Khula Enterprise Finance Ltd -Overview-

1. Khula Enterprise Finance Ltd-Overview- • Parliamentary Portfolio Committee on Economic Development • March 2010 1

2. Presentation Outline • Background • Mandate, Vision and Mission • SME Financing Landscape • SME Finance Role Players • Khula’s Current Business Model • Products and Delivery Channels • Financing Partners • Strategic Focus • Achievements • Limitations of the Current Model • Financial Implications • Cabinet Approval of Khula Direct • International Benchmarking Lessons on Direct Lending • Re-engineering Khula for Direct Lending • Strategic Priorities and Initiatives • Implications on the Balanced Scorecard and impact On End Users • Khula Direct Overview • Closing Remarks 2

3. Background • Khula, is a development finance institution (DFI) reporting to the Department of Trade and Industry (the dti), with an independent Board of Directors • Khula was established in 1996 and its mandate derives from the dti White Paper on the National Strategy for the Development of Small Business(1995). • The decision to establish Khula as a wholesale rather than a retail institution was taken after considering the following factors: • The role of the State is to create an enabling environment rather than to participate directly. • Government backed guarantees would assure Commercial banks and other financial institutions and get them to participate in the SMME sector. • As a wholesale financier; Khula works through a network of partners inter alia Commercial Banks; non-bank RFIs; and other partners – to ensure that SMMEs have access to finance. 3

4. Background (cont…) • Since the creation of the South African Micro Finance Apex Fund (SAMAF) Khula concentrates its efforts on the upper end of the funding gap - providing funding above R10k and therefore refers to lending to Small and Medium Enterprises (SMEs) rather than SMMEs. 4

5. Khula’s Mandate, Vision and Mission Mandate To address market failures in the SME finance sector by leveraging and unlocking private sector and other developmental funding for the creation of a vibrant SME sector. Khula’s main focus is the facilitation of access to finance by SMEs; maximising development impact and ensuring organisational sustainability Vision To be the development finance partner of first choice in the field of Small Enterprises Development Mission To provide finance, mentorship services and small business premises to SMEs through a network of partnerships and to encourage the sustainable development of SMEs whilst ensuring Khula remains financially viable • The achievement of the desired impact envisaged in the mandate would be through the development and implementation of a Khula SME bank 5

6. Khula’s Mandate is focused on three key areas … Promote access to finance Access to finance for SMEs Development impact Financial sustainability Create sustainable SMEs; in the mainstream economy, thereby contribute to economic development Long-term objective 6

7. SME Financing Landscape … Characteristics Characteristics Opportunity-driven/Entrepreneurial • Less than 200 employees • Turnover > R25m p.a. • Developed technical & business skills Medium enterprises Medium enterprises • Less than 50 employees • Turnover < R25m p.a. • Developed technical /limited business skills Small enterprises Small enterprises • Less than 5 employees • Turnover < R150k p.a. • Some technical /limited business skills Micro enterprises Micro enterprises Survivalist enterprises Necessity-driven/Survival Survivalist enterprises • Individual self employment • Turnover < R50k p.a. • Limited technical and business skills 7

8. SME Financing Landscape …Supply Financing Needs - Supply • Corporates • Banks/Financial Institutions • Private Equity/Venture Capitalists • Khula, IDC, NEF Medium enterprises Medium enterprises • Own resources • Banks & Corporates • Khula & PDCs Small enterprises Small enterprises • Own & family resources • Microlenders & Banks • SAMAF & PDCs Micro enterprises Micro enterprises Survivalist enterprises Survivalist enterprises • Own & family resources • Microlenders • SAMAF 8

9. SME Finance – Role Players Financing Needs - Supply Medium enterprises Medium enterprises Small enterprises Small enterprises Micro enterprises Micro enterprises Survivalist enterprises Survivalist enterprises 9

10. Khula’s Current Business Model • Wholesale financier with total reliance on intermediaries • Leverage private sector funding • Facilitator vs. Direct lender - role of the State as an enabler rather than direct participant • Capitalisation structure - funds are required in order not to erode capital base 10

11. Financing Gap Filled by Khula • Primarily black-owned ; owner-managed formal SMEs • SMEs requiring financial resources between R10 000 and R3 million • Start-up and expansions of early stage businesses • Focus on underserved provinces, rural areas and “urban poor” communities • Focus on women-owned enterprises 11

