This was a subject which recently came up in a discussion with an industry stakeholder and is worth unpacking in some detail. In this blog post, we explain why the answer to the question is “Yes” … but also … “it’s complicated”
In short, SME finance is expensive
The reality is that there are some very big funding gaps on the African continent – and South Africa as one of the most developed economies makes up a big part of that.
Firstly, there is a Trade Finance gap which is estimated to be over $100bn annually. This isn’t aspirational, early stage funding – this is simply cashflow that could unlock willing buyers and sellers who want to transact with one another.
Then we come to the question of early-stage or “venture” funding. If we strip out Enterprise and Supplier Development (ESD) funding, we have very shallow pools of funding available for entrepreneurs with ideas – whether these are service businesses or more structural manufacturing or industrial ventures. In reality, unless you have some deep Intellectual Property (IP) very few “Venture” Capital funds are willing to back businesses who don’t have somewhere between $500 000 and $1 million in annual revenue (R8.5m – R17m) and some form of business traction.
Banks can … leave SME finance in the bank
“Banks should fund SME’s” – this is a common argument that is put forward, but if we interrogate the ecosystem a bit, you will find a couple of issues here.
On the whole, South African banks are largely risk-averse. If we look at Standard Bank for instance, their Credit Loss Ratio for Business and Commercial banking was around 1.4% – this is pretty much on par with their peers. Structurally, you want banks to maintain good credit profiles, but this figure does demonstrate the risk appetite. If you put yourselves in the shoes of credit committees and bankers who are tightly measured against this figure, it does give you a clear indication of how they wish to deploy this capital.
If we assume that inflation runs at about 4% in South Africa and you could be getting around 7% just for leaving your money in a Money Market of even 9% in government bonds – there is not a lot of incentive to take risk on entrepreneurs.
Now we know factors influencing SME finance / lending … but why are the fintech lenders still so expensive in South Africa?
Over the last few years, we have seen a rising number of alternative SME lenders in South Africa – largely driven by developments in the fintech ecosystem. For example, we partner with the likes of Bridgement and Lula – two partners who are able to process your application and disburse up to R5m in 72 hours.
On paper, that is a very compelling option for entrepreneurs who often have variable cash-flow and need access to quick capital.
For most entrepreneurs who have done work with these and other lenders, they often despair when they look at the cost of this funding which comes in at somewhere between 15% and 22%.
Viewed through that lens – SME finance is very expensive – almost prohibitively so.
However let’s unpack this differently:
If we took a theoretical R500 000 business loan facility with Bridgement, here are 3 scenarios and their repayment structures:
R500k repaid over 3 months will have a cost of finance of R27 750 – 5.5% (cost of funding)
R500k over 6 months will have a cost of finance of R55 500 – 11.1%
R500k over 12 months will have a cost of finance of R111 000 – 22.2%
What can we learn about the cost of SME finance from the above example?
If we look at the above example from Bridgement, what it highlights is:
A) You need to know what the best type of funding is for your business
B) If you use your funding tactically for cash-flow generating activities, you can materially your cost of SME funding
C) Remember that platforms like Lula and Bridgement do allow for early repayment, which can change the cost profile dramatically
The mistake that many entrepreneurs make is that they look to take as much funding as possible over the longest available duration. Rather you should be focusing on your “Entrepreneur Capital Stack” and finding the right kind of funding for what you need at any point in time.
Are you an entrepreneur looking for an affordable SME finance solution?
We want to see entrepreneurs achieve their goals and be able to help them with their access to finance challenge. Whether you’re looking for short term working capital, aiming to access some of the government grants and incentives or you’re looking for more structural capital, we’re on hand to work with you.
