SME South Africa: An open letter to Cyril Ramaposa

Dear Honorable Deputy President Cyril Ramaphosa, Sir, all protocol observed.

Your opening address at the Global Entrepreneurship Congress, March 2017 had honorable intentions. Much, perhaps too much, is expected from SA’s entrepreneurs in order to achieve the honorable 2030 objectives of National Development Plan ‘NDP’.

On 15 February 2017 the World Bank presented a very disturbing outlook on SA to Parliament’s Standing Committee on Appropriations. The NDP targets six percent unemployment rate by 2030. To achieve this will require 600 000 new jobs annually from 2012 to 2030. However, on average, since 2012, South Africa has been able to make only 250 000 jobs annually.

This has already created a jobs crisis in SA, particularly in SA’s youth. If something is not done about unemployment the South Africa could degenerate into social chaos long before the NDP sunset date of 2030.

The NDP is already in tatters and in dire need of reform. It is thus a great pity that its principal architect, Trevor Manuel, has exited politics, stage left. Please note that Manuel, despite his enormous talents and successes in politics, has not started his own SME.

The NDP places has high expectations of Small and Medium Enterprises. But sadly, the SME sector is in deep distress and in urgent need of substantial and meaningful government intervention.

Where did the concept of SME South Africa come from?

South Africans still believe that old lie ‘The worst thig in life you can have is a job!’ So they pursue the SME dream. Many lose their careers, their savings and even their retirement funds. So let’s be careful here! There are rafts of SME casualties out there.

Perhaps It is worth starting off by looking at the origins of the SME dream, both locally and internationally.

The beginning of the end of the Cold War, 1955 – 1987, did not come from President Kennedy’s ‘Ich bin ein Berliner’ speech, 1962. Many in the crowd took it literally to mean ‘ I am a sausage’ and they relished that.

Move forward to 1987 and President Ronald Reagan’s  “Mr. Gorbachev, Tear down this wall!”. That hit the spot and the Cold War was soon over.

The abrupt end of the cold war in itself left a wave of collateral damage in California USA. Suddenly hundreds of thousands of Americans, no longer needed in the military and armaments industries, were put out of work. So they went home, cleared out their garages and started small businesses. Many flourished and California’s economy boomed. Politicians the world over have been trying to emulate the success story for the last 20 years. But few have stopped to consider if the California SME Boom was perhaps a once-off, caused by unique circumstances.

It all seems very glamourous to start a small business. People talk about the freedom of not having a boss, the fortunes to be made and the massive tax benefits. But the stark realities are different, particularly in SA

  • Those that made a pile on California had the benefit of an education and previous job experience. They simply put them to work for their own account. These are the very fundamentals of SME success. The chances of starting a sustainable SME without an education and previous work experience are less than 1 in 10.
  • America’s economy is just massive and has the suppliers, customers and distribution networks to buy whatever SME’s produce.
  • The California SME boom happened before everything could be outsourced on an email to China at a fraction of the price of producing it at home.

Back in SA there are some wonderful SME’s success stories during the period 1998 to 2010. But that’s all some time back now.

The stark realities to consider in an SME start-up in SA today.

  • Jobs are scarce in SA. There is little prospect in resigning and returning to a job if an SME fails. Early retirement or resignation can easily be a one-way ticket and possibly oblivion.
  • All attempts to simplify the ‘red tape’ or super-regulation of the SME sector in SA have failed. SME owners are today caught up in the administrative requirements that are choking all enthusiasm out of the SME sector.
  • Unless an SME can sort out its BBBEE accreditation it has little prospect of playing in either the private or public sectors. Yes, this can be simply achieved with 51% black ownership while turnover is below R10 million pa and there is plenty of fronting in the BBBEE space. But this is hardly a long-term solution to SME success.
  • SME’s have very limited opportunities of raising the funding needed to grow the business. This leaves the owner at huge personal financial risk when using their homes, savings and retirement fund payouts to fund their business. They literally risk landing their entire family on the street.
  • The primary cause of SME failure is generally not that the idea was not profitable but rather that the SME overtraded and could not be funded.
  • The Business Rescue provisions of the companies act have had little success in saving SME’s and are viewed by creditors as just another delaying tactic.
  • Cheap imports from China have overwhelmed much of what was SA’s SME sector. It is just amazing that even most ‘Tannie se Moer’ tee-shirts display a ‘Made in China’ label today.
  • Since 2010 the influx nearly one million foreign nationals have entered the SA SME space. Many have previous business experience and hence have set up businesses that thrive and grow. But many live under the fear of xenophobic attacks.

The cabinet now includes Minister Lindiwe Zulu plus a R4billion pa budget to help the SME sector. Perhaps even this initiative seems to be missing the plot.

