The Role of the IDC in Small and Medium Enterprise Development

1. The Role of the IDC in Small and Medium Enterprise Development Jorge Maia Head: Economic Research and Information Department Industrial Development Corporation of South Africa Stellenbosch, 6 June 2006

2. SA economic performance • Average annual GDP growth rate of 3% over the period 1994-2004 and 4.7% over the last two years • A rapid increase in fixed investment to expand the country’s productive capacity • South Africa’s general economic stability and sound macro-economic management widely acknowledged • Prudent fiscal policy and continued improvements in tax collections resulted in a substantial decrease in the budget deficit in recent years • Inflation is well under control and at levels last seen in the 1960s • Interest rates are at a 24-year low • Strong inflow of foreign capital into South Africa – reflecting increased investor confidence

3. Business confidence • The SA business community remains very upbeat about the future of the domestic economy • The positive business sentiment is echoed by the excellent performance of the Johannesburg Securities Exchange (JSE) • The JSE’s All-share index increased by 43% during 2005

4. Investment environment challenges Recent Investment Climate Survey* : • Survey revealed that overall conditions are conducive to investment activity • However, certain obstacles remain … • Exchange rate volatility (negative perceptions) • Relatively high cost of skilled labour (shortage of specific skills) • Crime (is factor, however, widely accepted that the crime rate is declining as a result of better policing) • Lack of competition in specific sectors of economic activity where there are high levels of concentration and significant barriers to entry Commitment of SA government to engage business in improving any element of the investment climate * Survey conducted by Citizen Surveys, a private SA firm . 800 firms were surveyed between January and December 2004. 75% of sample were in manufacturing sector; 14% in the construction sector and the remaining 11% in wholesale and retail trade

5. Sector-specific drivers of growth

6. Sector-specific drivers of growth

7. Sector-specific drivers of growth

8. Sector-specific drivers of growth

9. Manufacturing industry performance Strong domestic demand East Asian crisis and High interest rates (Prime rate = 25.5% in Aug ’98) Substantial strengthening of the Rand • Strong improvement in growth performance over past decade (2.9% p.a. vs 0.5% in previous ten years). • Strong rand adversely impacted on the export-oriented sector of manufacturing, resulting in a 1.4% contraction in Manufacturing GDP in 2003. • Domestic demand a key driver behind revival in 2004 and 2005 due to buoyant consumer spending.

10. Longest upward phase in the business cycle Manufacturing: Production capacity utilisation • Highest level of production capacity utilisation in the past 35 years. • Strong growth of domestic economy resulted in many sectors operating near full capacity. • Urgent investments in new productive capacity are essential to sustain higher economic growth momentum. • Low levels of investment in manufacturing perhaps an indication that business did not anticipate that the strong growth in the SA economy in recent years would be sustained over a prolonged period.

11. Manufacturing: Production capacity utilisation • A number of manufacturing divisions are now operating at more than 85% of capacity, with 85% capacity utilisation being regarded as full capacity. • At the sub-sectoral level, for example, the cement industry (part of non-metallic mineral products) is operating at almost full capacity, whilst new investment plans have been announced to meet increased demand in future.

12. SA sector performance: 2003 – 2005

13. Manufacturing: Business confidence • Business confidence in the manufacturing sector continued to improve in recent quarters. • Nevertheless, the confidence level still remains well below that of other sectors of the economy. • This is mainly due to a less favourable performance for exports on the back of a strong rand.

14. Manufacturing industry performance • Manufacturers switch production away from exports to the lucrative domestic market. • Exporters become increasingly pessimistic about export prospects due to a strong rand reducing their export competitiveness. • Import-competing manufacturers, on the other hand, also find it more and more difficult to face cheaper imports flooding some sectors in the domestic economy.

15. Investment opportunities Identified via ... A number of initiatives…. Examples of the most viable opportunities... • Infrastructure development • New power stations, restructuring of ports and new cargo handling facilities, improvement of rail infrastructure, development of dams and water infrastructure projects & road projects • - Sector investment strategies Business Process Outsourcing, tourism, agriculture and agro-processing, wood, pulp & paper, chemicals, bio-fuels, downstream minerals beneficiation, cutting- edge technologies (e.g. aerospace, fuel-cell technology, broad-band ICT infrastructure) • Skills development • - etc. Accelerated & Shared Growth Initiative

16. Investment opportunities A number of initiatives…. Examples of the most viable opportunities... - Building materials - Construction services - Electrification - Water reticulation - Telecommunications - Transportation - etc. Expanded Public Works Programme (EPWP) • Activities benefiting from: • Locating in industrial development zones • Current investment incentives (tax holiday, IDC schemes) • Promotion of small scale industries • - Offset programme Industrial Policy

17. Investment opportunities A number of initiatives…. Examples of the most viable opportunities... - Mineral sectors benefiting Aluminium, magnesium and titanium light metals, coating technology, incl. paints and thin films, platinum beneficiation, high performance magnesium alloys, production of titanium sponge, jewellery manufacturing, etc - Industry and enterprise competitiveness including technology enhancement, work reorganisation and research and development Minerals Beneficiation Strategy • - Transnet • - South African Airways • - Alexkor • - Denel • ACSA • etc. Privatisation Programme

