It is still conventional wisdom that small and micro enterprises (SMEs) are too small to finance, at least using the traditional methods of debt and equity capital. This is particularly true for banks and other formal traditional suppliers of business finance. There is a good reason for this – every investor is looking for a return or at the very least, preservation of capital. In the case of SMEs, the threat horizon is a bright red danger-signalling bouquet of, inter alia, informality, lack of collateral and lack of business skills. The big corporates on the other hand tend to have expert managers, formality, adequate collateral and seem focused on delivering a return to the shareholders. The focus on ability to attract financing would suggest that SMEs would be heading towards extinction. On the contrary, they seem to be firmly holding court in the Zambian economy as the Ministry of Small Medium Enterprise Development stated in November 2022 that SMEs comprise 97% of all businesses in Zambia and contribute a mammoth 70% of Zambia’s Gross Domestic Product (GDP). This notwithstanding, the government still wants to grow the SME sector. Clearly therefore, SMEs rather than being too small to finance should rather be seen cumulatively as too large to ignore. While agreeing that SMEs are too large to ignore, this short essay will seek to suggest further options beyond financing that can grow the SME sector in Zambia.
The encouraging statistics of number of SMEs and their contribution to GDP has been simplified into a homogenous whole for purposes of discussion in this paper. Presumably spurred by these statistics the Government of Zambia created focus on SMEs at cabinet level, in 2021, by crafting the Ministry of Small Medium Enterprise Development – MSMED. The Ministry like many other stakeholders in the SME ecosystem has tended to focus on lack of access to financing as the major problem facing SMEs. One of those other stakeholders is the Ministry of Finance which has reinforced this message. The two ministries have spoken of the need for banks to provide SME specific financing and to lower their interest rates on loans to SMEs respectively. The idea of bank finance is a paralyzingly important cog in the government’s SME policy. Without other complimentary and radical thoughts around how to make SMEs attractive to investment, the sector will simply not grow beyond the current levels and may even shrink detrimentally.
Taking into account the above, what then makes SME financing through traditional channels so challenging? There are many factors, but in my view, they all congregate into risk, specifically, that the risk of failure and loss is too high. The goal of those who then intermediate between financiers and SMEs has got to be primarily mitigating this risk. The Financial Sector Deepening Zambia (FSD Zambia) probably summarises it best as follows.
Micro, small and medium-sized enterprises (MSMEs) have historically been neglected by the formal financial service sector in favour of big corporate clients who bring in more money, take bigger loans and have formal collateral. Certain typical MSME characteristics, such as informality, lack of reliable financial information, perceived lack of business skills, family-owned structures, and inability to pledge adequate collateral to access credit, have discouraged financial institutions from serving MSMEs…
The FSD Zambia also importantly notes the mismatch between SME financial needs and the traditional financial service provider driven solutions.
How critical financing is to any business let alone SMEs is self-evident. To however elevate financing to the silver bullet that will miraculously cure the challenges of the SME sector would be digging a foundation for failure. In fact viewed through a different lens it is clear that there is need for a re-think of the financing models to apply to SMEs. As earlier alluded to, 97% of all businesses in Zambia are SMEs and they account for 70% of GDP. This is notwithstanding anecdotal evidence clearly supporting a conclusion that the majority of SMEs are financed outside the formal financial services sector. While all the other SME characteristics are clearly making it more difficult to access bank finance, it would seem SMEs have found a way to thrive outside formal financing from in particular banks.
Perhaps it is unrealistic to expect banks to be the engine of financing for SMEs. Banks out of all ‘investors’ tend to be the most risk averse in part because of their regulatory environment. We all expect to have access to our money on demand from our banks as indeed does their ever watchful regulator, the central bank, on our behalf. We can obtain more value from other sources of funds, in the case of Zambia, like the many ‘empowerment’ schemes including Constituency Development Fund, CDF. In fact, these funds should be re-purposed and deployed in a co-ordinated manner with the primary purpose of de-risking investments in SME and paving way for private capital to flow to SMEs. One way of doing this would be to utilise the available resources as guarantees for bank loans for those who would qualify for the empowerment funds after the rigorous vetting process.
Notwithstanding the seemingly high devotion to discussing financing even in this short prompt, capital is in my view the icing on the cake. One other important step in creating SMEs that will ultimately attract bank finance is developing healthy businesses. A valuable tool in this regard is the utilisation of a legal health check. The legal health check evaluates various legal elements, flags those matters requiring action and proposes appropriate action. An SME that utilises this tool has a simple due diligence output that speaks to the overall legal health of the business with focus on the legal risks as well as their mitigation.
In conclusion it is clear that SMEs like any other business require capital. However, there is need to work towards making SMEs investment worthy so they can ultimately attract capital. Bank capital though elusive is low hanging fruit and can be re-engineered and complimented through government driven guarantees and legal health checks. In fact making a legal health check a mandatory qualification for access to any public funds would provide the first layer of de-risking the SME sector for development.
Chishimba Chilekwa is a Legal Practitioner at CC Gabriel and Co Legal Practitioners
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This article is for general information purposes and is not intended to be and should not be taken as legal advice.