Small and Medium Enterprise access to funding

Economic Development

22 November 2010
Chairperson: Ms E Coleman (ANC)
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Meeting Summary

The Chairperson welcomed three delegations to the second day of public hearings, which had been convened to discuss issues affecting the access of SMEs to finance.

The Women’s Enterprise Development Initiative (WEDI) advocated a “hybrid approach” to SMME development, which combined a market-related return on investment with the desired social impact. The primary challenges to successful SME development were the failure of the market to develop a hybrid approach to SME financing
, fund managers who were incentivised to make decisions based on profitability rather than job creation; the lack of skill among enterprise development agencies (EDAs), market fragmentation and failure to attract women entrepreneurs.  A shift of mindset was needed among fund managers to eliminate the bias against women, and to balance the focus on profitability against the need for SMME development.  The government deserved praise for its investment of billions of Rands in SMEs, but it was questionable whether these resources had been effectively used.  There was a plethora of funds, many of which were funded by the government, but this was fragmenting an already complex financial “playing field, and a very small percentage of funding was trickling down to the intended SME target market. Reducing their number should not be considered until the various overlaps were fully discussed and understood.

Baloyi BridgeFin Consulting said SMEs in Africa had a high failure rate, with between 80% and 90% failing in their first two to three years, which was a “shocking statistic.”  Reasons why SMEs failed were poor corporate governance practices, inadequate management control, control flaws, inability to respond to changes in the economy, and poor cash flow management.  Access to funding was only partly a challenge; more important was access to the right type of funding.  SMEs needed an integrated funding model comprising venture capital funding, linked to a business mentorship programme, ensuring they received appropriate forms of funding and mentorship.  A mix of debt and equity financing would enable the SMEs to rely on equity funding in the early stages of development. They would be supported by business mentors with the relevant sector, product and market experience.  The corporate sector, as well as the government, was not doing enough to support SMMEs,  a major problem being late payment, taking into account that cash flow was a critical element of a small business’s operation.

Enablis, a non-governmental organisation (NGO), based in Canada,  which focused on developing SMMEs, focused on the entrepreneur as an individual first, before looking at his or her business needs, as the empowerment and provision of continuous support was considered crucial to the entrepreneur’s long-term success and sustainability of the business. An independent survey conducted last year among 100 of its members had revealed that they had each created an average of 10,2 jobs, despite the adverse economic conditions.  The organisation’s funding comprised the Enablis Khula Loan Fund, which provided access to First National Bank loan facilities and expansionary funding, and the Khula Enablis Accelerated SME Fund, which provided early stage “start-up” and expansionary funding, and financial support to women-owned and rural SMEs.  Enablis was reviewing its membership fee, currently R500, as it was not clear whether the cost factor was excluding potential members.


Meeting report

The Chairperson welcomed three delegations to the second day of public hearings, which had been convened to discuss issues affecting the access of SMEs to finance.  Only through this kind of intereaction was it possible to make South Africa a better place for all its people.

Women’s Enterprise Development Initiative (WEDI) submission
Ms Sharron McPherson, Executive Chair of WEDI International, described her organisation as an enterprise growth initiative which was committed to helping development agents create and use innovative methods of developing exceptional enterprises run by women.  Its objectives were to create quality, sustainable jobs, to reduce poverty, promote greater use of women in the economy, and to provide a vital link between private enterprises and public and private SMME development agents.

She said that for the past 20 years she had been advocating a “hybrid approach” to SMME development, which combined a market-related return on investment with the desired social impact.  Human capacity building was integral to the development process, as was the generation of viable and sustainable growth.

The primary challenges to successful SME development were:

Failure of the market to develop a hybrid approach to SME financing that incentivised fund managers to create jobs.  The government deserved praise for its investment of billions of Rands in SMEs, but it was questionable whether these resources had been effectively used.  There was a plethora of funds, many of which were funded by the government, but this was fragmenting an already complex financial “playing field, and a very small percentage of funding was trickling down to the intended SME target market.  Billions were being spent, but not achieving the desired impact.  A crucial part of the problem was that only a small percentage of the funds supported by WEDI were actually doing low equity value investment.  SMEs generally needed funds in the region of R1 million to R5 million, but analysis of over 80 funds had shown only two or three were actually doing this.  Futhermore, fund managers were incentivised to make decisions based on profitability, rather than job creation
 and social impact. This was a fundamental flaw in the investment model, and needed to be revisited.  SMMEs needed low-equity investment in order to deal with their debt commitments within the stipulated time frames.

