Financing SMEs and Entrepreneurs 2020

42. South Africa

Key facts on SME financing

Although estimates vary, the number of micro, small and medium enterprises (SMEs) in South Africa rose by 3%, from 2.18 million in the first quarter of 2008 to 2.25 million in the second quarter of 2015 (Bureau for Economic Research (BER), 2016). Of the 2.25 million SMEs, 1.5 million were informal, concentrated in the trade (wholesale and retail) and accommodation sector.

The evidence regarding firm dynamics in South Africa suggests that scaling up is a significant challenge for most SMEs. For instance, average annual growth rates are positively related with firm size, such that larger firms exhibit higher average growth. Lack of access to markets, technology, business infrastructure, information etc., are some of the constraints for SMEs scaling up.

According to the South African Reserve Bank data on bank statistics, total SME credit exposure to banks was ZAR 617 billion at the end of 2017, which accounts for 28% of total business loans. As indicated below, the low level of SME financing appears to be emanating from the demand side as the vast majority of SMEs indicates that they do not borrow from financial institutions, particularly banks.

Owner-funded capital represents, by far, the most widely used source of finance, followed by investments by family and business partners.

SME non-performing loans in the banking sector have declined since 2010, falling from 5.2% to 2.5% in 2017. The economic recovery following the 2009 recession and prudent lending criteria have likely contributed to the improvement. At 2.53% in 2017, the ratio of non-performing loans of SMEs was higher than that of total corporates (1.3%) by more than one percentage point.

Government funding for SMEs is provided through grants and financing by development finance institutions (DFIs). The outstanding direct government loans to SMEs at the end of 2017 amount to ZAR 11.48 billion, which accounted for 1.8% of all SME loans.

Credit guarantees are also in use in South Africa. ZAR 297 million were provided in 2017 by the IDC and SEFA up from ZAR 243 million in 2016, after having declined significantly in 2013 and in 2014.

The South African Government is also working on the establishment of a registry for movable assets and of a database with credit information. Both initiatives aim to make lending less risky and should therefore make bank financing more widely available.

Table 42.1. Scoreboard for South Africa

Indicator	Unit	2007	2008	2009	2010	2011	2012	2013	2014	2015	2016	2017
Debt
Outstanding business loans, SMEs	ZAR million	..	423 691	411 212	388 090	411 280	454 012	512 504	545 271	579 823	638 525	617 846
Outstanding business loans, total	ZAR billion	..	1 441	1 276	1 373	1 481	1 648	1 791	1 965	2 323	2 377	2 239
Share of SME outstanding loans	% of total outstanding business loans	..	29.39	32.23	28.26	27.76	27.55	28.61	27.75	24.96	26.87	27.59
Government loan guarantees, SMEs	ZAR million	8	99	226	201	439	227	105	105	223	243	298
Direct government loans, SMEs	ZAR million	..	4 829	4 909	5 915	6 900	7 383	7 269	8 748	10 565	10 898	11 481
Non-performing loans, total	% of all business loans	..	1.40	2.96	2.91	2.11	1.97	1.84	1.54	1.64	1.48	1.29
Non-performing loans, SMEs	% of all SME loans	..	2.89	5.23	5.20	4.07	3.36	2.92	2.94	2.51	2.55	2.53
Non-bank finance
Venture and growth capital	ZAR million	468	551	242	194	211	288	183	273	372	872	..
Venture and growth capital (growth rate)	%, Year-on-year growth rate	..	17.74	-56.08	-19.83	8.76	36.49	-36.46	49.18	36.26	134.41	..
Other indicators
Bankruptcies, SMEs	Number	3 151	3 300	4 133	3 992	3 559	2 716	2 374	2 064	1 962	1 934	1 868
Bankruptcies, SMEs (growth rate)	%, Year-on-year growth rate	..	4.73	25.24	-3.41	-10.85	-23.69	-12.59	-13.06	-4.94	-1.43	-3.41

Source: See Table 42.2.

