Ethiopian government wants industrialization will have been developed in a short period of time. The development of MSEs, which is considered to be one of the prerequisites for building strong industrial base, is constrained by various problems that hinder the transformations of them (Mead and Liedholm, 2000). This study investigated challenges affecting the transformation of MSEs Working on Textile in South Gondar Administration Zone. Objectives of the research; data collected through questionnaires were analyzed using statistical analysis such as descriptive (Frequencies, percentiles, Mean and Standard deviation) and inferential analysis (Pearson Product Moment Correlation Coefficient and Multiple Regression). Information was gathered using a five point Likert scale questionnaire from a sample of 40 micro and small scale owners and through an interview conducted to get enough information about the challenges described in the questionnaires. The sample owners are selected using stratified sampling and simple random sampling techniques. The empirical studies obtain eight major independent variables which seem to affect transformation of MSEs in South Gondar Administration Zone. those are Inadequate finance, Lack of working premises, Marketing problem, scarcity infrastructure, Poor management practices, backward Technology usage, poor Entrepreneurial and Political-legal challenges. The findings further indicated that among the independent variables Marketing, Entrepreneurial, technological and working premises challenges are the major challenges that significantly affected transformation rate of MSEs. But finance, managerial skill infrastructural and political-legal challenges were not the major challenges to affect the transformation of MSEs according to this study. The researcher recommended that: - the government and concerned body should establish well structured marketing sites, systematic and well organized entrepreneurial training center concerning MSEs, make deep awareness creation and finance to buy the necessary and appropriate technology and also access the suitable and appropriate working place in market networking for enterprises