Khula Enterprise Ltd: Priority areas for 2010/11

Economic Development

18 March 2010
Chairperson: Ms E Coleman (ANC)
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Meeting Summary

Khula Enterprise Ltd, a development finance institution with an independent Board of Directors, that reported to the Department of Trade and Industry, briefed the Committee on its mandate, vision and achievements, as well as the challenges it faced. Khula was set up in 1996 with the aim of being a wholesale rather than retail delivery institution. The State was an enabler, not a direct lender of funding, and gave government guarantees to ensure private sector funding. As a wholesale financier, Khula partnered with other institutions to ensure access to finance by small and medium enterprises (SMEs), its target market, whilst SAMAF lent to the small, “survivalist” enterprises. Khula typically  gave funding of between R10 000 and R3 million, generally for start up and expansion of early-stage businesses, and its main target market was black-owned small business, women entrepreneurs and those in under-served provinces.  It provided finance, mentoring services and small premises, through its network of partnerships, encouraging sustainable development  through increasing production and ensuring that it was reaching its market. Khula aimed to leverage private sector funding through the credit indemnity guarantee schemes and other funds. It was stressed that Khula required funds in order to not erode its capital base. It had changed its target market operationally, and thus produced new channels and products to increase disbursement. In December 2009 Cabinet had approved the extension of its mandate to direct lending activities. Khula had, since inception, disbursed over R2.5 billion to SMEs, had remained liquid and shown a surplus, which was put back into the business. However, there were challenges with the indemnity schemes, and would like to see more black owned businesses being assisted, as well as a more even reach throughout the provinces, which it could achieve by being a direct lender. The limitations of the current wholesale model were set out, and related to administration, lack of understanding by the market, risk and cost increases and capitalisation. Khula was initially capitalised with assets of around R330 million, as a once-off, but did not receive an annual allocation from National Treasury, and it needed additional funds, failing which it would start to erode its capital base and suffer losses. Should it not receive those funds, it would therefore not be able to achieve the strategic objectives. An international benchmarking exercise, as well as local research, was undertaken and the results were tabled. Legislation and organisational restructuring were needed to re-engineer Khula for direct lending. Its methods of support were set out, and in future Khula would require to go to more rural areas.

Members asked who had been supported by Khula in the past, and questioned whether the proposed changes would bring it into competition with the private sector. Members asked if consideration had been given to aligning with PostBank, which had a good rural reach, and questioned the uneven gender and geographic spread of loans, asked if there was a model or measurement for its mentoring programmes, and questioned the call for more funding, the sourcing of business, and the record-keeping.


Meeting report

Khula Enterprise Limited:
Mr Setlakalane Molepo, Managing Director, Khula Enterprise Ltd, gave the background of Khula Enterprise (Khula). He said that Khula was a development finance institution, which reported to the Department of Trade and Industry (dti). It had an Independent Board of Directors. He added that it was important to remember that; after Khula’s establishment in 1996, the mandate was derived from the Department of Trade and Industry’s White Paper on the National Strategy for the Development of Small Business (1995). The mandate was arrived at to ensure that Khula was a wholesale rather than retail delivery institution.

Mr Molepo stated that the State did not see itself as a direct lender of funding but rather as an enabler. The government backed guarantees were seen as the only means required to ensure private sector funding through commercial banks and other institutions, as well as participation in the Small, Medium and Micro Enterprise sector (SMME). As a wholesale financier, Khula worked through a network of partners to ensure that SMMEs had access to finance. Mr Molepo said that since the creation of South Africa’s Micro Finance Apex Fund (SAMAF), Khula had concentrated its efforts on the upper end of the funding, providing funding above R10 000, and therefore lending to Small and Medium Enterprises (SMEs) rather than Small, Medium and Micro Enterprises.

The main purpose of a development finance institution (DFI) such as Khula was to ensure that market failures, resulting from the private sectors not ensuring that the gap in the market was financed, were addressed. Therefore, Khula’s main focus was the facilitation of access to finance by SMEs, maximising their development impact and ensuring organisational sustainability.

