Finding finance for South African Small Business - Part 2

In this, part two of the article published by the Personal Finance website recently, Margarete King looks further at the options for finance when starting a small business in South Africa with a number of added case studies in support:

How small businesses bank
The research released last year by FinMark and Gauteng Enterprise Propeller (GEP) reflects the large range in sophistication among small businesses. Many of these are informal street vendors eking out a living from day to day, but "180 000 are likely to be engines of growth and employment creation", according to FinMark’s report on its findings.

Because of this stratification, the researchers devised the Business Sophistication Measures, ranging from BSM 1, which is characterised by younger, informal vendors living below the poverty line, to BSM 7, which reflects the most sophisticated segment of small business.

The main users of banking products designed for small businesses are BSMs 6 and 7. The less sophisticated the business, the more the owner relies on his or her personal banking account as the sole channel.

The data for the table below come from the FinMark Trust-GEP research, the findings of which are available on www.finmarktrust.org.za

How is a 'small business' defined?
In this article, the words "small business" are used in a loose way to refer to small companies and micro enterprises. In South African law, the exact definition of "small business" varies according to the legislation making the definition.

The National Small Business Act as amended in 2003 defines a business that has fewer than five employees and turnover of less than R200 000 as a micro enterprise. Very small enterprises are those with fewer than 10 paid employees and whose turnovers range from R500 000 (for enterprises in the agricultural sector) to R6 million for those in the wholesale trade sector.

A small business has fewer than 100 employees. Annual turnover as a defining quality ranges from less than R3 million (agriculture) to less than R32 million (wholesale trade). An enterprise in the transport, storage and communications sector is classified a small business if its turnover is less than R13 million a year, while the maximums for some other sectors are R6 million for construction, R19 million for the retail and motor trade, and R13 million for manufacturing.

In the second-quarter edition of Personal Finance magazine, Deborah Tickle writes in "Getting by with a little help from the taxman" that the income tax legislation defines as a small business one that has gross income of less than R14 million a year (plus other qualifications). For the tax amnesty that ended in June this year, the limit was turnover of R10 million.

Profile: Kate Carlyle
Mustardseed and Moonshine
Makes crockery
Employs: 35 people
Business established: 1992

"As much as banks say they are there for small business, they aren’t. Twenty years ago, they definitely weren’t. To get an overdraft was like trying to find hens’ teeth. I was told I was a risk and was doing something banks didn’t understand. To give them their dues, I didn’t know anything about business. My learning has been very organic – I learnt by experience."

Kate Carlyle’s workshop staff handmake teases, salad bowls, ramekins and other earthenware, with the designs inspired by flowers. The result is an extravagance of colour and shapes that might just baffle a desk-bound, numbers-focused bank manager. Even the name, Mustardseed and Moonshine, is, as Carlyle puts it, "whimsical". (It comes from Shakespeare’s A Midsummer Night’s Dream.)

Trying to borrow money is frustrating and insulting, she says. "Banks – when they say they need security for a loan, they don’t understand that most people have already put every penny into the business before they ask for money." Later she returns to the topic: "You are treated as though you are going to be a criminal – and you feel guilty, like when you see a traffic cop in the rear-view mirror even though you aren’t doing anything wrong."

Carlyle tells how, in the years when her business was new, she made her bank manager visit her studio. She showed him what she does, and introduced her staff and said: "These are the people who are important to me. This is who the banks should see as my ‘security’."

Carlyle says the biggest lesson she has learnt about financial institutions is that a small business owner needs to find someone in the branch to establish a relationship with. She says 10 or 15 years ago the relationship would be with the bank manager, who had the power to make decisions about loans and credit lines.

"Now it all goes through the Great Credit Granter in the Sky," she says. "Now you are doing third-party relationshipping. You hope the relationship manager has a great relationship with the finance loan person and the Credit Granter in the Sky and the buying-a-business-property people. These are the people who have to put your case forward, because your small business banker doesn’t have the power."

Banks are trying to serve their clients, she believes, pointing to the networking and educational forums her bank organises. She does learn from these forums, but is not picking up business from the networking. "But I go because I believe there is something I can offer or be offered."

Carlyle’s evolution from absolute novice to successful business owner has not included using the educational material available on banking websites. With a characteristic broad gesture she dismisses this, along with the mass communications she receives from her bank of special offers and new products, as "gumph". Other words include "boring and gimmicky".

What is not gimmicky is electronic banking: "I am a big internet banker – I can’t fault my bank on that." She values its efficiency and says that although she doesn’t know exactly what her banking costs are overall, she knows internet banking is cheaper than cheques and most of her clients prefer internet transfers. She has no cash business, so she does not incur the high costs of cash transactions.

She feels small business owners do not want one-size-fits-all banking packages, and are not properly advised about what is available. "They want to know, where are the hidden costs? What is it going to cost me? And they want to know what is really important for their business."

Profile: Philip Grütter
Indola
Creates cycling apparel
Employs: about eight people
Business established: 1998

Indola’s mountain bike and adventure racing wear is sleek, modern and intended for speed – quite a lot like how its creator, Philip Grütter, likes his banking.

