Khula Enterprise Finance Ltd-Overview-

Parliamentary Portfolio Committee on Economic Development

19March 2010

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• Background

• Mandate, Vision and Mission

• SME Financing Landscape

• SME Finance Role Players

• Khula’s Current Business Model

• Products and Delivery Channels

• Financing Partners

• Strategic Focus

• Achievements

• Limitations of the Current Model

• Financial Implications

• Cabinet Approval of Khula Direct

• International Benchmarking Lessons on Direct Lending

• Re-engineering Khula for Direct Lending

• Strategic Priorities and Initiatives

• Implications on the Balanced Scorecard and impact On End Users

• Khula Direct Overview

• Closing Remarks

Presentation Outline

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Background Khula, is a development finance institution (DFI) reporting to the Department of

Trade and Industry (the dti), with an independent Board of Directors

Khula was established in 1996 and its mandate derives from the dti White Paper

on the National Strategy for the Development of Small Business (1995).

The decision to establish Khula as a wholesale rather than a retail institution was

taken after considering the following factors:

• The role of the State is to create an enabling environment rather than

to participate directly.

• Government backed guarantees would assure Commercial banks and

other financial institutions and get them to participate in the SMME sector.

• As a wholesale financier; Khula works through a network of partners

inter alia Commercial Banks; non-bank RFIs; and other partners – to

ensure that SMMEs have access to finance.3

Since the creation of the South African Micro Finance Apex Fund (SAMAF)

Khula concentrates its efforts on the upper end of the funding gap - providing

funding above R10k and therefore refers to lending to Small and Medium

Enterprises (SMEs) rather than SMMEs.

Background (cont…)

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Khula’s Mandate, Vision and Mission

Vision

To be the development

finance partner of first choice in the

field of Small Enterprises

Development

Mandate

To address market failures in the SME finance sector by leveraging and unlocking private sector and other developmental funding for the creation of a vibrant SME sector. Khula’s main focus is the facilitation of

access to finance by SMEs; maximising development impact and ensuring organisational sustainability

Mission

To provide finance,

mentorship services and small business premises to SMEs through a

network of partnerships and to encourage the

sustainable development of

SMEs whilst ensuring Khula

remains financially viable

The achievement of the desired impact envisaged in the mandate would be through the development and implementation of a Khula

SME bank 5

Khula’s Mandate is focused on three key areas …

Long-term objective

Access to finance for

SMEs

Create sustainable SMEs; in the

mainstream economy, thereby contribute to

economic development

Promote access to finance

Financial sustainability

Development impact

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Medium

enterprises

Small enterprises

Micro enterprises

Survivalist enterprises

•Less than 200 employees

•Turnover > R25m p.a.

•Developed technical & business skills

•Less than 50 employees

•Turnover < R25m p.a.

•Developed technical /limited business skills

•Less than 5 employees

•Turnover < R150k p.a.

•Some technical /limited business skills

•Individual self employment

•Turnover < R50k p.a.

•Limited technical and business skills

Opportunity-driven/Entrepreneurial

Necessity-driven/Survival

Medium

enterprises

Small enterprises

Micro enterprises

Survivalist enterprises

Characteristics

SME Financing Landscape … Characteristics

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Medium

enterprises

Small enterprises

Micro enterprises

Survivalist enterprises

•Corporates

•Banks/Financial Institutions

•Private Equity/Venture Capitalists

•Khula, IDC, NEF

•Own resources

•Banks & Corporates

•Khula & PDCs

•Own & family resources

•Microlenders & Banks

•SAMAF & PDCs

•Own & family resources

•Microlenders

•SAMAF

Medium

enterprises

Small enterprises

Micro enterprises

Survivalist enterprises

Financing Needs - Supply

SME Financing Landscape …Supply

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Medium

enterprises

Small enterprises

Micro enterprises

Survivalist enterprises

Medium

enterprises

Small enterprises

Micro enterprises

Survivalist enterprises

Financing Needs - Supply

SME Finance – Role Players

R0 R10K R250K R1m R3m+

SAMAF

NEF

Khula

R0 R10K R250K R1m R3m+

SAMAF

NEF

Khula

IDC

Banking and Private Sector

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Khula’s Current Business Model

• Wholesale financier with total reliance on intermediaries

• Leverage private sector funding

• Facilitator vs. Direct lender - role of the State as an enabler rather than

direct participant

• Capitalisation structure - funds are required in order not to erode capital

base

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Financing Gap Filled by Khula

• Primarily black-owned ; owner-managed formal SMEs

• SMEs requiring financial resources between R10 000 and R3 million

• Start-up and expansions of early stage businesses

• Focus on underserved provinces, rural areas and “urban poor” communities

• Focus on women-owned enterprises

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Product Offering Suite of innovative financing instruments