SMEs in the national economy

SMEs play an important role in the South African economy. South Africa needs to create more than three million jobs for young people by 2020 and the National Development Plan (NDP) estimates that the country will need to create an additional 11 million jobs by 2030. 90% of these are expected to come from new and expanding SMEs.

Despite this policy imperative, there are differing estimates of the size of the SME sector in South Africa. According to Bureau for Economic Research, SMEs contribute to slightly more than 20% of GDP (before taxes and subsidies). The Global Entrepreneurship Monitor 2017 states that SMEs contribute to 36% of GDP, while according to the Minister in the Presidency, they contribute to 42% of GDP and employ 47% (7.3 million) of the workforce.

The importance of SMEs for employment is similarly unclear. Statistics South Africa’s first quarter 2017 Quarterly Labour Force Survey estimates that the informal sector (excluding formal SMEs) of the economy employs more than 2.7 million people, which accounts for about 20% of total employment. The number of SMEs in South Africa rose by 3%, from 2.18 million in the first quarter of 2008 to 2.25 million in the second quarter of 2015 (BER, 2016). Of the 2.25 million SMEs, 1.5 million were informal, concentrated in the trade (wholesale and retail) and accommodation sector.

Despite the sizeable contribution of SMEs to growth and employment, South Africa has one of the lowest creation rates of successful SMEs: according to the Department of Small Business Development (DSBD), 70% to 80% of small businesses fail in the first year and only about half of the survivors last for the next five years.

According to South African Revenue Service (National Treasury Panel, 2016), micro enterprises comprise 55.6% of registered firms in the formal sector, while small and medium firms constitute 33.7% and 9.5% respectively of the South African formal economy. The primary sectors feature relatively more medium enterprises, while small firms constitute a larger share of the manufacturing sector and micro firms account for the majority of the services sector.

SME lending

The lack of access to finance for SMEs remains a challenge in South Africa, inhibiting their growth and sustainability. Contributing factors to low access to finance include the lack of suiTable 3.formal finance products available to small enterprises, the lack of readily available credit information; the perceived riskiness of small enterprise finance; and the apparent lack of appropriate assets available to small enterprises for the purposes of collateral. All of these issues reduce the availability and increase the cost of credit for small enterprises.

According to the South African Reserve Bank data on bank statistics, total SME credit exposure1 to banks was ZAR 617 billion at the end of 2017, which amounted to 28% of total business loans. As indicated below, the low level of SME financing appears to be emanating from the demand side as the majority of SMEs indicates that they do not borrow from financial institutions, banks in particular.

Government funding for SMEs is provided through grants and financing by development finance institutions (DFIs). Some of these DFIs include the Industrial Development Corporation (IDC), the Small Enterprise Finance Agency (SEFA), and the National Urban Reconstruction and Housing Agency (NURCHA). The outstanding direct government loans to SMEs by DFIs at the end of 2017 was ZAR 11.48 billion, which accounted for 1.8% of all SME loans.

The take-up of debt finance among SMEs varies by economic sector. While almost 30% of micro enterprises in the services sector have total debt financing of ZAR 0-100 000, only around 20% of micro firms in manufacturing make little to no use of debt. Unsurprisingly, firms are more likely to take on debt the larger they are, with only less than 5% of medium firms in manufacturing making use of zero to ZAR 100 000 in debt financing (National Treasury Panel, 2016).

Credit conditions

Credit conditions for SMEs in South Africa are tight, particularly on the banking side. According to the 2015 SME Survey2, banks are the least likely source of funding for SMEs, with only 2% indicating that they rely on banks for funding. The survey suggests that SMEs are unsure about what kind of products or services they need from banks, as they are unable to articulate the products and services banks are currently not providing to them. Similarly, National Small Business Chamber’s 2016 Small Business Survey shows that 75% of SMEs did not apply for finance. This is supported by a study by Makina et al (2015), which shows that more than 50% of firms do not borrow because they either do not need finance or they do not “believe” in borrowing. Furthermore, 30.9% of firms do not borrow from formal institutions because they are either scared, or feel that they would not qualify for a loan. Low borrowing rates also appear to be exacerbated by the fact that some SMEs owners lack an understanding of the usefulness of credit for a business’ operational sustainability and growth.

