MSMEs in India

The Micro, Small and Medium enterprises (MSMEs) are the backbone of economic development in any
country. They are the incubators for talent, innovation and entrepreneurial spirit which is central to a
countrys development. Efficiently organized and innovative, MSMEs often exercise frugal management skills
and use local resources to create innovative products and services which cater to any countrys growing
needs.
There are about 30 million MSMEs in India accounting for 8% of Indias GDP, 45% of the total manufacturing
output, and 40% of Indias exports. Employing over 60 million, they churn out over 6000 products annually.
The contribution of Indian MSMEs to the GDP has been steadily growing over the years from about 5% in
2003 to 8.5% in 2011. However in order to continue scaling up, timely and adequate access to financial
services is an imperative, and this has been traditionally one of the biggest hurdles.
Funding Gap in MSMEs
The total gap in MSME funding is estimated to be around USD 126 Billion. Out of this, the debt gap is
approximately USD 84 Billion and equity GAP is about USD 42 Billion. Out of this the total equity supply is
only about USD 526 million, a huge shortfall. The major reasons for creation of this Gap are information
asymmetry which exists in Indian SMEs, the family owned nature of Indian businesses, and lack of
information regarding tapping the right kind and source of finance. Though the first two reasons are
systemic, lack of information can be easily resolved with targeted efforts from financial institutions and
government agencies.
Funding Structure
Traditionally, private funds from friends and family form the single largest source of finance to MSMEs in
India. MSMEs in India also rely heavily on private money lenders and the unorganized financial sector for
their requirements, where the terms of financing are unclear and interest rates are high. This small pool of
funding providers often forces many potentially viable and growth focused MSMEs out of operation.
Banks have been making steady strides in order to bridge this gap. However the approach followed by banks
to funding is very restrictive as the bank has to create value by controlling & managing risk. In any loan
application for a business, a Bank has to necessarily evaluate the risks involved, gauge collateral support
and the methods to mitigate those risks. Therefore it is not always possible for an entrepreneur to satisfy all
requirements and conditions which the Bank might pose. The above methods of financing are majorly debt
financing, and sources of equity funding remain elusive in India.
Private Equity Funding
Private equity and Venture capital is provision of equity capital by financial investors for medium to long
terms to companies with growth potential. Private equity in a broader sense encapsulates funding
requirements at all stages of development of any company and not only at the initial stage. However, since
well established companies have far greater sources of financing, this term is generally used for early stage
funding. Private equity firms in search of high return on their capital seek out firms with growth potential;
invest in these firms and exit after achieving their required return. However PE investment is not for
everyone. Some of the questions that any promoter should ask before venturing to solicit PE are:

Am I prepared to give up a part of the shareholding in the company?

Does my company have a technological, creative or a competitive advantage?

Do I have a trained/knowledgeable team to back me, to run the business with defined processes and
targets?

Is the sector in which my company operates a growth sector?

If the answer to most of the above questions is a Yes; then PE is worth considering. If most of the answers
are No, then your business is still not ready to take the plunge.
How will a PE firm help in growing business?
Most of the PE funds would not only provide medium to long term capital but would also act as a partner and
provide strategic and operational support. A PE firm might be able to help a business widen its geographic
access, provide strategic multinational partnerships, and also at times bring in customers using its vast
network and contacts. A PE firm might also be able to marshal better management frameworks improving

marketing efficiency or HR metrics. It could also improve new product development and provide technology
support which is generally sorely missing in any SME due to inaccessibility.
Private Equity Business Model
The overall business model of any private equity fund has four distinct stages, from forming a fund to exiting
from an investment.
1.

Raising Funds from Investors

2.

Investing Funds

3.

Managing the Investments

4.

