Trust equity to transform MSMEs

Along with its good oversight, equity brings greater financial discipline right from the start

By Author B Yerram Raju   |   Published: 7th Oct 2019   12:05 am Updated: 6th Oct 2019   10:17 pm

It is well known that the micro, small and medium enterprises (MSMEs) live in debt markets in India unlike in many other parts of the world where they access equity and debt in reasonably good proportion. In India, 93% of MSME credit is flowing to just 13 States. This skewed distribution requires correction.

Of late, genuinely worried about the continual decline in credit to MSMEs, the government of India introduced MUDRA to comfort these enterprises with Shishu, Kishore and Tarun products. But not even 10% of the total 17 million estimated enterprises was in the manufacturing sector. Then the government introduced 59Minute loan window. Both these efforts have not improved grassroots lending to the sector.

Driven to the wall, the Finance Minister pushed the panic button asking banks to do aggressive canvassing of loans for MSMEs and retail in 400 district-level shamiana meetings. The FM must be aware of both adverse selection of beneficiaries and moral hazard consequences. She expects the banks to tackle them effectively.

MSMEs

Convenient Option
But are there no other means of meeting the financial requirements of MSMEs? Why is equity not being explored as a convenient option? Is it because of the unorganised nature of the sector or because of the undependable clients in the sector? Or both?

Debt has been the most convenient option driven by perverse incentives right from 1950 when the Industrial Policy was announced. Debt, apart from being less costly, takes less than 30 days to deliver while equity takes at least nine months, if not more, where the promoters are assessed through a rigid due diligence process and corporate governance and board rules are put in place before filing the IPO. This process can be shortened if the enterprise has credible historical data for the pre-launch and good governance structure.

Movement from micro to small and small to medium is more governed by greater stake of the promoters through equity infusion. Therefore, such a transition is also extremely slow.

Enabling Ecosystem
District Industrial Centres, introduced in 1980-81 when George Fernandes was the Union Minister for Industries, have been engaged by the State governments to dispense the incentives, raw material like coal, iron, and help in realisation of unrealised debtors through the MSE Facilitation Councils since 2006. The Facilitation Councils, however, did not succeed to resolve the problem of delayed payments to MSMEs.

Manufacturers are the worst hit. Hence, the FM came out with a strict mandate to the PSUs and Central government departments to pay up all their bills by October 15, 2019, and confirm. Hope this would provide a lot of liquidity to the beleaguered MSMEs.

For the transformation from debt to equity access, the ecosystem, capacities and capabilities of firms and the perceptions of entrepreneurs play an important role. Several entrepreneurs are knowledge-insulated and mostly unwilling to unlearn in their growth journey.

Successful Model
Equity firms can participate with the MSMEs over a seven-year period with a gestation period of 1-2 years. Revenue sharing is the model on which it operates and is assessed after sectoral analysis and exits at an appropriate time. The participating equity firm also keeps enhancing skills and scouts for market opportunities of the partner firm. The model is a success in the US.

This equity comes at a cost of 5% more than the market price of debt. But it brings along with it good oversight and greater financial discipline right from day one. Structuring finances and structuring enterprise during the growth is a seamless process.

Scaling them up requires a different level of investments to wean away the entrepreneurs from the protective environment to self-dependence. The biggest problem they invariably come across is the choice of directors for governance. While the Institute of Directors has got on its platform thousands of trained directors, accessing them at affordable levels and verification and validation of their credentials pose problems.

Incentivise Transition
With the economy targeted for $5 trillion by 2022, MSMEs as growth engines and seedbeds of innovation have a significant role to play. Such a role requires that they seamlessly migrate to a higher level of operations during the growth stage.

Fiscal incentives can help such a transition. Having eased the rules for FDI participation and amended the corporate tax structure, it is time to look at what best can be done to make MSMEs go for greater aggregation and contribute significantly to the growing economy.

We have the potential to overtake China if we trust our MSME sector more than now and provide more long-lasting solutions than kneejerk reactions.


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