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Small businesses are a key driver of Chile’s economic growth and productivity, generating around 80% of the country’s employment. But things have gone from bad to worse for thousands of them in recent months. Many were just starting to recover from last year’s economic crisis when they were hit by February’s earthquake and ensuing tsunami which destroyed buildings and inventories.

Of the 20,000 businesses that suffered losses in the quake, or the looting that followed, many face costly repairs and have been forced to take out loans to rebuild. But for small businesses with few or no fixed assets, obtaining credit can be difficult and expensive.

However, the government has responded. In April, President Piñera announced a US$2.5 billion plan to support Small and Mid-size Enterprises (SMEs). The short term goal is to help businesses affected by the earthquake rebuild, but the plan also includes measures to promote entrepreneurship and innovation.

One permanent measure is a tax break for small businesses. A bill before Congress will allow businesses with annual sales up to US$2 million to reduce their income tax by the amount of profits reinvested in their business up to US$130,000.

“Reinvesting profits is one way for small companies to finance themselves and this measure will give them tax relief,” said the Undersecretary of Economy, Tomás Flores.

CORFO is providing financing for SMEs to rebuild after the quake through three channels: a US$120 million Reconstruction fund, which guarantees loans issued by banks; US$40 million in subsidies for micro and small enterprises administered by CORFO’s small business service, Sercotec; and US$20 million for Mutual Guarantee Societies (Sociedades de Garantía Recíproca, or SGRs), which help small businesses get credit at more competitive rates.

Corfo’s Reconstruction fund, which guarantees between 50% and 80% of the total loan, has generated loans for 4,500 small companies so far and aims to help around 15,000 SMEs by the end of the year.

“This is a short-term measure for companies whose buildings and machinery were destroyed in the quake,” Flores told bUSiness CHILE.

Micro-enterprises unable to obtain a bank loan can apply for a reconstruction subsidy. Sercotec has already handed out 6,800 such subsidies, averaging US$6,000 each, or double the number given out in a normal year.

“The idea is to get small businesses back on their feet as quickly as possible,” said José Luis Uriarte, general manager of Sercotec.

But demand for the subsidies has far exceeded expectations. Only about a third of business owners who have applied to Sercotec have received a subsidy.

“There is a long waiting list so we may have to increase Sercotec’s budget,” said Flores.

Chile has around 100,000 small and mid-size businesses with annual sales between US$100,000 and US$4 million and some 600,000 micro-enterprises with sales up to US$100,000, not counting the 800,000 informal businesses that don’t pay taxes.

“The problem is limited resources and unlimited needs but we are working to focus the available resources where they are needed most,” said Uriarte.

The cost of borrowing

Corfo’s Reconstruction fund is designed for small businesses to obtain bank loans at more competitive rates, which is important because many small businesses cannot afford loans at market rates.

The problem is that small companies are a greater risk for banks, which charge higher interest rates on loans that have a high chance of not being repaid.

“Interest rates in general are much lower than 18 months ago, but we have to study the creditworthiness of each client to determine their risk,” said Rodrigo Tonda, Manager of Banco de Chile’s small business division, Banca PYME.

Banco de Chile has helped 300 small businesses refinance loans since the earthquake and has been “pro-active” in pre-approving 3,000 clients a month for loans of up to US$30,000 each, said Tonda.

It also began offering loans guaranteed by CORFO in July, but banks aren’t doing enough to meet the demand for credit from small businesses, said Jorge Araya, president of Chile’s small business association Conapyme.

According to Araya, many small businesses can’t get bank loans because of their lack of fixed assets or their often checkered credit history.

“The banks only loan money to companies with solid financial standing, which eliminates the majority of small businesses,” said Araya.

And even if a company can get a loan, it is crippled for years by exorbitant interest rates, he said.

But companies are free to shop around for the best rate and competition in the banking sector is “strong,” counters Tonda.

The government’s small business guarantee fund (Fondo de Garantía para Pequeños Empresarios, or FOGAPE) administered by BancoEstado, which operates similar to CORFO’s Reconstruction fund, has allowed Banco de Chile to offer its clients lower rates and quadruple the number of loans approved in the last five months, said Tonda.

But rates for SMEs are still higher than for large companies. “We are seeing interest rates that are higher than consumer loans,” said Araya, noting that large companies obtain rates of 2.4% to 3.6% annually, while small businesses pay up to 20%.

Part of the reason is that nearly half of small businesses have had debt trouble. Some 40 percent of them are, or have been, blacklisted by DICOM, Chile's main credit bureau, which collects information about individuals and companies with outstanding debts.

“Once you’re on DICOM, it’s impossible to get a loan,” said Araya.

One reason so many companies end up in debt is that, under Chilean law, companies have 90 days to pay their suppliers, but SMEs have to pay sales tax and salaries monthly.

“Many companies have gone bankrupt as a result… it’s a vicious circle,” said Araya.

One solution is a bill before Congress that would allow SMEs to defer payment of the IVA sales tax until they are paid by their clients. This is possible due to Chile’s SME Statute, which came into force in February and allows the government to legislate differently for different size businesses.

But even those micro-enterprises with no history of credit problems have trouble obtaining financing. “More than a problem of access, it’s a problem of information,” said Tonda.

Micro businesses are too informal and should provide better information at the time of applying for a loan, he said, noting Banco de Chile offers advisory services and training courses to help its clients apply for financing.

Restructuring CORFO

CORFO is the government’s main instrument to support small and micro-enterprises, but it needs to be more efficient to meet their needs.

