/ 12 April 2019

The missed opportunity: SMMEs in the South African economy

Starting your own business isn’t easy: more than 70% of new South African businesses fail in less than two years of being in operation.
A major problem for businesses during lockdown is that they are not getting money coming in, so they have little liquidity. (Paul Botes/M&G)

We’ve all heard it before: small, micro and medium enterprises (SMMEs) are the hope of an ailing South African economy with low growth prospects and high unemployment; SMMEs are positioned to provide job opportunities and to contribute significantly to the GDP. SMMEs are the key to job creation and also globally known to be the mechanism to generate new jobs in society. Globally, over 95% of enterprises are SMMEs, which employ 60-70% of the working population.

But then there is the current reality. The SMME sector in South Africa provides an attractive and largely under-tapped market opportunity for the country’s economic growth through funder opportunities and corporate supplier development.

The National Development Plan envisioned that by 2030 SMMEs will contribute 60-80% to GDP increase, and generate 90% of the 11-million new jobs in our country. But, despite these ambitions, South Africa continues to have one of the highest unemployment rates in the world, with a 2018 Q4 unemployment rate of 27.1%. This is an official definition of unemployment, with a wider definition of unemployment putting the figure at beyond 35% of the total population.

In addition, a 2018 study by the Small Business Institute, leveraging IRP5 tax returns and corporate income tax data provided by the South African Revenue Services, the national treasury and existing research, shows that there are only about 250 000 SMMEs in South Africa, accounting for just 28% of formal jobs in the economy. This is despite SMMEs accounting for nearly 98.5% of the number of formal firms in the economy. South Africa also has a concentration of power sitting in only a few employers (mostly government and large corporates), leading to 56% of jobs coming from only 1 000 employers — and these jobs are growing at a faster rate than what SMMEs are creating.

Our country suffers from an under-skilled population, which is evident in a high unemployment rate, despite numerous job vacancies. (Photo: Paul Botes)

We have BBBEE codes driving investment in enterprise and supplier development each year and this gives rise to a plethora of opportunities for SMME development, funding as well as commercialisation and access to market.

It is evident through the Small Enterprise Development Agency (SEDA) SMME Quarterly Update and related estimates that SMMEs are not growing as expected.

So why aren’t we seeing the dividends of all this goodwill and good intention? Why is South Africa not changing its high level of unemployment and managing to see the benefits of a supportive environment that facilitates the survival and growth of small businesses, resulting in increased, sustainable job creation?

Access to funding

In many SMME forums the issue of access to funding is discussed as the biggest and most critical component of SMME growth. Access to finance is noted time and again as one of the primary challenges for SMMEs in the country, requiring urgent attention.

Despite the country’s strong formal financial sector as well as opportunities for funding through developmental finance institutions, private equity, venture capital and other grants, small and informal businesses still struggle to access finance. Most business owners and founders use their own personal savings or borrow from “friends, family or fools”, as the Enabling Environment for Sustainable Enterprises (EESE) survey findings show.

A 2010 FinMark trust survey found that 87% of small formal sector firms had never accessed credit, while the 2016 GEM survey found “problems with finance” led to 28% of entrepreneurs closing their businesses in 2016.

Through conversations with entrepreneurs and multiple studies into this access to finance issue, it becomes evident that South African SMMEs have found a way to innovate for finance, after hitting many brick walls when trying to access funding. SMMEs are “bootstrapping” their businesses through their own savings and finding ways to access loans to finance delivery on invoices. Entrepreneurs in South Africa in many ways have found ways to innovate for finance that their businesses need, usually after becoming disillusioned with the “many” opportunities for funding available to them.

The Global Entrepreneurship Monitor (GEM) reports show that South Africa has one of the highest business start-up failure rates in the world. Minister of Trade and Industry Rob Davies confirms that over 70% of new businesses fail in less than two years of being in operation. This results in a thin pipeline for funders such as development financial institutions, commercial banks and venture capital funds. This thin pipeline is also a function of the risk appetite of such funders, leaving a gap in the funding value chain for funding opportunities for early stage startups, which simply do not meet the funding mandate criteria of many funders.

In addition to the funding criteria, there is also a challenge cited by SMMEs that may be ready for finance (they have viable business models, match available finance, and have the necessary security) but are unable to secure the finance they need, due to their lack of finance readiness, i.e. they are unable to produce the financial documentation required by funders to assess bankability and affordability, in order to approve their funding applications.

There is a gap between funder expectations and SMME abilities, which often results in missed funding, painful investor-SMME relationships and punitive consequences for not meeting funding hurdles. Often this gap is due to another real problem for SMMEs regarding access to skills in order to increase their finance readiness.

Shortage of skills

South African SMMEs currently face great pressure to secure the right skill sets. They are facing a skills shortage. Most skilled people are employed by the public sector and large businesses in the private sector. As a result, SMMEs are faced with an access and affordability of skills problem. The demand for certain skills far exceeds the supply of such skills. The country suffers from an under-skilled population, which is evident in a high unemployment rate, despite numerous job vacancies. South African SMMEs face pressures in securing the right skills for their businesses. This skills shortage is further compounded in its impact on SMMEs, as they are often unavailable and/or unaffordable for SMMEs.

