Finding finance for starting a business in South Africa
Despite the current financial climate which make finding finance for starting a business in South Africa a bit more challenging, research shows that there are still plenty of solutions for SA entrepreneurs. The latest article in the Personal Finance website recently featured this thought provoking article by Margarete King.
Part one of the article below:
The major challenge facing would-be entrepreneurs is finding capital. In this, the first of a two-part series, we look at the financial and other support that banks offer to foster the growth of small business.
Over a million Gautengers, or one in six adults in the province, run small businesses. About 180 000 of these businesses are "engines of economic growth", employing an average of five people each.
This is according to research released in November 2006 commissioned by Gauteng Enterprise Propeller (GEP), a provincial government agency that supports small, medium and micro enterprises (SMMEs), and FinMark Trust, an independent trust whose objective is to make financial products more accessible.
Gauteng was chosen for the study because of its significance to the South African economy, but no province has a monopoly on entrepreneurs and the self-employed. Trade and Industrial Policy Strategies, an economic research institution, estimated that in 2004/5 there were between 2.75 million and 3.35 million economically active small businesses.
These enterprises range in sophistication from spaza shops to niche software development companies. But there is one thing that unites owners across the board: the difficulty of getting a bank loan.
The FinMark research in Gauteng found that only two percent of all the small businesses surveyed had used bank loans. It found that, across the board, the biggest problem when starting a business was finding the capital.
A majority of owners had borrowed from friends and family to start their enterprises, or had used pension payouts, savings or retrenchment packages.
The big four banks in South Africa offer the standard range of credit: overdrafts, revolving credit, term loans, business mortgages, vehicle and asset finance, property finance, and debtor finance.
This article is not a comprehensive review of all the loan products available from them. It highlights products and services that stand out and mentions any limits (such as minimum and maximum loan amounts) and other factors that may exclude your company (such as its age), where these details have been made available.
The following criteria appear to be the foundation for all bank lenders: the entrepreneur contributes 10 percent of the amount he or she is asking to borrow and then provides collateral of between 70 and 100 percent for the amount the bank lends.
(So if you want a loan of R100 000, you bring R10 000 to the table and the bank grants you a R100 000 loan if it considers you a good risk. The result is that you have capitalised your business to the tune of R110 000.)
Collateral can be in the form of a property, an insurance policy, someone standing surety, or a combination of these.
But with a large number of business owners saying they battle to obtain bank finance, there seems to be a mismatch between supply and demand.
Sibongiseni Ngundze, the managing director of Nedbank Small Business Services, says: "The challenge is for entrepreneurs to prove that they have an idea that can work. We have to have a measurable degree of certainty that we will be repaid.
"Big gaps tend to appear around the rigorousness of business plans."
He says Nedbank lays this approach – of entrepreneurs needing to show their ideas can work – over the lending criteria outlined above.
"We don’t let rigid criteria stand in the way. The primary factor is proven viability; that’s the main driver around financing decisions."
Any investments that you can cede to the bank will help your case when asking for a loan, he says.
Ngundze suggests that you, as a small business owner or prospective owner, can take steps to help yourself by using home loan finance. He says some entrepreneurs take a covering loan against their existing property and put that money into their business.
If you take a covering loan, the additional value in your property over and above the amount you still owe on your home loan can be leveraged as security for a business loan.
Home loan finance is much broader than, for example, a doctor who takes out a home loan because he or she will consult from a residential property. It is using your existing home loan to access capital. Ngundze says this financing option is not as widely used as it could be.
Nedbank Small Business Services deals with businesses that have a turnover of between R150 000 and R5 million, and typically employ fewer than 25 people. If your company fits the bill and you want to buy commercial or industrial property, the NedBond product allows you to borrow up to 70 percent of the purchase price or market value, which-ever is lowest. The approved amount must be more than R720 000.
Ngundze says the interest rate a small business owner is offered is a function of perceived risk and the ability to effectively mitigate the risk.
The bank looks at the likelihood of being repaid and the likelihood of something going wrong. The bank evaluates the viability of the business, the level of risk of the shareholders, the certainty of revenue streams and the likelihood of profitability in the short term, he says.
One former executive of one of the big four banks says: "Entrepreneurs need to be realistic with their expectations. They will be required to make some contribution towards financing the business and cannot expect the bank to fund all their requirements."
He says it is important that entrepreneurs do their research and fully understand their businesses when applying for a loan.
"We see many examples where the customer has not done any proper market research and does not understand the business.