“CORFO used to be very passive in terms of promoting its financing mechanisms and there was no coordination with the banks,” said Tonda.

But that is changing. Banks have a much closer relationship with CORFO today and they helped with the design of CORFO’s Reconstruction fund, notes Tonda.

Still, there is room for improvement. CORFO has around 70 programs but the government aims to reduce this to just ten that are run more efficiently.

“Many of CORFO’s programs are obsolete and bureaucratic,” said Flores.

Small companies have to hire an expert to apply for financing given the paperwork involved, but the future application process will be “much simpler,” promises Flores.

According to Araya, CORFO is failing to help micro businesses obtain financing, but beyond their immediate reconstruction needs this is not the government’s duty, argues Flores.

“The old way of lending money with no follow up or possibility of being repaid is not acceptable,” he said.

Instead, entrepreneurs with a bright idea should seek financing from the private sector, which is why CORFO is promoting the development of Chile’s incipient venture capital market.

“Venture capitalists invest in a portfolio of projects… they know that 90% of the projects won’t work out and 8% might break even, but 2% will produce substantial returns,” said Flores.

CORFO’s programs will still be needed, however, and the Economy Ministry plans to measure their results to determine which areas need to be improved. “This will help us learn where to put resources to the greatest use,” added Flores.

This is important since, although CORFO has a higher budget this year because of the earthquake, its budget will return to normal next year.

Sercotec also plans to collect data on companies that receive subsidies to measure their impact. “We can be much more efficient with the same resources,” said Uriarte.

That means learning from the experiences of other countries like the United States. Uriarte has met recently with officials from the Small Business Association (SBA), the U.S. equivalent of Sercotec, and aims to implement some of the SBA’s programs in Chile.

For example, the SBA has established Small Business Development Centers in different U.S. cities and Sercotec could open centers in Chilean cities outside Santiago, said Uriarte.

But the flow of ideas is not all one way. “They [the SBA] are very interested in knowing about the programs we have implemented after the earthquake,” said Uriarte.

Training for success

It’s one thing for Sercotec to give subsidies to small businesses affected by the earthquake, but another to help them become successful on their own.

Many small business owners lack the skills, time or motivation to make their businesses more productive, but help is at hand. Sercotec offers a training program benefitting around 10,000 small businesses annually that teaches skills in areas such as marketing and web design.

“The main problem is often not a lack of resources, but rather teaching managers how to be more efficient and take advantage of opportunities,” said Uriarte.

Another Sercotec program helps small businesses become more competitive by associating with others in the same area since they can obtain better prices working together, said Uriarte.

Conapyme’s Araya agrees that forming business associations and training are key to making small businesses more dynamic and innovative.

“Small business owners are so busy worrying about day-to-day matters that they don’t have any idea what’s going on in their industry,” said Araya.

Large Chilean companies should also invest in training their suppliers and subcontractors to help them become more productive and provide a better service, said Araya.

The mining firm Miñera Escondida, for example, has invested in training programs for over a thousand SMEs that supply its mine in northern Chile.

“Corporate Social Responsibility is about helping your suppliers to grow with you,” said Araya.

Enticing entrepreneurs

President Piñera aims to double Chile’s economic growth to an average 6% over the next four years, which means creating 100,000 new businesses and generating 800,000 jobs in the process.

But Chile is not yet a haven for entrepreneurs. In the Doing Business 2010 report’s category of Starting a Business Chile ranked 69th, with associated times and costs much higher than in OECD countries.

But the Economy Ministry aims to make Chile one of the top five countries in the world for entrepreneurs, starting with a bill that will halve the time it takes to start a new business from 32 days to 16 days.

“We looked at New Zealand, which is a benchmark in this area, and Colombia which has introduced a series of reforms quickly,” said Flores.

Starting a business in Chile can cost up to US$2,000 depending on the industry, but reducing these costs would help many informal businesses become tax-paying companies.

“We have to make it simpler and cheaper to start a new business,” said Araya.

Chile also needs to make it easier for entrepreneurs to fail. In the Doing Business report, Chile ranks 114th in Closing a Business partly because it takes 4.5 years, which is more than double the time in developed countries.

“If you go bankrupt in Chile it’s a kind of social death… but in other countries a failed business venture serves as experience to try again,” said Flores.

The government aims to change this by submitting a bill to reform Chile’s bankruptcy law later this year, said Flores.

In addition to making it easier to start and close a business, the government plans to import entrepreneurs to Chile.

The Economy Ministry’s program Startup Chile aims to bring 25 entrepreneurs to Chile from the United States this year as part of the ministry’s plan to promote entrepreneurship. The ministry will give them each US$40,000 in seed capital to create businesses in areas such as genetics and bioengineering.

“These startups will require local goods and services so there will be business opportunities,” said Flores.

It’s no accident that Chile is looking to the United States for entrepreneurs and ideas. After all, the U.S. is the world’s largest economy partly due to its investment in innovation and productivity, noted Uriarte.

The good news for small businesses is that the new government’s emphasis on efficiency should make CORFO easier to deal with and the path smoother for entrepreneurs.

Small businesses need help recovering from the earthquake, but subsidies and loan guarantees are a band-aid and not a permanent solution to their financing needs.

Chile needs its small businesses to grow and create jobs, but it also needs them to be more productive. This means providing seed capital and training, but also greater access to bank loans and venture capital markets.

Julian Dowling is editor of bUSiness CHILE