MSME Day: Can government and VC partnerships reduce working capital challenges for the sector?

Micro, small, and medium enterprises (MSMEs) are crucial for India’s economic growth, with a significant chunk of GDP—nearly 30%—coming from this sector alone. Despite their importance, these enterprises have long faced persistent challenges related to working capital.

Although the government has introduced various schemes to strengthen and support the MSME sector, many MSMEs remain unaware of these initiatives. When they approach banks to take advantage of certain schemes, they often face disinterest from the banks, which are reluctant to assume the risk of bad debts—a common issue in the MSME space.

So, how can the working capital challenges of MSMEs be resolved?

According to Mohandas Pai, former CFO of Infosys and Chairman of Aarin Capital, finance and capital are the two biggest problems for MSMEs, and a separate fund needs to be created by the government to boost their growth.

“The government should set up a Rs 50,000 crore fund, and they must say any SME that has been profitable for 5 years and is going for expansion, and the bank gives a loan for your equity of 30%, 25%, or 30%, and we will give you 15% cumulative preferentials. And it will be managed by the bank; the money will be given to the bank; the bank will do the appraisal; and the bank will hold it in its name, get it redeemed, and pay back the government. You need a scheme like that for them to grow up,” Pai adds.

The incubator platforms and VC firms are also partnering with the government to help MSMEs grow.

Shashank Randev, Founder VC and Co-Founder of 100X.VC, a venture capital firm for funding early-stage startups in India, says that venture capitalists (VCs) do not invest in MSMEs given their lack of innovation; however, a change is happening in the ecosystem where VC firms or investors are partnering with the government to roll out funds.

“I’m currently on the investment committee of the Maharashtra Innovation Technology Fund, which is a Rs 200 crore fund run by the Maharashtra government. Therefore, the mandate is very clear: we will invest 50% of the capital in startups and 50% of the capital in SMEs based out of Maharashtra,” he added.

According to Randev, other state governments are also experimenting with this, there’s possibly a national-level kind of fund that will come.

Loans under certain government schemes often add to the woes of MSME owners, as they rarely receive timely payments, and monthly EMIs further burden them. Since VCs don’t typically provide funding, a partnership between the government and VCs could help ease the financial strain on the sector.

Pai highlighted that the biggest challenge for SMEs is that big companies and the government often don’t pay them on time. This leads to cash flow issues, as SMEs spend much of their time chasing payments and lack sufficient working capital. To address these issues, SMEs need equity for expansion, automation to improve efficiency and reduce costs, and assurance that payments are made within 30 days. Therefore, establishing a private equity (PE) fund or another specialised fund for SMEs is crucial.

On the other hand, Vinod Kumar, President of the India SME Forum, says that there is no shortage of funds in India to lend to MSMEs. While there are substantial resources available for financing, investors are hesitant because they lack understanding of the sector, and many MSMEs cannot substantiate their cash flow.

“The biggest need is to formalise the sector. How many MSMEs are part of GST? Smaller countries like Malaysia and Georgia have more organised tax-paying systems. The government should incentivise and subsidise these enterprises,” he asserted.

Additionally, Kumar tells Business Today that there is a need to explore peer-to-peer lending and crowd funding, which have been significant innovations globally. If these three strategies are effectively implemented, external funding may not be necessary.