Project

On

Financial Markets

Topic:

MICRO , SMALL AND MEDIUM ENTERPRISE (MSME)

FINANCING

Year:

March 2010

By
Sanjay Sinha and Dr.Neerja Sinha

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 MICRO , SMALL AND MEDIUM ENTERPRISE (MSME)
FINANCING

Micro, Small and Medium Enterprises (MSMEs) have been recognised as

one of the most important sectors for the development of any economy all over the
world. This sector constitutes more than 80% of all business organisations all over
the world. In India too, its share is more than 90 %. This sector ensures that the
processes of economic growth in our country are inclusive, employment-friendly
and they contribute to greater regional balance in levels of development.

During the last decade alone, the MSME sector has progressed from the
production of simple consumer goods to the manufacture of many sophisticated
products like T.V. Sets, micro-ware components, electro-medical equipment etc.
Product range varies from simple items produced with traditional technology to
high-tech products, produced with sophisticated state of the art technology. Other
than this, the micro, tiny and small scale sector have been engaged in the
production of goods like wood products, hosiery and garments, cotton textiles,
beverages and tobacco products, food products, jute textile, leather & leather
products, transport equipments etc. These industries produce over 7500
commodities.

Understanding the importance of this sector the government has brought

about the enactment of the Micro, Small and Medium Enterprises Development
Act. To strengthen this important sector and to create more national awareness
about its growing importance in our national economic life there have been
amendments to the Khadi and Village Industries Commission Act, a
comprehensive Package for Promotion of Micro and Small Enterprises has been
announced and a National Commission for Enterprises in the Unorganized Sector

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 have been set up. The National Manufacturing Competitiveness Programme has
contributed to the graduation of tiny and small scale units in micro and medium
enterprises and in the process strengthened the industrial base of our economy. As
per the very latest statement of issued by SIDBI, the MSME sector currently
contributes 8 percent of the country's GDP, 45 percent of the manufactured output
and 40 percent of its exports providing employment to about 60 million persons
through 26 million enterprises.

With the passing of Micro, Small and Medium Enterprises Development

Act in June 2006, various components of this sector have been given a clear
cut definition.

Definition of Micro, Small and Medium Enterprises(MSME)

(a) Enterprises engaged in the manufacture or production, processing or
preservation of goods as specified below:
i. A micro enterprise is an enterprise where investment in plant and
machinery does not exceed Rs. 25 lac;
ii. A small enterprise is an enterprise where the investment in plant and
machinery is more than Rs. 25 lac but does not exceed Rs. 5 crore; and
iii. A medium enterprise is an enterprise where the investment in plant and
machinery is more than Rs.5 crore but does not exceed Rs.10 crore.

In case of the above enterprises, investment in plant and machinery is the

original cost excluding land and building and the items specified by the
Ministry of Small Scale Industries.

(b) Enterprises engaged in providing or rendering of services and whose

investment in equipment (original cost excluding land and building and

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 furniture, fittings and other items not directly related to the service rendered
or as may be notified under the MSMED Act, 2006) are specified below:

i. A micro enterprise is an enterprise where the investment in equipment

does not exceed Rs. 10 lac;
ii. A small enterprise is an enterprise where the investment in equipment is
more than Rs.10 lac but does not exceed Rs. 2 crore; and
iii. A medium enterprise is an enterprise where the investment in equipment
more than Rs. 2 crore but does not exceed Rs. 5 crore.
The enterprises included under this sector are:
• small road & water transport operators. (owning a fleet of vehicles
not exceeding ten vehicles)
• retail trade. (with credit limits not exceeding Rs.10lakh)
• small business. (whose original cost price of the equipment used for
the purpose of business does not exceed Rs.20 lac) and
• professional & self employed persons. (whose borrowing limits do
not exceed Rs.10 lac of which not more than Rs.2 lac should be for
working capital requirements except in case of professionally
qualified medical practitioners setting up of practice in semi-urban
and rural areas, the borrowing limits should not exceed Rs.15 lac with
a sub-ceiling of Rs.3 lac for working capital requirements.

