Thinking big: India's SMEs

A new breed of entrepreneur is taking India by storm. Who are they and how are they funding themselves?
ôIndiaÆs small and medium enterprises are on high octane,ö says CitiÆs Sandeep Ghosh who heads lending to this segment of companies for the US bank in India.

What are small and medium enterprises (SME) in the Indian context? Citi uses revenue as the determinant; it defines small as those who have sales less than $50 million and medium as those with sales between $50 million and $200 million.

The Reserve Bank of India (RBI) uses investment in fixed assets as the criteria. It defines small as a company where the investment in plant and machinery is more then Rs2.5 million ($61,000) but less than Rs50 million and a medium enterprise as one where the investment is more then Rs50 million but less then Rs100 million. For service sector companies the limits are somewhat lower but generally in the same ballpark. (The RBI uses these definitions to encourage banks to allocate part of their portfolios to such companies.)

Whichever way you choose to define the category, one thing is clear: in the current economic boom, companies of all sizes and shapes in India are on a roll. In stark contrast to the past, todayÆs economic boom is neither limited to specific sectors such as services û for example information technology and business process outsourcing û nor to large companies and business groups.

This leads to an obvious question: where are smaller companies finding the capital to fuel their growth ambitions?

CitiÆs emerging markets SME group dates back to 1996 û when it was launched in Taiwan, Hong Kong and Argentina. Shortly thereafter, in 1998, the group arrived in India.

ôIn the mid-nineties this segment was overbanked but underserved,ö comments Citi's Ghosh. ôWhat has not changed is that the space was and continues to be hugely attractiveö. Today, just nine years later, the SME category accounts for $2 billion of CitiÆs assets in India.

What makes this number even more remarkable is that the average exposure is less then $1 million. Ghosh explains: ôAt these levels our portfolio is not lumpy loans to a small number of companies but quite a granular portfolio broad-based across about 3,000 companies.ö

Citi has a tried and tested approach to identifying companies. Ghosh elaborates: ôWe identify segments where SMEs have a competitive advantage and sustainable proposition. This is key. We look for companies with upstream and downstream linkages with top-tier corporates and concentrate on geographies which have a critical mass within industry sectors. Finally, existing clients are the best source of new clients.ö

Genesis Colors obviously fits CitiÆs criteria as it banks with Citi and ICICI Bank. Coincidentally, Genesis was founded in the mid-nineties by a pair of ex-Citibankers Sanjay Kapoor and Jyoti Narula, both first generation entrepreneurs. They joined hands to set up a business marketing ties and other accessories under the brand, Satya Paul. As opportunities presented themselves they expanded the business, launching a full suite of designer garments under the Satya Paul umbrella, acquiring another couture brand, Deepika Gehani and opening multi-brand designer stores across the country.

Kapoor says a combination of his own entrepreneurial drive and the opportunity in the retail sector û which he terms ôa new industry driverö û spurred his decision. ôOpportunity is staring us in the face and young India is there to grab it,ö is KapoorÆs feeling.

Another example is AdImpactMedia. Founder and CEO Vibhav Parikh worked with Merrill Lynch, ICICI Securities and Citi before he was bitten by the entrepreneurial bug in 2005. ôAn investment banking career was no longer stimulating enough for me. Being young helped, because the ability to take risks was higher and secular economic growth across sectors has created new opportunities to exploit,ö explains Parikh.

AdImpactMedia installs LCD screens in prime locations across India û 200 screens are operational with another 1,000 contracted. Parikh believes, like Kapoor, that he is in the right place at the right time commenting that ôstrong growth in organised retail and real estate development has ensured a steady supply of quality locations at which to install our screens. The addressable market û defined in terms of preferred locations û is growing continuously which has helped us expand our network.ö

Or look at Parsec Technologies. Prabhat Agarwal, CEO and co-founder of Parsec, left a steady job with consulting firm Feedback Ventures in 1994 to start Parsec. The company provides contact centre solutions and specialised business process outsourcing (BPO) services. ôIt was a time when the industry was flourishing and everyone was talking about the software segment,ö says Agarwal of his decision to start a company in this area. Today ParsecÆs customer list includes leading companies, both in India and abroad.