There are some fundamental realities of the SME sector outlined by the Davis Tax Committee.

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When it comes to jobs and wealth creation the success stories in the SME sector come from the ‘missing middle’. These businesses are established, formalized, provide employment and can obtain the funding needed to grow. There may be 100 000, in all SA. According to SARS statistics only around 40 000 are profitable

The informal sector consists of an unknown number (perhaps millions) of ‘survivalist businesses.’ These businesses have little prospect of making anything more than put food on the table for their owners. They cannot grow because they have no real access to finance. Research shows that they do not provide ‘good jobs’ for others. And they cannot cope with super-regulation. The majority fail in the short term and are replaced by others.

Unemployment levels in SA exceed 27%. Without survivalist businesses, who knows where this number would be today. Perhaps SA would have already degenerated into social chaos. Minister Zulu probably recognizes this and consequently the thrust of the ministry of SME is to facilitate survivalist business. There is some merit in that. But it will not create a California dream scenario in SME SA.

In amongst this all sits the ‘lifestyle business,’ a very appealing prospect as an alternative for the employed who have to endure a daily commute and the monotony that goes with a job. ‘Work from home’ they say. ‘Work your own hours! Be your own boss! Enjoy a substantial tax advantage! Etc Etc’. Yes, everyone wants that. But the realities in SA are very different.

Survivalist and Lifestyle businesses, beware!

  • Business success is, to a very large extent, dependent on the owner’s discipline and work ethic. Working from home in a lifestyle business it is full of distractions.
  • Small business is a very lonely life. Few appreciate that a job carries the very important benefit of social interaction. Sitting at home working with kids and dogs drives many small businesses to failure.
  • Financial support is virtually non-existent without putting the business owner’s assets at risk. That is an enormous risk.
  • Customers and clients prefer to deal with established businesses. Small businesses have to have something pretty special to offer if they are going to attract a substantial customer base.
  • Small businesses cannot escape super regulation in SA. Hours, even days of time are taken up in form bashing and frustration that are normally dealt with by someone else when employed.
  • Job security is not only about a monthly salary that puts food on the table. Employers provide security in the form of medical aid, life and disability insurance and retirement plan. In SA these benefits are not provided by state and SME’s struggle to understand and implement their own private arrangements.

When to start an SME?

All the above considered the answer is ‘when all else fails and the owner really has no option!’ In SA it is only an extremely brave or foolish person who walks away from a good job to start an SME. That’s stark reality!

The young entrepreneur has a better chance of success. Simply put, they have not yet found the trappings of the expense and responsibility that goes with a family. They have the energy to make things happen and, very importantly, the time to recover if things don’t.

Then come the ‘Chapter Two’s’. This is usually the smart-arse, a ‘forty something or nifty-fifty’ who reckons they can cash in their pension, set up a coffee shop in George and provide employment to the extended family. This seldom works and should generally be avoided. Failures abound leaving the ‘fifty something’ with insufficient the time left to recover before hitting the shady pines retirement village.

Setting up a business for the kids sounds very glamorous. But ask the question ‘ why are the kids not employed or their own businesses?’ If the kids are sitting at home watching TV they will probably do the just the same, or even more, if you establish a family business. Rather attack the problem in the old Cosby manner ‘Go to the army! Or get a job! Or go to college! The emphasis is on the word GO!

The depressing prospect

All of the above creates the the generally depressing conclusion is the SME sector is never going to do it for SA.  The wonder that was the SA SME sector was short-lived and has been mostly overtaken in SA by a concoction of lack of funding, administrative chaos, foreign nationals and cheap imports. Perhaps SA should be looking for another plan. But the cabinet is busy with other important matters.

What are the SME rewards

Those that do make it the SME sector are rewarded for their hard work.

The price for being your own boss is long hours and no care-free holidays. And there is always those questions ‘when is competitor going to invade my space? What will happen if I am not here to run the business tomorrow?’ Far from being a care-free lifestyle it is probably the most stressful career choice. Know it! Most of the glamour is a perception.

If there is a reward for those SME’s that do make it then it is probably the tax benefit. And even that has changed.

In the past SME’s were cash businesses. SME owners appeared to have army boils on their thighs for all the cash they hauled around. Occasionally they would take a break to Sun City to launder the takings into tax-free gambling winnings. Forget it! Those times are long gone now.

Any business concluded in the formal sector is fully documented. Even customers prefer the convenience and safety of cash cards and internet transfers. Although the cash economy still exists in the informal sector the business owner is at enormous personal risk. Many have been murdered, just a day’s takings

The income tax act has some nifty provisions that do seem to give SME owners a wonderful tax profile.