As may be seen from the above definition, the segment which was earlier
known as tiny sector, have been recognized through a formal definition
(investment in plant and machinery upto Rs. 25 lac) and has been given the term
Micro Enterprise. The investment ceiling in investment in plant and machinery has
been raised upto Rs.5.0 crore for small enterprises engaged in production or
manufacturing as against Rs.1.0 crore earlier. It is expected that this enhancement
will allow these enterprises to go for technology upgradation and modernization

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which is one of the prime requirements for enhancing competitiveness in the
context of liberalization, globalization and to fulfil the conditions of WTO. Also,
for the first time, official recognition and definition has been given to medium
enterprises engaged in production or manufacturing as those having investment in
plant and machinery between Rs. 5 crore and Rs. 10 crore. The term industries has
been replaces by the concept of enterprises to include the service sector.

MSME finance and credit issues :

Finance forms the most critical input for a business enterprise whether
large or small. All firms require financing to grow and survive. Sources may
be external, such as loans, equity infusions, subsidies and government grants,
or internal such as generated cash flows. Many firms are self financed in the
beginning. Once the firms reach certain degree of maturity in the development
of their product line and customer base, external finance becomes available.

The problem of MSMEs regarding their need for finance is peculiar and very
different from the requirement of finance by the large scale enterprises. The reason
for peculiarity is that most of the SSIs operate on tight budgets and the business is
often financed through the owner’s own contribution and loans from friends and
relatives. They avail the minimum possible bank credit. In this scenario they
sometimes need working capital loan under emergency situations for a short term.

These situations may arise due to an unexpected large order, or due to

rejection of a consignment or an inordinate delay in payments. It is under such
situations that they look for institutional finance but the flow of institutional
finance is linked with the creditworthiness of the enterprise. Small enterprises,
due to their small size and low capital base, generally find it difficult to satisfy
the conditions laid down by the banks, particularly, in establishing the viability

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of the project, meeting collateral requirements and making timely repayment of
loans. Hence, they do not find a place among the preferred clients of the banks.

These problems have not gone unnoticed by the Government of India. it has
recognised the need for a focused credit policy for MSMEs and earlier more
importantly the SSIs. The Government has realised that timely availability of
credit is one of the most important factors for a small scale unit.

To improve the flow of credit, the RBI has constituted several committees
and working groups since 1991. Notable among the committees are Nayak
Committee, Kapur Committee and Ganguly Committee. Appropriate measures
are taken by the RBI and Government from time to time based upon the
decision of the Standing Committee on SSI set up at the RBI.

A multi-level institutional structure exists for financing of small

enterprises and non-farm enterprises in India. This consists of commercial
banks, cooperative banks, RRBs, State Financial Corporations. Credit to Micro
and Small enterprises comes under priority sector lending programme of
banks. The Reserve Bank of India (RBI) constantly reviews the flow of credit
to this sector. An exclusive refinancing bank, called Small Industries
Development Bank of India (SIDBI) was set up in 1990. The issue of providing
micro credit to micro enterprises through development of SHG-Banks Linkage
rests mainly with National Bank for Agricultural and Rural Development
(NABARD).

Priority Sector Lending

The Government of India through the instrument of Reserve Bank of

India (RBI) mandates certain type of lending on the Banks operating in India

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 irrespective of their origin. RBI sets targets in terms of percentage (of total
money lent by the Banks) to be lent to certain sectors, which in RBI's
perception would not have had access to organised lending market or could
not afford to pay the interest at the commercial rate. This type of lending is
called Priority Sector Lending. Financing of Small Scale Industry, Small
business, Agricultural Activities and Export activities fall under this
category. This is also called directed credit in Indian Banking system.

Financing Priority Sector in the economy is not strictly on commercial basis

as not only the general approach is liberal but also the rate of interest charged on
such loans is less. Part of the cost of these concessions are borne by RBI, by means
of refinancing such loans at concessional rate. Indian Banks, therefore, contribute
towards economic development of the country by subsidizing the business
activities undertaken by entrepreneurs in the areas which are consider "priority
sector" by RBI. The Reserve Bank of India is making an all out effort to increase
the role of the financial institutions in the small scale sector. It has asked the
commercial banks to chalk out their branch expansion strategies keeping in mind
the growth potential and the economic development needs of MSME. The RBI
wants that this expansion should be specially in the case of the under-banked
regions where the population per branch is more than the National average of
16000 person per branch.

Policy Package for Stepping up Credit to Small and Medium Enterprises

(SMEs), was launched with the objective of doubling the flow of credit to this sector
within a period of five years.

