Equity or debt funding: Which works better for SA’s SME sector?
JOHANNESBURG – South Africa’s small and medium enterprises (SME) sector is in dire need of new funding models to unlock growth in the sector, with traditional lenders and development finance institutions (DFIs) struggling to address the challenges of this complex and burgeoning market.
That’s the warning from Kumaran Padayachee, the chief executive of SME finance specialist Spartan, who says the equity-based approach favoured by major stakeholders and DFIs is based on ‘ivory tower models’ that don’t meet the funding needs of local SMEs.
“Equity is often seen as the ‘holy grail’ of funding in South Africa, but the reality is that it’s only appropriate for a tiny number of companies, and doesn’t take into account the broad continuum of needs of small businesses,” said Padayachee.
“Most of the small businesses we engage with are in the services business, and tend to need financing for a specific purpose at a point in time – like capital equipment to be able to service a contract, or bridging finance to smooth cash flow between projects. They need working capital, not a shareholder for life,” he said.
Padayachee says the equity funding approach is based on models created for bigger corporates, and as such, tends to rule out everyone except those at the top of the pyramid. While debt financing is generally the better option for small businesses, it’s often difficult for SMEs to get debt-based financing from traditional lenders without collateral.
The answer lies in creating funding models that are fit for purpose and meet the continuum of funding needs for South African SMEs. Currently, banks and DFIs have significant funds available, and the best of intentions, but their inability to empathise with the SME sector means their intentions simply don’t translate into results.
“There’s a huge opportunity for innovative funders to develop new lending models and risk assessment tools that talk directly to the needs of the SME sector. To do this, they need to understand the life cycles of SMEs in different industries, and be able to assess and turn around applications quickly,” said Padayachee.
“Our approach is to establish the needs of the SME, interview the entrepreneur, and then structure a debt-based funding package around their specific needs that doesn’t involve mortgaging their house or handing over control of a part of their business.”
Padayachee says Spartan’s track record in the SME sector is starting to attract the attention of DFIs, who are keen to forge partnerships to ensure more effective delivery of funding to the market. The company has provided funding to more than 5,000 SMEs to date.
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