Redistribution and Exit

After forming a fund, fund managers (referred to as General Partners or GPs) collect capital from investors
known as Limited Partners (LPs). The GPs who are in some sense employees of the fund then look out for
high growth companies to invest in. Limited Partners are generally sophisticated investors like pension funds,
HNIs, insurance companies, banks etc. because of their greater understanding of sectors, trends and risks.
Once the amount of required funds is raised, GPs select companies according to the funds mandate and
invest in equities of those companies, which is the second stage of the process. When they have fully
deployed the funds, they have generally created a portfolio of companies. In the third stage, fund managers
work closely with their portfolio companies, managing operations, subsequent fund raising, ensuring
business development and trying to time an exit from the investment. In fourth and the final stage, fund
managers exit their portfolio companies after having mostly made gains due to the change in valuation of
the company accrued due to growth.
Private Equity for Entrepreneurs
Though complex in structure to understand, cracking a PE deal can be a simpler process if Promoters and PE
fund managers understand each others expectations. Impeccable preparation and intelligent negotiation
can help an entrepreneur raise the right amount of money from the right kind of fund which can see their
business grow manifold. Almost all PE funds have a specific mandate as to the type of companies they can
fund which is generally based on parameters like turnover, sector, stage ,structure and the like. Thus, if a PE
fund rejects a business plan does not imply that the business is unviable or unprofitable. It is important to
understand that the PE fund cannot finance all types of businesses. Only highly profitable or growth oriented
business often get PE funding and thus only about 1% of all companies evaluated by PEs actually get the
desired funds.
The fund raising activity can broadly be divided into three to four stages which starts with the entrepreneur
readying a business plan.
Business Plan
A business plan not only forces the promoter and management to think about opportunities and challenges
facing their business but also serves as an initial point of contact and discussion between potential investors
and the promoter. Essential points that need to covered in the plan are the company history, business
potential, key highlights of the company, the management standing, products and services, analysis of the
industry, operational performance, commercialization and scalability, financial and volume projections,
capital requirements and last but not the least: exit strategy for the PE and the investor. Selection of the
right kind of private equity firm is most important. It is imperative to ascertain the credentials, prior
investment patterns and exits of the firm before the initial discussion.
The Negotiation
After the initial phase when the PE firm has accepted the potential of the business in principle, the long
drawn phase of negotiation normally would start.
Initial stages

The PE firm would first share guidelines for future negotiations. A deal would typically involve a lot of legal
and financial analysis as there might be different types of financing structures like quasi equity instruments,
mezzanine financing, preferred share agreement etc. The method of financing is dependent on the life cycle
of the business, growth projection as well as the mandate of the PE firm.
Price negotiation for a stake in a company is the most crucial aspect of a deal. A PE firm will use all kinds of
metrics to ascertain the value of the company which might include discounted cash flow valuation,
comparative methods or any other appropriate method.
Due Diligence
The Due diligence process would involve the PE firm thoroughly auditing the companys financial as well as
operational performance. If found satisfactory, the PE firm would draft an agreement after a final round of
negotiation. The final agreement could include certain protocols, warrants or statutes and thus needs to be
thoroughly examined before proceeding. An entrepreneur should also in this process independently analyze
and understand the value of his company, how earnings are to be divided, future relations and involvement
of the PE firm, PE firms exit strategy etc. All business advisors from management, legal counsels,
accountants, and auditors should be involved form the entrepreneurs side for this process to extract the
maximum value out of any deal.
It is important to understand that although short term goals of a PE firm and a promoter might be
contradictory, the long term objectives of balanced growth and profitability are common. There are various
exit routes for the entrepreneur as well as the PE firm which includes IPO, secondary sale, management
buyout, merger, liquation etc. The exit route will normally depend on the lifecycle, future economic condition
and the industry cycle.
Private Equity in India
The turn of the 21st century has brought with it greater globalization, regional economic slowdowns and a
change in geographic growth patterns with emerging economies out performing developing ones by a morethan-fair margin. This phenomenon, along with greater global capital flows has helped India become one of
the most preferred destinations for Private Equity investments. India has seen rapid growth in domestic
consumption. This coupled with favorable demographics has led to a lot of young entrepreneurs setting up
shops in important sunrise sectors which have attracted Private equity investments.
Empirical evidence shows that PE deal values are highly correlated with the Sensex, indicating that overall
economic sentiment has been a crtical parameter for investors to take long term calls.
Government Initiatives in MSME Funding
Government has always been cognizant of the funding gap which plagues Indian SMEs. In the 2012-13
budget, government announced an India Opportunity Fund of USD 878 Million to support Indian SMEs. This
entire amount will be routed to SIDBI and is divided into specific targeted sectors which includes:

Domestic MSMEs

Internationalization of SMEs

Sector Specific Funds ICE, Traditional Sectors, Defense, Infrastructure

IPO on SME Exchanges

Such initiatives would go a long way in bridging the financing gap and ensuring that India gets a steady flow
of entrepreneurs in various fields.
Conclusion
Globally, even though private Equity remains one of the most important and powerful engines in driving
innovation, Indian Entrepreneurs have still not fully recognized the potential of PE. It is therefore important to
build knowledge and instill mechanisms to help entrepreneurs recognize their potential. It is only when PE
funds are spoilt for choice will there be appropriate valuation and optimal capital utilization. Secondly it is
imperative that the process of establishing and making a company be made more promoter-friendly. The
biggest hurdle in getting PE funds on board is the information asymmetry and the question mark on the
integrity of Indian promoters, as many of them still carry the legacy of the License Raj and are accustomed
to bypassing laws and mandates. Finally, there is a need to firm up laws and regulations which make PE
entry and exits easy. All of these factors coupled together are necessary to attract more PE in India.

RBI Guidelines on rehabilitation of Sick Micro

& Small Enterprises
Definition of Sick SSI or MSME
A Micro

or

Small Enterprise (as defined in the MSMED Act 2006) may be

said to have become Sick, if

a. Any of the borrowal account of the enterprise remains NPA for three months
or more
or
b. There is erosion in the net worth due to accumulated losses to the extent of
50% of its net worth during the previous accounting year.

Handholding Stage of MSMEs

1. Timely and adequate assistance to MSEs and rehabilitation effort should
begin on a proactive basis when early signs of sickness are detected. This
stage would be termed as handholding stage as defined below. This will
ensure intervention by banks immediately after detecting early symptoms of
sickness so that sickness can be arrested at an early stage. An account
may be treated to have reached the handholding stage; if any of the

following events are triggered:

a. There is delay in commencement of commercial production by more than
six months for reasons beyond the control of the promoters;
b. The company incurs losses for two years or cash loss for one year,
beyond the accepted timeframe;
c. The capacity utilization is less than 50% of the projected level in terms of
quantity or the sales are less than 50% of the projected level in terms of
value during a year.
Action Points at Hand-holding stage
The bank branches should take timely remedial action which includes an
enquiry into the operations of the unit and proper scrutiny of accounts,
providing guidance/counselling services, timely financial assistance as per
established need and also helping the unit in sorting out difficulties which
are non-financial in nature or requiring assistance from other agencies. In
order to ensure timeliness for banks for taking remedial action/measures in
handholding stage, the handholding support to such units should be
undertaken within a maximum period of two months of identification of such
units.
This would enable banks to take timely action in identification of sick units
for their revival. The MSE units which could not be revived after intervention
by banks at the handholding stage need to be classified as sick subject to
complying with any one of the two conditions as laid down above and
based on a viability study the viable/potentially viable units be provided
rehabilitation package. The rehabilitation package should be implemented
speedily in a time bound manner. The rehabilitation package should be fully
implemented within six months from the date the unit is declared as
'potentially viable' / 'viable'. While identifying and implementing the

rehabilitation package, banks are advised to do holding operation' for a

period of six months. This will allow small scale units to draw funds from the
cash credit account at least to the extent of their deposit of sale proceeds
during the period of such holding operation'.
Units which should not be classified as Sick even after fulfilling conditions of
Sickness
Units becoming sick on account of willful mismanagement, willful default,
unauthorized diversion of funds, disputes among partners / promoters, etc.
should not be classified as sick units and accordingly should not be eligible
for any relief and concessions. In such cases steps should be taken for
recovery of banks dues. The declaration of a borrower as a willful defaulter
should be done strictly in accordance with the extant RBI guidelines.
Applicability of Sick Unit Definition
The above definition may be adopted for the purpose of reporting the data
for the year ending 31 March 2013, while for the purpose of formulating
nursing programme; banks should go by the above definition with
immediate effect.

Viability
The decision on viability of the unit should be taken at the earliest but not later than
3 months of becoming sick under any circumstances.
The following procedure should be adopted by the banks before declaring any unit
as unviable:

a. A unit should be declared unviable only if the viability status is evidenced by a

viability study. However, it may not be feasible to conduct viability study in very small

units and will only increase paperwork. As such for micro (manufacturing)
enterprises, having investment in plant and machinery up to Rs.5 lakh and micro
(service) enterprises having investment in equipment up to Rs. 2 lakh, the Branch
Manager may take a decision on viability and record the same, along with the
justification.