The main objectives of this policy are as follows:

i. Banks to achieve a minimum 20% year-on-year growth in credit to the

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 MSME sector, and
ii. Cover on an average at least 5 new MSMEs at each of their semi-
urban/urban branches per year.

iii. In order to ensure that credit is available to all segments of the Small

Enterprises sector, banks should ensure that :-

• 40 per cent of the total advances to small enterprises sector

should go to 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.
• 20 per cent of the total advances to small enterprises sector
should go to micro (manufacturing) enterprises with investment
in plant and machinery above Rs. 5 lakh and up to Rs. 25 lakh,
and micro (service) enterprises with investment in equipment
above Rs. 2 lakh and up to Rs. 10 lakh. (Thus 60 per cent of
small enterprises advances should go to the micro enterprises)

SCHEMES UNDER THE ABOVE POLICY PACKAGE

Scheme of Small Enterprises Financial Centres (SEFCs):

As per announcement made by the Governor in the Annual Policy Statement

2005-06, a scheme for strategic alliance between branches of banks and SIDBI
located in clusters, named as “Small Enterprises Financial Centres” has been
formulated in consultation with the Ministry of SSI and Banking Division,
Ministry of Finance, Government of India, SIDBI, IBA and select banks .SIDBI
has so far executed MoU with 15 banks so far (Bank of India, UCO Bank, YES

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Bank, Bank of Baroda, Oriental Bank of Commerce, Punjab National Bank, Dena
Bank, Andhra Bank, Indian Bank, Corporation Bank, IDBI Bank, Indian Overseas
Bank, Union Bank of India, State Bank of India and Federal Bank).
Deposit by Foreign Banks with SIDBI towards shortfall in priority sector
lending

The foreign banks having shortfall in lending to stipulated priority sector

targets /sub-targets will be required to contribute to Small Enterprises
Development Fund (SEDF) to be set up by Small Industries Development Bank of
India (SIDBI), or for such other purpose as may be stipulated by Reserve bank of
India.

The corpus of SEDF shall be decided by Reserve Bank of India on a year-to-

year basis. The tenor of the deposits shall be for a period of three years or as
decided by Reserve Bank from time to time. Fifty percent of the corpus shall be
contributed by foreign banks having shortfall in lending to priority sector target of
32 per cent of ANBC. The balance fifty per cent of the corpus shall be contributed
by foreign banks having aggregate shortfall in lending to Small Enterprises sector
and export sector of 10 per cent and 12 per cent respectively, of ANBC or credit
equivalent amount of Off-Balance Sheet Exposure, whichever is higher, on a pro-
rata basis. The contribution required to be made by foreign banks would, however,
not be more than the amount of shortfall in priority sector lending target/sub-target
of the foreign banks.

Role of Small Industries Development Bank of India (SIDBI) to be enhanced

SIDBI was set up with the mission to empower the Micro, Small and
Medium Enterprises (MSME) sector with a view to contributing to the process of
economic growth, employment generation and balanced regional development. It is

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the principal financial institution responsible for promotion, financing and
development of the sector. Apart from extending financial assistance to the sector,
it coordinates the functions of institutions engaged in similar activities.
The four basic objectives of SIDBI for orderly growth of industry in the
small scale sector are:
 Financing
 Promotion
 Development
 Co-ordination

Taking into account the fact that the majority of such enterprises are at the
lower-end of the sector and are outside the ambit of institutional finance. Hence,
concerted efforts have been made by SIDBI to promote micro finance across the
country to enable the unemployed persons to set up their own ventures. There are
more than 100 Micro Finance Institutions (MFIs) developed by SIDBI that are
engaged in implementation of its micro finance programme.

Also, Credit Guarantee Cover Fund Scheme for Small Industries was
launched jointly by the Government of India and SIDBI (on a 4:1 contribution
basis) in August 2000, with a view to ensure greater flow of credit to the sector
without collateral security. It picked up during the last two years of the Tenth Plan
and till the end of March 2007, 68062 proposals were approved and guarantee
covers for Rs 1705 crore were issued.

Common guidelines/Instructions for Lending to Small Enterprises by RBI

1. Disposal of Applications
All loan applications for MSE units upto a credit limit of Rs. 25000/- should
be disposed of within 2 weeks and those upto Rs. 5 lakh within 4 weeks

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provided, the loan applications are complete in all respects and accompanied
by a " check list".

