DM168

BLACK ECONOMIC EMPOWERMENT

Why enterprise supplier development funds are missing the mark

Enterprise supplier development funds are prominent in SA, partly due to the change in the BBBEE ratings methodology, which made it the most significant element on the scorecard. But it’s not making the impact it should.

An interest rate of 15% a year. That was the rate (prime + 5%) we were offered by one of the big four SA banks on a R500,000 loan in 2008. We didn’t hear back from the other three.

We needed the funding to get our financial services business, Gradidge-Mahura Investments, off the ground.

The loan, on which repayments commenced immediately, was plainly unaffordable in the context of a start-up not yet generating any material cash flow.

As an alternative, we approached a government-backed development finance institution.

Aside from their bank-like lending rate of prime + 4%, they rejected our meticulous business plan. We eventually secured a R1-million loan from what was then an early iteration of an enterprise supplier development (ESD) fund. The terms?

A flat interest rate of 5%, with no interest accruing or repayments due for the first six months. Without that loan, Gradidge-Mahura Investments may very well have remained a dream.

Rise of the ESD fund

Nearly 14 years on, and our business is self-sustaining with more than 20 full-time employees. It also makes a significant contribution to government revenues – in fact, accounting for all taxes paid, the South African Revenue Service has made more money from the business than the founders have! It’s hard to quantify the impact of providing employment, but the ripple effects – like being able to support family members and educate children – are clearly significant.

Today, ESD funds are more prominent in SA. This is partly due to a 2015 change in the BBBEE ratings methodology, which made ESD the most significant element on the scorecard. In principle, that regulatory amendment was great because it helped create a larger pool of capital from which SA’s small businesses could draw funding. But in practice, the ESD mechanism isn’t making the impact it should.

Great idea circumvented

Companies that want to earn ESD-related scorecard points can support qualifying businesses themselves, or hand over their ESD spend to a third party that will do it on their behalf. The underlying problem with many of today’s ESD funds is one of intention. Instead of making the development of small businesses the primary key performance indicator, they are either choosing to prioritise a return on the capital they disburse, or are being mandated by their funders (i.e. the businesses trying to improve their scorecards) to do so.

The result of this dynamic is twofold:

  • Small businesses with modest growth expectations are often denied funding; and
  • The lack of a developmental mindset leaves valuable small-business potential untapped.

There’s also a moral issue at play here. Should the businesses benefiting from their improved BBBEE scorecard also be targeting a market-related return on their ESD spend? In our minds the answer is clearly no.

We’ve come face to face with an ESD fund motivated by return, rather than impact and development. Here is a list of their three most vexing demands:

  • Provide collateral for the loan amount.
  • Share your revenue (not profit!) with us.
  • We will sign off your salary increases.

Naturally, we pushed back with questions about how they were being remunerated, and why their funding came with such repressive and patronising conditions. No explanation was forthcoming on the former.

For the latter, they cited the need to recycle funds into other qualifying businesses. That rationale made little to no sense since there is a constant flow of ESD money coming from their funders.

How many small SA businesses with potential have been left high and dry by these lending criteria? More than we can afford, and more than would have been the case if ESD funding had stuck to its developmental pattern instead of chasing returns.

What real ESD looks like

The purpose of any ESD initiative is not simply to lend or invest money into SMEs. The ‘D’ stands for development, which can and should include non-financial elements like mentoring, training or in-kind support.

As our business plan was coming together, we came across a picture in a community newspaper of two black entrepreneurs who had been given office space by an investment bank as part of their enterprise development programme. We applied to that programme, and were granted free office space for two years, which was later extended to three.

In 2011, we secured a similar deal on new premises, and then the power of genuine ESD occurred. The income-statement relief that comes with free office space, plus the infrastructure and marketing support we were given, gave us the breathing room and means to grow our business. And grow we did.

The asset manager who provided the space and support not only achieved their desired BBBEE status, but also created a new client – our business. That circular return on ESD spending is more powerful and sustainable than trying to squeeze fledging businesses for every cent they can afford.

Think like an entrepreneur

Another downside to ESD funds that prioritise returns over development is the people they employ. Instead of entrepreneurs who understand what it takes to scale a business, you get individuals who tailor funding solutions that are completely disconnected from the reality and needs of a small business.

If we are to unleash the true potential of ESD funding, the people and businesses disbursing it need to get closer to the SMEs that approach them for help. To provide the right support – financial or otherwise – they must work to understand the underlying business models, and the vision and skills of the respective entrepreneurs.

This change in approach is important for another reason. There’s a hushed line of thought that ESD spending is a tax for doing business in SA, that the businesses absorbing the funding are somewhat inferior investment propositions. That belief breeds the dangerous “us versus them” paradigm that, in turn, creates latent tension between funder and beneficiary – development rarely takes place under such conditions.

The ‘D’ stands for development, which can and should include non-financial elements like mentoring, training, or in-kind support.

We believe that working more closely with ESD beneficiaries will help to reduce that counterproductive thinking because funders, or their nominated ESD funds, will feel that they have skin in the game; small business success becomes their success.

Call to action

Our business is proof that ESD support with a developmental mandate works. But the prevailing “return first” mindset is too common, given the intended goals of the legislation, the dire state of our economy and the number of frustrated entrepreneurs.

What can we do?

  • The Department of Trade, Industry and Competition should review how ESD funds operate to establish whether their lending and development practices serve the purposes of the legislation.
  • ESD funds should recalibrate, measuring their success on the number of businesses developed, jobs created, communities impacted.
  • Entrepreneurs approaching ESD funds for support should take a negotiatory approach to any offer they receive, and work together to raise awareness about unreasonable ESD lending.

It’s no secret that the fates of our economy and people are inextricably tied to the success of small businesses in SA. Without any hyperbole, ESD funds have the potential to put our country on a path to inclusive prosperity. Standing in their way is a focus on returns instead of development. BM168 

This story first appeared in our weekly Daily Maverick 168 newspaper which is available for R25 at Pick n Pay, Exclusive Books and airport bookstores. For your nearest stockist, please click here.

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