Khula’s vision was to be the development finance partner of first choice to SMEs. Mr Molepo said that Khula’s mission was to provide finance, mentoring services and small premises to entrepreneurs through its network of partnerships. It would also encourage the sustainable development of SMEs while ensuring that Khula remained financially sustainable. Khula’s intention was to add value to society by increasing production and ensuring that the channels reached the market which they intended to serve. The impact envisaged in the mandate would be achieved through the development and implementation of a Khula SME bank.

Khula’s mandate was focused on three key areas. Firstly, it would promote access to finance for SMEs. Secondly, it focused on creating sustainable SMEs in the mainstream economy, thus having a developmental effect. Lastly, Khula’s long term objective was to create financial sustainability.

Mr Molepo then presented the characteristics and supply of the SME financing landscape. He pointed out that the micro and survivalist enterprises that were necessity driven were catered for by SAMAF. These enterprises were typically limited to one individual or less than 5 employees, and were many times funded by an individual and his/her family. Khula focused on the small and medium enterprises, which were opportunity driven. Small enterprises typically had less than 50 employees, with a turnover of less than R25 million per annum. Medium enterprises typically had less than 200 employees with a turnover of more than R25 million. These entrepreneurial enterprises were typically funded by banks, financial institutions, corporate entities and DFIs such as Khula. Mr Molepo indicated that Khula provided finance of between R10 000 and R3 million, and that banks and the private sector tended to shy away from funding which required less than R1 million.

Moving on to Khula’s current business model, Mr Molepo said that Khula was a wholesale financier with total reliance on an array of partners, referred to as intermediaries. Khula was looking to leverage private sector funding through the credit indemnity guarantee schemes and other funds. Khula was more of a facilitator than a direct lender. The capitalisation structure of Khula was that it required funds in order to not erode its capital base.
           
Mr Molepo tabled a slide showing the typical financing gap filled by Khula. As already explained, its funding was between R10 000 and R3 million. It lent primarily to black-owned and owner-managed SMEs focusing on women-owned enterprises, under-served provinces and rural areas. Most of the funding was needed for start-up and expansion of early stage businesses. As a wholesaler, it provided business loans, credit guarantees, equity funds and Joint-Ventures, pre and post-loan mentorship, business premises and managed third-party funds.

The development impact of Khula and the products offered would then result in asset accumulation, job creation, regional development and economic transformation.

He indicated that some of Khula’s financing partners Ithala Development Finance Corporation, Business Finance Promotion Agency, Anglo Zimele, True Group, Small Enterprise Foundation and Marang Financial Services.

Mr Molepo then explained the strategic focus of Khula. At the outset it had primarily focused on providing credit indemnity guarantees. In 2004 it took a new strategic direction, which was  aimed at increasing the organisation’s reach and impact, in order to better support the needs of SMEs. Khula changed its target market operationally and therefore new channels and products were produced in order to increase disbursement to SMEs. Khula managed to keep bad debts and claims as low as possible, but it was feeling pressure as a result of the current global economic recession.

Mr Molepo said that public opinion and perceptions of Khula were improving. He added that, in order to raise delivery and make a more meaningful impact, Cabinet had, in December 2009, approved Khula’s mandate to include direct lending activities.

Mr Molepo then indicated the approvals and disbursements of Khula over the past 5 years. He said that Khula had seen steady growth of its approvals as well as the money being provided to businesses. Its loan book had grown from a mere R569 million to R985 million. In the 13 years of Khula’s existence, irrespective of the limitations of the models used, Khula has managed to disburse more than R2.5 billion to SMEs. Khula has also managed to remain liquid and continued to show a surplus each year irrespective of undercapitalisation. Khula has also built up an asset base of approximately R1.2 billion.

Mr Molepo explained the challenges that Khula experienced through the indemnity schemes. He said that banks, irrespective of the support given by government guarantees, were still falling short of their responsibilities. Khula was experiencing a decline in terms of what the banks should be doing by virtue of guarantees issued by government.

Mr Molepo said that ideally Khula would like to see more black owned businesses being assisted, as well as a more even reach throughout the provinces. Currently, black owned business made up 52% of Khula’s SMEs. KwaZulu Natal (KZN) received the most assistance at 42% of business, while other provinces received little or no assistance. Mr Molepo said that the solution lay in Khula becoming a direct lender. He said that this would enable Khula to determine where it was going as an institution rather than over-relying on its intermediaries.