Alternative sources of SME financing

Alternative sources of funding play an important role for SMEs in South Africa. In fact, the SME Survey indicates that the single most likely source of funding – as indicated by 57% of respondents - was their own capital. The next most likely source of funding, indicated by 28% of respondents, was from business partners and family members.

According to the Southern African Venture Capital and Private Equity Association (SAVCA), the value of venture capital investments during 2016 was ZAR 872 million, up 134% from ZAR 372 million in 2015. The total number of investments grew by 23% from 93 in 2015 to 114 in 2016. The average deal size of new investments rose to ZAR 7.6 million in 2016 from ZAR 4 million in 2015. More than two thirds of venture capital deals in 2016 were categorised as Growth Capital while Seed Funding and Start-up Capital totalled 42% (53% in 2015). Over the past decade, 538 venture capital deals worth ZAR 3.6 billion were recorded, which on an annual basis averages to 54, ZAR 6.8 million venture capital deals per year.

Other indicators

According to the South African Reserve Bank (SARB), SME non-performing loans in the banking sector have declined since 2010, falling from 5.2% to 2.5% in 2017. The economic recovery from the 2009 recession and prudent lending criteria are likely to have contributed to this improvement. The ratio of non-performing SME loans remains higher than that of total corporates, which was 1.3% in 2017. However, data on non-performing loans for SMEs that are financed by DFIs is difficult to obtain, as some of these DFIs do not record non-performing loans by firm size. SEFA, which only provides credit of up to ZAR 5 million to SMEs, recorded a 32% impaired advances to gross loans ratio in 2015-16 (up from 24% in 2014-15).3

Government policy response

The South African Government acknowledges that a lack of access to finance is one of the major constraints for SMEs’ development. As a result, the government is committed to address the structural constraints in the small business market in order for the formal credit market to be more accessible. To achieve this, the government is currently proposing to introduce or support the measures detailed below.

Credit information sharing

Credit information services for retail and corporate clients are well established and highly developed in South Africa through a range of credit and risk assessment tools. However, they are not as developed for small enterprises, and in general, information asymmetries prohibit lenders from making sound credit decisions in the SME space. Financial institutions are also reluctant to provide their services to SMEs because of higher monitoring costs. To address this challenge, the government plans to support the establishment of a shared information system, which will form the basis for lending criteria to small businesses. The system will include as many relevant data providers as feasible and ensure that access to the information provided by lenders is as unrestricted as possible.

Credit guarantee schemes

Small enterprises are characterised by a high rate of infant business mortality in South Africa. This high failure rate, coupled with stricter prudential regulations under Basel III after the global financial crisis, results in a cautious approach to extending credit to the SME market. In order to address the high risk of enterprise failure, and start-up failure in particular, risk sharing through partial credit guarantee schemes can be introduced. Under such a scheme, the risk of default is shared between the credit provider and the provider of the credit guarantee, usually the government. The guarantee does not fully cover the default amount, but rather, covers an agreed portion of the default amount. Currently, the IDC and SEFA provide credit guarantees, with ZAR 297 million provided in 2017 up from ZAR 243 million in 2016, following significant declines in 2013 and 2014.

SEFA operates the Khula Credit guarantee scheme which issues partial credit guarantees to lenders for SME borrowers whose access to finance is specifically impeded by a lack of collateral. The scheme indemnifies commercial banks and other financial institutions against SME credit defaults, with indemnities of up to 90% of loan amounts. The scheme is fully funded by the government through equity and budgetary appropriations. The scheme currently works through mutually exclusive partnership arrangements with South Africa’s four major commercial banks and is regulated by terms of agreements that were concluded in 2007. The uptake of these guarantees by commercial lenders has unfortunately been very limited. Consequently, the South African Government is formally assessing the scheme to identify constraints underlying its limited usage and address limitations through a redesign of the program’s parameters.

