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Unlocking economic growth through SME financing

11 Nov 2016

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It is undeniable that South Africa remains characterised by a high unemployment rate. Since 1994 South Africa’s unemployment rate has remained around a stubbornly high 25%. Latest available data from Statistics SA notes that the unemployment rate at the end of the third quarter of 2017 is 27.7% (Q3 2016: 26.6%.)

Updated: 1 December 2017

To put the scale of South Africa’s unemployment rate into context, the approximately 6.21 million (Q3 2016: 5.6 million) unemployed individuals exceeds the combined population of three SADC countries being Namibia, Lesotho and Swaziland. It’s clear that unemployment together with poverty and inequality has been, and remains, one of South Africa’s key development challenges. The high unemployment rate is exacerbated by a declining labour absorption rate (the percentage of the employed working-age population) and does not bode well for an economy operating in a low growth environment.

Government has recognised the challenge, and through the National Development Plan 2030 (NDP), has set ambitious targets in terms of reducing the unemployment rate. According to the NDP the employment rate is envisaged to decrease to 14% by 2020 and 6% by 2030.

In the context of economic growth, economists, governments and policy makers remain optimistic regarding the role that Small Medium Enterprises (SMEs) can play as levers for economic development in developing economies such as South Africa. Research undertaken in this respect highlights the fact that generally, an active SME sector creates opportunities resulting in higher volumes of production, employment, entrepreneurial talents and increases in export of goods. Furthermore, it is noted that, in addition to being a lever for increasing economic growth, SMEs can eventually grow into larger firms that are able to contribute to increased employment opportunities as they evolve through the business cycle.  In South Africa, the SME sector is estimated to contribute between 35%-45% and 50%-60% toward Gross Domestic Product and the labour force respectively, according to research undertaken by Global Entrepreneurship Monitor and The Banking Association of South Africa over the last two years; this highlighting the importance of SMEs to the South African economy.

Access to finance and economic growth

Recent research pointed to the strong evidence of a relationship between financial development and economic growth.  The evidence suggests that if SMEs have easy access to financial services which includes access to finance, it helps to improve their operational capacity and efficiency thereby increasing their levels of income generation. Increased levels of SME earnings equally help to reduce poverty and income inequality as they are able to increase the number of people they are able to employ and within that, upskill promising staff.  Through the availability of financial services, SMEs’ capacities are enhanced for employment creation and income expansion leading to economic growth. In addition to employment creation, SMEs compared to large corporations are able to adjust quickly to changing market conditions during adverse economic periods. This attribute enables SMEs to contribute to the growth of the overall economy through employment and income generation even in times of an economic downturn. 

Furthermore, these SMEs through their activities ensure income stability and growth at the individual and national levels.  Empirical studies have contributed to establishing the positive impact that access to finance has on SMEs and their contribution to the overall economic growth of a country.  From the perspective of output, SMEs contribute to a nation’s national output (product) through the manufacturing of goods and the provision of services to both individual consumers and enterprises.  Apart from the local market, the goods and services generated by SMEs also benefit foreign consumers through exports.  In effect, the country benefits from the activities of SMEs through the provision of goods and services and the generation of incomes, and innovation.

SMEs are largely thought to be more innovative than larger firms for three reasons: a lack of entrenched bureaucracy, more competitive markets, and stronger incentives (such as personal rewards). Small businesses are indeed crucial innovators in today’s economy and are the technological leaders of many industries. A prime example of a SME which, through innovation, has added value from an economic development perspective is Uber, which grew from three vehicles operating in New York in 2008 to having more than 150 000 drivers on its platform operating in more than 250 cities globally as at September 2017. On the demand side, SMEs consume a variety of goods and services, which stimulates increased economic activity in various sectors of the economy.  For their suppliers, SMEs’ demand for these goods and services creates income-generating potential – for these enterprises and for the country at large.

Challenges faced by SMEs

Notwithstanding the major contribution of SMEs to economic development, these enterprises face numerous internal as well as external challenges impeding their ability to contribute toward the country’s economic growth and employment levels.  Despite government’s commitment to growing and supporting the country’s SMEs, these firms continue to face an extremely hostile business environment, including lack of skilled staff, burdensome regulations, tough local economic conditions, lack of finance and the high costs associated with employing staff by virtue of minimum wage requirements, labour brokers, and lost productivity due to strikes.  Additionally, the literature around this issue identifies numerous other challenges faced by South African SMEs; these include a weak entrepreneurial culture and poor management skills, among others, which ultimately results in high rates of business failures. Results from the 2016 National Small Business Survey, in which close to 18,000 small businesses throughout South Africa were canvassed, found that around 75% (2016: 60%) of small businesses younger than five years cited lack of funding and insufficient cash flow as the biggest obstacle preventing growth. One of the key challenges faced by SMEs, and an issue widely identified as a challenge not only locally but globally, relates to the ability of these businesses to access finance.

Futuregrowth is cognizant of the importance the SME sector can play in terms of stimulating economic growth and employment creation; and bearing this in mind have invested in various entities that focus on providing access to finance to SMEs. An example of a funding platform into which we have made an investment is SA Taxi, a niche development finance institution focused on providing funding to independent taxi operators. SA Taxi facilitates financial inclusion in that it services individuals who are largely underserved by traditional credit providers and it thus fills a critical funding gap, providing credit to entrepreneurs who would otherwise be excluded from the formal economy.

Furthermore, from a SME empowerment perspective SA Taxi has since inception facilitated the creation of over 420 000 black-owned SMEs through providing access to financing an income generating asset, a taxi. Many entrepreneurs have used funding provided by SA Taxi as a stepping stone for starting other businesses by using the profits earned by operating taxis. One such example is *Mr Sipho Dlamini from Johannesburg who has grown his minibus taxi business to five vehicles. Mr Dlamini diversified his business interests through taking a stake in a construction company which develops low cost houses, as well as a Coca Cola vending franchise. This example, being one of many, highlights the importance of SME funding to stimulate employment creation through combining access to finance with entrepreneurial flair and passion. In addition to providing access to finance to SME owners, many funders also provide forms of mentoring to their borrowers. Business Partners, another of Futuregrowth’s investee companies, for example, provides mentoring for up and coming entrepreneurs where funding is extended to the SME. To date Business Partners has over 300 SME mentors across South Africa available to support SME owners with industry specific knowledge sharing and specialised assistance where required.

Conclusion

The research on the positive impact of a vibrant SME sector from an economic growth and employment perspective is noted. However, the provision of finance to SMEs continues to be a challenge inhibiting the growth of SMEs and ultimately limiting the positive impact these entities can have on the economy. Given the importance of a well-functioning SME sector to the South African economy, Futuregrowth has taken an active role in facilitating access to finance to SMEs.  Futuregrowth has over the last decade made available equity and/or wholesale funding lines to development finance institutions specifically geared toward providing finance to SMEs. Through providing finance to other development finance institutions we have indirectly contributed to the sustainability of the sector and facilitated job creation and positive economic growth.

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SMEs / SME financing