the enterprise’s primary challenge is at a point and time. Whilst finance is key, in some instance the primary need of a business might be access to market, which is why it would not make sense to start building a factory and manufacture products without first establishing if there is a strong clientele to consume the products. Skills and support to run the enterprise might be another principal requirement.
Besides the glut of development finance agencies, as already illustrated, the appetite of funding these small businesses is still not fulfilled. For their part the DFI complain that the quality of applications that they receive from would-be-beneficiaries are of an extremely poor quality, the applicants on the other hand complain about the unwieldy bureaucratic processes they have to navigate in these institutions.
This impasse points to a deep seated misalignment between the funders and their intended constituency, part of the contributory factor to this situation is a consequence of the appointment of wrong people to key and critical positions within the FDIs. Employees who do not know how to execute their mandate and persons who have never been entrepreneurs in their lives and are not attuned to the thinking of entrepreneurs. The main culprits in this instance seems to be unqualified and disinterested loan officers, who are failing in their primary responsibility of translating the vision of the entrepreneur into a bankable enterprise. By all accounts the current crop of loan officers seem to be more concerned with taking orders and pushing of paper, that eventually end up in the black hole of their bureaucratic processes, leaving the applicants all at sea. There have been instances of businesses waiting for 4-6 months to learn whether their applications have been successful or unsuccessful.
The funders also seem not to have an appreciation to the fact that SMMEs are not a monolithic group requiring similar kind of services, for instance it not all businesses that require marketing support.
This unimaginative state of affairs is also directly attributable to the fact that South Africa as a country, is generally not endowed with a populace that is naturally inclined towards being entrepreneurial. Government’s penchant of appointing civil servants, political cronies and sourcing employees from commercial banks, forms a fundamental contributor to the failure of these entities in discharging of their responsibilities.
However it should also be noted that entrepreneurs and would-be-business-people, also suffer from unrealistic expectations and not mitigating for the risks that come as part of the inherent nature of being a businessperson. One of the ways in which this phenomena manifests itself is through extraordinarily bullish business plans. On the other hand the current economic climate is also a contributor to this unsubstantiated optimism.
In many other instances, people fall in love with the idea of running their own businesses and being their own boss, without first investing time in research and establishing the requisite facts. Having said that, the inescapable fact is that entrepreneurs are dreamers by nature, however the aspiration of running and owning one’s own enterprise has to be undergirded by a strong sense of realism. Part of this pragmatism entails taking the time to acquire an intimate understanding of what the financier is looking for, in order to respond as accurately as possible towards those requirements. In this way you are able with a greater degree of certainty, whether the type of funding you require is debt, equity, capital and to have an informed conversation with the funder
Despite an understanding of the challenges they are faced with, the country’s SMME sector has been found desperately inept when required to sing from the same hymn sheet. To date there is no association or organisation that can claim that it speaks on behalf of all the SMMEs in South Africa. Due to this disorganisation, business organisations generally tend to treat SMMEs as an afterthought rather than a forethought.
Inefficiencies in the DFI space aside, it is still incumbent upon businesspeople to appreciate that due to being tax payer funded institutions and tied to government’s objective of growing the economy and creating jobs, DFIs have therefore a favourable disposition towards high impact socio-economic businesses like shopping centres, even though access to big name franchises is another battle front that is heavily loaded against SMMEs. In other words, the more jobs and economic growth a business venture is likely to create, the better the prospects of it receiving funding from the Northern Cape Economic Trade and Investment Promotion Agency (NCEDA), as an example. It therefore stands to reason that if a business requires funding for an innovation that will result in the loss of jobs, it is highly unlikely that a NCEDA and its counterparts, for instance, will be willing to fund the venture as it stands diametrically opposed to the high socio economic impact principle.