2. Collateral
The RBI has instructed that no collateral security is required for obtaining
loans till Rs.5 Lac by MSE (both manufacturing or production and providing
or rendering of services, including those units financed under the Prime
Minister Employment Generation Programme of KVIC). Banks may on the
basis of good track record and financial position of the MSME units,
increase the limit of dispensation of collateral requirement for loans up to
Rs.25 lac (with the approval of the appropriate authority).

3. Composite loan
A composite loan limit of Rs.1 crore can be sanctioned by banks to enable
the MSME entrepreneurs to avail of their working capital and term loan
requirement through Single Window.

4. Specialised SME branches

Public sector banks have been advised to open at least one Specialised
branch in each district. Further, banks have been permitted to categorise
their SME general banking branches having 60% or more of their advances
to SME sector in order to encourage them to open more specialised SME
branches for providing better service to this sector as a whole.

5. Delayed Payment
Under the Amendment Act, 1998 of Interest on Delayed Payment to Small
Scale and Ancillary Industrial Undertakings, penal provisions have been
incorporated to take care of delayed payments to MSME units which inter-
alia stipulates

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 • agreement between seller and buyer shall not exceed more than 120
days
• payment of interest by the buyers at the rate of one and a half times the
prime lending rate (PLR) of SBI for any delay beyond the agreed period
not exceeding 120 days. Further, banks have been advised to fix sub-
limits within the overall working capital limits to the large borrowers
specifically for meeting the payment obligation in respect of purchases
from SSI.

After the enactment of the Micro, Small and Medium Enterprises

Development (MSMED), Act 2006, the existing provisions of the Interest on
Delayed Payment Act, 1998 to Small Scale and Ancillary Industrial Undertakings,
have been strengthened as under:

i. In case the buyer to make payment on or before the date agreed on

between him and the supplier in writing or, in case of no agreement

before the appointed day. The agreement between seller and buyer shall
not exceed more than 45 days.
ii. In case the buyer fails to make payment of the amount to the supplier, he

shall be liable to pay compound interest with monthly rests to the

supplier on the amount from the appointed day or, on the date agreed on,
at three times of the Bank Rate notified by Reserve Bank.
iii. For any goods supplied or services rendered by the supplier, the buyer

shall be liable to pay the interest as advised at (ii) above.

iv. In case of dispute with regard to any amount due, a reference shall be

made to the Micro and Small Enterprises Facilitation Council, constituted

by the respective State Government.

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6. Guidelines on rehabilitation of sick SSI units (based on Kohli
Working group recommendations)

As per the definition, a unit is considered as sick when any of the borrowed
account of the unit remains substandard for more than 6 months or there is
erosion in the net worth due to accumulated cash losses to the extent of 50%
of its net worth during the previous accounting year and the unit has been in
commercial production for at least two years. The criteria will enable banks
to detect sickness at an early stage and facilitate corrective action for revival
of the unit.

As per the guidelines, the rehabilitation package should be fully

implemented within six months from the date the unit is declared as
potentially viable/viable. During this six months period of identifying and
implementing rehabilitation package banks/FIs are required to do “holding
operation” which will allow the sick unit to draw funds from the cash credit
account at least to the extent of deposit of sale proceeds/ RBI has framed
broad parameters for grant of relief and concessions for revival of
potentially viable sick SSI units.

The FIs and commercial banks have been advised to put in place loan
policies governing extension of credit facilities, Restructuring/Rehabilitation
policy for revival of potentially viable sick units/enterprises and
nondiscretionary One Time Settlement scheme for recovery of non-
performing loans for the MSE sector, with the approval of the Board of
Directors and implement recommendations with regard to timely and
adequate flow of credit to the MSE sector.

7. State Level Inter Institutional Committee

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In order to deal with the problems of co-ordination for rehabilitation of sick
micro and small units, State Level Inter-Institutional Committees (SLIICs)
have been set up in all the States. The meetings of these Committees are
convened by Regional Offices of RBI and presided over by the Secretary,
Industry of the concerned State Government. It provides a useful forum for
adequate interfacing between the State Government Officials and State
Level Institutions on the one side and the term lending institutions and banks
on the other. It closely monitors timely sanction of working capital to units
which have been provided term loans by SFCs, implementation of special
schemes such as Margin Money Scheme of State Government, National
Equity Fund Scheme of SIDBI, and reviews general problems faced by
industries and sickness in MSE sector based on the data furnished by banks.