Khula

o Business Loans

o Credit Guarantees

o Equity funds and Joint-Ventures

o Pre- & post Loan Mentorship

o Business Premises (Retail & Industrial)

o Manage third party funds

Wholesale

SMEs

o Asset accumulation

o Job creation

o Regional development

o Economic transformation

End-user

Financing Partners[Banks, RFIs, Corporate Sector Partners, Public

Sector Partners]

o Working Capital

o Guarantees

o Equity Finance

o Bridging Finance

o Asset Finance

o Invoice Discounting & Factoring

o Group lending

Retail

Khula Products

Financing Instruments

Development Impact

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Financing Partners

Some of Khula’s Financing Partners are:• Ithala Development Finance Corporation• Business Finance Promotion Agency (BFPA)• Anglo Zimele• True Group• Small Enterprise Foundation (SEF)• Marang Financial Services• Business Partners• New Business Finance (NBF)• .Meridian Fund• Identity Development Fund (IDF)• Enablis• Standard Bank• Nedbank• Absa• First National Bank, etc 13

Strategic Focus

• In 2004 Khula took a new strategic direction aimed at growing the organisation’s reach and impact in order to better support the needs of SMEs.

• Khula changed its target market, operational model and introduced new channels and products increased disbursements to SMEs.

• Bad debts and claims were kept as low as possible but pressure is being

felt as a result of the impact of the present global economic crunch.

• Public opinion and perceptions about Khula are steadily improving.

• To raise delivery to the next level and make more meaningful impact, Cabinet in December 2008 approved that Khula’s mandate be extended to include direct lending activities.

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Approvals and Disbursements

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Achievements (cont.)

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Utilisation of Indemnity Scheme By Banks

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48%

52%

White Black

17%

42%

6%

0%

4%

19%

8%0%

3% 2%

GP KZN WC NW MPU

LIMP EC NC FS Other

66%

34%

Male Female

2008/09 SME PROFILE

• Funding to Black SMEs at 52%

• Investments to GP/WC/KZN at 64%

• Disbursements to women at 34%

• End-user facilities increased from 2 472 to 2 829(up by 14%)

• Estimated jobs created at R100k per job – 3 150

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Achievements (Cont…)

• Disbursed more than R2.5bn to SMEs since inception

• Remained liquid

• Continued to show a surplus each year irrespective of under-capitalization

• Built up asset base to approximately R1.2bn

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Limitations of the Current Model

• Wholesale Model

1) Distance from end-users and assumed risk

2) Limited ability to drive development and control destiny

3) Over-reliance on co-operation from partners that have purely commercial

objectives

• Model not clearly understood by the target market

• State support for SMEs is concealed, leading to distorted market

perceptions

• Model adds a layer between Khula and the customer, increasing risk,

costs of delivery and interest rates charged.20

Limitations of the Current Model (cont…)

• Khula Capitalisation

• Structured as an administrative entity low overhead structure channelling funding through banks and RFIs.

• Initially capitalised with some cash/assets (assets are non-performing and non-core) to earn interest/income to fund overheads and distribute remainder to RFIs as loans – R330 million

• Khula does not receive an annual grant from National Treasury.

• Actual amount of available funds that Khula can disburse is limited.

• Khula requires a properly structured balance sheet based on a rolling 5-year investment horizon, which should include a portfolio of strategic equity investments with high level of profitability to subsidise the developmental initiatives/targets

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Financial Implications

• Since 2004/5 Khula alerted the shareholder that by 2010 Khula would no longer be able to maintain its momentum of delivery to its target market without additional funds.

• If no funds are received and Khula continues its current strategic thrust it will start eroding its capital base and suffer losses.

To be financially sustainable and deliver on its mandate and strategic direction, Khula requires capital injection that would allow for a portfolio of strategic investments with a high level of profitability to subsidise the highly developmental initiatives and allow for increased demands on capital disbursements.

Change in Khula’s Articles of Association, so that through an Act of Parliament, Khula becomes a flagship SME Bank, which will also allow Khula to borrow so as

not to be reliant only on government funding

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2012/13 2011/12 2010/11

Funds requested R500m R400m R300m

Approvals

Without funding R75m R55m R53m

With funding R1,007m R965m R808m

Disbursements

Without funding R142m R255m R476m

With funding R769m R757m R736m

Net profit

Without funding - loss (R22m) (R13m) (R27m)

With funding R32m R13m (R26m)

Funding vs. Non-funding Disbursement/Profitability Scenarios

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• Low impact and unsatisfactory results of Wholesale Model led to

submission of Khula Direct Lending Proposal to Cabinet.

• In December 2008, Cabinet approved the “KHULA DIRECT”

business case subject to Shareholder:

a) Approval of business & implementation plans

b) Capitalisation of Khula

• In 2009, the content of Cabinet approval was discussed with the

Portfolio Committee, which confirmed the need for the business plan,

international benchmarking study and local research.

• Both the international benchmark study and local research were

undertaken.

Cabinet Approval of Khula Direct Model

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International Benchmarking Lessons On

Direct Lending• Government is prime funder and key player

• Government support and commitment to SMEs at highest level of government

• Research and developments of new products is the key elements

• Centralize the risk management processes

•Clearly defined and easy to understand and client recruitment and credit process which ensures that they get the “Correct clients.”

