This is not the best of times for our SMEs ( Small and Medium Enterprises) in Nigeria. Most SMEs depends on importation, foreign exchange, Electricity and government spending to survive. The free fall of naira in the Forex market and the single Treasury account have made financing SMEs a big challenge. In midst of all these, there are many internal obstacles to access funding which owners of SMEs have to address. If entrepreneurs cannot gain access to finance through the regular system, they may not start up a business or they may simply go out of business, which represents a potential loss to the economy. This will of course worsen unemployment, social ills, youth restiveness, violence, economic and political unrest. But the other danger is that these start-ups would most likely abandon the formal system altogether and operate in the informal economy, sidestepping taxes and regulations, and thus not making a full contribution to economic growth and job creation. ■
Obstacles to SME Access to Financing
The difficulties that SMEs encounter when trying to access financing also include:
- Incomplete range of financial products and services. This difficulty is due to lack of information on both the bank’s and the SME’s side about SME’s. Most SMEs have a poor record keeping culture. This makes it difficult for banks to assess their performance. Banks may avoid providing financing to certain types of SMEs, especially start- ups and very young firms that typically lack sufficient collateral, or firms whose activities offer the possibilities of high returns but at a substantial risk of loss. This closes the door for start up entrepreneurs as banks and risk management criteria do not favour them.
- Volatile Growth Pattern
SMEs by their very nature tend to show a far more volatile pattern of growth and earnings, with greater fluctuations, than larger companies. Their survival rate is lower than that of larger companies – one analyst found that manufacturing firms with fewer than 20 employees were five times more likely to fail in a given year than larger firms. Thus, SMEs are at a particularly severe disadvantage when trying to obtain financing relative to larger and more established firms.
- Lack of distinction between the owner and the business
It can also be difficult for potential creditors or investors to distinguish the financial situation of the company from that of its owners. The entrepreneur may have re-mortgaged his or her house to acquire the start-up funds for the company. For example. If there are two cars in the driveway, can one or both be considered part of the company’s assets? If the owner dies, is there someone to take over the business, or will the business end with him or her?
- Lack of Succession Plan. Most SMEs do not have a succession plan hence prospective lenders are afraid of what the death of their borrower will mean to the business and their money. Though the SME may have several stakeholders, but again unlike a large company, they are likely to be the friends and family of the SME owner. What happens if one of them decides to take his or her money elsewhere; will the other stakeholders make good on the investment; will they look for a new investor in their own circle, or will they ask the bank for more money?
Above we discussed about obstacles to SMEs access to funding. Even at the heat of the economic challenges tending towards economic recession, people are still building houses, buying cars, getting married etc. Consequently if you want to start your own businesses there are many avenues to funding which you can exploit.
Where Startup SMEs Can Find Funding
Despite the importance of start up SMEs, they face particular problems when attempting to access financing, as they represent a higher risk than existing SMEs or large firms. They are thus not really candidates for traditional bank loans. Moreover, banks are mindful of the fallout from the burst of the stock market in the late 2000s. Banks are yet to recover from the shock of losses sustained from the Stock Market crash and the mortgage credit burst which led to global recession leading to the collapse of banks and major industries. Consequently where can SMEs find funding?
Investors Can Provide Risk Capital
Startup SMEs rely on investors who will provide risk capital, generally in return for a share in the company. The risks for the investor are high, but so are the potential rewards if he or she is backing a winner.
Financing for start up SMEs is complicated by the fact that these firms are likely to require a range of financing vehicles at different stages of their development eg equity, debts. lease finance, loans etc.
Seed Money From Family and Friends
The “seed” money to start up the company generally comes from friends, professional contacts and family.
Government Grants
The SME may also be able to tap into government funds or university grants for developing prototypes or carrying out feasibility studies.
Business Angels
Increasingly, “business angels” are seen as a vital link in the financing chain at the early stage of business development, as they bring business experience to the table as well as their own capital.
Creative Financing Models
Creative financing models, quasi cash and Capital are emerging to augment the traditional sources of fund. In the present knowledge economy, SMEs are exploring Knowledge Capital, Skills Capital, Wisdom Capital, Sweat equity, Bootstrap finance, online bartering, mentor funding etc These are developing areas of SMEs funding that has emerged from knowledge based economy. The above creative sources of entrepreneurship funding are well covered in subsequent chapters of this book
Venture Capitalists
As SMEs begin to grow, but have yet to establish a track record or size and collateral that would give them access to bank financing, they tend to turn to other types of risk capital offered by venture capitalists, who favour larger projects at later stages of the business cycle. Funds are usually obtained from institutional investors, especially pension funds, but financial intermediaries and the corporate sector are also major investors.
Although there are many countries (including developing countries) where the venture capital industry is still under-developed, the global venture capital industry is now a relatively mature industry that has succeeded in mobilising hundreds of billions of dollars from institutional investors and deploying these funds to attractive business opportunities throughout the world.
In contrast to the formal venture capital sector, the role played by early stage risk capital, although not well known, is more relevant for SMEs, and thus represents an opportunity for government policy intervention, than bank funding.
Extracts from the book: Entrepreneurial Finance
By Chris Egbu, CMC,MBA,FCA
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