Goldilocks entrepreneurs: Too small to get loans, too big for scheme sops

Amit understood needles and stitches, time-and-motion studies and manufacturing crises. He did not yet understand the other things that entrepreneurs faced: The trouble in getting basic services, in getting electricity, in getting a loan, in finding land. While seeking a loan, he found himself spending days in the branch of a large public sector bank, wrestling with paperwork and trying to convince the bank officers of the viability of his business. After missing 10 days of work, and still facing additional demands for changes and information, Amit gave up on the attempt entirely. As of 2017, the total supply of credit to SMEs and micro enterprises was estimated to be around Rs 70 trillion ($1 trillion). About 84 per cent of this came from informal sources, including self-financing, loans from friends and family, and moneylenders. The rest was from banks, non-banking financial companies, government financial institutions, and other formal sources. Public sector banks, which provided Rs 5.4 trillion ($77 billion) —nearly half of all formal credit — to these enterprises, found that 12 per cent of their loans were non-performing assets and likely had to be written down. This, unsurprisingly, has led to caution.

Amit had given private banks a try previously. He recalled an interview with an agent for a Rs 10 lakh loan ($14,000). At the time, he was running a factory out of a temporary shed near an industrial area. The interview, which took place at Amit’s factory, seemed designed to browbeat him. The agent was clearly unimpressed with what he saw. His questions betrayed his suspicions. “What will you do if your business suffers a loss? What collateral do you have to repay the loan? What if you get kicked off the property? What if you cannot repay the loan and are destitute?” After a certain point, Amit found the questions insulting. “What if you meet with an accident going home? How will you file your report then?” he snapped back at the agent. The man was not amused. Amit’s loan request was turned down. The agent’s boss then called to say that while Amit’s report was not promising, they could have a meeting to “settle” the matter. There was always some problem or the other with banks. It became clear they would only lend Amit money if he could prove he had a permanent establishment — the very thing Amit was seeking a loan to build.

He didn’t even know of the existence of credit from small, regional and local banks, that are often tasked with filling the credit gap for entrepreneurs like him. In Europe and the United States, for instance, they provide loans to a third of all SMEs. This figure is only 6 per cent in India. Their branches make up only 15 per cent of all bank branches in India, in contrast to 32 per cent in Europe. Amit’s faith in government policies and incentives was quickly dashed too. Nothing he found applied to someone starting off at his level. If anything, he realised, popular government schemes tended to encourage and further the growth of businesses that were already established, or else catered to micro entrepreneurs. He was too small for some and yet, not small enough for others — a Goldilocks entrepreneur. He could not, for instance, get a traditional business loan because he had nothing to offer by way of collateral. His firm was too large to access micro enterprise schemes like MUDRA loans or microfinance. Amit would almost definitely not be on the radar of a venture capitalist because of his inability to scale rapidly and the limited innovation in his business model. 

“Small businesses have a 100 per cent risk and attract 0 per cent sympathy,” Amit said. “A big businessman gets 30- and 50-days credit from his suppliers, but if I ask for the same credit, they say no.”

Even specially demarcated commercial land meant to facilitate trade just ended up in the hands of more powerful people. As a small businessman, Amit could barely make rent. He tried to get an electrical connection for small industries that assured him of power at a lower tariff, but the experience was so onerous that he settled instead for regular power. Amit remembered the struggle. “When I asked an exporter how to do business, he said, ‘This is bad work, full of losses.’ People are insecure that you will take their work.” Amit soldiered on, renting a tin shed in a slum so that he could undercut rivals, commuting on a bike, juggling three jobs. There were times he wanted to give it all up. “I thought of leaving the stitching business, but my wife insisted I continue.” Step by step, just as his wife had said, they found ways forward. They ate cheaply if they went out, holidays were spent at home, and cash gifts from relatives were saved. They needed the money to buy land, build a factory, pay for materials, and buy machines. It wasn’t like someone would just give them the capital they needed. So, imagine his surprise when an exporter who trusted him gave him the land for a factory for a small down payment. “We’ll figure out the rest,” he remembered the exporter saying, appreciating that someone believed in him. Amit didn’t think his struggles were over. Even today, with 50 machines on hand, and a turnover of Rs 250 lakh ($350,000) a year, he doubted anyone would extend him a business loan. Still, if there was one person he could rely on, it was his indomitable self. “I always felt like if others can do it, why not me?”

In recent years, Amit found that formalisation came with its own costs. He hired a full-time accountant for Rs 25,000 ($350) a month to keep records straight and navigate the new Goods and Services Tax (GST) filing system, which he found complicated. “I don’t mind paying taxes, but the processes are too extensive. I used to manage this before myself, but now to tally things is impossible.” He added, “At least everything is digital and above board, and there are no unpleasant surprises later.” Amit was less sanguine about paying an agency to keep abreast of labour laws and regulations, which numbered over 200 across state and central levels, with over 1,800 possible filings annually for larger firms. “The formalities involved are too complex for a business person to manage,” he said. “You need to meticulously detail your submissions by number of employees, hours worked, daily wages of so much, and you need to format it accordingly.” Any deviance would attract a notice from the Ministry of Labour and then it would be a “tension waali baat”, a stressful matter.

In the last few years, India has shot up 53 places in the Ease of Doing Business rankings, which assesses countries on 10 different dimensions including credit, property, registration and taxes. This has not necessarily translated to an easier business environment for small and medium entrepreneurs like Amit. The average number of days to register commercial property in more developed states (such as Maharashtra, Gujarat and Delhi) is 116 days. In Uttar Pradesh, Chhattisgarh and Odisha, the time taken is higher — 136 days on average. These two figures are far higher than the time used in the official rankings, based on Mumbai (85 days) and Delhi (55 days). Against this, the average in high income OECD countries is only 20 days. There is one part of the ease of doing business that all states and cities perform poorly in: Enforcing contracts and efficiency of the judicial system. In this category, India is still ranked 163rd out of 190 countries. Even in Mumbai and Delhi, the time it takes to resolve a contract dispute through the judicial process is 1,445 days versus 582 days in high income OECD countries. Entrepreneurs feel the weight of slow dispute resolution. Small business owners naturally struggle to absorb the high costs and loss of revenue caused by lengthy judicial proceedings.

India’s focus on the two extremes of entrepreneurship— high-growth start-ups and micro enterprises—has inevitably meant a lack of focus on entrepreneurs like Amit. It is in between these two extremes that the country will need to invest. India needs many SMEs, each of whom may not individually hire many people, but collectively, they can provide a quantum of productive employment that the country needs. And they need to be spread across the country — not just in the major economic centres. Since these types of firms use local inputs and often start off by catering to local demand, they can be drivers of widespread development, drawing the informal and formal sectors closer together. We call this the “everywhere entrepreneurship” movement. The bright lights of this movement are local SMEs — the restaurant, health clinic, salon, textile manufacturer and car garage—that use tried and tested business models to solve local problems. They are unlikely to become tomorrow’s large corporations, but stitched together, they are integral to the future of India.

N Chandrasekaran is chairman and Roopa Purushothaman is chief economist and head, policy advocacy at Tata Sons. Published with permission from Penguin Random House India