Movable asset register

The lack of an adequate range of assets to serve as collateral when applying for credit is a primary financial constraint for SMEs seeking funding from the financial sector. Credit providers generally accept immovable (fixed) assets as appropriate collateral for loans. However, most SMEs’ capital in South Africa is movable in form (livestock, inventory, raw material and equipment). Creditors do not accept movable assets as collateral because these assets cannot be seized easily should the debtor default. It is also very difficult for lenders to ascertain whether these assets have already been taken as collateral by other creditors. The establishment of a movable asset register would allow SMEs to put up these assets as traceable and legitimate forms of collateral, without having to rely on their owners’ fixed private assets (for example an owner’s residence).

A movable asset register would also provide a legal and institutional framework that would record the ownership and use of movable assets as collateral for small enterprise finance and perfect credit providers’ legal claims on such collateral, should debtors default. Lenders’ ability to make legal claims on movable assets used as collateral would lower the risk of lending to small enterprises which would in turn lower the cost of administering credit and increase SME access to loans. By further addressing the development of the financial infrastructure and tools detailed above, credit providers will be in a better position to advance credit to viable enterprises at risk-appropriate prices.

Figure 42.1. Trends in SME and entrepreneurship finance in South Africa

Source: See Table 42.2.

Statlink

Table 42.2. Definitions and sources of indicators for South Africa’s scoreboard

Indicator	Definition	Source
Debt
Outstanding business loans, SMEs	Businesses with a turnover less than ZAR 400 million. Gross loans and advances which includes both on- and off-balance sheet exposures	SARB BA200
Outstanding business loans, total	Sum of Corporate and SME loans Gross loans and advances which includes both on- and off-balance sheet exposures	SARB BA200
Government loan guarantees, SMEs	Guarantees provided (SMEs only) as at the end of the year	IDC and SEFA
Direct government loans, SMEs	Direct loans provided by IDC (SMEs only) as at the end of the year, excluding equities	IDC, Land Bank, and NURCHA
Non-performing loans, total	Businesses with a turnover less than ZAR 400 million where an exposure is overdue for more than 90 days	SARB BA200 and BA210
Non-performing loans, SMEs	Sum of Corporate and SME loans overdue for more than 90 days	SARB BA200 and BA210
Other indicators
Bankruptcies, total	Total number of liquidations	P0043 - Statistics of Liquidations and insolvencies, Statistics of South Africa
Venture capital	Value of venture capital investments	Southern African Venture Capital and Private Equity Association

References

BER (2016). The Small, Medium and Micro Enterprise Sector of South Africa. Research Note No 1 2016. Small Enterprise Development Agency.

http://www.seda.org.za/Publications/Publications/The%20Small,%20Medium%20and%20Micro%20Enterprise%20Sector%20of%20South%20Africa%20Commissioned%20by%20Seda.pdf

Global Entrepreneurial Monitor (2017). Can small business survive in South Africa? South Africa Report 2016/7. http://gemconsortium.org/report/49833

Makina et al (2015). Financial Access and SME Size in South Africa. Occasional Research Paper, FinMark Trust. http://www.finmark.org.za/wp-content/uploads/2016/01/Rep_Financial-Access-and-SME-Size-in-SA_Dec2015-1.pdf

National Small Business Chamber (2016). National Small Business Survey, 2016.

Southern African Venture Capital and Private Equity Association (2017). SAVCA 2017 Venture Capital Survey.

http://savca.co.za/wp-content/uploads/2017/09/VC-Survey-2017-Electronic.pdf

Statistics South Africa (2017). Quarterly Labour Force Survey, First Quarter 2017.

http://www.statssa.gov.za/?p=9960

Notes

← 1.  Including both off and on balance sheet data

← 2.  SME Survey (Pty) Ltd, www.smesurvey.co.za

← 3.  These figures are calculated from SEFA annual reports.