12. Business Loans • Credit Guarantees • Equity funds and Joint-Ventures • Pre- & post Loan Mentorship • Business Premises (Retail & Industrial) • Manage third party funds Khula Wholesale • Working Capital • Guarantees • Equity Finance • Bridging Finance • Asset Finance • Invoice Discounting & Factoring • Group lending Financing Partners [Banks, RFIs, Corporate Sector Partners, Public Sector Partners] Retail SMEs End-user • Asset accumulation • Job creation • Regional development • Economic transformation Product Offering Suite of innovative financing instruments Khula Products Financing Instruments Development Impact 12

13. Financing Partners Some of Khula’s Financing Partners are: • Ithala Development Finance Corporation • Business Finance Promotion Agency (BFPA) • Anglo Zimele • True Group • Small Enterprise Foundation (SEF) • Marang Financial Services • Business Partners • New Business Finance (NBF) • .Meridian Fund • Identity Development Fund (IDF) • Enablis • Standard Bank • Nedbank • Absa • First National Bank, etc 13

14. Strategic Focus • In 2004 Khula took a new strategic direction aimed at growing the organisation’s reach and impact in order to better support the needs of SMEs. • Khula changed its target market, operational model and introduced newchannels and products increased disbursements to SMEs. • Bad debts and claims were kept as low as possible but pressure is being felt as a result of the impact of the present global economic crunch. • Public opinion and perceptions about Khula are steadily improving. • To raise delivery to the next level and make more meaningful impact, Cabinet in December 2008 approved that Khula’s mandate be extended to include direct lending activities. 14

15. Approvals and Disbursements 15

16. Achievements (cont.) 16

17. Utilisation of Indemnity Scheme By Banks 17

18. 2008/09 SME PROFILE • Funding to Black SMEs at 52% • Investments to GP/WC/KZN at 64% • Disbursements to women at 34% • End-user facilities increased from 2 472 to 2 829(up by 14%) • Estimated jobs created at R100k per job – 3 150 18

19. Achievements (Cont…) • Disbursed more than R2.5bn to SMEs since inception • Remained liquid • Continued to show a surplus each year irrespective of under-capitalization • Built up asset base to approximately R1.2bn 19

20. Wholesale Model 1) Distance from end-users and assumed risk 2) Limited ability to drive development and control destiny 3) Over-reliance on co-operation from partners that have purely commercial objectives Model not clearly understood by the target market State support for SMEs is concealed, leading to distorted market perceptions Model adds a layer between Khula and the customer, increasing risk, costs of delivery and interest rates charged. Limitations of the Current Model 20

21. KhulaCapitalisation Structured as an administrative entity  low overhead structure  channelling funding through banks and RFIs. Initially capitalised with some cash/assets (assets are non-performing and non-core) to earn interest/income to fund overheads and distribute remainder to RFIs as loans – R330 million Khula does not receive an annual grant from National Treasury. Actual amount of available funds that Khula can disburse is limited. Khula requires a properly structured balance sheet based on a rolling 5-year investment horizon, which should include a portfolio of strategic equity investments with high level of profitability to subsidise the developmental initiatives/targets Limitations of the Current Model (cont…) 21

22. Financial Implications • Since 2004/5 Khula alerted the shareholder that by 2010 Khula would no longer be able to maintain its momentum of delivery to its target market without additional funds. • If no funds are received and Khula continues its current strategic thrust it will start eroding its capital base and suffer losses. To be financially sustainable and deliver on its mandate and strategic direction, Khula requires 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 demands on capital disbursements. Change in Khula’s Articles of Association, so that through an Act of Parliament, Khula becomes a flagship SME Bank, which will also allow Khula to borrow so as not to be reliant only on government funding 22

23. Funding vs. Non-funding Disbursement/Profitability Scenarios 23

24. Cabinet Approval of Khula Direct Model • Low impact and unsatisfactory results of Wholesale Model led to submission of Khula Direct Lending Proposal to Cabinet. • In December 2008, Cabinet approved the “KHULA DIRECT” business case subject to Shareholder: • a) Approval of business & implementation plans • b) Capitalisation of Khula • In 2009, the content of Cabinet approval was discussed with the Portfolio Committee, which confirmed the need for the business plan,international benchmarking study and local research. • Both the international benchmark study and local research were undertaken. 24

