Small and medium enterprises (SMEs) have long been the true creators of employment in most countries. This is particularly true both in the US and in India. In the US, there are 28 million small businesses and they have created over 65% of the new jobs over the last two decades. In India, according to the most recent census, there are over 31.1 million SMEs which create employment opportunities to over 73.2 million people and account for 8.7% of India’s GDP.
These are the officially reported figures and the actual impact of the sector is likely to be significantly higher. SMEs play a vital role in fostering local economic development. They create and retain jobs, they provide reliable access to essential goods and services and they improve the quality of life in a community. In many low-income communities, SMEs are the primary sources of employment. In spite of playing an important role in the economy, SMEs are under-served in terms of their ability to raise capital to support their enterprises and face several structural barriers to growth.
Some of the key challenges facing SMEs are:
a) Limited Access to Capital: SMEs in the US struggle to get credit from banks after the global economic crisis in 2008. Banks have become more risk-averse and have shied away from lending to SMEs. This situation has put a strain on even stable SMEs to raise capital to support their growth needs. The situation is even stark in India where a majority of SME rely on predatory money lenders who charge anywhere between 3-10% monthly interest on their loans.
b) Access to Professional Services: Another key factor that limits the growth of small businesses is limited access to professional service providers such as lawyers, CPAs, human resources and marketing professionals. Typically, the services provided by these professionals are cost-prohibitive for most SMEs, but access to such services is critical to overcome some of the important barriers for growth faced by SMEs.
c) Inadequate Management Training: Many entrepreneurs who launch SMEs have expertise in their field, but have limited management training and experience that is vital to sustaining an enterprise. As a result, they face challenges particularly in hiring and retaining a skilled labor force. They don’t have a sufficient network or access to mentors. Therefore, their growth potential is limited even further.
What are the most effective ways to address these challenges?
There have been a lot of innovative solutions being implemented around the world.
1. In India, Avishkaar Venture Management, India’s first rural-focused venture capital firm, has been providing micro-venture capital to SMEs in agriculture, dairy, healthcare, water and sanitation, handicrafts, technology for development, education and renewable energy sectors for over 10 years. A typical investment size ranges from $50,000 to $500,000. Avishkaar also works very closely with its investee companies and provides support and mentorships to these firms. Avishkaar is considered to be one of the pioneers in the sector and has successfully delivered commercial returns, while advancing economic development in rural communities in India.
2. In Nicaragua, Agora Partnerships provides entrepreneurs with knowledge, network and capital they need to succeed. Agora Partnership screens high-potential entrepreneurs in Nicaragua and organizes an Investor Conference to connect socially-conscious investors with SMEs. It also provides deal closing services which involve due diligence support, term sheet analysis, financial modeling, closing support and post-investment support for SMEs. A typical investment is around $100,000.
3. In the US, Community Development Financial Institutions (CDFIs), such as Seedco Financial Services, invest anywhere from $50,000 to $750,000 in SMEs which cannot access credit from banks. The target customers for this loan product are traditionally disadvantaged businesses such as minority-and-or-women owned enterprises, SMEs located in low-income communities and other segments of the market which banks typically don’t finance. Seedco Financial combines its affordable capital with ongoing business assistance in the form of advisory services, workshops, connecting entrepreneurs to business mentors and providing subsidized access to professional services.
All these business models, combine business support along with credit and provide an opportunity for entrepreneurs to develop their management skills. The demand for the credit plus business training models discussed earlier in this blog vastly exceeds the availability of such services. But, we cannot have inclusive growth without SMEs. And, for that to happen, the availability of flexible financial products and business assistance programs will have to be successfully scaled up.