Ultimately FDIs would serve black owned SMMEs if they would amongst others stop the replication of the same ineffective and uninspired DFI model, and start to amongst others;
Add the ubiquity of development finance institutions (DFI) to the NDP, you would be forgiven for thinking South Africa is an SMME owner’s nirvana, especially for the previously disenfranchised black majority. The list of the country’s FDIs include the Industrial Development Corporation (IDC), the Development Bank of Southern Africa (DBSA), National Empowerment Fund (NEF) and Small Enterprise Finance Agency (SEFA), and a whole host of some eight provincial entities like the Limpopo Development Agency, Khula Finance in Kwazulu Natal, which means bar the Western Cape every province has a provincial FDI. As if that was not enough some of the metros are replicating this model at a local level, a case in point being the Tshwane Enterprise Development Agency and the Johannesburg Development Agency.
The proliferation of DFI and other initiatives notwithstanding, the reality is that the majority of black owned SMMEs are still finding it difficult to access funding and support from these agencies, commercial banks and enterprise development funds set up by large corporations for a whole host of reasons.
The enterprise development funds should ideally be one of the major drivers of SMMEs financing and support, largely because large corporations are required by law to contribute towards enterprise development, however the reality is that enterprise development initiatives have largely proven to be ineffectual. Properly implemented, enterprise development would be a much better and a sustainable solution, because entrepreneurs would have easier access to the market place and benefit from the expertise and mentoring from these corporations.
Even though South Africa has one of the most advanced and sophisticated banking systems in the world, the commercial banks have failed to come to the party in so far funding SMMEs is concerned, funding only 10% of start-ups. This in large part due to the fact that banks are traditionally conservative institutions, more concerned with the protection of the interests of their depositors. Similarly they have to comply with the South African Reserve Bank’s regulatory framework in order to ensure there is proper mitigation against a run on the banks. Given their aversion to risk, the reality is that banks are ultimately more geared towards providing funding to small enterprises that have reached a certain level of maturity, ultimately without a strong asset base to serve as collateral banks are unlikely to extend their facilities to start ups. This automatically rules out the majority of black people who in the main do not have the requisite collateral to satisfy the requirements of the commercial banks.
This lack of access to funding is further compounded by the fact that, statistics indicate that 90% of new businesses will fail within the first three years of being operational.
In response to this market failure, the government created a myriad of DFIs with the express mandate of stimulating economic growth. Their obligation notwithstanding, these DFIs have been found wanting because they have adopted the same commercial approach implemented by the commercial banks. Which is why these institutions routinely fail to disburse the funds they have been allocated by government to their constituencies.
The bleak outlook aside, there is hope, provided that entrepreneurs start boxing clever, and apply some ingenuity in their funding application processes by amongst others gaining an understanding of which funding is required for the stage the business is in, because the funding requirements of a start-up and those of a running concern are different, consequently the possible financiers for each phase of the business are different. However, the reality is that the average SMME operator is not educated enough to appreciate some of these nuances, which means they are automatically placed at a disadvantage when they are engaged in conversation with the funders.
For instance manufacturing is an equipment driven and asset heavy industry, accordingly the most likely funder for such a venture is an asset financier. On the other hand the ICT sector and other types of consultancy businesses do not require any capital expenditure funding or CAPEX because it is a space driven by intellectual capital, and therefore most of the capital required is to pay for the expertise in the form of salaries.
Having said that, one of the major shortcomings of entrepreneurs is a singular focus on finance, without taking the time to gain a thorough understanding of what the enterprise’s primary challenge is at a point and time. Whilst finance is key, in some instance the primary need of a business might be access to market, which is why it would not make sense to start building a factory and manufacture products without first establishing if there is a strong clientele to consume the products. Skills and support to run the enterprise might be another principal requirement.
Besides the glut of development finance agencies, as already illustrated, the appetite of funding these small businesses is still not fulfilled. For their part the DFI complain that the quality of applications that they receive from would-be-beneficiaries are of an extremely poor quality, the applicants on the other hand complain about the unwieldy bureaucratic processes they have to navigate in these institutions.