▪ Lack of skill among enterprise development agencies (EDAs).  Enterprise development funding was a sub-set of private equity funding, but the two were not the same.  A lot of private equity funders were managing government funds, and were responsible for developing and growing SMES, but did not know how.  Technical support was an essential component of development, and fund managers baulked at the cost implications of this.  The result was a high default rate – in the region of 60% to 80%, which was not good by any standard.


▪ Market fragmentation.  Ms McPherson said South Africa might learn from the American example where, in the late 1960s, the US Government had established the Small Business Investment Corporation (SBIC), which was today responsible for between 64% and 70% of all venture funding.  It was a national organisation which topped up, by as much as 200%, what the private equity market invested in SMMEs.  This meant that SMME investment was not “ad hoc”, but focused, consistent and national – across all 52 states, and in urban, peri-urban and rural areas.  More than 3 million people were today employed by entities backed by the SBIC.  While one could not just transplant successful overseas models into South Africa, there was a need to study these examples to see how they might help local SMMEs.


▪ Failure to successfully target women.  Of the R64 billion available for SME investment, less than 10% ended up in the hands of woman-owned and operated SMEs.  The main reasons for this situation were a  lack of capacity at fund manager and EDA level to get the funds to the people who needed it, as well as a lack of capacity on the part of the SMEs themselves to properly absorb the funds already available.  Financing was not always the problem, for instance, when stock remained idle in warehouses owing to a lack of marketing expertise.  Technical assistance was therefore an integral part of any funding enterprise.


▪ Ms McPherson proposed the development of an “SME University” – a circle of excellence rather than bricks and mortar -- which would create a forum of the country’s best thinkers, together with stakeholders from the public and private sectors, and SMEs themselves, communicating about what was working and what was not, on a sustained basis.  Research had shown that this model, which was desperately needed, would work in South Africa.

Discussion
Ms H Line (ANC) asked what the specific reason was for the failure to target women entrepreneurs, and what the possible solution was.

Ms McPherson said women would not be successfully targeted until there was a mindset shift.  Women seeking finance were less likely to receive support than their male counterparts.  Funders needed the capacity to make better decisions on who they were lending to.  Another challenge was that historically, women had not owned property, and therefore did not have collateral as security for debt financing.

Mr S Marais (DA) asked why women should be specifically targeted, as this could be construed as sexist.

Ms McPherson replied that over 90% of food placed on the table in Africa was put there by women.  They were an under-utilised resource, and any attempt to achieve the “millennium goals” without women would be futile.  Targeting women was therefore not just the right thing to do, but the smart thing to do!

Mr Marais asked what sort of incentives were needed to encourage fund managers to invest in equity in SMMEs.

Ms McPherson said it depended on the mandate that came down to the fund, which often placed emphasis on the importance of job creation, but managers generally put their own interests first, which depended on their ability to ensure the profitability of the fund.

Mr Marais and Mr Z Ntuli (ANC) asked for WEDI’s view on development finance institutions (DFIs), which were used to fund SMMEs where higher risks were involved. 

Ms McPherson said DFIs had started giving money to entities like the IDC which in turn received financing from multi-national funders to provide the DFIs with resources to invest in SMMEs.  This placed the SMMEs “back at square one,” having to deal with organisations worrying about their profitability, and which needed a change in mindset.

Mr Ntuli asked how WEDI went about transferring skills and knowledge to women entrepreneurs.

Ms McPherson described a “transformative process” where women were not only able to obtain knowledge, but also use it and be measured in its application.  In order to ensure that a potential SMME was sustainable, an assessment had to be made – of both the person and the business – before an investment decision was made.  A programme was then tailored to meet the specific needs of both the business and its owner.

Mr N Singh (IFP) said he had visited a “centre of excellence” in Gaberone where SMMEs were being trained, and asked for further information on this type of operation.

Ms McPherson said the “SME University” was not a unit that sat in a business school, but rather a “space” which replicated a national forum for SMME development, allowing a wide range of stakeholders to communicate in an environment which could not take place in a business school “incubator.”

Mr N Gcwabaza (ANC) said SMMEs operated in widely varying environments, with a range of different challenges which needed to be addressed.  He asked what the main factor was in blocking funds from reaching women entrepreneurs.

Ms McPherson agreed that the different challenges meant there was no “one size fits all” solution, as urban and rural women based their decisions on different factors.  It was therefore important to assess the specific needs which prevailed in different geographic areas.  The blocking of funds was mainly due to fund managers not being properly incentivised.

