Growing the SME Space

Posted by EMERGE Editor

January 7, 2010

(2 votes, average: 5 out of 5)

 Loading ...

SMEs are defined in various ways in India, typically via amounts of capital invested. The RBI has defined Micro Enterprises as those with less than 10 to 25 lakhs (depending on whether the business is engaged in Services or in Manufacturing) in capital employed, Small Enterprises as those with not more than 2 to 5 Crore and Medium Enterprises as those with not more than 5 to 10 Crore in capital employed. Other countries use the number of employees and total revenue also as parameters for classification. Worldwide, it is estimated that 99.3% of all enterprises are small or medium in size.

This blog  is specifically about regulatory changes that can be made in India with regard to SMEs  to help their growth in number and, to some extent, in size. It is important to remember that the objective is to increase the number of SMEs more than to help SMEs grow beyond a specific size. Growth in size will typically automatically happen beyond a threshold level – say, 1 Crore in revenue. It is in the smaller sizes that SMEs need significant attention.

Why SMEs need to be encouraged

• SMEs are the best engines of employment, since they provide more jobs per rupee of capital and per rupee of revenue than larger companies do. It is estimated that Indian SMEs have a labour intensity of nearly 4 times that of large enterprises.
• They develop and grow new technologies and new business models that larger companies are by definition too risk-averse to deal with.
• As an overall group of companies, on a per-rupee-invested basis, they create greater wealth than larger companies.
• SMEs have the best record as an overall group in supporting ethnic and communal diversity in the principals and employees that they involve.
• The growth of SMEs very clearly encourages individuals from disadvantaged groups to leverage their own strengths to break out of traditional social limitations.
• Unfortunately, SMEs are susceptible to being overwhelmed by large companies because of a lack of marketing skills, brand recognition, sales skills, etc.

Examples from other countries
Various governments have developed different models for SME support, mostly based on local needs and culture.

• The Chinese Govt. has put together a number of wide-ranging initiatives to develop entrepreneurs in what was till recently a State-controlled economy. Govt.-funded industrial parks, a Govt.-funded grant-in-aid model via an Innovation Fund, a clear bias for purchasing from local vendors and so on has grown China’s entrepreneurs to 44 MN recently.
• In Japan, large enterprises have been encouraged to use the services and products of smaller companies as part of their own delivery model. The MITI, i.e. the Ministry for International Trade and Industry, through its Small Business Agency, also acts as a VC for start-ups in the technology arena. Japan has also established specific tax breaks for angel investors that encourage them to reinvest into other start-ups.
• In the UK, the Govt. has rolled out a number of programs including R&D grants and aid, small-business loan guarantees, reduced tax burdens on small businesses and a generally-supportive Governmental model managed through the Small Business Services agency and the Enterprise Directorate.
• In the US, the Govt. has taken a strong position in supporting SMEs by earmarking a large percentage of Govt. contracts (23%) specifically for SMEs. This is actively administered by the Small Business Administration, a quasi-Govt. organization that helps various departments implement their Small Business support programs in line with Federal guidelines. The US also has a very strong grant-in-aid model through the Small Business Innovation Research (SBIR) program.
• Some city governments in the US have established office facilities with high-speed Internet connections and server infrastructure, to encourage local entrepreneurs to start up without high starting costs. With a “portfolio” approach, city governments have grown local employment significantly, thanks to some of these start-ups growing well.
• Most countries that have a positive support program for SMEs have simplified the processes for the setting up and shutting down of small companies. Regulatory complexities increase with the size of the enterprise, but are very limited at small sizes.

What the Indian Govt. can do
There are a number of tried-and-tested things – and some new ideas – that the Indian Govt. can implement to help SMEs in number and extent. It is important to recognize that most of the infrastructure-related mechanisms are not candidates for a PPP model of implementation. The returns from this support must be seen as accruing to society at large over a time-frame of a few years, not to specific investors on a three-year balance-sheet basis. In that sense, SME support can be considered a social endeavour more than an economic one, although its impact is all economic.

1. Restructure Tender guidelines that specifically restrict the involvement of SMEs. Such restructuring will ensure that SMEs are involved in the execution of Govt. contracts that may have otherwise been won by larger players. It will also provide the basis for private enterprise to use the services of SMEs in various ways in their own business. Some of these factors are described below.

• Bidders need to submit Bid Security, i.e. money that the Govt. will hold on to for weeks on end. That’s typically 2% of the expected contract value, so a company bidding on a 10 Cr order needs to pony up 20 lakhs. Not the kind of chump change we can have lying around in SMEs.
• Bidders need to have had a minimum annual turnover usually five times the contract value. That clearly precludes SMEs, particularly since Govt. deals usually run to tens of Crores, at a minimum.
• Solvency certificates that bidders need to submit are typically twice the expected contract value. That covers assets owned by the bidder, so that clearly leaves out the smaller players.
• Bidders need to have been around for three to five years, so that leaves out startups.
• Sub-contracts are usually not allowed, so winning bidders are forbidden from using outside resources.

2    Establish a program where a significant percentage – 25%, say – of all tender-based spending is earmarked for execution to SMEs. This is a significant shift in attitude, where the Govt. actively supports the growth of a horizontal sector of industry instead of unwittingly discouraging it, as it does now. It is also one of the most effective ways to develop employment growth via SMEs, as has been seen in the US.

