Up to 75% of South African small businesses fail within the first year. The biggest causes include a lack of funding or poor financial management. Yet, many small businesses struggle to secure funding, either because they haven’t been in business long enough, or because they don’t understand the intricacies of the lending market.
Speaking in a recent episode of the Sage #SmallBizAfrica podcast, Leonard said some reasons SMEs fail to secure funding include:
- Not having a compelling reason to borrow money;
- Applying for a loan that the business is unable to repay; and
- Not being in business for at least a year with revenue under R1 million.
“Many small business owners don’t understand that they can only borrow a percentage of their turnover. No lender – whether a bank or an alternative lender – will advance a loan equal to their entire turnover.”
Alternative lenders are not registered with the National Credit Regulator (NCR) and cannot loan money to businesses that don’t meet the one year / R1 million minimum requirement. These businesses are considered start-ups and would have a better chance securing funding through an equity partner or personal finance, says Leonard.
Research has shown that around 40% of small businesses struggle to access funding because they don’t meet traditional lending criteria, which are not small business friendly.
“Small businesses have a better chance of accessing funding if they already have all their finances in order. Cloud-based accounting solutions can help them pull any finance report they need for their loan application,” says Leonard.
Banks vs alternative lenders
Banks should be a small business’s first choice for funding, says Leonard, because they’re the cheapest. But they’re often slow to grant funding because of the checks and balances businesses must complete.
In cases where these businesses need money fast – for example, to pay invoices or salaries, or to fulfill a purchase order – alternative lenders are a good supplementary option.
However, the downside of accessing money within a day or two, she says, is the cost of alternative lending. This is why the benefits of accessing funding should outweigh the cost of acquiring it.
Tips for lending success
Before business owners apply for funding, they need to know why they need the capital. “Lenders won’t just hand over money,” says Leonard. “They’ll want to know the purpose of the loan, like expanding into new markets or paying salaries.”
Once lenders know why the business needs funding, they can decide what funding product is right for them.
“There’s been an uprising of alternative lenders in South Africa. It can be confusing, overwhelming, and time-consuming to find the right one,” she says. “That’s where credit marketplaces like FundingHub come in. We can guide you towards the right lender without you needing to know the intricacies of the available products.”
Credit marketplaces can also help small businesses avoid unsecured lending, or “loan sharks”, says Leonard. “Small businesses might get excited at the prospect of same-day loans, but they’re often ripped off by high interest rates and undisclosed costs.”
This happens because alternative lenders are not regulated by the National Credit Act (NCA). This makes it even more important to find a lender that realises the importance of self-regulation. She advises partnering with a lender registered with the South African SME Finance Association (SASFA), which encourages transparent and responsible lending. This is a relatively new association and is gaining momentum among alternative business lenders.
Banks and responsible alternative lenders are also more understanding and accommodating with loan repayment terms, if the business runs into financial problems, she says. “Lenders are in business because you’re in business. They want to see you succeed. As soon as you have a problem repaying your loan, talk to them about renegotiating your repayment terms.”
Starting a business in South Africa is not easy, says Leonard. One of the biggest challenges facing small businesses is cash flow problems caused by slow or late payers. State-owned enterprises (SOEs) and large corporates tend to be the worst offenders.
“When a small business has to wait between 30 and 90 days for payment, they run into cash flow problems and also incur finance charges. At the end of the day, that big order they secured is not as profitable as it could have been. As a result, we’ve seen a surge in products like invoice and purchase order funding.”
Small businesses are starting to realise that alternative funding can be an enabler of their success. It might be expensive but it’s better than losing out on a big deal or not being able to fill a large order.
Leonard says everyone has a role to play in enabling small business success. Government should enact policies that establish reasonable payment terms and create funding vehicles that help start-ups through the first tough year. They can then approach alternative lenders for the next round of funding.
The private sector should change their payment terms, especially as they diversify their supply chains to include more small businesses and meet B-BBEE requirements. “It has to be a collaborative effort. We have to work together to empower the SME space and micro enterprises if we want to grow the economy.”
Small businesses should keep in mind that a loan is technically a business expense – and capital alone doesn’t guarantee their success. They should also focus on better managing their cash flow through regular forecasts and negotiating payment terms with clients; hiring and outsourcing to the best people; and having a business plan with clearly defined goals and steps to achieve them.