Mr X Mabasa (ANC) said that because there was a plethora of financing agencies, should consideration not be given to restructuring and reducing their number, so that they became more focused and effective.  Furthermore, as WEDI viewed the need to provide technical assistance as part of the financing “package”, should the Small Enterprise Development Agency (SEDA) be integrated into the financing instutions so that one did not have different agencies handling capacity-building on the one hand, and funding on the other.

Ms McPherson said that while the current situation was unwieldy, reducing the number of funding agencies should not be considered until the various overlaps were fully discussed and understood.

Baloyi BridgeFin Consulting submission
Mr Chris Baloyi, director of Baloyi BridgeFin, explained the importance of SMEs, saying that a recent survey of Organisation for Economic Development and Cooperation (OECD) countries had shown that they comprised 96% to 99% of private sector enterprises in the countries surveyed.  In South Africa, the SME sector contribution to gross domestic product (GDP) was estimated at 41%, and about 50% of the work force was employed by SMEs.  However, SMEs in Africa had a high failure rate, with between 80% and 90% failing in their first two to three years, which was a “shocking statistic.”

He listed several reasons why SMEs failed, such as poor corporate governance practices, inadequate management control, control flaws, inability to respond to changes in the economy, and poor cash flow management.  Access to funding was only partly a challenge; more important was access to the right type of funding.  Traditional bank funding in the form of overdrafts or loans were not appropriate for the early stages of SME development owing to the interest and repayment burden, and the need for security.  SMEs rather needed seed capital funding, where financiers took equity in the SME and shared the risk with the entrepreneur.  SMEs also lacked critical skills for business success in such areas a finance, legal matters, marketing and sales.

SMEs needed an integrated funding model comprising venture capital funding, linked to a business mentorship programme, ensuring they received appropriate forms of funding and mentorship.  A mix of debt and equity financing would enable the SMEs to rely on equity funding in the early stages of development.  They would be supported by business mentors with the relevant sector, product and market experience. 

Mr Baloyi pointed out that venture capitalists would take equity in SMEs and become part owners, compared to banks, which required interest repayments, and provided longer term funding (five to seven years) than banks (usually 12 to 24 months).  Their presence in the SME’s management team would help to ensure good business management.  Business mentors, usually retired executives, younger professionals with a passion for entrepreneurship, or specialist firms such as his own, could act as a sounding board for new SMEs for the first six to 24 months of the SMEs’ development.

He proposed that the government (20%) and banks (80%) needed to pool funds in a dedicated venture capital vehicle which would focus mainly on funding SMEs.  The SME mentorship programme should be partly funded through contributions from the banking sector to the Skills Development Fund, so that the cost of mentorship could be included in the project costs covered by the SME funding.  The venture capital financing institution should have regional offices in nine provinces, with staff skilled in assessing business proposals, and with access to a data base of business monitors.

Discussion
Mr Marais agreed that SMMEs were the “engine room” for creating jobs, and asked how large companies could be encouraged to make greater use of them.

Mr Baloyi said rather than adopting a blanket approach, it would be better to create incentives which were appropriate for different sectors, such as manufacturing or agriculture.  At present, such incentives did not exist, so interested parties such as government and funders in the different sectors should consider what incentives to introduce.

Mr Marais said that a mentor was an adviser to an SME, not a decision-maker, so if there was to be a link to his performance, there needed to be some form of agreement.  He asked how this would be achieved.

Mr Baloyi said for mentorship to be effective, it had to translate into a transfer of skills, so contracts with targets needed to be put in place.  Mentors would be required to spend time at SMEs’ premises, so that they could impart knowledge and answer questions,

Mr Singh asked whether the corporate sector was doing enough, in terms of corporate social responsibility, to promote SMMEs, and added that it might be appropriate to bring them to the committee to discuss SMME issues.

Mr Baloyi said the corporate sector, as well as the government, was not doing enough.  A major problem was late payment to SMMEs, taking into account that cash flow was a critical element of a small business’s operation.

Mr Singh commended Mr Baloyi’s mentorship proposals, and asked whether some form of accreditation should be introduced as proof that skills had been acquired.

Mr Baloyi replied that there were many organisations already providing accreditation, but the training needs of entrepreneurs varied.  What was needed was a very practical course for people lacking business skills, particularly for those who were already in business.

