Risky business

Take any government small business finance agency, withdraw its soft, development money, privatise it and send it into the jungle of commercial finance to fend for itself. What will happen?

The low-return, high-risk nature of small-business finance predicts one of two things. It will either fail or it will evolve away from small businesses as its seeks out increasingly larger, more established businesses to finance.
Commercial small business finance is not so much a niche as a purgatory between the black hole of development finance and the paradise of corporate finance.

Business Partners has done neither. The small business finance company that emerged as the privatised version of the old regime’s Small Business Development Corporation in 1996 has stuck to its market and succeeded.

Incoming managing director Nazeem Martin, who takes over from Jo’ Schwenke at the end of this year, says the average size of a Business Partners deal is R1,2-million—closer to its minimum of R250 000 than its maximum of R20-million per deal. And its investment portfolio has grown threefold from R564-million in 1997 to R1,67-billion last year. It’s not had to ask its shareholders for more capital.

How do they do it? Martin’s first answer is all chief executive speak: “The secret to Business Partners’ success is it has, over the years, been able to attract people who are passionate about entrepreneurs and entrepreneurship and go about their work with missionary zeal. And all the systems that we have internally are—you can call it games if you want—that we play to ensure that that missionary zeal remains intact.”

Business Partners comes from a development background and Martin is adamant that “just deciding to invest in SMEs are by their very nature development [finance]”.

He says that the maximum return an investor can hope for from small businesses is 25%, because most are lifestyle businesses. Very few of them want to grow empires, let alone succeed in doing so. From that 25% an investor has to deduct the cost of making and maintaining the investment (about 8%), bad debt (2% to 5%) and tax, bringing the likely yield down to about 10%. “If you’re lucky,” says Martin.

With such an outlook, the missionary zeal needs to apply to the shareholders, who could get the same, if not better, returns by keeping their capital in the bank.

Martin agrees: “The fact that [shareholders] are willing to live with [these] kinds of returns means that they have a development motive.”

But with the exception of the government’s small business finance agency, Khula, which owns 20%, shareholders all are hardened exponents of the profit motive. They include Remgro (20%), Sanlam (7%), Billiton (6%), the four banks (3% to 4% each), Old Mutual and De Beers.

The shareholders’ commitment may waver as Business Partners moves further from its origins but, for now, Martin has no doubts about what they want. “They love what we do, they want us to do more. They put it quite quaintly: ‘We want you to touch more SMEs.’”

As Martin describes the organisation that he is about to take over, you get the sense that its success stems from a combination of carefully balanced factors. The one is the shareholder intent—which requires a commercial return, balanced with a development motive.

Then there is the staff incentive system, which is designed to balance the volume of deals, the rand value of the investments and the risks they pose. Each loans officer is measured by his or her “contribution” in a system that Martin says is unique to Business Partners. If a loans officer makes investments that go bad, it severely affects his or her bonus. If he or she only seeks out safe deals, the returns are so low that targets aren’t reached. So each loans officer strives for a balance between risk and return.

The third balance that Business Partners seems to have refined is between equity finance—where the company takes shares in the business it finances - loan finance and royalties. Pure equity finance does not work, says Martin. The kind of businesses that approach Business Partners for finance can’t match its investment, so it ends up taking the majority of shares, which breaks the business owners’ drive.

Also, with pure equity, Business Partners has only one way of realising a return on investment—when it exits three to seven years after the investment. A small business may be profitable by then, but still unable to buy back its shares from Business Partners.

By working out a balanced finance package—that includes taking a minority share, royalties based on turnover and loan finance—the business owner retains a majority and can afford to buy back the remaining shares on exit. Business Partners gets the return it requires and, most importantly, the owner can get the finance without necessarily having 100% collateral.

Martin says one of the challenges of his tenure will be to popularise the idea of risk finance among South Africa’s business owners, who think of the banks first when they need finance. This even though banks require full collateral for their loans, which the owners seldom have. Risk finance “may be more expensive, but at least they can get it”, says Martin.

Another development that Martin will preside over as managing director is Business Partners’ move into other African countries. He says the World Bank’s International Finance Corporation (IFC) became so intrigued by Business Partners’ risk finance model that it asked the company to pilot it in Madagascar as well as Kenya.

The IFC put up the capital and, with government and donor money, established technical assistance funds to help the financed business owners with skills development. Business Partners charges a management fee.

Back home Martin intends to establish a similar technical assistance fund, which business owners can access at no interest. The idea is to make the commercial mentorship and consulting service that Business Partners provides to its clients more affordable.

Martin hopes to do this by capitalising on the good relationship between Business Partners and government, which he says has not been better since the withdrawal of state support in 1996. If he manages to do so, he will have added another possible outcome for a privatised government small business finance agency. It may come full circle as its success persuades the government to embrace it once again.

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