18. Investment opportunities A number of initiatives…. Examples of the most viable opportunities... Revival or resuscitation of previously viable industries: Forging and casting, boilers, tooling, several sub-component manufacturers, railway lines Expansion and/or improved competitiveness: Locomotives (refurbishment/upgrading), wagons & coaches, railway sleepers, alloys, transformers, pumps, valves, taps, cables, overhead transmission lines, conductors Partnerships with global suppliers so as to set-up local subsidiaries to: • Produce components of turbines • Assemble turbines • Produce components of engines (electrical as well as diesel) • Produce components of switchgears • Build locomotives, wagons & coaches Capex Programmes of State-owned Enterprises

19. Investment opportunities A number of initiatives…. Examples of the most viable opportunities... • Soccer World Cup 2010 • Infrastructure upgrades in meeting the objectives of the 2010 Soccer World Cup, including: • Stadium upgrades and new stadiums, • Airport upgrades, • Road upgrades • Accommodation • etc.

20. Investment opportunities A number of initiatives…. Examples of the most viable opportunities... Transport Services & Logistics Road freight, commuter bus service, port services, ship maintenance Chemicals Industries Bio-fuels, man-made fibres, tubes and pipes, composites,soaps and other cleaning products, plastics for automotive industry Wholesale & Retail Trade Shopping centre development in townships and rural areas, convenience stores, franchising investments, warehousing facilities High Growth Potential Industries

21. Investment opportunities A number of initiatives…. Examples of the most viable opportunities... • Construction • Construction project development (Soccer World Cup 2010, Eskom & Transnet capital expenditure programmes, Power generation projects, Gautrain Project, etc), building materials (cement plants, concrete making, concrete recycling); mobile brick plants; construction services • Mining and Mineral Beneficiation • Platinum group metals, iron ore, coal, diamond cutting and polishing, jewellery manufacturing • Waste Management • waste treatment, waste recycling (paper and board, plastics, metal & glass) High Growth Potential Industries

22. Investment opportunities A number of initiatives…. Examples of the most viable opportunities... - Wood and Paper Industries forestry products, furniture, packaging, paper recycling - Services Sectors Tourism (eco, accommodation, conference facilities), health and educational services, information technology, business process outsourcing High Growth Potential Industries

23. • Investment opportunities A number of initiatives…. Examples of the most viable opportunities... - Free State: logistics, biofuels, knowledge-based industries - Gauteng: logistics, commuter passenger transport - KwaZulu-Natal: ethanol, agriculture, water, sanitation, energy - Mpumalanga: rail infrastructure - Limpopo: infrastructure development, cultural and recreational facilities, logistics - North West: logistics, bio-diesel, livestock, infrastructure development, warehousing facilities - Eastern Cape: forestry, agriculture, livestock, infrastructure development - Northern Cape: diamond cutting & polishing, jewellery manufacturing, iron ore and manganese mining, logistics, infrastructure, radio telescope project - Western Cape: oil & gas hub, steel beneficiation cluster, infrastructure development Provincially-led Projects

24. The IDC: Corporate profile • Established in 1940, the IDC is a self-financing, state-owned development finance institution • Provides financing to entrepreneurs engaged in competitive industries • Follows normal company policy and procedures in its operations • Pays income tax at corporate rates and dividends to the shareholder • Independent Boardof Directors • Reports on a fully consolidated basis, with its Annual Report freely available to the public IDC Head Office in Sandton, South Africa

25. Vision and mission “To be the primary driving force of commercially sustainable industrial development and innovation to the benefit of South and the rest of Africa” • Contribute to the generation of balanced, sustainable economic growth in South Africa and Africa • Economically empower the South African and African population • Promote entrepreneurship through the building of competitive industries and enterprises based on sound business principles

26. The IDC’s core strategies Job creation Promote entrepreneurship Facilitate BEE Regional development Small and medium enterprise development Africa’s development Encourage social transformation IDC needs to maintain its balance sheet integrity to ensure that it can deliver the above on a sustainable basis.

27. New sectoral involvement • Now • Agriculture • Mining • Manufacturing • Services - related • energy • tourism • IT • telecoms • motion pictures • healthcare & education • transport & storage • venture capital • government / corporate tenders • franchising • financial services • Other • public private partnerships • development agencies • 1997 • Agriculture • Mining • Manufacturing • Property

28. IDC’s financial instruments • IDC offers a wide array of financial instruments, including : • Equity • Quasi-equity • Commercial debt • Wholesale & bridging finance • Share warehousing • Guarantees • Export/import finance • Short-term trade finance • Wholesale venture capital • These may be provided singly or in combination Flexible Deal Structuring