"Alternatively, the customer presents us with a very good business case, but when we sit down to discuss this with them, it becomes apparent that a consultant has drawn up the business plan on behalf of the entrepreneur and he does not understand the business plan because he has not been party to it."
In addition, banks see many cases in which the entrepreneur lacks the necessary passion and drive "and thinks that owning and running a business is a get-rich-quick solution rather than that it takes hard work and determination to be successful".
Whatever kind of business you run, Standard Bank’s website has a table to advise you on what sort of finance is appropriate for your requirements. For example, if you need to buy office equipment, it tells you that you could use business revolving credit or vehicle and asset finance, that a medium-term loan is an option, but that an overdraft is not recommended.
Standard Bank’s business mortgage allows small business owners such as accountants, doctors and vets the opportunity to buy, extend, or improve a residential property where a portion of the property is used for business purposes.
This is different from the bank’s professional practice bond, which, the website says, is intended to allow the "professional market", such as lawyers and doctors, to buy commercial or residential properties that are mainly for business purposes. You can use a professional practice bond to borrow up to 80 percent of the property’s assessed value, and the maximum loan is R10 million.
Absa’s website says its Black Economic Empowerment Asset Financing is designed for black business transactions where moveable assets make up a large portion of the funding requirement.
If you own a black economic empowerment (BEE) company in the transport sector and have a contract with a reputable company, you can approach Absa Vehicle and Asset Finance for a loan to buy assets and vehicles, and to fund the first three months’ working capital. The initiative is a partnership between Absa and the Industrial Development Corporation.
You will need to contribute your own cash, but Absa says the amount is usually only 2.5 percent of the total amount you would like to borrow.
At present, you cannot apply if you stand to benefit from the taxi recapitalisation programme, but this is likely to change in future.
The business loan offered by First National Bank (FNB) is intended for businesses that are at least three years old or have an annual turnover of at least R5 million. The minimum you can borrow is R20 000 and you can repay it over a period of one to 10 years.
The bank’s Flexi Business Loan is a revolving credit facility. You can draw on it as you need until you reach the approval limit and, once you have repaid 25 percent of the loan’s value, you can immediately withdraw up to the original capital value.
If your business has been operating for a minimum of two years and you have maintained a well-managed set of accounts over that time and have a successful credit history with FNB, you can apply for between R50 000 and R200 000. The repayment period is 12 to 60 months.
FNB collaborates with its stablemate, WesBank, to offer asset-based finance. WesBank Corporate finances capital equipment, so you can approach it for credit to buy industrial machinery, trucks, computer hardware and office equipment.
FNB Enterprise Solutions is a subsidiary of FNB that specialises in SMMEs with low equity and/or with little collateral. You can apply for finance of between R500 000 and R5 million if you want to start or expand a business.
Funding of between R1 million and R20 million is available for acquisitions and management buy-outs and buy-ins, particularly for BEE enterprises. FNB also has facilities for "emerging entrepreneurs" who want loans to operate franchises or to bid for tenders, or more generally for black-owned SMMEs.
Sharing the risk
Khula Enterprise Finance, an agency of the Department of Trade and Industry, is trying to tackle the problems posed by a lack of collateral.
This institution does not lend directly to small businesses but through a number of intermediaries, such as commercial banks.
Khula’s credit indemnity scheme provides guarantees for small business that would be granted credit from a financial institution if they had adequate collateral. The Khula website says: "The purpose of the indemnity scheme is to share the financing risk with banks." The entrepreneur or small business owner applies for a loan with a commercial bank, and the bank then applies to Khula on his or her behalf for a credit guarantee after completing all the viability tests. You pay three percent of the loan every year for the duration of the guarantee.
You have to be involved in the day-to-day running of the business to qualify for assistance from Khula, and most banks want you to contribute at least a 10 percent of your own capital.
You can access Khula financing only once, and you do not qualify to use it to start a new business if you already own a business, even if you have never used Khula debt finance before.
All four retail banks examined in this article help entrepreneurs access financing via Khula.
Another government agency, the Umsobomvu Youth Fund (UYF), offers micro loans of between R100 and R100 000 and its SME Fund makes loans from R100 001 to R5 million available specifically to black South Africans aged 18 to 35, or black women of any age.
There are a number of initiatives in which funders link up, including:
The Enablis-Khula Loan Fund. This partnership between Enablis Entrepreneurial Network, Khula and FNB Enterprise Solutions provides 90 percent guarantees for loans extended to businesses that focus on information and communication technology.
