Facilitating and digitalizing business registration

The most common challenge faced by informal MSMEs is the lack of access to financial resources. In many cases, official business registration is a prerequisite for opening bank accounts and loan applications. In addition, informal MSMEs, especially startups and micro-enterprises, cannot often maintain precise bookkeeping and financial records, undermining their credibility with financial institutions. With these challenges, informal MSMEs frequently seek alternative financing sources, including personal savings, family borrowings, remittances and microfinancing.

Another challenge is the lack of market access. Without official registration, MSMEs may not gain access to international markets. For example, according to a survey conducted by the Federation of Associations for Small and Medium Enterprises of Cambodia (FASME) in 2018, MSMEs have a low level of registration and contribute to less than 10 per cent of exports of the country. However, they account for more than 90 per cent of all business entities.234 MSME informality has hampered government departments in clearly understanding the demands of MSME and in delivering policies supporting exports from MSMEs in a demand-driven approach.

In addition, limited access to BDS poses another issue for the informal MSME. As noted earlier in this guide, informal MSMEs lack the information on registering their business and the benefits of registration without the help of BDS. For example, Cambodia’s Entrepreneurship Development Fund (EDF) and the Skills Development Fund (SDF) are open mainly for registered MSMEs, making it difficult for government departments to fully understand the demands of informal MSMEs and deliver tailormade programmes.235

To improve coherent MSME registration, governments need to establish policies that provide a one-stop service for MSME entrepreneurs to register their businesses and promote efficiency and transparency of the business environment. Here, policies need to embrace digitizing the business registration process. On the government department side, this avoids having to enter paper forms into a computer system. The online process skips such and creates a paperless registration.

Important policy issues on informality
The major hindrance of business formalization is the absence of a clear understanding of informal enterprise (totally or partially informal). The lack of statistical information on micro-enterprises and informal enterprises make it challenging to grasp a complete and accurate understanding of the sector in most of the region. The issue of MSME informality is critical to developing the business sector and the economies in many countries. Understanding the root cause of informality can help policymakers focus their reforms and interventions on the most critical issues. The literature suggests the following reasons which might explain the behaviour of these MSMEs:

  • Business registration procedures are complex and costly
    In many cases, MSMEs remain informal simply because the regulations and procedures for registration and licensing are overwhelming or burdensome. For example, in the Philippines, it takes 13 procedures and 33 days, costing 23.3 per cent of per capita income.236 Enforcement of regulations related to business formalisation is not effective and not evenly applied, thus altering the cost/benefit balance between formality and informality. This result in resistance from unregistered businesses. Since informal enterprises do not pay taxes or registration fees, an unfair burden is created on micro-enterprises that want to register and those already registered. Here, governments should also focus on declaring a window period of six months to a year (depending on industry and sector type) for micro-enterprises to proceed with registration at a no tax or very nominal tax rate.
  • Informal businesses are not adequately informed and fully aware of the costs and benefits of formalisation
    Business owners are assumed to make a rational decision about the optimal level of formality based on the projected costs-benefits weighted by the risk of being fined if found non-compliant. In practice, business owners may have only limited information on actual costs and benefits, while the source of information is often their peers running informal enterprises. They may take the wrong decision and remain stuck in informality. It is imperative to provide the complete set of information to entrepreneurs in the pre-start-up phase.
  • The general business environment is not favourable, resulting in high and unaffordable compliance costs for businesses after becoming formal 
    Business registration is the first regulatory barrier when a small business decides to become formal. After registration, a formalized company must face many other regulations like dealing with construction permits, getting electricity, registering property, getting credit, paying taxes, accessing land, labour, etc.237
  • The financial, fiscal and regulatory burden on registered companies is too heavy, making unregistered businesses baulk at decisions to become formal
    Compliance requires the use of resources (time and money) that, at least in the short term, may diminish the productivity of businesses, as it would mean an additional financial burden on micro-enterprises. Registration with the state entails taxes, social contributions, health and safety controls, and labour requirements often set high and strict. The rates for corporate income tax or other duties or levels of social assistance are in some cases beyond the affordability of small businesses when they become formalized.
  • Lack of well-designed incentives and government support programmes offered to businesses if formalized
    In many cases, there is a lack of well-designed programmes by policymakers to support small businesses when they decide to go formal. Incentive schemes in access to finance, business development services (BDS), and access to public procurement opportunities, among others, are absent.
  • Lack of a vision to benefit from digitalization to facilitate the formalization of MSMEs 
    Digitalization has brought tremendous opportunities and challenges, and rapid internet penetration across populations could be low-hanging fruit. Digitalization has important implications for policies and efforts to formalize businesses and improve the formality of the entire economy as a whole. Governments need to have a strategy in promoting formalization by taking advantage of digitalization. They should facilitate dialogue with businesses, gathering their data and facilitating the submission of information.
Resources

234 UNDESA (2018). Supporting MSMEs to Achieve the SDGs in Cambodia through Streamlining Business Registration Policies.

235 Ibid.

236World Bank (2019), Doing Business 2020

237World Bank (2020), Ease of doing business index (1=most business-friendly regulations) 

238 Ayadi, R. and S. Gadi. 2013. “Access by MSMEs to Finance in the Southern and Eastern Mediterranean: What Role for Credit Guarantee Schemes?” MEDPRO Technical Report No. 35/April.