SME Access to Finance: Battling Barriers with Innovative Solutions

1. An Overview Of Battle Bay Trading’s Proposal for SME Access to FinancePresentation to the PCED 16 November 2010

2. Content

3. Executive Summary • Battlebay Trading is a black owned and controlled company that proposes to establish an arm that will focus on assisting small and medium size companies in South Africa to access funding. • The academic literature around economic development indicates that a number of factors are important in ensuring SME succeed in developing countries. These include: • Access to Finance • Lack of formal business knowledge by the entrepreneur • Compounded by lack of access to useful information. • Insufficient training of the managers they employ. • Inadequate incentive structures and compensation model. • Lack of understanding of markets by the entrepreneur • Limited knowledge of potential suppliers. • Low awareness of competitive landscape. • Growth of strategies poorly adapted to current circumstances. • The most commonly cited barrier to economic development in developing economies is insufficient access to capital in terms of both the quantity of available capital and the quality thereof, that is the terms upon which finance is offered. • It is the experience in South Africa and other developing countries in Africa that entrepreneurs rely predominantly on internally generated funds (such as retained earnings) and informal sources (friends, family and informal lenders) to generate the capital they need for investment projects.

4. NYDA SME SURVEY 2010

5. Where are the Gaps? • It is also evident that owners of small and medium-sized enterprises and promoters of medium-sized investment projects are different to micro-enterprises and larger companies in terms of the ability to service their financing needs. • While micro-enterprises have tested and successful financing models and larger companies combine deep relationships with financial institutions with large balance sheets to raise capital, small and medium-sized enterprises typically operate in environments where most financial institutions and investors do not have the skills to appropriately and profitably serve and engage with them. This relative lack of supply of funds to them is referred to the “missing middle”.

7. THE MAIN TARGET PRIVATE SECTOR PROFILE FINANCIAL SERVICES No. of employees Banks Medium and long term needs Big enterprises 200 Medium enterprises 50 TARGET Small enterprises 5 Micro enterprises 1 Short term needs Self employment No. of firms Microfinance

8. What are the issues? • “My government and I are aware of the obstacles that have prevailed small businesses – historical injustice which prevented the majority of South Africans from gaining access to finance and other resources, restricted their access to major markets, and indeed, prevented millions of people from becoming entrepreneurs. These practices have resulted in what is now a very distorted economy, in which so many small businesses and black businesses are confined to the margins of economic activity” - (Message from Former President Nelson Mandela, in ‘ The President’s conference on small business, brochure, 1995) • Development of SME has been an apex priority for almost 15 years. Given the aforementioned quote as well as what our current President highlighted in the State of the Nation address, there is a need to take cognisance of the lack of improvement in that regard. • Improving the access to finance of small and medium enterprises is crucial in fostering entrepreneurship, competition, innovation and growth in South Africa. Access to sufficient and adequate capital to grow and further develop their activities is a difficulty faced by many South African SMEs. This situation is compounded by the difficulties in accessing finance as SME financing is considered by many financial providers as a high risk activity that generates high transaction costs and/ or low returns on investment. • Moreover, SMEs need to meet the challenge of adapting to the changing financial environment and the increasing complexity and extent of financial report.

9. DEMAND: DIVERSE NEEDS BY FIRM GROWTH CYCLE AS WELL AS SIZE • Own savings START-UP • Venture capital • Working capital • Bridge Financing NORMAL OPERATIONS • Discounting receivables • Trade credit EXPANSION • Reinvestment of profits • Term lending • Equity investment

10. MACRO ECONOMIC FRAMEWORK Situation • Unstable economic context • Finance concentrated on a narrow segment • Resistance against the reduction of inequalities • Ressisence against the assistance of Black Entrepreneurs Possible Actions • Support for governments in implementing: • expansion of Black Economic Empowerment policy • policies in favour of investment in the « middle segment » of private sector

11. LEGAL AND REGULATORY FRAMEWORK Situation • Unsufficient security for property rights, colateral guarantees, recovery of loans, etc.. • Regulations rules not adapted to medium term loans • Ceding of tenders and invoices Possible Actions • Support for reforms, in favour of SMEs, of : • civil and business law • bank and financial regulations