The constitution gives everyone has the right to trade. Permission to trade is not regulated by the tax act. This is often confused with local authority regulations that may require a hawkers license or prohibit commercial use of residential property.

Many budding entrepreneurs pay far too much attention when the only requirement is actually to register for tax.

A micro-SME is entited to rely on the Turnover Tax system. Accountants don’t like the system because it does them out of a lot of fees. But if business income (excluding consultancy income) is less than R1million per annum the Turnover Tax System has a lot to offer.

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A micro business with turnover of less than R335 000 per annum does not pay tax at all regardless of the profit. Even at a turnover of R999 999 a micro business only pays tax of R14 150.

A micro business with turnover of less than R1million simply has to track turnover and submit a return twice a yearand it will be totally tax compliant. There is no need to pay accountants. If the micro business cannot cope with E –Filing they can walk into the SARS SME helpdesk and get them to complete the forms.

Generally, only once a business has a turnover of more than R1million is it necessary to even look at establishing a company. Then the tax act has a further package that protects SME owners with fantastic tax reductions with the Small Business Package where business income is less than R20 million pa.

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There are a few tricks to properly take advantage of the SBC package and it is generally worthwhile employing a bookkeeper to get it right. Yes, an SME will pay a lot less tax than an employed taxpayer without doing anything illegal. But the compliance burden is massive for anyone but a trained bookkeeper or accountant.

Not that there isn’t a tax advantage to having a job. The employees tax system is now so refined that there is little hassle in completing tax returns. In contrast the SME owner will be subjected to a lifetime of paperwork and risk involving not only income tax returns but also VAT and Employees tax. Make no mistake, SME’s probably spend as much on bookkeepers and accountants as they ever achieve in tax savings. So the tax saving is actually a myth for most.

Conclusion

Millions of South Africans exist by trading as micro businesses. There is a lot to be said for that. But this is survivalist stuff and by no means the outcome the NDP so desperately needs..

There is a growing grey economy in SA. This is very risky stuff and it takes a thick skin and/or big balls to play in that space.

There are a handful who have successfully created lifestyle businesses. Most have previous employment experience and have made niche businesses for themselves, not others. But it is a lonely life where dedication and discipline are far greater factors than the glamour of it all. Many were driven to lifestyle business by other factors such as retrenchment or early retirement. They have no option.

The California SME boom was a once-off success story that has been over for some time. Perhaps the problem is that politicians and economists have failed to come up with any other bright ideas so they keeping banging on the same worn out drum.

The blame game

Of course a large proportion of the current cabinet will once again blame Finance Minister, Pravin Gordhan and National Treasury, for the distress within SME SA. Perhaps they should be looking else ware. PG and NT seem to be blamed for everything these days.

The task of NT is to determine the tax policy that is needed to achieve government policy. It is up to each department to spend the money wisely.

South Africa’s corporate tax incentives of 5 billion pa are trivial in the context of R1,5 trillion State expenditure. But when analysed further they become a joke.

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The Small Business Corporation tax incentives have been criticized by the Davis Tax Committee as being far from the prefect solution. A substantial portion of the incentive is swallowed by profitable niche businesses that are not dependent on it.

Similarly, the effect of Youth Employment Tax Incentive ‘ETI’ seems to be not much more than a nifty R3 billion perk to big business. SME’s do not have the PAYE credit or administrative systems to share in the spoils.

The other tax incentives in the SME space, primarily the Venture Captal Company ‘VCC’ and the Small Business Funding Entity ‘SBFE’ are so complicated and full of hurdles that there has been insignificant uptake.

On the other hand the benefit of the SBC tax incentive is more than recovered from the SME sector in the form of Skills Development Levy ‘SDL’. SME’s are required to pay SDL even though they do not have the resources to reclaim any benefit through the SETA system. It is more than ironic that the SME sector is in fact subsidizing the formal sector through SDL levies.

To date, all of the above has been ignored.

The design and implementation of business incentives does not fall on the finance minister and National Treasury. This is the mission of the Department of Trade and Industry and the Ministry of Small Business. And it would not seem that they have achieved the dot in the i of the word shit in creating an environment conducive to conducting business in SA. But the respective ministers, Davies and Zulu escaped the night of the long knives. Perhaps Davies secured his position by attending the Gupta nuptials at Sun City. Who knows?

Dear Honourable Deputy President Cyril Ramaphosa, Sir, all protocol observed, this letter has gone on for far longer than it should. But the message to you, the business leader in the cabinet, is clear. Please find us some leaders who can design an implement incentive package that makes it worth even considering the SME sector in SA today.

 

 

 

 


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