What financiers do when funding an SME, and what they can do better
The micro, small and medium enterprises
(MSMEs) are the backbone of economic development in any country and more so in
India as we have a huge population to be served. They are the incubators for
talent, innovation and entrepreneurial spirit, which is key to a country's
development.
The Indian
small & medium enterprises (SMEs) sector is considered as the backbone of
the economy, contributing 45 per cent of the industrial output, 40 per cent of
the country's total exports, employing 60 million people, creating 1.3 million
jobs every year and producing more than 8,000 quality products for the domestic
and international markets.
With
approximately 30 million SMEs in India, around 12 million people are expected
to join the workforce in the next 3 years with the sector growing at a rate of
8 per cent a year. Efficiently organized and innovative, MSMEs often exercise
frugal management skills and use local resources to create innovative products
and services which cater to any country's growing needs. However, in order to
continue scaling up, timely and adequate access to financial services is an
imperative, and this has been traditionally one of the biggest hurdles.
Funding Gap in MSMEs
For SMEs,
obtaining and securing the right source of finance is a major challenge. Lack
of available funding for SMEs has been brought into sharper focus post-credit
crunch.
The total
gap in MSME funding is estimated to be around $126 billion. Out of this, the
debt gap is approximately $84 billion and equity gap is about $42 billion,
while the total equity supply is only around $526 million. Many growth
businesses are started by entrepreneurs, often with little experience of how to
raise finance to fund his/her growth.
The major
reasons for creation of this gap are information asymmetry which exists in
Indian SMEs, the family-owned nature of Indian businesses, and lack of
information regarding tapping the right kind and source of finance.
Funding Structure
Traditionally,
private funds from friends and family form the single largest source of finance
to MSMEs in India. MSMEs in India also rely heavily on private money lenders
and the unorganized financial sector for their requirements, where the terms of
financing are unclear and interest rates are high.
Banks have
been making steady strides in order to bridge this gap. However, the approach
followed by banks to funding is very restrictive as the bank has to create
value by controlling and managing risk.
In any loan
application for a business, a bank has to necessarily evaluate the risks
involved, gauge collateral support and the methods to mitigate those risks.
Therefore, it is not always possible for an entrepreneur to satisfy all
requirements and conditions which the bank might pose. The above methods of
financing are majorly debt financing, and sources of equity funding remain
elusive in India.
Government Initiatives in MSME Funding
The
government has always been cognizant of the funding gap which plagues Indian
SMEs. In the 2012-13 Budget, the government announced an India Opportunity Fund
of $878 million to support Indian SMEs. This entire amount will be routed to
SIDBI and is divided into specific targeted sectors, which include:
Domestic
MSMEs >> Internationalization of SMEs >> Sector Specific Funds
-ICE, Traditional Sectors, Defense, Infrastructure >> IPO on SME
Exchanges
Such
initiatives would go a long way in bridging the financing gap and ensuring that
India gets a steady flow of entrepreneurs in various fields.
Some simple guidelines to funding SMEs
It is
imperative for the financing company to understand the needs of the MSMEs and
the capability of them to repay the loans they take.
>>
Very rarely does the intention issue come up with the MSMEs. They are the first
generation entrepreneurs from each of their families and do not leave any stone
unturned to make their venture a success.
>>
MSMEs do not have the wherewithal or the money to develop much needed finance
team within their organization and end up hiring on a part time basis a small
time chartered accountant to look into their accounts. While this suffices
their need, however, when it comes to borrowing from large financial
institutions, NBFCs or private equity investors fall short of creating the
necessary documentation. For a financing company this can perhaps be overcome
by watching the SME at work in their offices or unit, gauging if their
operations are genuine and then helping them raise their financial reporting
standards.
>>
Asking key questions and judging the mentality/attitude of the MSMEs and the
passion will tell more than looking for non-existent financial documents. A
lifestyle of MSE promoter/partners/teams tells a lot about their future.
>>
These micro and small enterprises serve much larger enterprises in their
processes through job works / parts manufacturing, process outsourcing, supply
chain etc. Strength of the principle plays a vital role. For example, a micro
enterprise that manufacturers nuts and bolts for Maruti Suzuki largely draws
its past, present and future performance from the performance of Maruti Suzuki
as a company. During the boom phase, almost all of the suppliers/small time
manufacturers of parts grew at a rapid pace and expanded. Some even ventured to
cater to different industries rather than be defined by auto industry.
>>
Another key aspect which almost every financier observes these days is their
performance on loans/lines taken in the past. Key to this is Credit Information
Bureau of India Ltd (CIBIL). A lot of information is derived out of the CIBIL
report and plays a key role in assessing future performance on loans given to
MSEs.
>>
With specific mention to the micro enterprises, there exists one other key
issue which is the way they operate. For example, businesses typically run by a
family with father as the proprietor and children being inducted into business
subsequently. Presence of business / legal existence proof also comes up as a
hindrance. In some cases, simple rules like submitting your Know Your Customer
(KYC) form requiring at least two proofs are not met as these customers fall
short as they usually hold only IT returns. We do need to understand these
aspects and help in generating another proof. A simple way could be assisting
in installation of a landline at customer's office whose bill would suffice as
a second proof.
It goes a
long way in understanding these customers and the challenges they face to able
to fund them with right products at the right time and help them grow. Be with
them on the ground and see what they see, it is that very easy to assist them.
After all they are the priority sector, and we carry the responsibility to
bring in the financial inclusion.
(The author is Vice President and Portfolio
Head, SME & Retail Lending, Capri Global Capital Ltd).