Mr Gcwabaza asked how unemployed people who had no resources, but wanted to start their own business, could be helped.

Mr Baloyi said his organisation helped unemployed people to gain access to capital by analysing their businesses and establishing whether they had a viable business plan.  If they found they had identified a niche market, or already had contracts, they were invariably able to find partners who would provide funding and share in the business.

Mr Mabasa expressed concern that the big shopping malls were detrimental to the interests of SMMEs.  He also commented that big businesses were able to squeeze lower prices out of SMMEs, which fed down to reduced benefits for the employees of these SMMEs.

Dr P Rabie (DA) asked whether the proposed funding model would cater for all segments of the market.  He also enquired whether all the role players had been consulted to see if the model was viable or not.

Mr Baloyi said the concept had been quite widely discussed, and there was general agreement on the need for an umbrella body, but no conclusion had yet been reached on the final form of the model.

Enablis submission
Ms Sally Moodley, CEO of Enablis, said her organisation was a non-governmental organisation (NGO), based in Canada,  which focused on developing SMMEs.  It recruited its members in South Africa from the top 300 entrepreneurs participating in its business plan competitions, which last year attracted 2 500 applicants.  Entrepreneurs operating in the SME sector were accredited as members before they became eligible to receive any of the Enablis services.  Apart from providing networking and capacity-building support services, it also provided access to finance through its banking arm, Enablis Financial Corporation.  It received financial support from the Canadian government, as well as local and international companies.

As a member-driven organisation, Enablis focused on the entrepreneur as an individual first, before looking at his or her business needs, as the empowerment and provision of continuous support was considered crucial to the entrepreneur’s long-term success and sustainability of the business.  Of its approximately 650 members, 70% were black and 35% were women.  The three main elements of its operation were financing, in the form of loan guarantees and equity investments, networking and capacity building.

Ms Aimee-Noel Hartley, Communications Manager of Enablis, said an independent survey conducted last year among 100 of its members had revealed that they had each created an average of 10,2 jobs, despite the adverse economic conditions.  Over 70% had reported steady or increased turnover and profits during the previous year, while 38% had created new businesses.  Based on 6 687 actual jobs created by members surveyed in the period 2005 to 2009, it was estimated that the number of jobs created by all Enablis members had been 13 355, leading to a further 73 454 jobs being created indirectly.

Mr Darryl Ron, Senior Investment Officer of Enablis, traced the history of the organisation’s funding, comprising the Enablis Khula Loan Fund, which provided access to First National Bank loan facilities and expansionary funding, and the Khula Enablis Accelerated SME Fund, which provided early stage “start-up” and expansionary funding, and financial support to women-owned and rural SMEs.  Both these funds operated over a ten-year cycle – five years’ investment and five years’ disinvestment.  The Loan Fund had disbursed R20m to 53 entrepreneurs, of whom 33 were historically disadvantaged individuals (HDIs), and 14 women.  The Accelerated SME Fund had disbursed R25m to 53 entrepreneurs, of whom 36 were HDIs, and 18 women.  The success of the programme was reflected in the fact that 26 of the recipients had already repaid their commitments in full, and were now eligible for normal bank financing.  Post-investment monitoring was one of the factors which set Enablis apart from other funding institutions. 

Discussion
Mr Singh asked if there was a charge, or membership fee, for individual entrepreneurs.

Ms Moodley replied that there was a membership fee, which had at first been pegged at R1 000, and then reduced to R500.  The fee had been established on the basis that members would not appreciate Enablis services unless they contributed towards them, and was not intended as a means to generate funds.  However, as members were battling to pay even this reduced amount, Enablis was having another look at the level of fees, as it was not clear whether the cost factor was excluding potential members.

Mr Marais asked how Enablis retained its members, to remain sustainable as an organisation.

Ms Moodley said making use of a business plan competition ensured that better quality entrepreneurs, who were really interested in their businesses, were attracted as members.  As a dynamic organisation, Enablis adapted to meet its members’ changing needs, with two or three new programmes introduced each year, supported by mentorship, while the annual surveys and day-to-day communication ensured close contact.

Mr Mabasa asked whether those households which had benefited from the Enablis-supported creation of jobs were enjoying a reasonable standard of living.

Ms Hartley said the organisation could not attest to the well-being of all the households, but she felt that overall there was an acceptable improvement in their lives.

The Chairperson expressed her thanks to the presenters, and said the contents of the submissions had been noted and would be considered by the committee.

The meeting was adjourned.

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