Small and Medium Enterprises (SME) in India

In 2006 there were 26 million micro, small and medium businesses in India. 97% of these businesses do not show up in international statistics because they are unregistered or operate as sole proprietorships and partnerships. Only a very small percentage of businesses in India (> 3%) are incorporated. Over 98% are ‘Micro’ enterprises do not have employees and provide services to local markets with minimal investment. They use traditional techniques and do not have access to bank credit.

In India, businesses are classified as Micro, Small or Medium depending on the amount invested in plants & machinery (MSME). Within Manufacturing sector, micro businesses have  an investment  range of under USD $ 50 thousand. Small businesses have an investment range between USD $ 50 thousand and less than USD $ 1 million. Medium businesses have an investment range between USD $ 1 million and USD $ 2 million. SMEs form 95% of the total manufacturing and manufacture thousands of quality products that are used domestically and exported. As per estimates from SME Chamber of India, 21 Million SMEs in the manufacturing sector contribute 45% of the nation’s industrial output and 40% of the total exports.

Within the service sector, micro businesses have  an investment  range of under USD $ 20 thousand. Small businesses have an investment range between USD $ 20 thousand and less than USD $ 400 thousand. Medium businesses have an investment range between USD 400 thousand and USD $ 1 million. MSME employ ~ 60 million people and contribute ~ 20% to India’s GDP.

Internet Usage in India

India’s Internet base in 2013, was 150 million users representing about 10 percent of the country’s total population. Indians primarily use the internet is for communication including email and social media.  India has 110 million mobile internet users.

India’s eCommerce Market

India’s eCommerce market is USD $16 billion industry and is estimated to grow at a CAGR of 40% $18 billion by 2015 from $4.75 billion in 2011. The eCommerce market grew by 88 percent in 2013. Popular products sold in India include tech and fashion categories like iPads,  digital cameras and jewelry. 78 percent of shoppers prefer to shop on mobile phones for deals. Approximately 75 percent of online shoppers in India are 35 years old or younger.

Venture Capital and IPO in India

On an average less than 100 Indian companies get VC funding each year.  The average VC deal size in India is 20 crore (USD $4 million). The average pre-money valuation at 40 – 60 crore (USD $10 million). Very few businesses receive angel funding and government schemes for startups fund approximately 100 businesses every year.

Approximately 50 companies get listed (IPOs) on Indian stock exchanges. Most companies listed on exchanges (NSE and BSE) are quite illiquid. To stand a chance of an IPO on the NSE or BSE, a company must ideally have revenues of over 100 crore.

IT Services

Indian IT services is USD $52 billion and grew at 17% during the year 2011-2012. About USD $ 40 billion is from exports and the remaining USD $ 12 billion is from the domestic market.

Private Capital Report (Part 1)

The following are highlights relevant to facilitating private capital deals extracted from the Pepperdine University Private Capital Markets Report 2014. The report covers all privately held companies and not just main street businesses with revenue between $0 and $5 Million.

Business Types

Approximately 20 % of all transactions closed in the last 12 months (from a sample of 120 deals) involved manufacturing, business services (17%) and consumer goods and services (12%).Other business types in the mix included Manufacturing, Business services, Consumer goods & services, Financial services & real estate, Information technology, Health care & biotech, Wholesale & Distribution, Basic materials & energy, Media & entertainment, Construction & engineering.

Closing Rates

More than 30% of deals put in the market were not transacted. The top three reasons for deals not closing were valuation gap (26 %), unreasonable seller or buyer demand (21 %), economic uncertainty (12 %), and insufficient cash flow (12 %). Other reasons deals did not close include insufficient cash flow, Lack of capital finance and seller misrepresentation. For deals that did not close because of valuation gap, the gap was between 20% and 30%. 84% of deals required between 6 months and 12 months. The median time required to complete a deal seems to be between 8 to 10 months.

Typical items required to close a deal include reviewing Business Plans (1st quartile), meeting with the business and all stake holders (2nd quartile), creating proposal letters, term sheets and signing the letter of intent (3rd quartile).

Valuation

The most popular methods used to value privately held businesses were: Recast (adjusted) EBITDA multiple (58 %), Revenue multiple (13 %) and EBITDA (unadjusted) multiple (10%). Other methods used to value privately held companies include cash flow multiple (9%), Net income multiple (4%) and EBIT multiple (3%).  Overall, re-casted EBITDA multiple and EBITDA multiple account for more than 2/3rds of all valuations completed.

For example, manufacturing businesses with EBITDA between $0 and $1 Million had an average multiple of 3.8.  Across all business types the average multiple for companies with EBITDA between $0 and $1 Million was 4.2. The average multiple for a business type increases as the EBITDA increases. For example, construction businesses with EBITDA between $0 and $1 Million had an average multiple of 3, but with EBITDA between $11 and $25 Million had an average multiple of 10.

There was a shortage of capital for companies with less than 10 million EBITDA and excess of capital available for companies with more than 10 million EBITDA.

Deal Structure

Business deals can be structured using several instruments including Cash at Close, Seller Financing, Earn out, Mezzanine Financing and Seller Retained Equity.  Approximately 40% of deals closed included contingent earn-outs covenants. Other financial instruments used to close deals included Seller Financing (30%), lowered multiple of EBITDA (20%), Rollover (17%) and adjusted amount of equity sold (13%).

