The growth in alternative funding models for small and medium enterprises (SMEs) may be attributed to the structural misalignment between small businesses and traditional lenders such as banks.
Around 80% of the funding needs of SMEs are not met by banks, mainly because they do not have the structural capacity, says Kumaran Padayachee, CEO of Spartan, a financing company for small companies.
He says there has been growth in alternative funders in certain emerging and developed markets, certainly in the US, UK and Europe.
More than 100 options locally
South Africa has more than 100 alternative funders, although they are not all well-known because some are niche and specialised.
Development funding bodies such as the Small Enterprise Agency, the Industrial Development Corporation and the National Empowerment Fund are better known, but also pose unique challenges to small businesses.
Crowdfunding has not been that successful, even globally, and is now called ‘market place’ since there aren’t enough individuals buying into the concept and the model has shifted towards institutional investors.
There is an increase in financial technology (fintech) based solutions, however it seems South Africa is not as fintech-driven as the rest of the world. Padayachee says we are behind countries in East Africa, Asia and even Latin America.
He refers to Alibaba in China, the largest online commerce company. Customers are able to apply for a loan in three seconds and it is approved in one second.
The company has around 200 million active customers (they have many more customers, but 200 million are active). Since Alibaba has all their information, it is able to use programming algorithms for fast approval.
“It is not a fair comparison with South Africa, but it gives an example of how people are thinking differently about using technology,” says Padayachee.
Jenny Retief, CEO of Riversands Incubation Hub, says a basic requirement for any small business that is not always present is proper costing and pricing models.
She says in many instances companies require little external funding. The key is to manage their supplier side relationships and to negotiate supplier terms that are in line with customer payment terms.
“Most external funding comes at a price, either through interest costs or some other strings attached. Alternative funding models are increasingly contract or deal specific. It is almost like taking equity in the deal or project as opposed to taking equity in the business.”
In her experience these models are most relevant when the entrepreneur has exhausted their traditional bank finance possibilities.
“You might just have run out of road on being able to get mainstream finance even though your credentials, your deal and your abilities are still sound.”
Funding plus expertise
They may be at a higher price than bank funding, but can be a plus when they come with some expertise. The funder may, for example, review the client contract and advise you on terms you should have in the contract to avoid being hurt. “These funders are trying to fill what is often called the missing middle.”
Padayachee says SMEs need to take accountability. They need to do proper research on the mandate and requirement of funders. In many instances this is not done and their applications are rejected. They then tend to shift the blame.
“A big problem that we have found is that SMEs do not have the basics around their financial accounts timeously ready,” he says.
“You have to be in a state of readiness all the time because as you grow you are going to need funding more often.”
He empathises with SMEs who do not always have the executive capacity to plan forward. However, if they never do a one- or two-year projection they do not have the foresight to be proactive around sourcing their funding.
They either do not comply with the requirements or they apply at the last minute and are forced to accept less favourable terms, says Padayachee.
In the agricultural sector one of the biggest stumbling blocks is land ownership. Commercial banks remain the primary source of funding, with R97 billion of the current R158 billion of farming debt sitting with them, according to figures provided at a recent FNB pre-harvest information session.
Jannie de Villiers, CEO of Grain SA, says small farmers planted only 30% of their available hectares last season because they cannot find the financing to do the rest.
Dawie Maree, head of agriculture information and marketing at FNB South Africa, says offering loans to farmers who do not hold the title deeds remains a major risk.
FNB is in the process of establishing a fund with its own resources as well as development funds from the international community to assist farmers without security.
“As the financial sector we need to ensure that everybody gets financing at a reasonable rate that allows them to be profitable. We need to refigure our financial models,” says Maree.
This include developing more complex credit structures to have blended finance to help with access to markets, skills and funding.
Blending finance is broadly seen as the combination of official development assistance with private or public resources, generally with the aim of leveraging development finance from other players.