12. INFRASTRUCTURE OF FINANCIAL MARKET Situation • Lack of secured informations about SMEs • Cost of risk analysis too high for SME lending Issues Credit scoring: is it feasible in emerging limited markets? How to transfer the technology? External rating: due to the cost of expertise, is it only available for highly competitive SMEs? Credit bureau: analyse best practices in disseminating and sharing information on SMEs

13. COMMERCIAL BANKS Situation • SME finance is not a natural, profitable segment for banks ‘activity • But some banks, in a competitive context, are willing to bridge the SME finance gap Possible Actions • Integrated assistance to banks, combining: • refinancing avalaibility of medium term funds • guarantee funds, properly designed cessions • Advise on risk analysis and reduction of costs

14. VENTURE CAPITAL Situation • Well adapted to SMEs’ needs : bureaucratic-free and closely involved • But tends to be reserved to highly competitive « big » SMEs : require a high level of profitability Possible Actions Analyze experiences of downscaling venture capital Environmental measures facilitating mobilization of local private savings for SME investment Develop new instruments combining equity and debt financing

15. What We Suggest?

16. Proposed Implementation Overview Externally Financial Exposure and guidance of SMME to Funding Mechanism Exposure to Equity Investments Access to Bridge and Working capital FUNDING.. Developmental Integrated Emerging Supplier Development Programme Special Purpose Mechanism Promotion of Cooperatives Management Quarterly Supplier Summits to discuss Impact of Project Early Supply Chain Involvement Engagement with Private Sector SME Development Management Limited Resources Achievement Of Targets Ample Resources Supplier Database Allow for SME accessibility B-BBEE Reporting functionality Supplier listed per commodity Supplier rotation, quarterly update of Approved Supplier List Procurement Contract Unbundling Setting additional Quotas for Youth and Woman SCM Process initiatives and Monitoring Demand vs. Supply Initiatives Internally Compliance Signature of Invoice purchase agreement to Financier Cession of Right to receive payment of invoice in favour of Financier Early payment terms as Tool of Execution National Provincial and Local Government Strategic Plans/Projects

17. SUPPLY: A SYSTEMIC PROBLEM ENVIRONMENT LEVEL • Macro economic framework • Legal and regulatory framework FINANCIAL SECTOR LEVEL • Market infrastructure • Commercial banks • Bridge Financing institutions • Other finance institutions FIRM LEVEL • Business Associations • Networks and clusters • Procurement Platforms

18. MUTUAL GUARANTEE FUNDS Situation • A dynamic partnership which reinforce the banks’interest by: • sharing risk through financial solidarity • adding a judgment on human an professional qualitites of the applicant Possible Actions Analyze success stories of functioning mutual guarantee funds and networks, particularly in western countries

19. BRIDGE FINANCING Situation • Bridge Financing reduce SME finance gap by lowering risk and transaction costs • But there is a lack of Bridge Financing companies, due to regulation constraints Possible Actions Analyze lessons of experience with SME bridge financing Regulation reforms encouragement of bridge entities to assist SME

20. BUSINESS ASSOCIATIONS Situation Generally Business Associations lack institutional capacities, and are weakly representative of SME segment Possible Actions • Support Business Associations to act efficiently to reduce SME financing gap, through: • dialogue with the State to improve environment • organisation of mutual funds, collaboration with financial institutions to guide their services • training or certifying of SMEs to lower risk level

21. NETWORKS AND CLUSTERS Situation These SMEs’ grassroot organisations can play a powerful role to reduce SME finance gap at the 3 levels of environment, financial sector and non-financial support for SMEs Possible Actions Projects supporting networks and clusters of SMEs, where the financing needs have been successfully tackled

22. SUPPLIERSUMMIT Situation indirect access to manufactures creates inflated margins as SME try to make a profit Internal weaknesses of the firms in relation to investments information assymetries: difficulties ot the SMEs to provide relevant required data Lack of direct involevement by Large corporate except to meet Enterprise Development targets Possible Actions A quaterly supplier development summit that also creates Procurement platforms for the suppliers

23. What do Services do we want to provide?

25. Thank You BATTLE BAY TRADING Kgomotso Selokane Thabang Moropa