The Business Partners-Khula Start-up Fund was created to help entrepreneurs establish enterprises and to expand in the early stages of the businesses.
FNB-UYF Progress Fund. Loans of between R100 000 and R8 million are available for young black people aged 18 to 35 years who need financing to start or expand their businesses, or who want to buy an existing business. The application form can be downloaded from the FNB website (www.fnb.co.za). The fund gives you access to subsidised mentorship by way of the Umsobomvu-FirstRand Foundation Technical Assistance Fund.
The UYF Business Partners Franchise Fund invests between R150 000 and R3 million in franchises owned by young black people.
If you are refused a loan, the bank or banks must give you written reasons. These reasons should be able to help you pinpoint your shortcomings so that you improve your chances when you next apply. If a bank does not give you written reasons, ask for them, and complain to the bank if you do not get them. If your complaint is not dealt with within 20 working days, take your complaint to the Ombudsman for Banking Services.
Gavin Chait is a development economist at Whythawk Ratings, a company that rates small business development consultants in the Western Cape and Gauteng. He says it is close to impossible for start-ups to get a loan.
"We have polled several thousand businesses, and between 10 percent and 15 percent of applicants for bank loans got financing. [The finding that two percent of businesses in Gauteng had received bank loans is a measure of all businesses, regardless of whether they had applied for loans or not.]
"[The poll shows that] In order of frequency of loans granted, Absa was first, followed by Standard, and then, a long way off, FNB and Nedbank."
Chait says specialist business banks, such as Khetani and New Business Finance, granted more loans than FNB and Nedbank, although there were regional variations.
People should first look to their own sources of financing, before approaching banks, Chait says. If you own a property, he recommends you use an access bond to borrow from your home loan rather than use your home as security for a business loan. "The bank will probably add on six percentage points of interest if it knows the loan is for a small business."
Chait does not agree with the aspect of the government’s retirement reform plans that will prevent employed people from accessing their pension savings before retirement, as will happen when the national pension savings scheme becomes a reality. This will cut off one of the potential sources of funding for small businesses.
"Government should not protect people from their choices," he says, while acknowledging that he can see why the government wants to do this.
"People should be allowed to take chances and to fail, otherwise we become a risk-averse society, with no entrepreneurs. We would be like Europe, which struggles to create new businesses.
"At the same time we have to be honest – we need to scare people witless because starting a business is the toughest thing you can possibly do; you can lose too much money too easily," Chait says.
The former bank executive says it’s not all about financing. "In the first two years of a business’s life, the banking industry is risk-averse. But businesses don’t only need lending. They need help with sound business plans and proper cash flow."
Cash flow could indeed be a problem, considering that the FinMark-GEP research found that across all small businesses, most do not know where the next customer is coming from. This could in turn be linked to training, or the lack of it: 42 percent of formal businesses told researchers they needed to develop business skills. The FinMark-GEP research found BSMs 6 and 7 were most aware that support was available to small businesses, but awareness was not pervasive at 48 percent and 58 percent, respectively.
There is a great deal of basic information about starting a business that is freely available on bank websites, and you don’t have to be a customer of a particular bank to use it.
The content and presentation appears to be updated pretty regularly, so if you are just starting out or if there are parts of your business about which you know little (technology, for example), it is probably worthwhile keeping an eye on the sites.
In particular, there is plenty of information available on how to write a business plan. Clearly, the banks and government funding agencies value this highly and want you to be competent in this field.
(Ironically, one piece of advice you are given is to negotiate the longest possible payment cycle with your creditors. If you can arrange to pay for a service or for goods 30 days after receipt rather than immediately, that will help your cash flow – or so the advice goes. The problem is that bigger entities have the power it negotiate, or demand, terms of 90 days or more, and countless small businesses have gone to the wall while sweating out the three-month wait. It is a strategy you can use, but the chances are it is going to be used against you far more powerfully.)
Standard Bank’s Small Capital Handbooks are available in PDF format on the bank’s website (www.standardbank.co.za). In addition to this remote support, Standard Bank has mobile bankers, who visit new customers at their businesses to explain their products in detail, discuss your business’s needs and recommend banking solutions.
Nedbank’s online educational offering is sparse, and when asked about this Ngundze points to Nedbank’s hands-on technical assistance provided by its partnerships with Khula Credit Guarantee, Business Partners and Sizanani (a joint initiative of the Banking Association of South Africa, which was previously known as the Banking Council of South Africa, and the big four retail banks).