ôThe SME space is hugely attractive,ö explains CitiÆs Ghosh. ôThe banking wallet is large in an absolute sense and in a relative sense growing faster than the wallet of the top tier corporates. Revenue streams are annuity and not episodic with attractive returns/yields if risk is managed well.ö

In contrast to when he started his business a decade ago, Kapoor, the CEO of Genesis, believes that ôtoday the liberalisation of the banking sector and widespread availability of private equity has made it easier to raise capital.ö Kapoor and Narula started their business with money raised from a friends and family network.

In May last year, Genesis Colors raised funding from JM Financial in its first round of private equity. It was a win-win situation û Genesis Colors needed to continue investing in the business to sustain the 80% year-on-year growth it has demonstrated over the last two years while private equity is keen to participate in one of IndiaÆs high-growth areas, retail.
Indian entrepreneurs have typically found it challenging to raise the debt funding their businesses needed û especially when they are small and have no track record.

ôBanks become more responsive as the size of the business grows. The paradox of banking is the less you need them, the more they are available and vice versa, ö comments Kapoor wryly.

ôVenture lending is still an unknown concept in India. The SME departments of banks lend only to companies with established business models and steady cashflows or backed by well-known business groups,ö is the view of AdImpactMediaÆs Parikh.

ôWhat Indian entrepreneurs need is more early stage investing from venture capitalists and angel investors willing to back strong ideas and execution capabilities,ö says ParsecÆs Agarwal.

Agarwal was one of the lucky few. His proposition interested ICICI enough to provide him with seed capital the year after he founded Parsec. In 1995 ICICI invested Rs3 million in the company. It may seem like a miniscule amount but it was enough to keep Parsec afloat for the critical first few months.

Agarwal was keenly aware that capital was a scarce commodity. He focused on keeping overheads low. Parsec operated in laboratory space provided by AgarwalÆs alma mater, the Indian Institute of Technology in Delhi, for the first few years of its existence û in stark contrast to the office building Parsec now owns in Gurgaon, DelhiÆs satellite suburb and home to the BPO revolution the country is witnessing.
Parsec has since raised external funding from two investors: Rs50 million from Gujarat Ventures and then Rs40 million from the Small Industries Development Bank of India.

ôRaising capital is only one of the many hurdles you will face and at various stages I thought about throwing in the towel,ö says ParsecÆs Agarwal as he highlights another of the realities inherent in start-ups û being small makes you vulnerable to external factors.

In 2001 Parsec went through tough times when a slowdown in the US market adversely impacted performance. But Agarwal remained convinced of the potential of the product and segment. He successfully restructured the company and repositioned its offering. Today ParsecÆs main product Paragon is considered a leading call centre solution from an Indian company. On the back of this Parsec has shown 100% year-on-year growth since 2002.

One of the reasons all banks are not comfortable lending to SMEs is that it requires a considerable change in orientation from normal asset- and collateral-based lending. SMEs rarely have the kind of assets which would provide the security.

CitiÆs Ghosh highlights the two most important factors. ôFundamental business strength is the ultimate safeguard. We try to fund businesses that have a strong underlying model. Secondly, cash is king û we have a strong focus on cashflows rather than collateral,ö he says.

Kapoor, Narula, Parikh and Agarwal all have business degrees. In yesteryears, these degrees served to make Indians risk-averse. Opportunities for employment, for example in banking, or with leading multinational companies beckoned. Turning your back on well-paid jobs, with plenty of benefits, to take a gamble on entrepreneurship was almost deemed a recipe for disaster.

Further, unlike the west, India has no ôgap yearö tradition. Both the prevailing culture and the strong competition in the job market combine to ensure that IndiaÆs youth typically goes straight from educational institutions into the workplace. Against this backdrop, young people with professional degrees also worried that they would be viewed with suspicion as risk-takers were their entrepreneurial ambitions to fail and they then entered organisations.

All this has changed. AdImpactMediaÆs Parikh says: ôIncreased job opportunities have provided aspiring entrepreneurs with reliable fall-back options and this has increased their risk appetitesö. Parikh is right. Finding a job in India today is no longer the challenge it used to be û since a booming economy has created a plethora of choices.

ôThe Indian entrepreneur scores on creativity, ingenuity, flexibility and imagination,ö comments CitiÆs Ghosh.

Ghosh is right but perhaps the last word should come from an entrepreneur. ôIf you are committed to the business then donÆt take shortcuts or lose faith because the tide will turn and fortune will smile,ö says ParsecÆs Agarwal, smiling to himself. He can afford to û all the way to the bank.

This article is reprinted from FinanceAsia magazine's India country report.
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