• Quick turn-around times due to clearly defined loan disbursement processes

• Place strong emphasis on credit risk management

• Extensive Network of branches which enable them to visit SMEs

throughout the country

• Commitment to SME support in the country at the highest level of government

• Provide integrated support - Financial and non-financial.

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Local Research Findings

• FinMark Trust report estimates that demand for R10k – R50k exists for 525,000

enterprises (27% GP) and 160,000 enterprises require R50k – R250k (50% in GP)

• Poor access to finance in rural areas – costly to supply, low density

• Banks have to factor cost of capital into their price – makes products expensive –

don’t easily fund < R50k, always seek security

• Inflexible approach to financing SMEs

• Unsuccessful SME lending due to 75% borrowers being self-employed cf. micro-

finance model which bases collections on salary deductions

• 41.6% of all credit consumers had impaired credit files in December 2008

• Lack of security can be substituted with credit history in paying for

• rent,

• telecommunications (other than prepaid)

• municipal services

• retail purchases on credit

• Insurance

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Re-Engineering Khula for Direct Lending

KHULA

Re-engineering the current operations

Development of an SME Bank

Strengthened risk management and

monitoring and evaluation

Operations Restructuring

Cost and cashflow management

Alignment of the Human Capital Management

Implementation of Khula Direct

Processes

Structure

Systems Products

People Branding

Recapitalisation

•Legislative enablement is Key

•Organizational restructuring for Khula Direct

• Retraining & re-assignment of staff

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Strengthened risk management and monitoring and

evaluation

Re-engineering current Operations

Cost of cashflow management

Alignment of Human Capital

Strengthening the risk management of all of Khula’s investments and partnerships, especially the larger transactions

Strengthening of cost and cashflow management

Restructuring of operations to ensure meeting of existing commitments and effective support to Khula Direct

Realignment of human capital intervention to ensure meeting of existing commitments and effective support to Khula Direct

Khula to play a prominent role in shaping and positioning SME development through research and development.

Influence of Khula on SME policy formulation Branding and positioning of Khula

Position the Khula organization/brand as the flagship DFI in SME financing

Key Strategic Priorities

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Budget Implications to Some Key Balanced Scorecard (BSC) KPIs

Key BSC targets 2010/11

KPI

Without Funding With Funding

Target Target

Value of facilities approved to intermediaries

R53 million R808 million

Value of facilities disbursedto intermediaries

R477 million R736 million

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Performance indicator Budget

New loans to end users

Facilities disbursed to end users in priority provinces

Facilities disbursed to black businesses

Facilities disbursed to women owned businesses

Facilities below R250K disbursed to end users

2 000

40%

70%

45%

40%

Impact to the End Users 2010/11

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Key Elements of Khula Direct Model

• Field staff = close relationship with customers• Process up to approval

• Hunt for deals (1st screen)• Capture details (scoring = 2nd screen, reply with proposed products and terms)• Business concept (3rd screen, reply with draft term sheet & CPs)• Pre-approval support for business plans and CPs for 75% of LT deals• Comprehensive due diligence only for larger/longer/more complex deals (25% of LT)• Regional office prepares submission• Approval by Credit/Investment Committee

• Regional office owns customer & manages field staff• Head Office establishes and manages products, credit policy, risk management, portfolio management• Customer interfacing

• Highly responsive• Greater degree of responsibility looking after people’s businesses• Branding • Increased compliance

• SME support and education programmes• Seda to provide pre-investment support• SA Guide to Business Programme in partnership with USAID • Regional information sessions• Post loan mentorship interventions 31

Market Positioning

Geographic location

Product set

Pricing

Degree of security

Owner’s contribution

Phase of business

Size of deal

Size of business

Experience of entrepreneurs

Market sectors

Position in value-chain

Competitiveness

Growth prospects

Export opportunities

Less urban, deeply rural

Address needs of whole business - simple

Risk-based. Earn fees and interest

Low on small facilities, be creative

Low (higher pricing) - commitment

Start-up, early growth, expansion

R10k – R3m, mostly around R250k

SME

Preferably as good as it gets, in industry

All, except sin industries

More secondary than tertiary

Indifferent globally, locally must be unique

Yes, increase employment

Outside of local community

Crite

ria th

at d

efine

our

pos

ition

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Concluding Remarks

• Khula is a DFI dedicated to the needs of small business

• Key differentiator is focus on start-ups, small loans and underserved

provinces

• Khula has undergone a strategic shift to enhance focus and delivery

• Maximum outreach and impact will be achieved, in part, through:

• Direct lending to SMEs

• Targeted use of Credit Indemnity Scheme

• More direct approach to wholesale funding through RFIs

• Utilisation of the Financing Partners infrastructure

• Capitalisation is required to follow through with strategic choices made

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THANK YOU

Khula Client Liaison Centre number

08600 KHULA (54852)

Website - http://www.khula.org.za

Email - helpline@khula.org.za

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