One must determine the buyer person before negotiating a deal. Buyer personas include financial buyers, strategic buyers, passive investors, life-style buyers and so on.  One would expect strategic buyers to pay a premium, but report found 29% businesses sold to a strategic buyer did not witness a premium. 52% if businesses sold to a strategic buyer witnessed a premium of 1% to 20%.

Business Environment

The most important issues currently facing privately held businesses are Domestic economic uncertainty (34%), Access to capital (24%), Government regulation and taxes (20%), Political uncertainty / elections (9%), Global economic uncertainty (6%) and Inflation (3%). Domestic economy and government regulation are the biggest issues facing private held small and medium sized businesses followed by access to capital.  For smaller privately held companies, one would expect the main issues would be domestic uncertainty, access to capital and competition.

Canadian Small Business Data

Small Business Stats for CanadaThe following is a summary of small business statistics released by Statistics Canada in 2012.

Small businesses contribute between 25 and 40 percent to Canada’s GDP. At the end of 2012 there were over 1 million small businesses in Canada that had employees. Specifically, there are 1,107,540

employer businesses in Canada. Of these 1,087,803 are small businesses with 1 to 99 employees. 18,169 are medium-sized businesses with 100 to 500 employees and 1,568 large businesses with more than 500 employees. In other words 98% of businesses in Canada have less than 100 employees. Ontario has 381,001 small businesses, Quebec has 232,531 small businesses, British-Columbia has 169,178 small businesses and Alberta 151,866 small businesses. Ontario, Quebec, BC, and Alberta account for 934,576 (or 86%) of all small businesses in Canada. Of the 1,107,540 employer small-businesses, 55.1 percent have only 1 to 4 employees (also known as micro businesses).

Small businesses employed about 70% of total private labor force – that is more than 7.7 million individuals. More than 80 percent of small businesses that started in 2008 survived for one full year and 72 percent of small businesses that started in 2007 survived for two years. There were 3,200 bankruptcies in 2012, which is 56% lower than 2000.

Approximately 22% of small businesses produce goods. Goods producing businesses include manufacturing, construction, forestry, fishing, mining, quarrying, and oil and gas. The rest of the businesses provide services. Examples of businesses that provide services are wholesale and retail trade, accommodation and food services, professional, scientific and technical services, finance, insurance, real estate and leasing and health care. More than 550,000 (over 50%) small businesses are concentrated in wholesale trade and retail, construction, professional and technical services.

Wholesale and Retail Trade industrial sector is the largest small businesses employer and employs approximately 1.8 million individuals. Accommodation and Food Services is the second largest employer with 1 million employees. Other sectors with large number of employees include Manufacturing, Construction, Technical services and financial services. On an average, small businesses create 100,000 jobs each year and since 2010, over 530,000 jobs have been created by small, medium and large businesses combined.

Approximately 50% – 55% of firms in Canada have 0-10% growth rates and the average growth rate seems to be 5% for manufacturing and service sectors. Approximately 15-20% of all businesses have 11% – 20% growth and only 7.5% to 10% of businesses have more than 20% growth rates (high growth firms). Approximately 25% of all small businesses have zero or negative growth rates.

According to the Organisation for Economic Co-operation and Development (OECD), to qualify as a high-growth firm it must have an average annualized growth rate greater than 20% per year over a three-year period, and it must have 10 or more employees. Growth rates can be recorded in terms of revenue or in terms number of employees. Highest concentrations of high growth firms in Canada are in construction, business, building and other support services and professional, scientific and technical services. Canada has fewer high growth firms as compared to the United States.

Canadian enterprises of all sizes exported goods worth approximately $374 billion in 2011. Small businesses accounted for 23.9 percent, medium-sized businesses accounted for 16.2 percent and large businesses accounted for 59.9 percent. Unsurprisingly, almost 90% of Canadian SMEs export to the United States and only 32% export to Europe. China and Latin America ate emerging export destinations with approximately 20% and 10% small businesses exporting to these countries respectively.

Finally, the manufacturing sector within small businesses has the highest innovation. Transportation and warehousing has the lowest percentage firms innovating. Other sectors with high – level of innovation include knowledge-based industries and professional, scientific and technical services.

Is Canada more entrepreneurial than the US?

As per census.gov there are approximately 27 million businesses in the US in 2008. However, more than 21 million forms are non-employer firms. Approximately 6 million firms are employer firms. Of these only 18 firms have more than 500 employees, which is negligible. So we can conclude there are 6 million businesses with 1 to 499 employees and 2.5 million businesses with 5 to 499 employees in the US.

As per statscan, in December 2012, Canada had 1.2 million small businesses with 1 to 499 employees on payroll. Similar to the US, approximately 50% of the workforce is employed by small business. Canada is approximately 10% of US population, so one would expect Canada to have 600 thousand small businesses. With 1.2 million small employer firms, Canada may be twice as entrepreneurial as the US. That said this analysis is purely qualitative and does not take into account the quality and size of the average business. The results are also surprising given the fact that US leads Canada significantly in the ease of doing business report compiled by the World Bank.