Ngundze says: "We have a network of 600 business advisers across the country. If a person enters an area of operation that they do not possess critical skills in, we would recommend – and make it mandatory when we believe it necessary – that they take up mentorship. That helps them gain access to skills and, consequently, the requisite funding.
"If anything is going wrong, the coach or mentor makes a diagnosis and suggests actions. The coach also has the responsibility to submit reports regularly to the bank."
Nedbank holds seminars that are free and open to all interested entrepreneurs. The seminars are intended to impart practical skills, and the subject matter includes topics such as how to prepare a business plan, how to create an implementable market plan, and how to deal with hiring and firing. The seminars are advertised through the media.
Absa provides mentorship programmes to help you complete an application for finance and to create a business plan. Mentorship is also intended to encourage the transfer of skills. To support the one-on-one contact, there are downloadable booklets available on Absa’s website (www.absa.co.za).
If your business hits a rough patch, Absa has business crisis managers who can provide solutions. There is a cost, however, and the price is related to the complexity of the situation.
If you receive funding from Absa, a "New Enterprise banker", or a mentor, will visit you every month to monitor progress against your business plan. This is what Absa calls its Aftercare programme.
A new development is Absa’s small business advisory centres. They are not bank branches but can be described as "media centres", where customers get information, Donovan Steenkamp, Absa’s general manager of customer value proposition for small business, says. The centres help Absa prepare its clients to be small businesses owners, he says.
So far three centres have been opened – in Soweto, Durban and Cape Town – and more are planned.
Absa has an agreement with the Small Enterprise Development Agency (Seda) to place Absa educators in Seda agencies to provide mentoring and coaching. Seda is a Department of Trade and Industry institution, and Steenkamp says Absa will not be punting its own products. "The aim is to build continuity and familiarity so that when clients do engage with banks they are not foreign entities," he says.
Absa’s initiatives are to unlock new markets and to find alternative ways to help small businesses so that the traditional banking model evolves, Steenkamp says. There will be a particular focus on Khula loans. "We see it [Khula’s guarantee scheme] as a great instrument," he says. "Absa accounts for more than half of Khula loans; all the other banks together account for the rest."
FNB has a number of contact points for the bank’s clients to access support. The bank has made available 700 mentors, primarily experienced business people with knowledge of specific industries. There are relationship managers at branch level, and there is also a call centre.
FNB’s website has links at the bottom of the site to FNB’s partners, BizNetwork and Enterprise Support SA. You can register yourself on the Enterprise Support SA website, which has self-help tutorials, or you can also ask Enterprise Support SA for a mentor or consultant, for which you have to register your company.
Jo Schwenke is the managing director of Business Partners, an investment house that lends money to SMMEs and sometimes takes a shareholding in the businesses. Business Partners has equity of R2 billion at present and last year it invested R800 million.
He says small businesses don’t only need money – they also need support after getting money. That means monitoring, ensuring that proper systems are in place and evaluating projected performance against actual performance. Business Partners’s mentorship section keeps a database of mentors who specialise in SMMEs. "Thereafter we match humans with humans and facilitate meetings," Schwenke says.
He stresses that a mentor "must transfer know-ledge and skills over time".
Typically, mentors are retired executives, either from the middle or top ranks of executive structures, with a personal commitment to giving something back. If you use a mentor, you can expect to pay about R1 500 a day, Schwenke says.
He advises you, as a business owner who may want to use a mentor, to make sure you put a ceiling on the total amount you are going to pay and to make sure you agree to a deliverable result – such as, "I will understand how these finances work by the time this mentoring is over".
Chait says the hype around business plans "is all rubbish, every last drop of it.
"There’s nothing wrong with business plans per se but they have become a religion. They are becoming ever more fancy and complex when they should be simpler and simpler. A business plan is an entry ticket – banks won’t let you in without one. Then they put it aside. Banks are not speculators. They really want to know: will you be able to pay us back? If not, what can we take in return?"
He feels mentoring is far more useful than preparing a plan for a bank: "If you work through the process with a mentor, the success rate [of businesses] is dramatically improved. It’s like having a personal trainer at a gym – someone to help you set targets and someone to notice if you don’t make them."
High cost of banking
There are millions of potential engines of growth out there, but many are stuck in the traffic jam of skills shortages and can’t go anywhere, or the road is wide open but they can’t speed ahead because the petrol light is flashing and they have no cash to top up the fuel tank.