25. International Benchmarking Lessons On • Direct Lending • Government is prime funder and key player • Government support and commitment to SMEs at highest level of government • Research and developments of new products is the key elements • Centralize the risk management processes • Clearly defined and easy to understand and client recruitment and credit process which ensures that they get the “Correct clients.” • Quick turn-around times due to clearly defined loan disbursement processes • Place strong emphasis on credit risk management • Extensive Network of branches which enable them to visit SMEs • throughout the country • Commitment to SME support in the country at the highest level of government • Provide integrated support - Financial and non-financial. 25

26. Local Research Findings • FinMark Trust report estimates that demand for R10k – R50k exists for 525,000 enterprises (27% GP) and 160,000 enterprises require R50k – R250k (50% in GP) • Poor access to finance in rural areas – costly to supply, low density • Banks have to factor cost of capital into their price – makes products expensive – don’t easily fund < R50k, always seek security • Inflexible approach to financing SMEs • Unsuccessful SME lending due to 75% borrowers being self-employed cf. micro-finance model which bases collections on salary deductions • 41.6% of all credit consumers had impaired credit files in December 2008 • Lack of security can be substituted with credit history in paying for • rent, • telecommunications (other than prepaid) • municipal services • retail purchases on credit • Insurance 26

27. Re-Engineering Khula for Direct Lending • Legislative enablement is Key • Organizational restructuring for Khula Direct • Retraining & re-assignment of staff KHULA Development of an SME Bank Re-engineering the current operations Implementation of Khula Direct Operations Restructuring Alignment of the Human Capital Management Processes Systems Products Cost and cashflow management Strengthened risk management and monitoring and evaluation Structure People Branding Recapitalisation 27

28. Key Strategic Priorities Re-engineering current Operations Alignment of Human Capital Restructuring of operations to ensure meeting of existing commitments and effective support to Khula Direct Realignment of human capital intervention to ensure meeting of existing commitments and effective support to Khula Direct Cost of cashflow management Strengthened risk management and monitoring and evaluation Strengthening of cost and cashflow management Strengthening the risk management of all of Khula’s investments and partnerships, especially the larger transactions Influence of Khula on SME policy formulation Branding and positioning of Khula Khula to play a prominent role in shaping and positioning SME development through research and development. Position the Khula organization/brand as the flagship DFI in SME financing 28

29. Budget Implications to Some Key Balanced Scorecard (BSC) KPIs 29

30. Impact to the End Users 2010/11 30

31. Key Elements of Khula Direct Model • Field staff = close relationship with customers • Process up to approval • Hunt for deals (1st screen) • Capture details (scoring = 2nd screen, reply with proposed products and terms) • Business concept (3rd screen, reply with draft term sheet & CPs) • Pre-approval support for business plans and CPs for 75% of LT deals • Comprehensive due diligence only for larger/longer/more complex deals (25% of LT) • Regional office prepares submission • Approval by Credit/Investment Committee • Regional office owns customer & manages field staff • Head Office establishes and manages products, credit policy, risk management, portfolio management • Customer interfacing • Highly responsive • Greater degree of responsibility looking after people’s businesses • Branding • Increased compliance • SME support and education programmes • Sedato provide pre-investment support • SA Guide to Business Programme in partnership with USAID • Regional information sessions • Post loan mentorship interventions 31

32. Market Positioning Geographic location Product set Pricing Degree of security Owner’s contribution Phase of business Size of deal Size of business Experience of entrepreneurs Market sectors Position in value-chain Competitiveness Growth prospects Export opportunities Less urban, deeply rural Address needs of whole business - simple Risk-based. Earn fees and interest Low on small facilities, be creative Low (higher pricing) - commitment Start-up, early growth, expansion R10k – R3m, mostly around R250k SME Preferably as good as it gets, in industry All, except sin industries More secondary than tertiary Indifferent globally, locally must be unique Yes, increase employment Outside of local community Criteria that define our position 32

33. Khula is a DFI dedicated to the needs of small business Key differentiator is focus on start-ups, small loans and underserved provinces Khula has undergone a strategic shift to enhance focus and delivery Maximum outreach and impact will be achieved, in part, through: Direct lending to SMEs Targeted use of Credit Indemnity Scheme More direct approach to wholesale funding through RFIs Utilisation of the Financing Partners infrastructure Capitalisation is required to follow through with strategic choices made Concluding Remarks 33

34. THANK YOU Khula Client Liaison Centre number 08600 KHULA (54852)Website -http://www.khula.org.zaEmail -helpline@khula.org.za 34