29. Financing criteria • Project/business must exhibit economic merit in terms of profitability & sustainability • Fixed assets & working capital for new start-up ventures or expansion of existing businesses • R1 million minimum • Owners/shareholders contribution 40% of funding is normally a requirement • Equity participation: Considered as an alternative if loan finance inappropriate;minority investments; IDC exit within reasonable period • Some developmental impact such as: value addition; job creation; export earnings; expanding industrial base; poverty reduction; empowerment • Environmental compliance • IDC may require security, the form and nature relating to clients circumstance • Seek no shareholding control or management participation

30. Appraisal process Initial Screening Basic Assessment Feasibility Completed Feasibility not fully investigated MOU/Co-operation Agreement Term Sheet Due Diligence Feasibility Study Decision-making (Investment Committee) Legal Agreements Disbursement Post-investment Management

31. The IDC’s approach to SME development

32. The role of SMEs in the SA economy • SME development: a national priority • TheNational Small Business Actwas promulgated in 1996 • Numerous policies were adopted and programmes to implement these policies were introduced • SMEs play a vital role in stimulating economic development • Higher degree of labour intensiveness • Lower average capital cost than large-sized enterprises • Often use local recycled resources • Provide opportunities for aspiring entrepreneurs ( especially the unemployed) • Vital role in technical and other innovations • SMEs are viewed as bridging gap between the first and the second economy

33. The role of SMEs in the SA economy Contribution to GDP Contribution to employment

34. The role of SMEs in the SA economy • Challenges • Access to finance • Little or no entrepreneurial experience • Lack of technical and financial skills • Low survival rate of new businesses

35. IDC financing of SMEs Definition • IDC’s focus of the definition is on small to medium enterprises (excluding the micro enterprise segment) • A business is classified as small medium enterprise (SME) if it fits any two of the following criteria: • Less than 100 employees • Less than R50 million annual turnover • Less than R30 million total assets value

36. IDC financing of SMEs Various approaches geared towards developing SMEs: • Franchising(providing finance to franchisor and franchisee) • Agency Development and Support (serves as a support and resource facility to fulfill IDC’s developmental role through the establishment of agencies -particularly in rural areas) • Risk Capital Facility (targets private SME sector through BEE) • Special development financing schemes (Pro-SME Jobs Scheme)

37. IDC financing of SMEs Pro SME Jobs Scheme … Capital allocation: R600 million. Key objectives: To promote employment creation and SME development by encouraging businesses to embark on labour intensive start-ups / expansions. Pricing and individual loan limits: Interest rate of prime less 5% applicable for the full period of the loan (max. 7 years). This period includes any grace period for capital repayments. The low interest rate finance will be limited to R25 million per project.

38. IDC financing of SMEs Pro SME Jobs Scheme (cont) … • Criteria: • The financing is available for SMEs in all sectors within the IDC’s development mandate. • Applicants must be independent companies or groups complying with at least 2 of the following 3 parameters: less than 200 employees; or less than R35 million turnover; or less than R40 million in total assets at application date - or after the 1st year of full production in the case of start-ups. • The business must have economic merit, i.e. have prospects of acceptable profitability, and must comply with the IDC’s normal funding criteria.

39. IDC financing of SMEs Pro SME Jobs Scheme (cont) … • Criteria (cont.): • At least 10, direct, permanent new jobs must be created. • The total capital cost of the new or additional assets (buildings, machinery and working capital) must not exceed R150 000 per job opportunity (calculated at peak funding requirement). The new or additional assets are the total assets involved in the start-up or expansion – not only the portion to be financed by IDC.

40. Development Financing Schemes (cont.) Generic issues • All schemes are effective as from 10 November 2005, and will be on offer until 1 December 2006 or earlier if the R1 billion capital allocation is depleted. • In cases where the results of the financing provided under the schemes are not in line with the set objectives, IDC has the right to increase the interest rate to a “prime based risk adjusted rate”. • All the normal IDC fees (including the breakage/cancellation fee) will be applicable except for the Pro Franchising and Pro Orchards schemes. • The minimum IDC facility is R1 million (except for franchising). • Only direct, permanent new jobs will be taken into account for the purposes of qualifying for finance, with the cost per job calculated at peak.

41. IDC financing of SMEs • Since 1995, the IDC has funded over 3600 SMEs with a total value of R13.5 billion • In 2004/05 financial year (9 months), over 70% of the number approvals pertained to SMEs.

42. IDC financing of SMEs • Most of the SMEs funded by the IDC are in the agriculture, hunting, forestry and fishing sectors.

43. IDC business support in SME sector Entrepreneur development assistance will include: • Providing greater pre-investment support for high potential / high impact investments • Closer monitoring of clients • Providing technical support post investment • Focused training to meet needs of specific entrepreneurs • Providing generic training and systems to support new entrepreneurs • Encouraging the development of women entrepreneurs • Encouraging the development of disabled entrepreneurs

44. Concluding remarks • Job creation is overarching objective of IDC financing • Increase focus on the development of entrepreneurs • Intensify balanced development and spread job creation across regions (including rural areas, various provinces, townships) • Emphasis on expansionary BEE projects • Continue to focus on Government’s policy objectives

45. Thank You