Micro, small and medium enterprises (MSMEs) play a pivotal role in India’s industrial development, as they help hone and nurture the talent and skills of entrepreneurs. The MSME sector contributes 8 per cent to the country’s GDP, 45 per cent to the manufactured output, and 40 per cent to exports, and provides employment to 60 million people through 28.5 million enterprises.

The main challenges faced by MSMEs are:

Inability to capitalise on market opportunities that require large production facilities, and benefit from economies of scale, homogenous standards and regular supply;

Difficulty in procuring raw material, machinery and equipment, consulting services, technology, and skilled labour;

Their size hinders internalisation of functions such as market research, market intelligence, supply chain management, technology innovation, training and division of labour — which impedes productivity;

Emphasis on preserving narrow profit margins forces them to neglect innovations that could improve their product, and processes that could help capture new markets;

Inability to competewith big players in terms of product quality, range of products, marketing and cost;

Lack of infrastructure and skilled labour, and limited options and opportunities to expand business;

Poor IT and knowledge infrastructure;

Limited access to financing and other services needed to sustain business.

The most important factor hindering the growth of MSMEs, however, is the lack of timely and adequate availability of alternative finance (venture capital or private equity) and traditional credit (bank loans).

As a majority of MSMEs are owner-driven, they often lack formal organisational structures. The higher transaction costs involved keep away venture capitalists and other risk capital providers from investing in this sector.

Before investing, venture capitalists or equity investors look for the following in an MSME venture:

A strong business model that is scalable in the near future;

The business andtechnology expertise of the management team;

Key differentiating points and strengths for sustainable competitive advantage;

Visibility regarding future revenue generation.

Banks and financial institutions have set basic guidelines for disbursing loans, which include:

Past operational and financial performance evaluation;

Availability of assets for security and collateral;

Skills, experience and qualifications of the promoter and key management team;

Future business and growth plans and projections;

The company’s strength, and visibility regarding future profits;

Reference checks from buyers, suppliers and other financial institutions.

Several factors influence lending to MSMEs, including the high administrative costs of small-scale lending, quality of data and information provided, perception of micro- and small enterprises as high-risk, weak financial health of MSMEs, rising number of non-performing assets (NPAs), and the inability of many companies to provide adequate collateral.

A change in mindset is needed to create sustainable business models, to help entrepreneurs capitalise on investments, financing and services. Entrepreneurs should be willing to restructure their enterprises and work towards the creation of professional structures, develop an international outlook, acquire skills necessary to keep pace with global developments, develop a strong technological base, and inculcate a competitive spirit. Corporate structuring of MSMEs will enable greater transparency of financial and other information for outsiders, especially lenders. Therefore, it is time for the MSME sector in India to inculcate corporate discipline.

(Avinash Gupta is Senior Director, and Narayan Shetkar is Director, Deloitte Touche Tohmatsu India Pvt Ltd.)

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