The dire state of our small business sector

Toby Chance says three recent reports are a wake-up call for policy-makers

Evidence points to a marginalised small business sector

Three recently released reports paint a dismal picture of the contribution small and medium enterprises (SMEs) are making to the economy. They are a wake-up call for policy-makers who assume that SMEs are the main jobs drivers and will create 90% of new jobs by 2030.

Compared to its peers, South Africa has a smaller number of firms in proportion to the size of the economy and a much higher proportion of jobs coming from large firms and government. With smaller firms closing down and shedding jobs, and larger firms getting bigger though not necessarily hiring more people, it is inevitable our unemployment rate will increase further.

The reports focus on the formal SME sector and extract data from Treasury, SARS, commercial banks and other providers of finance as well as firms seeking finance. They each claim, in their respective focus areas, to be the most comprehensive studies yet done.

They home in on changes in tax receipts over time, access to finance and the quantum of firms and their contribution to employment to gauge whether the sector is making its expected contribution to the economy and participants are succeeding or struggling.

At the Small Business Initiative Indaba last week, preliminary findings released from its research conducted in partnership with the Small Business Project reveal that South Africa is very much the “outlier” compared to its peers. It found there are only 250 000 formal SMEs (firms employing less than 200 people) in South Africa. Though they comprise 98,5% of all formal businesses, they employ only 28% of the formal workforce. Using SARS corporate income tax and PAYE data, the findings indicate that SA’s 1 000 largest firms account for 56% of jobs, though this includes government which skews the numbers significantly.

By contrast, in the Organisation for Economic Co-operation and Development countries, over 95% of businesses are SMEs, employ between 60% and 70% of the working population and contribute up to 60% to GDP.

According to the Enterprise Observatory of SA survey of tax receipts, released in April, “only 25% of firms have earned sufficient to be liable for company tax; firms with a taxable income below R10 million decline at a rate of 31 per week; a mere 635 companies are responsible for 77% of company tax; and from 2009 to 2015 company losses as submitted to SARS increased by 85% and for the last two years were higher than the taxable income assessed.” Reduced profitability and an alarming shrinkage in the number of SMEs submitting tax returns are evidence that the “missing middle” of SMEs vital to a thriving economy is in deep trouble.

The SMME Access to Funding report, released in early July, uses the FinFind dataset, where applications for funding are matched to providers of funding. 86% of firms in the dataset turn over less than R1 million a year while 75% were early-stage or pre-revenue. This is very much at the bottom of the pyramid and the report notes it is here that the demand for finance is greatest but the supply is least.

Black business owners are seeking smaller loans to start businesses while white, coloured and Indian business owners seek larger loans to grow existing businesses. Hence, it points to a “credit gap” in South Africa of between R86 bn and R346 bn.

On employment, the report estimates that firms with a turnover of less than R100 million employ in total between 2 and 3 million people, or a maximum of 30% of the formally employed. This echoes the SBI/SBP findings.

These three reports emphatically demonstrate an inadequate supply of new firms feeding the economy and too few firms overall. Black-owned firms in particular are finding it hard to get established and grow because of a lack of finance. Decades, even centuries of exclusion have prevented black entrepreneurs from building up a pool of assets which typically are required to start a business.

Most start-ups rely on own savings and family and friends offering patient finance, but black households do not have this luxury so they turn to external sources of finance. The high failure rate of these start-ups leads to debt piles and non-performing loans, which in turn raises interest rates to punitive levels creating a vicious cycle.

Fifteen years of BBBEE has done little to create a self-sustaining black entrepreneur class. The emphasis on ownership in the scorecard has led more to rent-seeking in existing white-owned businesses than to the formation of new, innovative small businesses. The DTI’s goal of creating 100 “black industrialists” will barely scratch the surface and is further evidence of a band aid approach rather than the fundamental structural reform the economy needs for new businesses to spontaneously emerge and thrive.

Where is the Department of Small Business Development in this picture? Sadly, nowhere. All the significant studies are private-sector initiated and funded. The Department has admitted its research capacity is limited and it has little to offer in this debate.

What the Department should be doing is bringing together all the role-players and drawing conclusions to feed into policy and legislation to remove the blockages hindering the formation and growth of small businesses.

The SME sector performance can be summed up in three metrics: the number of start-ups created annually, their survival rate and their growth rate over time. Then, add people employed, turnover, corporate income tax paid and IRP5 receipts to give us a picture of their contribution to the economy. If these numbers go up consistently, we know we are on the right track.

Government policies and our distorted history are compounding to drain the lifeblood out of our small and medium enterprises. For them to claim their rightful place in the economy a completely new approach is needed.

This starts with improving the entrepreneurial incentive so that more new businesses are created. Reducing regulations and red tape, paying invoices on time, levelling the playing field between big and small businesses, a focus on competitiveness and integration rather than compliance and protection, and collaboration between business and government to improve the risk/return while reducing the cost of borrowing, are obvious next steps.

More broadly, SA’s economy needs to be reconceived to have large companies work with small companies to ferret out export opportunities and the small companies should, wherever possible, look to piggyback on the large companies’ existing asset bases. This requires a determined effort by the likes of Business Unity SA, Business Leadership SA and the CEOs initiative to place collaboration with small business front and centre of its policy initiatives and to take the lead along the path government has failed to tread.

Toby Chance MP is DA Shadow Minister, Small Business Development.

This article first appeared in Business Report.