Limitations to the current wholesale model included the fact that it had created a gap between Khula as an institution and the end user. There was a limited ability to drive development and control the destiny of Khula, and over-reliance on cooperation from partners who had purely commercial objectives. The target market did not clearly understand this model, because the State support of the SME was not apparent, which led to distorted market perceptions about the source of funding. This model also added a layer between Khula and the customer, which increased the risk, cost of delivery and the interest rates charged.

The limitations extended to the issue of capitalisation. Khula was structured as an administrative entity and had managed to keep a low overhead structure in order to channel as much funding as possible through to the end user. Khula was initially capitalised with assets of around R330 million. Mr Molepo said that it was important that members were aware that this was the only capitalisation received from  government. Khula did not receive an annual grant from National Treasury and therefore the actual amount of funds available to disburse was limited. Khula required a properly structured balance sheet based on a rolling 5-year investment horizon, which should include a portfolio of strategic equity investments with a high level of profitability to subsidise the developmental initiatives.

Mr Molepo said that since 2004/5, Khula had alerted the shareholder that it would be unable to maintain its momentum without additional funds. If Khula did not receive any funds, and continued its current strategic thrust, it would start eroding its capital base and suffer losses. Khula, in order to remain financially stable, required a capital injection that would allow for a portfolio of strategic investments with a high level of profitability, to subsidise the highly developmental initiatives and allow for increased strategic demands on capital disbursements.

Mr Molepo indicated the funds requested by Khula for the periods 2010/11, 2011/12 and 2012/13. He outlined the limited capacity at which Khula would operate if it did not receive funding, and warned that, without funding, Khula stood the chance of operating at a net loss.

In December 2008, Cabinet approved the Khula Direct business case, and in 2009, the content of the Cabinet approval was discussed with the Committee, which confirmed the need for the business plan, international benchmarking study and local research.

Mr Molepo outlined some of the lessons learnt from international benchmarking on direct lending. In other countries, the government was the prime funder and key player, was supportive and was committed to SMEs at the highest level. Research and development of new products was a key focus, and there was centralisation of risk management processes to ensure consistency. The client recruitment and credit processes were clearly defined, and easy to understand, and ensured that the institution would be offered the correct portfolio, which would therefore increase its success rate. There would be quick turnaround times, due to clearly defined loan disbursements. A strong emphasis was placed on credit risk management. There was an extensive network of branches which enabled the institutions to visit SMEs throughout the country, and the support provided was financial and non-financial.

Mr Molepo said that research had been done locally. FinMark Trust had estimated that there were 525 000 enterprises, which required funds of between R10 000 and R50 000, and 160 000 enterprises which required between R50 000 and R250 000. Most of these SMEs were in Gauteng. There was poor access to finance in rural areas due to high cost to banks and low density. Because banks were factoring into their prices the cost of capital, this made the product too expensive. Most people could not get loans of less than R50 000 because banks were always looking for security in their loans. A lack of security could be substituted with credit history in paying for rent, telecommunications and municipal services SMEs were perceived to be high-risk and banks were not willing to lend. Where there had been unsuccessful SME lending, this was because 75% of borrowers were self-employed. 41.6% of all credit customers had impaired credit files in December 2008.

Mr Molepo outlined what was needed in order to re-engineering Khula for direct lending. He said that this would have to be achieved through legislation, but organisational restructuring in Khula would also be necessary. Khula staff would need to be retrained and reassigned. The overarching requirement would still be the need for capital.

Some of the key strategic priorities of Khula in the coming year were identified. Khula needed to re-engineer current operations as well ensure the alignment of human capital. The cost structure needed to be maintained, and risk management and monitoring had to be evaluated. Khula had to ensure that it influenced SME policy formulation in South Africa and must work on the company branding.

Mr Molepo announced that, without funding, Khula’s target for approvals would be R53 million, while the target should it receive funding would be R808 million. He said that Khula had to ensure that it approved new loans to 2 000 end users, of which 70% would be disbursed to black users.