The financing for Indola came from an overdraft, which Grütter secured using his life insurance policy. He had approached what was then the Small Business Development Corporation for a loan, but when he saw there was no help forthcoming he found the money himself and that is the way he has operated since. He has used his own resources to grow.

Grütter outsources some of the functions of his business to cut, make and trim (CMT) operations, so the number of people he is required to pay can vary dramatically and is sometimes as many as 50. This isn’t a problem because of "amazing" internet banking. The costs are lower than over-the-counter transactions, and it is more convenient and secure. "I sometimes need to pay CMTs in Mitchells Plain," he says. "I can pay them by internet transaction on a Wednesday and they can withdraw from an ATM on a Friday. It is very empowering to individuals."

Indola products are not yet sold via the internet – that is the next phase of development. Instead, the business acts as a wholesaler, and Grütter says "99 percent of retailers we supply pay us over the internet". This form of transaction has speeded up the pace of business very much, he believes, and has resulted in very few cash sales for Indola.

His bank’s SMS notification services "give the people you are paying a huge sense of security, regardless of whether the SMSs are from the bank or from me. I can even copy text off the website showing I have paid the beneficiary. It is very effective."

Indola apparel is made from imported fabric that is sourced from a local distributor, and, as a result, Grütter says he does not have to deal with what he calls the "logistics of importing".

When the discussion turns to banks and the way they service small business owners, Grütter says: "The world is too fast-paced for the kind of relationship implicit previously, unfortunately.

"Am I happier with banks than 10 years ago? Yes, because the technology works very well, but the personal relationship is a thing of the past."

He feels the skills levels of South African bank staff aren’t on a par with the First World. Cost-cutting and down-sizing by banks has caused the quality of service to clients to decrease. In the United States, a call centre operator will answer within three rings, he says. "Here it doesn’t happen ... but I don’t want to live in America."

Grütter believes the call centre system can work if properly administered. The theory is that it is not necessary to speak to the same person each time. With a reference number, any employee can pick up the record. But it is still problematic, he says. "It is an increasingly complex world and there are definitely barriers to entry."

"New banking" is extremely empowering, he says, but it requires skill and training for the user and the supplier of the banking products.

Profile: Unus Matthews
All Seasons
Car hire, airport transfers, tours and concierge service
Employs: eight people
Business established: 2000

Unus Mathews is frustrated by what he sees as a lack of transparency in banks, and their rigidity. But he is also tenacious, so he keeps bouncing back, testing the rule book and thinking laterally.

All Seasons’s business model has developed over the years, but it began purely as a capital-intensive car-hire business, for which Mathews wanted to borrow R1.2 million to buy vehicles. After he submitted his business plan, the bank sat on it for a month. Then on a Friday ("I remember it was a Friday because it was just before I left for mosque") Mathews received a phone call to say his application had been turned down. He remonstrated; the call ended. On Monday morning, the bank phoned to say vehicle financing worth R1 million had been granted. "To this day I don’t know what happened between Friday afternoon and Monday morning," he says.

He would have preferred a R1 million cash loan instead of vehicle financing for 10 cars, because then every cent he put back into the account would reduce the interest payable. "The bank said: ‘That is a very good idea ... but we don’t work like that.’ "

Now Mathews wants to buy more vehicles, but has been told that he cannot because he is over-exposed, although the amount outstanding on the vehicle financing is down to R300 000.

"It should count for something that I have a track record, that I am still here in a tough industry. My assets far exceed my liabilities. You can’t measure me against the same criteria as a major car company. When banks deal with a small guy, it costs more.

"Twenty years ago, when you built up a relationship with a bank manager, it was much better. Now you build up a relationship with a computer. The computer rates you."

Two years ago, he received a computer-generated letter from his bank with a licence to spend R200 000 on a car for himself. "I took the offer to the bank and asked: ‘Can I buy two Nissan Almeras for my business instead?’ They said no. I don’t understand this. I am the sole member of my close corporation. The risk is the same."

He relates how he won a contract with the City of Cape Town for which he needed an additional four vehicles. This would have cost R10 000 a month in repayments, but the contract would have yielded R40 000 a month in turnover. The bank refused him the financing and he resorted to borrowing vehicles and taking a far less lucrative five-percent margin instead.

It is ironic perhaps that a business called All Seasons suffers from seasonal cash flow problems. "In winter I die," Mathews says. "That’s why we have expanded into concierge and airport transfers."

Bank charges amount to between R700 and R900 a month, and All Seasons operates a current account, 11 hire purchase agreements and a credit card point-of-sale machine.

He believes banks could do more to help smooth out the rough times. "I expect the bank to offer me the best products, and to tell me about them." He did not know that it is possible to structure hire purchase agreements with a rest period for lean times – the bank told him some time after the agreements had been signed, he says.

All Seasons has decided to change its strategy and in future will buy cars that are three or four years old for cash rather than fund them through bank products. Mathews acknowledges that he will do this while having to maintain standards and turnover, which is a demanding task, but he also says during the interview that he is addicted to stress.

Mathews says small business has a problem, and "being the wrong colour is also a problem. It will eventually change, but if we don’t change fast enough, we are creating problems."