How SMEs can overcome funding gaps…

After receiving funding at a breakneck pace, winter seems to have set in for startup communities. Stories are circulating about startups opting for belt-tightening measures and suspending operations following a dry spell of funding. This problem is more acute at the level of MSMEs (Micro, Small and Medium Enterprises) and SMEs (Small and Medium-sized enterprises), the growth drivers of the economy. 

Where availing of finance is concerned, let’s review the situation of some established startups. 

As many as 44 unicorns were born in 2021, but only 23 emerged on the horizon last year, the Hindu has reported. The only bright part was that nine of the 23 unicorns emerged from non-metros; the report points that funding to startups in non-metros grew to 18% of the total inflows share.

A reality check may have set in after the initial startup funding euphoria. “Cars24, Meesho, Blinkit, Unacademy, Vedantu, Trell, OKCredit, Lido Learning and others are among a host of startups which are reported to have laid off employees as the startup ecosystem faces rough weather,” notes the Business Today.

Ola aspired to get listed on the bourses but was forced to change its strategy – the firm was prepared to raise funds at a 40% lower valuation. Around this time last year, Byju Raveendran, founder and CEO of Byju’s, had discussions with international and domestic banks to raise $400 million into his company. The aim was to revive investors’ interest at a time when valuations were under stress worldwide. Citing operational stresses, Swiggy scaled down its Supr Daily service and even suspended the Swiggy Genie service.

Why the funding tap is off occasionally?

The underlying theme is that businesses with humble beginnings face a constant challenge of funding. The reasons are manifold.

  • Understandably, investors prefer to wait and watch if the business can promise a favourable return. 
  • Many companies might approach the same investors. Having a competitive edge is the key to attracting funding. Many startups struggle to have that differentiator.
  • As has been mentioned in recent times, overpriced valuations often hurt startups. The recent episodes of corporate governance at startups have compelled the SEBI to examine their valuations closely. 
  • Regulatory hurdles and a lack of knowledge about domestic and international markets are the other logjams. 

Generally, attracting funding is a daunting and often cumbersome process for SMEs and MSMEs. Without a strong fundraising strategy, they even fail to get off the ground. Owing to their low-ticket size, lenders enforce stringent eligibility norms. Firms without a credit history are deemed risky. Deprived of timely funding, these companies are unable to honour their production commitments. They fail to procure raw materials to conduct operations smoothly.

High collateral against loans was a bottleneck in the past but not anymore. The Government of India has offered collateral-free credit to SMEs and MSMEs through the Credit Guarantee Fund Scheme for Micro and Small Enterprises (CGMSE) scheme. MSME Business Loans in 59 Minutes, Mudra Loans, National Small Industries Corporation Subsidy, Credit Link Capital Subsidy Scheme for Technology Upgradation and Udyogini are other initiatives aimed at keeping these businesses in fine fettle. Yet, SMEs and MSMEs need more assistance to break open the clots in the financial arteries. Not able to communicate the nature of the business to the lender could be an issue as well. 

SME ratings, the lifeline

Many years ago, a story was reported about a Delhi-based businessman whose bank refused to fund his electronic business. The bank was unable to understand his technology-driven enterprise. Perhaps, he couldn’t offer a perspective of his business. A chance reading of a newspaper article turned around his fortunes. The report highlighted about MSMEs getting ratings from a few SME-rating organisations in Coimbatore and getting access to finance from banks. He had his firm rated and secured a loan. This is a shining example of how SME rating institutions can serve as a lifeline to these business entities.

Unlike big businesses, SMEs have no organised information on the dynamics of their industries, functional details, and even the promoter’s track record. Naturally, their creditworthiness is assessed by specialists – in this case SME rating institutions – who use rating models and methodologies specific to the MSME sector. In addition, SME ratings offer an unbiased evaluation of their financial performance and operational capabilities. Potential investors and lenders thus perceive these SME rated entities as less-risky borrowers. Favourable SME ratings that provide an accurate and independent assessment of MSMEs financial health and prospects can give these businesses access to equity and debt financing. They can also negotiate better financing terms. 

SMEs also face challenges in complying with tax laws, labour laws and other government regulations. Since they’re largely ignorant of these policies, they find the processes complex and expensive. Invariably, they can’t dedicate their resources towards non-core business activities. These compliances require the expertise of professionals, which is where rating agencies come in.

SME rating institutions also delve into critical areas like the pedigree of the management, comparative business performance and customer satisfaction levels. For instance, SMERA, World’s first SME rating agency, measures business credibility on benchmarks specific to these businesses. Besides providing a meticulous assessment of business and financial risks, SMERA evaluates organisational parameters like operations, finance, compliance and technology. For greenfield and brownfield business expansion, SMERA evaluates the feasibility of the capex project.

Additionally, it focuses on:

  • Growth plans, risk appetite, and style of conducting business (cautious or aggressive).
  • Promoter’s value systems.
  • The soundness of governance.
  • Automation of operations.
  • Sustainability policies.

SMERA has also updated its rating product into a short, crisp, and in-depth analysis-driven report on various business parameters of startups that helps bankers make informed lending decisions. Through SMERA’s 360° methodology, banks get complete clarity on an MSME’s financial risk, (accounting quality, past financials, financial flexibility), management risk (the company’s experience in the relevant sector, aspects of governance, integrity of owners) and business risk (market position, operating efficiency). Now, SMERA’s analysis tools like Techno Economic Viability (TEV) provide an appraisal of the feasibility of the technological parameters of a project. TEV also helps in measuring the financial viability of projects after factoring in market risk, regulatory risk, and financial risk.

The stark realities

Recently, The Times of India reported that the demand for MSME loans grew by almost 1.6x times last year as compared to the pre-pandemic levels. Their financial needs aren’t limited just to the expansion of business. In the absence of training initiatives, retaining skilled labour remains a challenge. These initiatives need a considerable amount of funding. Consequently, in an intensely competitive business environment, many SMEs lose trained resources to competitors. Owing to funding constraints, they’re unable to invest much in advertisements, and marketing and are unable to keep pace with digital transformation. But these are just gaps, not monumental hurdles that can’t be overcome. SMERA can vouch for it. 

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