8. Empowered Committee on MSMEs

As part of the announcement made by the Union Finance Minister, at the

Regional Offices of Reserve Bank of India, Empowered Committees on
MSMEs have been constituted under the Chairmanship of the Regional
Directors with the representatives of SLBC(State Level Bankers Committee)
Convenor, senior level officers from two banks having predominant share in
MSME financing in the state, representative of SIDBI Regional Office, the
Director of Industries of the State Government, one or two senior level
representatives from the MSME/SSI Associations in the state, and a senior
level officer from SFC/SIDC as members. The Committee will meet
periodically and review the progress in MSME financing as also
rehabilitation of sick Micro, Small and Medium units. It will also coordinate
with other banks/financial institutions and the state government in removing
bottlenecks, if any, to ensure smooth flow of credit to the sector. The

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committees may decide the need to have similar committees at
cluster/district levels.

9. Debt Restructuring Mechanism for SMEs

As part of the policy for stepping up credit to small and medium enterprises,
a debt restructuring mechanism for units in SME sector has been formulated
by Department of Banking Operations & Development of Reserve Bank of
India and advised all commercial on 2005-06. These detailed guidelines
have been issued to ensure restructuring of debt of all eligible small and
medium enterprises.

10. Cluster Approach

60 clusters have been identified by the Ministry of Micro, Small and

Medium Enterprises, Government of India for focused development of
Small Enterprises sector. All SLBC Convenor banks have been advised to
incorporate in their Annual Credit Plans, the credit requirement in the
clusters identified by the Ministry of Micro, Small and Medium Enterprises,
Government of India.

As per Ganguly Committee recommendations banks have been advised that

a full-service approach to cater to the diverse needs of the MSE sector may
be achieved through extending banking services to recognized MSE clusters
by adopting a 4-C approach namely, Customer focus, Cost control, Cross
sell and Contain risk. A cluster based approach to lending is considered to be
beneficial:

a. in dealing with well-defined and recognized groups;

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b. availability of appropriate information for risk assessment and
c. monitoring by the lending institutions.

Clusters may be identified based on factors such as trade record,

competitiveness and growth prospects and/or other cluster specific data.

Apart from the above , the Ministry of Micro, Small and Medium
Enterprises has approved a list of clusters under the Scheme of Fund for
Regeneration of Traditional Industries (SFURTI) and Micro and Small
Enterprises Cluster Development Programme (MSE-CDP) located in 121
Minority Concentration Districts.

Accordingly, appropriate measures have been taken to improve the credit

flow to the identified clusters of micro and small entrepreneurs from the
Minorities Communities residing in the minority concentrated districts of the
country.

11. Continuation of the Credit Linked Capital Subsidy Scheme ( CLSS)

for Technology Upgradation of Micro and Small Enterprises

Government of India, Ministry of Micro, Small and Medium Enterprises has

approved CLSS for the XI th Plan with the condition of ceiling on the loan
under the scheme is Rs. 1 crore.with the rate of subsidy being 15% for all
units of micro and small enterprises. Calculation of admissible subsidy will
be done with reference to the purchase price of plant and machinery instead
of term loan disbursed to the beneficiary unit and SIDBI and NABARD will
continue to be implementing agencies of the scheme.

Though the Indian Government along with the Reserve Bank of India it has

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 come to the conclusion that non-availability of timely and adequate funds at
reasonable cost is one of the most important problems facing the MSME
sector. Take, for instance, credit. Since the nineties the share of commercial
bank credit that goes to the SSI sector is falling (though growing in absolute
terms). Some of the major causes for low availability of bank finance to this
sector are the high-risk perception, inadequate data and usage of external
credit rating (there is need to scale up external ratings), weak corporate
financial systems, early stage high transaction cost for small loans and high
costs of the banks in lending to MSMEs. The lack of adequate collateral
further hampers availability of funds to the sector.

Innovative Financing

The small enterprises have, so far, depended mostly on banks and

traditional modes of financing namely term loan and working capital from
banks. Micro finance through MFIs (Micro Financing Institutions) and SHGs,
(Self-Help Groups) is an innovative means of financing, but is its initial stage
and at best only an indirect form of bank finance. Unlike large enterprises which
raise finance from capital market and external sources like foreign financial
investors besides commercial banks, small enterprises and other non-farm
enterprises are solely dependent on banks.

