Sefa forced to review its business model after sustaining heavy losses

The Small Enterprise Finance Agency, Sefa, presented its annual report to Parliament on Wednesday. CEO Thakhani Makhuvha hit the nail on the head when he said “cash is king” in business.

He was referring to his cash-hungry clients, thousands of small and micro businesses for whom a cash injection from Sefa is often the only thing that keeps them going. But he could have been referring to his own organisation, which is bleeding cash at an alarming rate.

In the year ending March 2016, Sefa disbursed R1,2 billion to SMEs and cooperatives, but wrote off R380 million on loan impairments and bad debt provisions. 67% of its direct loans are impaired – meaning two thirds of the money it lends to its clients will not be paid back. This compares to its target of 39%.

Whether on the measure of its budgeted or actual impairment provisions, Sefa’s business is unsustainable and Makhuvha admitted as much when I questioned him on the matter in Committee.

Sefa received R204 million from the Economic Competitiveness Support Package, ECSP, and R202 million from Treasury’s Medium Term Expenditure Framework. The ECSP was introduced in Finance Minister Pravin Gordhan’s 2012 budget as a set of measures to stimulate the economy, amounting to R9,5 billion over three years. This source has now dried up.

In the year reported, Sefa made a loss of R378 million and has cash reserves of R551 million. It has a draw-down facility of R920 million from the IDC which it can call on. But at its current cash burn rate Sefa will be forced to cease operations in three or four years.

Faced with such a prospect, the executive has initiated some drastic measures, cutting expenditure and reducing its exposure to direct lending. Its cost-to-income ratio has been brought down to 130% from its budgeted 157%. Though a good start, this compares to ratios of around 60% achieved by SA’s main commercial banks.

Sefa has imposed a head count freeze with only cost of living increases allowed, pushed out its planned expansion of outlets and invested in its property portfolio in preparation for selling it off to generate more cash.

Most significantly, it has cut is direct lending in half. In 2015/16, Sefa received 7,356 funding enquiries, 635 completed applications and approved 302 of them. These are mainly start-ups or early stage businesses for which Sefa is their only hope of receiving funding.

With little or no track record, no equity to trade or assets to put up as security, commercial banks won’t touch them. They have not tapped into SA’s angel or venture capital markets, probably because they don’t know they exist. Their prospective customers do not offer preferential payment terms. So cash flow is their biggest problem, followed by an inability to fund capital investment. This is where Sefa steps in.

Sefa entered the direct lending market in 2013 and disbursed R41 million. By 2015 this had shot up to R446 million, a ten-fold increase. The organisation was not prepared for such an expansion and its lending criteria were too lax, leading to these catastrophic losses.

When Sefa first presented to the Portfolio Committee two years ago it was very proud of its impressive disbursement growth. But pride comes before a fall and now there are signs of humility and realism creeping in.

There is a laser-like focus on both selection and collection, to improve the quality of businesses funded and the likelihood of their repaying the loans.

On the selection front, Sefa is working with the National Gazelles Programme managed by its sibling the Small Enterprise Development Agency, Seda, which has identified 40 high-growth potential SMEs which are likely to be better funding prospects than the norm. It has enlisted the support of Business Partners, active in this field for over 30 years, to train its investment officers, is tightening credit criteria and drawing on improved credit bureau and scorecard data.

On collections, it has a dedicated unit that builds one-on-one relationships with clients, restructures loans if they become too burdensome to repay, calls on professional collections and legal services and if necessary forces clients into liquidation as first creditor.

One of the most contentious issues is the cession of client debtors’ books to Sefa. Sefa is working with the Department of Small Business Development to try and persuade Treasury to issue a practice note allowing this. It will mean Sefa will not have to rely on its clients’ goodwill and honesty to get its money back.

Sefa is not the only organisation going this route. Many of SA’s factoring houses, which lend money to companies who cede their debtors in return, could reduce their charges if they could enter three-way contracts which include them alongside their client’s customers. This would enable Sefa and the factoring houses to get first call on money due, which would be paid directly to them so bypassing their clients.

Sefa is a relatively small player in the small business finance arena but has big ambitions as a development finance institution. CEO Makhuvha pleaded with the Committee to heed his call for more funding but I expressed the strong view that until Sefa could prove broad beneficial economic impact of its lending activities I could not support any more taxpayers’ money going its way. 

With the prospect of further cuts in Minister Gordhan's medium term financial statement in two weeks time, Sefa could even find its cash window closing sooner.

I urged the Sefa Executive to adopt a “joined-up” approach which looks at the totality of the small business ecosystem before settling on a business model that is sustainable. It has learned some hard lessons from rushing into this market too fast. If it’s serious about having long-term impact it must go beyond simply seeing itself as a lender of last resort to SMEs at the end of the funding queue.