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Author: Edmund Higenbottam, Patrick Ball

Publication: Making Finance Work for Africa Blog

Category:

Date: 8 June 2020

Receivables Finance: Innovative approaches to unlocking Access to Finance for African SMEs

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Restricted access to finance for SMEs remains a roadblock to growth for economies worldwide. Economies across the African continent remain no different:

  • in South Africa, where SMEs are estimated to employ between 30 and 50% of the workforce and contribute 20% of GDP[1], the estimated credit gap for SMEs in SA between $6 and $23 billion;[2]
  • in Kenya, recent estimates put the MSME Finance gap as a percentage of GDP at 31%, totalling nearly $20 billion.[3] Similar estimates put SMEs providing 80% of the country’s employment and contributing 20% of GDP;[4] and 
  • in Côte d’Ivoire, 2016 government reports indicated that SMEs constituted 80% of all firms in the country yet received just 12% of total investment. A further 70% of SMEs are estimated to be unable to obtain bank credit.[5]

Across the Continent, SMEs – typically defined as those with fewer than 250 employees, turnover less than $2 million and capital needs ranging from $20,000 to $2 million – are continually frustrated by raising capital from traditional funding channels such as banks, who still typically require traditional (and expensive) information sources such as audited financial statements that few SMEs have a consistent need for or access to collateral security that SMEs have access to. The current pandemic-induced economic crisis is accentuating this situation, with SME demand for funding increasing at a time when bank lending will be, in many instances, less active to these companies.

Against this backdrop, an increasing number of alternative funders and funding platforms are working in these markets to unlock this finance. Increasingly banks are also using this product as a preferred risk-managed tool to fund SMEs. The models focus on receivables finance, which broadly defined is a form of asset-based finance that uses outstanding invoices as the essential collateral securing the loan. “Receivables finance” can take the form of traditional factoring activities – for example, full turnover or single invoice discounting – as well as “reverse factoring”, which is debtor-led typically via an large so-called “off-taker” such as an retail supermarket chain, construction company, government body or multi-lateral organization. Also referred to as “supply chain” or “value chain” finance, the financing principal is the same as factoring except “reversed” to focus on a typically larger debtor that is likely a better credit risk than its smaller SME suppliers and thus is used as the anchor counterparty to motivate lending from traditional financiers. The institutions who provide this funding stream to SMEs need funding themselves in the wholesale market. Verdant Capital is responsible for a $30 million invoice discounting facility in Africa, providing such wholesale funding to institutions. 

Ultimately this “asset-lite” financing model better aligns to SMEs who are more likely to have a steady stream of purchase orders and invoices that can be more easily used to secure financing than the traditionally required fixed assets. Moreover, the short-term nature of the invoices, typically with maturities up to 120 days, align well with securing the shorter-term working capital financing needs of SMEs. The classic working capital “financing gap” is driven by the fact that cash flow constrained SME suppliers may need more immediate payment than its large buyers typically provide on standard credit terms of 30+ days – and without consideration for the fact that the SME often is forced to extend the payment period by its larger buyer.

Increasing digitization and supply chain complexity are two trends that have supported alternative funders to creatively finance SMEs receivables finance mechanisms. These trends leverage the relative ease at which invoices can be digitized to serve as financeable collateral and ultimately monitored via online platforms, enhancing both liquidity available to SMEs and risk management practices to funders who often may be located at great physical distances (even across borders) from the SMEs.

Innovative recent funding models include those using proprietary online platforms and applications to provide short-term capital, in the form of an “equity solution”, directly to SMEs. The funder invests directly in the transactions, rather than the companies themselves, without charging interest, but taking a share in profits generated from the transaction. The model can be used to finance the “performance risk” attached to purchase orders – so-called “payables finance” – but also the “payment risk” that develops later in the transaction process, whereby the funder takes control of the collections on behalf of the SME, as with a normal factor. Technology is critical to the value proposition at each stage – from algorithm enhanced credit analysis, digitally-uploaded invoices, and online processes for assigning and monitoring receivables and segregated bank accounts – helping take cost and time out of the process for providing funding (to SMEs) and repayments (to funders).

Innovative reverse factoring financing models focus on credible off-takers that support SME-sensitive supply chains like agriculture and construction. For example, in West Africa, MSME farmers in the critical cocoa value chain have benefited from emerging collaboration between MFIs and local cooperatives to provide seasonal-sensitive input and harvest financing, with credit risk lowered via purchasing partnerships with traders and global chocolate manufacturers. Ancillary support to this primary financing activity for the farmers include agricultural extension services as well as specialized asset financing (i.e. to finance trucks for transport to market) and school loans to support the children of farmer families.

In South Africa, there is similar coordination between banks with agricultural lending experience and the nation’s network of farming cooperatives that represent essential “touchpoints” for regional agribusiness communities. Financing can take the form of seasonal-sensitive working capital facilities to support agricultural exports such as macadamia nuts and apples. Delivery is enhanced via emerging digital distribution channels while risk management is “physically complemented” by embedded bank staff within the regional cooperative branches.

Example reverse factoring financing models beyond the agriculture sector include: 

  • the SME-heavy construction sector value chains supporting larger real estate developers in primary and secondary cities in Kenya and Senegal; and
  • African-based SMEs providing satellite equipment and services to larger, pan-African mobile telecommunications companies such as MTN and Millicom (via Tigo brand) implementing projects to increase bandwidth and connectivity across the Continent.

In all these examples, one clear – and intended – demonstration effect of these disruptive funders and platforms is to leverage early financial support into a growth trajectory that consistently “crowds in” traditional financiers. Graduating SMEs to scale and financial sustainability, utilizing technology and unique funding models, is a proven recipe for unlocking SME financing at the bottom of the pyramid.

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[1] Source: Small Business Unit of South Africa (“SBI”) https://www.smallbusinessinstitute.co.za/wp-content/uploads/2018/10/SBIbaselineAlert1final.pdf and https://m.engineeringnews.co.za/article/sme-sector-critical-to-growing-south-africas-economy-pityana-2019-04-11.

[2] Source: 2018 Finfind study, sponsored by the South Africa SME Fund. https://www.accesstofinancereport.co.za/pdf/SA-SMME-Access-to-Finance-Report-2017-FINAL-VERSION-FOR-RELEASE-on-10-July-2018.pdf

[3] Source: SME Finance Forum. https://www.smefinanceforum.org/data-sites/msme-finance-gap

[4] Source: iBAN/InclusiveBusiness.net. https://www.inclusivebusiness.net/ib-voices/key-challenges-missing-middle-kenya

5] Source: Oxford Business Group. https://oxfordbusinessgroup.com/analysis/finance-boost-small-businesses-should-benefit-additional-funding-over-coming-months  

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