With the growing financial need, emergence of new product lines,

emergence of risky and untried ventures, it is high time that some innovative
means of financing for the non-farm unorganized enterprises are explored.

SIDBI, the premium institute in the country, dealing with alleviating the
problems of the MSME sector is exploring all the possibility of linking SMEs, with
capital market. Financial instruments have to be designed to link SMEs with the

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huge amount of money of capital market. The emergence of clusters and with
emphasis on making them as the strategy of SME development, would make
it possible to rope in capital market to SME financing. This will bring new capital
to this sector.

Making various Risk-capital options available to the MSME sector is

essential and a lot of them are being tried internationally and now in India. They
may be summarised as follows:

Risk Capital Options

Some of the major risk capital options available for MSME sector
internationally and in India are given below. These need to be introduced and/or
strengthened:

Venture Capital
Venture funds typically provide equity and may or may not also provide tied
credit. Good quality venture funding can improve the credit rating of the
company allowing it to access commercial loans or other forms of finance.
However, there are some expected problems with exit that can impact funds
entry into these areas. For the MSME, it has possible disadvantages of
reduced operational flexibility, etc.

Ventures like bio-tech, food processing, IT, pharmaceutical and other

knowledge based sectors in India need creation of venture capital funds
to meet the equity requirements. In the initial phase of their working.
Knowledge sector including BPO, KPO, Life sciences, on-line business,
technology-enabled design and manufacturing as well as in emerging areas
of Nano-technology and environmental technology.

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Factoring Service
Third area of innovative financing, which needs popularization in India, is
the development of factoring services. This is necessary since a major
problem faced by MSMEs, is delayed payment from the units to whom they
have supplied goods. Banks can work as factors on behalf of
MSMEs, to collect the dues on their behalf by discounting the bills at
nominal service charge. Likewise, other means of financing SMEs, such as
lease finance, hire-purchase finance and propagation of incubation centres
could be undertaken to inject additional fund to the MSMEs in order to
bridge the financial gap.

Angel Investors
Angels are typically high net worth individuals who wish to invest some of
their surplus funds in new ventures. They can prove to be a good source of
capital and advice at an early stage in the development of the company. For
the investor, they bring opportunity to make high returns from investing at
an early stage in an MSME. The problem areas are unwillingness of MSME
to bring in an external investor in case of equity sale, the high risk for
investor and risk of relationship between the investor and the MSME
manager breaking down.

Public Listing
MSMEs with a good track record can access funding from the public
through the public listing process first through the initial public offer (IPO).
A functioning IPO regime for MSMEs will enable the entry of other types of
risk capital in the earlier stages. However, the IPO route is limited to bigger
MSMEs having an established strong record of past performance and
reputation in the market.

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Following supplements to risk capital can also be explored:

Loan Funds
A pure loan fund supported by the Structural Funds can be leveraged by
using private capital. While Loan schemes are a major source of capital for
MSMEs, usually lenders will require collateral or will go through a credit
scoring process which may discriminate against start-up companies.
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Guarantee Associations
Guarantee Funds or Guarantee Associations issue guarantees to MSMEs in
order to facilitate access to external finance (mainly loan-based, but also
equity) in return for a fee to cover both the risk and administrative and
processing costs. They facilitate access to loan finance on improved
financial terms for MSMEs and reduce the degree of risk for the lending
institution. However, they cover only part of the credit risk and often apply
to only a limited range of financial instruments. Requires the creation and/or
existence of strong associations which typically take many years to set-up
and operationalize.

Micro Finance
Micro finance is typically designed for businesses with small financing
requirements. It can meet the market failure in starting and developing micro
businesses. However, apart from high cost of setting and administering
loans, it caters to only small requirements and generally requires the
presence of a homogenous and well networked social group.

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Changes required in the FI/Banking System to implement the schemes of
SIDBI

To enable the FII or the Banks to bring about these innovative tools of
innovative financing a risk-credit ecosystem needs to have the following elements:

• Availability of risk capital at every stage.

• Availability of good quality entrepreneurs.
• Mentoring/advisory credit with hand holding.
• Appropriate and adequate exit options for all stakeholders.
• Appropriately incentivising risk-capital providers.
• Reducing informational imperfections.
• Ability to accept risks failure in early stage financing.

