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finance

Rich aunties and friends with benefits

Rich aunties and friends with benefits that they can share – that seems to be what you need if you seek to finance a business in the informal sector in South Africa. In its comprehensive survey of businesses that are not registered for value-added tax (and can thus be taken to be informal), STATS SA found that the overwhelming majority of informal businesses do not source any external financing.
It was estimated that there are about 1.1m individuals operating informal business in South Africa – 64.9% of whom needed to borrow money to start operations. Of those who needed money to start operations, 74.4% used their own money.
Of the quarter of businesses that used external money, the majority received their financing from friends and relatives. Over 80% of businesses that receive financing cite their source as friends and family. Banks finance just 8% of these businesses – it is notable that this is double the percentage that banks financed in 2001. Microfinance institutions (NGOs and credit societies combined) have penetrated this market to the same extent as commercial banks.
There are at least two reasons why this statistic should not be cause for alarm. Firstly, even in the ultra-sophisticated world of tech start-ups in Silicon Valley and other such entrepreneurial places, it is almost taken as a rule that the first round of financing for a new venture will come from friends and family. These are the people you need to convince of your concept in its initial stages. And as Tamara Mellon, the co-founder of Jimmy Choo, confirmed in an interview on Bloomberg TV, there is nothing that keeps someone on their toes as the prospect of losing their family’s money.
Once the concept has been proven, an entrepreneur can then hope to receive funding from angel investors, who are normally wealthy private investors with an appetite for risk and oftentimes a desire to mentor a budding business owner. And as the business takes off, venture capitalists, banks and other commercial funders come to the party. Eventually, listing on the stock exchange might represent a way to access large scale funding from the general public and institutional investors such as pension funds; and also an opportunity for early investors to sell their stakes and realise the value of their investments.
But secondly, and on a less optimistic note, the informal businesses that were the subject of the STATS SA survey are likely to be very small, survivalist businesses. These are not, for the most part, businesses that were formed to pursue profitable market opportunities; rather they came about because the founders simply could not find any other alternative for making a livelihood. It is not surprising that these businesses cannot raise external finance. The outside financier would simply not recover their investment.
Of course, amongst these informal businesses there must lie some gems that have the potential of growing and scaling up. In an environment where there is almost no source of meso-financing (that gap between microfinance and corporate finance) and where commercial lenders prefer to finance consumption or well-established enterprises, these figures should be a cause of concern. In instances where small, informal businesses are ready to make the leap from the garage to the mainstream economy, the lack of enterprise development support and financing in this country stifles that move and so we remain with untapped opportunities and high unemployment rates.

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