Why business builders are not adequately supported

In the previous blog we concluded that small and medium enterprises (SME’s) are vital for the creation of employment and economic growth in low-income countries. Developing SME’s start with selecting the ‘real’ entrepreneurs (the business builders). Persons with the traits of an entrepreneur like high energy level, high need for control, thoughtful risk takers and high degree of determination. How are they facilitated to play their important role?

Actually, there are many organizations in low-income countries like Uganda that target entrepreneurs to stimulate economic development. Governmental organizations, non-governmental organizations (e.g. developmental aid organizations), banks, micro-credit providers, business associations, universities. In Uganda I counted at least 200 organizations involved in stimulating entrepreneurship. But I think we can easily double that number. A substantial amount of developmental aid is directly or indirectly focused on business owners. Actually, the entrepreneur is one of the most popular target groups for developmental effort! Problem solved?

To answer the question of appropriateness of the services provided by these organizations we should first ask the question: What are the constraints for the ambitious and capable small or medium business owner (the business builders) to grow their enterprise?

Unfortunately there are many. The single most overriding constraint (evidenced by many research) for entrepreneurs is the mobilization of financial resources. Another highly important constraint is knowledge and experience, both industry specific (technical skills, production, quality management) and general (how to do sales, financial management, HRM and people management). Depending on the industry other often referred constraints are: infrastructure (utilities and transportation), market access and regulations and corruption.

Because the mobilization of financial resources is the largest, let’s examine the financial services landscape through the eyes of the business builders. My statement is: there is also a ‘missing middle’ in the present support for business builders

Several types of organizations are active in providing financial services to entrepreneurs:

Microfinance institutions

Micro finance institutions (MFI’s) provide micro financial services. In Uganda there are 90 MFI’s active (many of them having more than one outlet). Most well known service of MFI’s is micro-credit. Microcredit is the extension of very small loans (microloans) to the unemployed, to poor entrepreneurs and to others living in poverty who are not considered unbankable. These individuals lack collateral, steady employment and a verifiable credit history and therefore cannot meet even the most minimal qualifications to gain access to traditional credit. The interest rates charged for micro-credit are significant. And so are the overhead costs incurred by the small amounts of the loans and the time intensive collection. MFI’s have adapted different methodologies to compensate for risk, like learning people to save first before they can apply for a loan and loaning to groups instead of persons to create peer-pressure for loan repayment.
Micro-credit is probably the most hot type of developmental aid. Because it works. State of the art micro-credit suppliers are capable of providing micro-credit on a self-sufficient level. Microcredit is increasingly gaining credibility in the mainstream finance industry and many traditional large finance organizations are contemplating microcredit projects as a source of future growth. The United Nations declared 2005 the International Year of Microcredit. In 2006 the founder of micro-credit in developmental countries, Mohammed Yunus, was awarded with the Nobel price. In The Netherlands Princess Maxima is an ambassador for micro-credit.

Is microcredit capable of addressing the financial resource mobilization problems of the business builders? The answer is a clear No. Because in most cases microcredit is too micro. It is a service well suited for micro enterprises (with limited growth potential). But in most cases the entrée and expansion investment for more ambitious and more promising ventures are far higher than the micro-credit loans offer. This is an important constraint of the impact of micro-credit: it is well-suited to establish micro enterprises but the impact on the creation of small and medium enterprises is limited.

Banks
There are ca. 20 to 30 banks active in Uganda, both African and multinational. The most important service banks provide to entrepreneurs are loans. The loans provided are significantly higher than micro-credit. The amounts provided are adequate for the needs of SME’s. But there are other reasons why these loans are not accessible or not suited for SME’s.
- For most entrepreneurs it is very hard to apply for a loan. They are ‘unbankable’. The criteria are harsh to meet. Most banks only loan to entrepreneurs with suffice guarantees (e.g. properties) which most entrepreneurs do not have. The procedures to apply for a loan are very burdensome. And to compensate for risk the interest rates for loans is very high.
- Presently, some banks provide loans to people without guarantees. But interest rates on this loans generally range between 25% and 30%. Capital is an expensive resource.
- The provided loan products are not adequate structured for investments in growing businesses. Most loan products are short term finance. Long term investments cannot be financed with these services. Also, in most cases after disbursement the payment of the interest and pay back of the loan starts immediately. The entrepreneur needs to payback before the cash inflow of the financed investment arrives.

Risk capital providers
There are some risk capital providers (private equity, developmental banks and international financial institutions) providing (quasi) equity. These institutions and investors are not reaching the business builders and small and medium enterprises because minimal investments are in most cases 1 million dollars. In Uganda, only large enterprises need that kind of investments.

To conclude: there is a massive gap in the provision of finance to small and medium entrepreneurs. The most interesting business opportunities are precisely located in this gap. The present financial landscape is not addressing the needs of those small and medium enterprises. Every real entrepreneur faces this gap when trying to build his business.