Guidelines for Rehabilitation of Sick Micro & Small Enterprises

1)The declaration of the unit as unviable, as evidenced by the viability study, should
have the approval of the next higher authority/ present sanctioning authority for both
micro and small units. In case such a unit is declared unviable, an opportunity should
be given to the unit to present the case before the next higher authority. The
modalities for presenting the case to the next higher authority may be worked out by
the banks in terms of their Board approved policies in this regard.
2) The next higher authority should take such decision only after giving an
opportunity to the promoters of the unit to present their case.
3) For sick units declared unviable, with credit facilities of Rs.1 crore and above, a
Committee approach may be adopted. A Committee comprising of senior official of
the bank may examine such proposals. A Committee approach will improve the
quality of decision as collective wisdom of the members shall be utilized, especially
while taking decision on rehabilitation proposals.
4) Decision of the above higher authority should be informed to the promoters in
writing. The above process should be completed in a time bound manner not later
than 3 months.
5) The banks may, however, take decision in cases of malfeasance or fraud without
following the above procedure.. Reliefs and Concessions for Rehabilitation of
Potentially Viable Units
6) Banks may decide on the reliefs and concessions for rehabilitation of

viable/potentially viable units based on their own Board approved policies as

conveyed in our circular RPCD.SME & NFS.BC.No.19/06.02.31/201112 dated
September 12, 2011.

One Time Settlement

The banks are to put in place a Non-discretionary One Time Settlement scheme for
recovery of non performing loans for the MSE sector, duly approved by the Board of
Directors as conveyed in circular No.RPCD.SME&NFS.BC.No.102/06.04.01/2008-09
dated May 4, 2009. It is also reiterated that the One Time Settlement scheme
implemented by the bank is given wide publicity by placing it on their banks website
and through other possible modes of dissemination. You may also allow reasonable
time to the MSE borrowers to submit the application and make payment of the dues
in order to extend benefits of the scheme to the eligible borrowers.

Delegation of Powers
11. The delay in the implementation of agreed rehabilitation packages should be
reduced. One of the factors contributing to such delay was found to be the time taken
for obtaining clearance from the Controlling Office for the relief and concessions. As it
is essential to accelerate the process of clearance, the banks may delegate sufficient
powers to senior officers at various levels such as district, divisional, regional, zonal
and also at head office to sanction the rehabilitation package drawn up in conformity
with the prescribed guidelines.

Important changes brought out in

Existing Guidelines

New Guidelines

the revised guidelines based on the

recommendations of the Working
Group on Rehabilitation of sick
MSE units visvis Existing
Guidelines Sr. No.
1

A MSE unit is

A MSE is considered

considered sick

sick when

when:

a) any of the
borrowal account of

a) If any of the
borrowal accounts
of the unit remains
substandard for

the enterprise
remains NPA for
three months or
more

more than six

months i.e. principal
or interest, in
respect of any of its
borrowal accounts
has remained
overdue for a period
exceeding 1 year.
The requirement of
overdue period

OR
b) There is erosion
in the net worth due
to accumulated
losses to the extent
of 50% of its net
worth.
The stipulation that
the unit should

exceeding one year

have been in

will remain

commercial

unchanged even if

production for at

the present period

least two years has

for classification of

been removed.

an account as sub
standard is reduced
in due course;
OR
b) There is erosion
in the net worth due
to accumulated
cash losses to the
extent of 50 per
cent of its net worth
during the previous
accounting year;
and
AND
c) The unit has been
in commercial
production for at
least 2 years.
2

No stipulated time

The decision on

frame for deciding

viability of the unit

the viability of a

should be taken at

unit.

the earliest but not

later than 3 months
of becoming sick
under any
circumstances.

The procedure for

The procedure for

declaring a unit as

declaring a unit as

unviable not

unviable has been

specified.

laid down

While the concept

Incipient sickness or

of incipient sickness

handholding stage

was there was no

defined

definition of
incipient sickness