Khula presently relied on field staff or loan officers to build close relationships with the potential customers. Mr Molepo said that it was also important to hunt for transactions and find entrepreneurs who were ready and knew exactly what they were doing, as these transactions, taking up little time, would then leave more time to spend with other businesses who needed more guidance. There would also be regional offices and a head office in charge of managing products, credit policy, risk management and portfolio management.

Mr Molepo said that SME support and education was provided by means of pre and post loan mentorship as well as regional information sessions, in order to provide holistic support to the potential end user. In order to market the company and reach more potential customers, Khula needed to position itself in less urban and more rural areas. Mr Molepo said that Khula needed to address business more holistically while still considering the risk involved in every transaction.

In conclusion, Mr Molepo summarised that Khula was dedicated to the needs of small business. Its key differentiating factor was its focus on start-ups, small loans and underserved provinces. Khula had undergone a strategic shift to enhance focus and delivery and that maximum outreach and impact would be achieved through direct lending, the credit indemnity scheme, a more direct approach to wholesale funding and the utilisation of the financing partner’s infrastructure. He stressed again that capitalisation was required to follow through with the strategic choices which were made.

Discussion
Mr P Rabie (DA) wanted to know what the success stories of Khula were and in what sector it operated. He also questioned whether its move to provide funding to small and medium enterprises would result in competition with the private sector. He also asked, in response to Khula’s wish to extend its reach into rural areas, what rural areas Khula was least concerned about.

Ms Nomonde Mapetla, Chairperson of Khula, mentioned that Stoned Cherry, a highly successful fashion label, was started with funding provided by Khula. Khula also assisted in the opening of the Gugulethu shopping mall.

Mr Molepo also added that Spier Wine Farm was funded by Khula.

Mr S Ngonyama (COPE) wanted to know if Khula’s priority was sustainability or to ensure that it was in a position to fund and thereby create a mass of entrepreneurs. He also asked whether Khula had considered aligning itself with PostBank as the latter was quite prominent in rural areas. Addressing the profile of Khula end users, Mr Ngonyama questioned the uneven spread of loans throughout the country as well as only 34% female end users.

Mr Mtembeni Mkhize, Deputy Chairperson, Khula, said that there was a concern with rural areas in the Eastern Cape and Limpopo but added that outreach into all provinces was the goal, and that with the movement deeper into rural areas Khula would also be addressing the issue of gender of their end users. He noted that in rural areas, men were usually absent from households, often working far away, so more women entrepreneurs were likely to be found in those areas.

Mr Mkhize said that by ensuring that entrepreneurs were able to reach their full potential, the sustainability of their businesses would maintained.

Mr Mkhululi Mazibuko, Chief Operating Officer, Khula, noted that Khula had already started engaging with the PostBank with a view to possible alignment.

Ms D Tsotetsi (ANC) wanted to know if Khula had a model or measurement for the mentoring programmes that it was running.

Mr Mazibuko said that there was a direct relationship between the level of mentorship provided and the levels of funding that could be provided.

The Chairperson wanted to know if Khula was perhaps living beyond its means, as it had indicated that it would not meet any of its targets without government funding. She also questioned the similarity between Khula and SAMAF.

Mr Mkhize said that Khula was similar in some ways to SAMAF but repeated that SAMAF targeted “survivalist” enterprises while Khula focused more on entrepreneurs. He added that while Khula’s full targets would not be met without funding, its plans to reach out into more rural areas would still be carried out.

Mr Molepo added that he did not believe that Khula was living beyond its means. He reiterated that Khula had distributed R2.5 billion to SMEs in the 13 years, and that every cent made was ploughed back into the business. He added that Khula was more than ready to make the step into direct lending.

Mr X Mabaso (ANC) wanted to know if Khula had a register of businesses who had applied for funds and whether Khula kept records of which enterprises were accepted and rejected, as well as the reasons for the decisions. He also asked if it kept in contact with those rejected. He wondered if Khula waited for businesses to approach it, or if it went in search of new opportunities. He finally asked what the impact of the Khula board was.

Mr Mkhize said that the function of the Board of Directors of Khula was to understand the mandate of the State and the role that Khula had to play, and use this as the basis for directions on how to impact upon the developmental State. He said that a register was kept of all SMEs that had approached Khula.

The meeting was adjourned.



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