The SMME ecosystem in South Africa has focused in many ways on attempting to upskill the key players in SMMEs through mentoring, coaching and training efforts. These efforts have assisted in some ways to lift the game of SMMEs, however, the skills shortage continues. Many SMMEs are learning important elements required for business (finance management, operations support, sales processes, etc) but are mostly not implemented into the business due to ability, skills and time shortages. Thus, despite access to coaches and mentors, as well as having training on the aspects of business, SMMEs often find themselves without the benefit of implementing these in their businesses.

S’onqoba Vuba is cofounder and managing director of Perpetu8. 

Red tape reigns

South Africa’s labour laws have been found to be a significant regulatory obstacle (OECD, 2015) to business growth, particularly when it comes to registering a company, regular compliance for the company as well as when laying off staff. Small business owners have found regulatory requirements time-consuming and often, a requirement that they are just not often skilled enough to manage and execute. This often results in SMME non-compliance or additional expenses and time spent on attempting to gain compliance.

There is also the difficulty of matching the fluidity of small business to the stringent requirements of labour laws. SMMEs find that once they have employed workers, the law makes it difficult to lay the workers off if the business can no longer afford to keep them, or if they prove to be unproductive. Labour laws, according to GEM, do not provide for cyclical declines in small businesses.

Government departments are looking into this issue of red tape, but until there are some clear actions and changes, the burden continues to rest on SMMEs.

Future of SMMEs

The National Development Plan (NDP) aims to create 11-million jobs and grow the economy by 5%. Currently, the economy is forecast to grow by 1.2% and unemployment is at 27%.

Within the SMME development ecosystem there are numerous players performing different roles. There are funders providing funding to SMMEs, there are support platforms providing work and networking spaces, as well as space for coaching and training. Large amounts of money are spent on physical spaces as well as face-to-face training sessions.

However, SMMEs are still not showing the positive upside of these interventions. The reality is that its heavy lifting and hard work. However, there are opportunities aligned to how the world is changing. We are experiencing unprecedented amounts of technological change through digital; there is a growing trend towards temporary workers in the country; and there is proven literature around best practice in building a business for more exponential growth.

These opportunities challenge our current tried and tested ways of doing things and in many ways the first adopters of these opportunities are starting to show the benefits. As a country we are aware of these changes and opportunities and through a Presidential Commission on the Fourth Industrial Revolution, are looking to develop a countrywide plan to leverage this global phenomenon.

SMMEs are actually well-placed to leverage, given their lack of legacy and their nimble nature. SMMEs have innovated for finance when its needed and now there is an opportunity to innovate for the skills scarcity problem. The future world of work speaks to a growing trend for temporary workers and a focus on on-demand human capital for work needed by companies.

This opportunity is one that is ripe for the taking and allows the connection of SMME management teams that cannot afford full-time specialised and scarce skills professionals, with the world of on-demand temporary workers in industries that are looking to make an impact through leveraging their skills in other ways, and to harness skills and interests that are often not utilised in their typical full-time roles and jobs.

In addition SMME-to-SMME market access opportunities can be developed, where SMMEs are each other’s service providers and clients instead of constantly chasing only large corporate and government clients. Leveraging on-demand skills allows for a sustainable way to build up successful and sustainable businesses, ready for large-scale investments, that can achieve scalability in a structured way.

Perpetu8 aims to create a bridge between micro and small businesses and the attainment of medium enterprise classification. In so doing this will develop more sustainable and successful SMMEs in South Africa that start to move the economy to growth, and will enable Africa to partake in shaping the 4th Industrial Revolution, rather than merely being a follower.

The goal and vision is to see lesser tax and business compliance requirements for SMMEs. The cost of tax and business compliance for smaller businesses is meaningfully higher in comparison to their revenue and the cash flow at their disposal. The Labour Relations Act legislation has been key in protecting the rights of the employee, but it has allowed for the employer to reconsider terms that do not benefit the employee. Some modifications are needed in labour practices that will bring flexible working relationships that strive to move with the times and trends in work spaces.

Large South African corporates are encouraged to support and also buy shares in SMMEs, allowing small businesses the confidence to grow and close the gap when it comes to access of funding.

The increase in local companies being added to large corporate supplier databases shows that there is an uptrend in this area. In addition, the education of local SMMEs in international business will allow South African SMMEs access to foreign funding and investors. The easier and more transparent access to funding becomes, the greater the opportunity for sustainable small businesses.

Administering of fair and corruption-free tender processes will allow equipped and qualified companies to add more value to enable the development of small businesses. Ensuring that once tenders are issued and a company has started with the contract, that they are paid in 30 days or less will mean more surviving small businesses; it will allow them to pay their suppliers and employees on time. Business legislation must aim to create a platform that makes it viable to employ young individuals with potential and create support programmes for SMMEs to train them. There is a significant financial and time investment required to train a young person, which can make SMMEs sometimes wary to do so, so providing compensation for training will make it worthwhile for them.

For small businesses to thrive they have to be flexible, adaptive, well-versed in skills, and have access to funding and mentorship. Small businesses need to be hungry for innovation and learn to adapt in an ever-changing era. The uncompromising business landscape of today requires entrepreneurs to be agile and free of any unnecessary operational and administrative problems, allowing them to direct their business towards application of knowledge, implementation of systems and profitability.