Bridging SMME funding gap to fire up innovation

Kathy Gibson reports from Sandton – While SMMEs lament the lack of funds available to them, investors battle to find investable SMMEs, creating a vicious cycle that results in a dire shortage of new small businesses and the resultant innovation they bring.

The newly-released South African SMME Access to Finance Report seeks to uncover the real reasons for poor SMME funding, and attempt to put small businesses and funders together.

Paul Smith, CEO of small business research consultancy Igniter, points out that the report was defined in the context in high unemployment and the potential ability of SMMEs to create jobs – they are expected to create 90% of new jobs in South Africa.

“It’s a global problem,” he adds. “It is agreed that the smaller a business is, the harder it is to get revenue. Banks struggle to service SMMEs; and there are high costs for both funders and the SMMEs themselves.”

Some of the global solutions include banking solutions that have been documented in some markets; credit guarantee schemes; and digital technologies and fintechs that are reducing financing costs.

SMME finance is seen as a growing opportunity and structures are being put in place in many markets to make it more attractive.

In South Africa, SMMEs are struggling to access finance, and SMME lending is still low. There is also a lack of SMME lending data, while government guaranteed schemes are still a very small part of the SMME lending arena.

Local SMMEs, especially at a micro level, often don’t have formal loans. Financing would tend to be from friends and family, or bonds on houses.

“There are a number of obstacles to finance that have been identified,” Smith adds. “And there is a research gap.”

On the funding side, it was found that a highly concentrated banking sector negatively impacts SMME access to finance, and banks face obstacles to lending.

Meanwhile, informal lending is underdeveloped and even declining in the South African environment.

One the one hand, traditional credit scoring models and poor business credit data are hampering finance, although venture capital is growing and fintechs are starting to offer new and innovative funding models.

A major issue that the report tackled is around the large credit gap in the South African context: SMMEs are seeking between R86-billion and R346-billion in finance that they are unable to access, with micro and early stage businesses particularly hard-hit.

Currently, most of the 148 lenders in the report are using traditional credit scoring models that require collateral, and other measures that are resulting in many profitable small businesses not being able to access finance.

Financial institutions relying on traditional credit reports to make credit decisions have had limited to no visibility on the new credit usage behaviour of SMMEs from alternative data sources. Banks struggle to serve SMMEs as they treat business as a single market and, as such, apply traditional lending methods that use collateral and traditional financing scorecards as a one-size-fits-all approach. This approach is detrimental to SMMEs trying to access finance.

The report recommends augmenting the traditional credit risk models with the development of accurate new predictive models of credit assessment using new sources of data/alternative data. Alternative data refers to the inclusion of non-financial payment reporting data in credit files, such as telecommunication and energy utility payments, average salaries paid per month to employees, litigation and compliance defaults, and social media ratings, amongst others.

Innovative approaches are required to solve the access to finance gap in South Africa. Using new credit scoring models and digital channels that will enable lower distribution costs and lower funding risk for funders will enable a greater number of SMMEs to access finance.

The report states that around the world “800+ digital SMME lenders are developing a wide variety of business models that are able to successfully lend to SMMEs at scale, using new sources of data, channels and credit models”.

High-level findings from the report include:

* The potential of the SMME market for funders is significant, and the credit gap is estimated to be between R86-billion to R346-billion.

* Startups and micro businesses are the most underserved in the formal business market, and represent the largest funding gap.

* 44% of the SMMEs who requested funding were for amounts less than R250 000.

* The top four reasons SMMEs requested funding in 2017 was startup capital, buying equipment, expanding businesses and working capital. Together they make up 62,4% of the total SMME funding requests.

* SMMEs have poor knowledge of their business’ credit record, with 61% not knowing their businesses credit score, yet this remains the standard way that funders access their credit worthiness. There is a need for alternative credit scoring and risk assessment models.

* Low human capital and a lack of skills are a barrier to accessing finance. Finance readiness is a challenge for SMMEs (i.e. not having financial statements and the other documentation required by funders to qualify for finance).

* 86% of the funding requested on the Finfind platform was from micro businesses.

* Medium size businesses represent 3% of the formal SMME sector but employ 39% of the employees.

* The Finfind platform received R40,9-billion in funding requests in 2017.

* The median size of funding requested by an SMME is R400 000.

* The median size funding request from a micro business is R300 000, for a very small business it is R500 000, for a small business it is R1-million and for a medium size business it is R3,6-million.

* 73% of the loan amounts requested were for R1-million or less.

* 29% of the requests were for funding between R250 000 and R1-million.

* The most common SMME funding product offer is a long-term loan.

* The manufacturing sector has the most industry-specific funding products (43), followed by ICT/technology and agro-processing.

* SMME lending has remained flat since 2008, but lending to large businesses has increased.

* 66% of the funding products are products offered by the private sector, and the remaining 34% are government products.

* 68% of the businesses that requested funding were owned by males, and 32% were owned by females.

* 66% of the businesses were black-owned, 19% were white, 10% were coloured and 5% were Indian.

* 21% of the businesses were owned by black women, and accounted for 66% of the total businesses owned by women.

The report analysed a data set, provided by Finfind, of SMME funders and SMMEs seeking finance. It was sponsored by the SA SME Fund and identifies access to finances challenges, gaps and potential solutions. The Finfind 2017 cleaned data sample of 11 033 SMME funding requests is larger than the South African GEM report and is one of the most comprehensive studies on access to finance in the SMME sector in this country.

“The SA SME Fund has sponsored the research study to help provide an additional fact base on the availability, or lack of credit and debt financing for SMMEs. Whilst the SA SME Fund’s focus is primarily on equity investments, we recognise that multiple funding options are required for the needs of SMMEs at different growth stages. This report will augment our understanding of these needs,” comments Lisa Klein, Interim CEO of the SA SME Fund.