According to various reports by the Ministry of Micro, Small and Medium Enterprises (MSME), the SME sector has emerged as one of the most vital parts of the Indian economy- be its contribution to the GDP, or to the exports or for giving employment. However, they face several roadblocks in realizing their full potential- lack of proper infrastructure, sub skilled workforce, limited access to the latest technology and inadequate government backing. Except for the last one, all other problems stem from weak funding access for SMEs as they face difficulty in raising capital both via debt and equity.
The poor access to the credit could be attributed to the fact that the banks perceive high credit risk associated with financing SMEs, as they face several internal and external issues including weak management capability, low skilled employees, the concentration of customers and small margins. The banks look for collateral, which many businesses cannot provide either due to their small size or due to the business model. In addition, the bad loan problem with banks (especially the PSBs) has further made it difficult for SMEs to get credit. Of late there has been a rise of several NBFCs including many Fintech companies. They have more flexible appraisal process, however, they charge much higher interest rates in comparison to the banks. Thus, the SMEs are left with two choices- either borrow at a higher cost or grow slowly without external funding.
The other option to raise capital is equity dilution. However, the SMEs are not able to raise much money as the private funds are more inclined to invest in startups. At this stage, it is important to differentiate between startups and SMEs as they have radically different business models and funding arrangements. While startups are pursuing answers to a problem, SMEs already have a proven business model. It is generally observed that many startups are not profitable while SMEs are profitable and intend to secure a financially sustainable spot in a local market for the long run. The reason SMEs find it difficult to raise private capital is that the potential upside associated with any private investment is lower in comparison to that with startups- When an investor can easily get a return of 10-12% from mutual funds, stocks, why would he invest in a SME for the same return but much higher risk?
Of late, the government has worked upon improving the fund access for SMEs by relaxing the regulations. The most significant being improving access to the public markets. It is often considered that tapping the public money for growth is only for the large companies but with dedicated platforms by BSE and NSE, SMEs can also raise money. The requirements and compliance associated with listing on the SME platforms are much lower in comparison to that on the Main Board of either exchange. This is a funding source the SMEs should definitely look at.
Another exciting avenue for the funds is to tap the foreign capital- cost of raising capital from an international market is much lower than that in India. Since the cost of raising capital for a foreign investor/lender is lower, the charges are also much lower than what is charged by the Indian banks or the return expected by the private investors in India. While it is true that there are few restrictions and compliance requirement which need to be followed while raising funds from the international market, the low cost and flexibility clearly offset the difficulty. The SMEs must look at it as well.
All SMEs need to do, is to change their traditional mindset to capitalize the numerous opportunities they can tap to fuel their growth.
About Kshitij Singh
Kshitij Singh Yadav serves as the Director of Plutus Business Advisory and brings with him over 5 years of experience in corporate finance, private equity and debt syndication, transaction advisory and business development across different verticals.