One of the main drains on cash flow is the high cost of business banking. For this reason, many small business owners use only personal savings accounts. According to the GEP-FinMark research, business banking becomes prevalent only in more sophisticated businesses (See ‘How small businesses bank’ in Part II of this article and the table here).
Penelope Hawkins is the managing director of research company FEASibility, which prepared a report in 2006 for the Competition Commission’s inquiry into banking. This report is the sequel to the 2004 Competition in South African Banking Report commissioned by the National Treasury and the South African Reserve Bank (SARB). The chapter on small businesses in the 2004 report concludes that:
Access to finance, and the quality and cost of services that small businesses receive from banks are key to their profitability and prosperity.
During its existence a small and medium enterprise (SME) can access a number of different sources of finance, but there is little effective competition between the providers of such finance.
The lack of competition in banking restricts choice for SMEs and increases the cost of access to banking services.
Banks are reluctant to finance initial capital, and even established businesses have difficulty in accessing working capital.
The deposits of small businesses are three times as much as the advances extended to them.
Small firms pay a premium for access to financial services, in terms of both interest rates and fees, relative to individuals.
Small firms in South Africa pay more for a similar bundle of services than their counterparts in the United States, Germany and Australia, but less than their counterparts in Britain and Canada.
Hawkins says as far as she is aware, there has been little update on the 2004 report with regard to banking for small businesses. And the issue hasn’t been dealt with explicitly as part of the Competition Commission’s inquiry.
But she says: "Typically, there is a similarity between a small business and a poorer individual in the way both are regarded by banks: they are both seen as more risky, and there are not the advantageous packages that there would be for big corporates [and wealthy clients]."
The view of small businesses as risky is longstanding but may be exacerbated by the implementation of Basel 2, Hawkins says. Basel 2 refers to the regulations aimed at achieving a uniform approach by banks and banking regulators to risk management across national borders.
"Under Basel 1 principles, a big corporate, such as Anglo American, had the same capital adequacy ratio against a loan as The Corner Store.
"Under Basel 2, there is a differentiation based on risk. The bank may need to hold 30 percent of the capital loaned to Anglo American, but 100 percent for The Corner Store. This makes it more expensive to serve The Corner Store. There is logic to charging a higher interest rate to smaller businesses."
Hawkins says it is difficult for a small business person to compare the price of bundled products and services across banks.
A consumer survey that was presented at the Competition Commission’s inquiry shows that bundles of products are not comparable, and fees that differ, based on the average balance in the account, further confuse things.
She says the survey findings refer to private individuals but apply to small business. In fact, with small business the difficulties of comparing may be further complicated by the type of loan product you have.
What do the banks say about why business banking is more expensive than personal banking?
Bobby Madhav, the KwaZulu-Natal chairman of FNB Commercial, says: "This is a Third World country. There are risks as far as moving cash is concerned. Insurers don’t fully insure us and banks pay a heavy price for crime. Cash is expensive, but society is cash-driven and access to the electronic platform is difficult. Banks have thousands of products.
"The destiny of your banking is in your hands. South Africans want a Rolls-Royce but want to pay the minimum amount."
One activity that will really get your meter running and push up banking costs is depositing cash: the more you deposit, the more the bank charges you.
Schwenke, of Business Partners, says: "Let’s be realistic: people take pleasure in bashing banks. Most charges are very reasonable. But I was a business owner once and it always used to upset me to pay to deposit cash. Cash deposit fees are immoral. I can understand it if you have a large number of coins. But to charge for depositing notes is outrageous. It takes no time to count them."
Hawkins says small business owners have to ask: what is the relative cost of cash versus other instruments, such as payment cards? "Of course, some are locked into cash, such as The Corner Store," she concedes. "But this may change over time."
However, Hawkins also says that when banks put a high price on a service, they may be trying to influence behaviour. In this case, she says, it would be to move as many consumers and business owners as they can to card and electronic transactions.
So is the high cost of cash partly valid and partly a smokescreen that banks hide behind to pump up their fees? The 2004 report to the National Treasury and the SARB recommended that penalty fees should be on a cost-plus basis, which means they should reflect the cost incurred by the bank in providing that service, plus a profit margin.
The terms of reference of the banking inquiry include the relationship between cost and price.
The inquiry panel set up by the Competition Commission is drafting its report to the commission and its findings will probably be known by the end of the year.
In the meantime, small business owners do their best to avoid transaction charges, especially the high cost of depositing cash.
One owner, whose business turnover is 25 percent cash, says: "We never pay cash into our bank account. We pay the cash into our suppliers’ accounts. They pay the cost of the deposit."