Monday, 23 May 2016

Entrepreneur Fund: has potential, could do better

President Zuma made much of his May 9th announcement of a new fund to finance entrepreneurs. It’s the first tangible deliverable of the collaboration government and business promised after their emergency meeting convened in February, prompted by the fallout from Nenegate.

The DA’s 2014 election manifesto called for the formation of a National Venture Capital Fund. How does this new fund stack up?

Zuma and Finance Minister Pravin Gordhan, and business at large, are relieved South Africa has so far avoided the dreaded ratings downgrade. The announcement came just three days after Moody’s retention of its investment grade rating for the country, seemingly emphasising government and business in partnership are serious about supporting small businesses and the important role they play in creating jobs and stimulating growth. 
The entrepreneur fund task team established at the February meeting, headed by Discovery’s Adrian Gore and Bidvest’s Brian Joffe, consulted the banking, fund management and SME support sectors (but surprisingly, not the venture capital or private equity sectors) before recommending how the fund should be constituted and managed. The government is tight-lipped and very little detail has emerged yet, but indications are they intend getting it off the ground as early as July.

Business and government have gone down this road before, with the establishment of the Small Business Development Corporation in 1981. Though the political environment was very different than today's its purpose was to provide support – both financial and non-financial – for the small business sector, including black-owned businesses, which were long marginalised in South Africa’s highly concentrated and racialised economy.

The SBDC operated successfully and was largely private-sector run, with little government interference, until it was unbundled by the 1995 National Small Business Act. Renamed Business Partners and with government’s stake reduced to 25%, at its 35th anniversary last year it reported 70 000 investments totalling R16,1 billion creating 600 000 job opportunities.

Business Partners’ success can be ascribed to its conservative asset-backed funding strategy and blending of financial with non-financial support, particularly mentorship. This has kept net loan impairments to a laudable 1,7% and its cost to income ratio to 34%, as reported in its 2016 annual results.

The 1995 Act also spun off what is now the Small Enterprise Finance Agency, reporting to the Department of Small Business Development, which has a very different track record. Sefa recently reported to Parliament that its direct loans book showed a 58% default rate, meaning it cannot collect on more than half of the loans it gives out. Its cost-to-income ratio is 150%, that is, for every rand it receives in interest and investment income, it pays out R1,50 in costs. It survives on annual government bail-outs. The comparison with Business Partners is stark.

Sefa aims to wean itself off bail-outs by 2019. Yet it is under pressure from some quarters, particularly the ANC, to devote more of its capital resources to the under-funded micro and informal sectors where the clamour for funding is greatest. Trouble is, the risks are higher too, meaning Sefa, and its micro financing intermediaries, have to charge higher interest rates to recoup their losses.

At the heart of the conundrum of avoiding losses while addressing the financing needs of an under-serviced sector is establishing a clear mandate. Sefa defines itself as a development finance institution, but does this mean it should be self-funding or should it take more risks and be prepared to treat more of its funding as grants, which non-paying loans end up becoming?

The new entrepreneur fund faces the same dilemma in defining its mandate. Its goal is to identify, fund and support – through a “Peace Corps” of mentors – high-growth potential businesses which can become drivers of job creation. It will not lend directly, but be a wholesale lender to specialist SME fund managers including the likes of Edge Growth, Awethu Project and Anglo-Zimele.

SME fund managers are notoriously cagey about revealing their performance both in terms of financial returns and impact. A research project conducted by NGO Catalysts for Growth is expected to report in July on some of the factors determining high vs low impact and no doubt the new fund managers will be looking for insights from this research.

The task team aims to have business commit R1,6 billion by the launch-date, matched 1:1 by government. Minister Gordhan has not said where his fiscally-constrained government’s contribution is coming from.

There is no clarity on the fund’s governance structures and to what extent its board will have government representation. The Department of Small Business Development wants government to have a strong say over its mandate but the task team is reportedly pushing back on that demand, fearing this will distort its sole aim of supporting fundable businesses.

This highlights a conundrum in the small business ecosystem - the lack of an active market in funding start-up and early-stage businesses. Entrepreneurs claim they can’t find funding, funders bemoan the lack of fundable businesses. If one accepts this as true, it begs deeper questions of why the economy is failing to produce more viable new businesses and how to incentivise a dynamic corps of angel investors.  

The DA has made it clear to the entrepreneur task team that throwing more money and mentors at the SME sector will not have the catalytic impact needed to stimulate economic growth and job creation.  

For this to happen more fundamental interventions are required, aimed at reducing the regulatory overload, eliminating red tape and labour market reform to encourage hiring of new workers. We hear Minister Gordhan is addressing these constraints, but if real and specific measures are not announced soon government will be rightly accused of window-dressing. The DA has already gazetted a Red Tape Impact Assessment Bill which will be tabled in Parliament in August.

Greater emphasis also needs to be placed on education and skills development, and placing higher value and status on entrepreneurship as a career choice. 

The other side of the bargain must come from business. Barriers to entering the mainstream economy for small firms are still immense. To overcome this, the fund must link access to finance with accessing new markets, specifically by strengthening supply chain linkages between big and small businesses. 

This will be more effective than B-BBEE driven enterprise and supplier development programmes, which have suffered from a tick-box mentality and over-emphasise suppliers such as cleaning services, catering and stationery. Many programmes have a distinctly charitable or CSI flavour to them, suggesting they are non-core and low on CEOs’ priority lists.

Big business should understand that supplier development, oiled by the new fund, can be turned on its head and seen not as SME support per se, but an exercise in improving their own competitiveness first and foremost. Small firms tend to be more innovative, nimble and cost-conscious, factors which can only benefit their larger customers if they work collaboratively.

This approach can also work well to improve the cost-effectiveness of government procurement. The fund should support businesses which can improve service delivery and reduce costs through innovative solutions but must avoid favouring government cronies at all costs.

Judiciously managed, it can reconcile the dilemma of balancing the need for cost competiveness with bringing more new black-owned businesses into supply chains, thus dealing with government’s goal of obtaining 30% procurement from black suppliers.

The Treasury is expected to announce amendments to the Public Finance Management Act soon, providing much needed clarity to this issue.

Another question hanging in the air is how the new fund will play a part in financing the National Gazelles, high-growth early-stage businesses identified through the Department of Small Business Development, and the Black Industrialists Programme promoted by the DTI. If its board has significant government representation, expect pressure to be brought to bear in this direction.

Put plainly, the new fund is the first initiative by business and government in 35 years to have a potentially meaningful impact on economic transformation by recognising the crucial role of small and medium enterprises in the economy.

To avoid mandate overlap, an option that should be considered is re-focusing Sefa on the informal and survivalist segment, thus fulfilling its developmental mandate, while directing the new fund towards more financially viable, high-growth businesses, including start-ups.

Whatever its focus, the fund must not be a confusion of charitable intentions mixed with bureaucratic box-ticking. The fund sponsors must see supporting dynamic entrepreneurs as the nation’s most compelling path to reinvigorating the economy with fresh ideas and irrepressible drive. Given today’s global environment, the emphasis must be on competitiveness, not compliance or charity.

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