This impasse points to a deep seated misalignment between the funders and their intended constituency, part of the contributory factor to this situation is a consequence of the appointment of wrong people to key and critical positions within the FDIs. Employees who do not know how to execute their mandate and persons who have never been entrepreneurs in their lives and are not attuned to the thinking of entrepreneurs. The main culprits in this instance seems to be unqualified and disinterested loan officers, who are failing in their primary responsibility of translating the vision of the entrepreneur into a bankable enterprise. By all accounts the current crop of loan officers seem to be more concerned with taking orders and pushing of paper, that eventually end up in the black hole of their bureaucratic processes, leaving the applicants all at sea. There have been instances of businesses waiting for 4-6 months to learn whether their applications have been successful or unsuccessful.
The funders also seem not to have an appreciation to the fact that SMMEs are not a monolithic group requiring similar kind of services, for instance it not all businesses that require marketing support.
This unimaginative state of affairs is also directly attributable to the fact that South Africa as a country, is generally not endowed with a populace that is naturally inclined towards being entrepreneurial. Government’s penchant of appointing civil servants, political cronies and sourcing employees from commercial banks, forms a fundamental contributor to the failure of these entities in discharging of their responsibilities.
However it should also be noted that entrepreneurs and would-be-business-people, also suffer from unrealistic expectations and not mitigating for the risks that come as part of the inherent nature of being a businessperson. One of the ways in which this phenomena manifests itself is through extraordinarily bullish business plans. On the other hand the current economic climate is also a contributor to this unsubstantiated optimism.
In many other instances, people fall in love with the idea of running their own businesses and being their own boss, without first investing time in research and establishing the requisite facts. Having said that, the inescapable fact is that entrepreneurs are dreamers by nature, however the aspiration of running and owning one’s own enterprise has to be undergirded by a strong sense of realism. Part of this pragmatism entails taking the time to acquire an intimate understanding of what the financier is looking for, in order to respond as accurately as possible towards those requirements. In this way you are able with a greater degree of certainty, whether the type of funding you require is debt, equity, capital and to have an informed conversation with the funder
Despite an understanding of the challenges they are faced with, the country’s SMME sector has been found desperately inept when required to sing from the same hymn sheet. To date there is no association or organisation that can claim that it speaks on behalf of all the SMMEs in South Africa. Due to this disorganisation, business organisations generally tend to treat SMMEs as an afterthought rather than a forethought.
Inefficiencies in the DFI space aside, it is still incumbent upon businesspeople to appreciate that due to being tax payer funded institutions and tied to government’s objective of growing the economy and creating jobs, DFIs have therefore a favourable disposition towards high impact socio-economic businesses like shopping centres, even though access to big name franchises is another battle front that is heavily loaded against SMMEs. In other words, the more jobs and economic growth a business venture is likely to create, the better the prospects of it receiving funding from the Northern Cape Economic Trade and Investment Promotion Agency (NCEDA), as an example. It therefore stands to reason that if a business requires funding for an innovation that will result in the loss of jobs, it is highly unlikely that a NCEDA and its counterparts, for instance, will be willing to fund the venture as it stands diametrically opposed to the high socio economic impact principle.
Ultimately FDIs would serve black owned SMMEs if they would amongst others stop the replication of the same ineffective and uninspired DFI model, and start to amongst others;
- Appointing appropriately skilled personnel;
- Ensuring that there is clear coordination between the national, provincial and local DFIs;
- Turning some of the DFIs into skills hubs;
- Overhauling the generic DFI model, and ensure there is a regionalised approach. For instance given the Beit Bridge passage, Musina’s focus could be on funding logistics oriented enterprises;
- Coordinating market access for SMMEs;
- Improving transparency and turnaround times. There is no reason why a loan application should take 6 months;
- Rethinking collateral driven lending;
- Ensuring skills resident in the DFIs are aligned to the vision of the DFI; and
- Reskilling of loan officers.