• Allow SMEs that win these contracts to partner with larger companies to execute them. This will ensure that the contracts are completed in time and in budget, it will also give SMEs the opportunity to apply their own value-addition in terms of technology or process.
• Establish a cross-departmental organization tasked with the specific objective of ensuring that 25% of all contracts from all departments get parceled out to SMEs.
• Establish departmental and personal incentive models that help Govt. officials see benefit in encouraging SMEs through this program.

3    Establish grants and aid for R&D efforts by SMEs, with the stated goal of commercializing the results in the Indian market. An agency much like the NSF in the US, but focused on SMEs, can do wonders for innovation and invention in India.

• Establish a well-funded agency with clear guidelines not only about the amount of funding but the target number of companies to be funded within specific time-frames.
• Provide specific support for IP creation, with tax breaks for SMEs that patent and/or copyright their technology.
• Encourage State governments to provide similar support for more local – and possibly smaller – companies that focus on smaller markets or more remote markets.

4    Establish a Credit Guarantee program that is widely and easily accessible to entrepreneurs in conjunction with traditional bank lending. This will enable entrepreneurs to access debt funding from their existing commercial banks, without the need for collateral or personal guarantees.

• Banks normally have a very good understanding of their customers, so much so that they can differentiate between entrepreneurs and fly-by-night operators very easily. The availability of an external guarantee will make debt flow easier into SMEs.
• The Guarantee can work like an insurance program with the corpus funded by the Govt. That may make the interest rates a little higher than the lowest available, but the non-collateralized model would make it very effective for a large number of SMEs.
• The Credit Guarantee Scheme of the Ministry for Micro and Small Enterprises needs to be advertised more aggressively, directly to entrepreneurs.

5    Provide specific drawbacks on taxes and statutory dues to SMEs, so they can operate with a smaller cash outflow in the early years of establishment.

• Any lost revenue will be more than recovered in employment growth and in the overall growth of the economy.
• The drawback can be made to apply only to SMEs that have a small capital base, have small revenues and are, say, less than three years in operation.
• Companies that have benefited from such draw-backs can be required pay back the amounts at later stages in growth.

6    Restructure taxes for capital gains from the sale of SME stock, such that investors are encouraged to invest into and expand small businesses.

• Currently, the Govt. provides specific capital-gains-related benefits to NRI and foreign investors that do not apply to local investors – an unfortunate twist that limits local interest.
• Change the approach to sweat equity, allowing entrepreneurs and their senior employees to earn larger chunks of their companies with better results.
• Provide reinvestment encouragement, much like individuals reinvesting in real estate, so that high-net-worth individuals are constantly encouraged to reinvestment returns back into SMEs.
• Provide special tax frameworks for M&A, specifically where at least one of the two parties involved is an SME, thereby encouraging such activity among small companies, strengthening them and the job market overall.

7    Improve the administrative framework to reduce the impact of regulation and taxes and fees on SMEs. This will reduce the effort that SME managers have to put into managing their relationships with various Govt. agencies and leave them more time to focus on building their businesses.

• At an informal discussion online at the EMERGE Community, a NASSCOM member counted twelve different types of taxes and fees that companies routinely need to pay. The amount of payment is not in question – the paperwork needed to maintain all these various registrations is.
• New companies or companies with small equity bases can be given exemptions from large taxes like TDS, filing of specific returns and so on till they become large enough to pay those taxes and use the right professional support to file the returns.
• The insistence on the production of various records, both in written and print form, and the threat of the wrath of the Govt. is a significant deterrent for individuals to become entrepreneurs.

8    Establish high-quality physical infrastructure across the country, including in Tier 2 and Tier 3 cities, for entrepreneurs to use before revenue-growth.

• Such facilities can be provided free of charge for the first few months or till specific business milestones are hit, whichever happens earlier.
• Companies benefiting from these services can be required to continue local employment for specific terms, with a definite percentage of their employees, so as to ensure growth of local employment.

9    Smoothen the regulatory process to shut down enterprises. It is essential that companies be seen as part of a continuum of regenerative business models, a number of which may die a natural death.

• Regulations need to be established that will provide for companies with no outstanding public debt or statutory responsibilities to be able to voluntarily shut down in a standard manner.
• This will also reduce the social stigma attached to a failing enterprise. It is critical that society see entrepreneurs for what they are – engines of growth – and this will help that process.

This blog does not discuss a number of other areas that impact businesses significantly. Some of the issues not discussed in this document are:

• Contract law and its enforcement
• Cross-border trading
• Employment and labour issues
• Intellectual property protection
• Investor protection
• Processes for collection of taxes
• Real Estate-related issues.

A separate, more detailed analysis is required to address those and other issues.

Post Contributed by Narasimhan (Kishore) Mandyam, CEO, PK4 Software Technologies Pvt. LTd

Related posts

1. Sharing Space with the Leadership in the Cloud Computing and SaaS Space is my Reason of Being at the NASSCOM EMERGEOUT Conclave I am glad to be attending the third edition...
2. It’s time to “EMERGE OUT” into the spotlight We are all set to host our first ever...
3. Consumer Internet and Enterprise Space This is the fourth part in the series on New...
4. Command and control – One company’s quest to make a mark in the mail server market space. Xgen operates in the competitive mail server marketplace, yet has...
5. Developing Tier2 and Tier3 cities for IT, way to go or no way Jose? I keep hearing time and again that time is...

If you enjoyed this post, please consider to leave a comment or subscribe to the feed and get future articles delivered to your feed reader.

NASSCOM EMERGE Blog © 2008-2010

• Home
• write for emerge
• Profiles