To enable the supply of good 'quality' entrepreneurs and projects, following

areas need to be focused upon:

Incubators
Business incubators need to be set in partnership with technical and higher
educational institutions to help the potential entrepreneur in the early stages.
They aid the creation of higher 'quality' projects for later stage funding.
Recognition of incubators as a priority sector activity can help in spreading
incubators both in the public and private sectors. The incubators in India
primarily provide the infrastructure setup with hand holding. There is need
to linkup to risk capital for incubatee companies, particularly start-ups, to
take care of expenses relating to manpower, IPR, initial marketing, product
development etc. Further, the incubators need to develop strong linkages
with Angel Networks and Venture Capital Funds to provide equity at start-
up stage.

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Angel Networks
Internationally, these have been highly successful in providing both risk-
capital as well as mentoring for budding entrepreneurs, many of them at the
seed stage itself. There are certain taxation and exit issues affecting the
growth of this sector in India. Appropriate and adequate policy action aimed
specifically at this source of funds is required.

Small Cap Exchange

As the characteristics of small companies do not match the requirements of
the stock exchanges servicing larger companies, there is a need to accelerate
the setting up of a small cap exchange, either independently or as a part of
the established exchanges. Equally important is ensuring easier IPOs for
MSMEs as exit will make it easier for VCs and other types of risk capital
providers to unlock their investment in the units.

Incentives for institutional and individual risk-credit providers

The risk capital in early stage investment particularly in small companies
have a high risk high return portfolio with a small number of ventures
succeeding. Appropriate tax and other incentives need to be designed for
different types of risk-capital providers. Incentives of Risk capital have been
devised in some countries to encourage entrepreneurship and start-up
ventures. Such models can be studied for possibility of replication in India.

Publishing Success Stories

Publishing success stories particularly of first generation entrepreneurs, is a
high motivator for job seekers to take risk and set up ventures.

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Corporatisation
Awareness needs to be created among MSMEs about advantages of
conversion from Proprietorship / Partnership to a corporate entity (after
reaching a certain size of stature). The corporate structure with greater
transparency enables flow of capital vis-a vis Partnership / Proprietorship
concerns

Insolvency
In early stage financing, the failures due to technology, marketing etc are
high. This requires a regime that allows for second chance options in case of
genuine failures.

Information/Skill Gaps
Institutional solutions as outlined above would be much more effective if
they are also accompanied by capacity improvements. Moreover, there are
also gaps in information and skill availability both for entrepreneurs as well
as finance providers.

Some examples discussed were:

• Entrepreneurship development programs at graduate level

• Organizing of Business Plan Competitions in colleges
• R&D centres and technical institutions
• Institute referral services, laboratory facilities
• Process certifications via technical institutions and universities
• Promotion of greater faculty and industry interaction by building in
appropriate flexibilities and incentives for research staff in research and

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 academic institutions Strengthening the entrepreneurs accessibility to
expertise in a range of areas such as assistance with IPR filings
• Enable access to marketing, HR and other business development services
etc
• Ensuring risk-capital provider's easy access to multiple sources of
information on the industry, activity and the entrepreneur (Government
support is required for such information to be made available on a large
enough scale)

Conclusion

With greater emphasis on a market based economy that addresses the

requirements of rapid and equitable progress, the role of MSMEs has only become
more important. However, this also requires that there be greater entry and spread
of the MSME sector. This, in turn, requires their access to financing with minimal
transaction costs. It is well recognized that unlike in many developed countries,
Indian MSMEs do not currently have access to a well funded ecosystem of risk-
capital availability. India, therefore, needs a properly designed and adequately
resourced risk-capital regime. It will need to be a combination of many different
routes. However, it will need to be based on Indian realities and the reality of the
Indian MSME sector.

Merely creation of greater number of financing bodies is not the solution.

The systems, rules, procedures, and practices governing the granting of capital,
monitoring, and exiting will need to be thought through carefully. This, in turn,
will require a multi-dimensional and multi-departmental approach, where human
capital, expertise, financing, legal regimes, all need to be changed to suit the
requirements of India's new MSMEs. These will not be dependent on government

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largesse and subsidies, but on the entrepreneurs ability to harness all available
technologies and resources.

Already with government support, and also newer private initiatives, such an
ecosystem is emerging. The government needs to catalyze these activities by
removing the bottlenecks that prevent the market for risk capital from evolving.

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