Sources of Finance for SMEs and Difficulties in Raising the Finance

Published: 2019-06-13 20:30:04
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The key issue that faces the small or medium-sized entrepreneurs is capital for starting the business or for expansion. From experience, managers of these small companies are always avoiding to know what it available for them when it comes to finance sources to venture into business. The companies usually try to look into various sources for obtaining finance for effective running of their businesses. However, they are usually faced with quite some difficulties that limit their access to various forms of finance sources (Brookfield). Finance availability has been a major issue in the success, growth, and development of the SMEs (Ou, Charles, and Haynes). The modes of finance applied by the SMEs covers the internal sources like individuals savings and saved profits (Abdulsaleh, Abdulaziz and Worthington, 2013) to external sources which are informal like families and friends contributions (Abouzeedan, 2003), venture capital, bank loans, and formal like banks, financial institutions (Hall, Graham, Hutchinson and Michaelas, 2004). This paper, therefore, discusses the various sources of finance for SMEs and looks into difficulties that limit them from accessing such finance.

One of the common sources is the initial finance of the owner whether from the personal savings or family and friends contribution. Most assets are not tangible and thus seeking finance from the external sources are not realistic (Astebro, Thomas, and Irwin, 2003). Another known source is financing from a business angel. Angel investors are people who form equity investments in organizations which exhibit potential to grow. They usually invest in such businesses in the initial stages of growth. Angels usually back greater risks chances, with the strength of greater returns. Some are involved in their investments while others through an angel group. However, the common trend they use is investment through groups having a lead angel.

At the primary stages, the amounts of funding available are low. Organizations may be in a position of attracting large amounts from angel groups at the growth stage. The angels can give various finance rounds and continuously co-invest with certain equity sources as more finance for growth is needed. A business should view outside the capital they applied when embarking on angel investment. Many can come up with important primary experience of developing business, especially at the initial stage. Their abilities and knowledge will be incorporated into the business together with their contacts network. Many of them concentrate investment in a given geographic area and thus constitute local experience and networks. Angels are always involved in faster decision making, without multifaceted evaluation. However, getting the right angel investor usually takes time (Maxwell, Andrew, Jeffrey and Moren, 2011).

Trade credit is also another known source of finance for SMEs. One-third of entire debt of SMEs in 1998 in the USA was estimated to be the trade credit (Berger, Allen, and Udell, 2006). Trade credit is taken to be a postponement of payment for products and services after they have been given out or given as an outcome of a contract between the supplier and the firm (Garcia, Juan, and Pedro, 2010). Therefore, for a company it is a finance source appearing on the balance sheet as a liability while it is an asset for a supplier in the receivable accounts (Cull and Robert, 2006). Factoring is also another significant source of capital for a company. It involves giving finance assistance to the company through invoice purchases given to the business by a financier or a bank. The factor will progress most of the rate of the invoices on notice with the balance forwarded when the client provides payment for the invoices. The factor functions on the companys behalf, involved in the management of the sales ledger and collection of money from the customers. Factoring thus combines finance provision with service factor, assisting the client with credit regulation that can be valuable specifically for smaller organizations.

Smaller companies can also access venture capital as a source of finance. Venture capital involves funds raised from investors that are redistributed and invested in high-risk organizations that are starting. Venture capitalists come up with decisions on the venture to undertake besides their controlling, contracting and screening roles. Furthermore, through the performance of these functions, venture capitalist nearly contributes to strategic planning and decision making in the organization. The capital market for venture involves various organizations like a public company, private limited company, and small companies. Venture capital exhibits more specific features as compared to more conservative sources of capital. Companies using venture capital are always involving greater levels of unevenness information and ambiguity besides greater intangible assets. Furthermore, the condition where a company constitutes greater inducement for active regulation occurs in a condition that venture capitalist has focused stake investment in the organization. Controlling here may involve having more time in the organization and frequent meetings with the managers. Venture capitalists can also give strategic access to fresh suppliers and clients besides strategic partners (Abdulsaleh, Abdulaziz and Worthington, 2013).

Bank loans also give a common source of finance. Banks have been taken to be the main external source of finance for SMEs. Bank loans are assumed to be available to the SMEs under both reasonable and competitive basis. SMEs are usually concentrating on bank financing for them to bring their financial structure to normal (Berger and Allen, 2005). Banking finance gives greater return rates to the SMEs despite it being a more expensive source of finance as compared to other sources. It can also assist SMES in the accomplishment of better levels performance as compared to other sources of finance. The reason being that SMEs are effective in the use of the funds when they under the monitor of the bank (Abdulsaleh, Abdulaziz, and Worthington, 2013).

Public equity also provides finance to the SMEs. The source is usually significant when the SMEs are looking into ways of expanding their businesses. Equity capital is the capital that has been put in the organization without particular date of repayment, where the equity capital supplier invests in the business effectively. Equity capital can be provided both internally and externally. Internal equity refers to the funds got from the recent owner-manager, colleagues, family members or the saved profits in the company. External equity is got from external ways, and not from friends and family members. Equity financing is usually preferred in comparison debt as a financing method for fresh SMEs as they are prone to a shortage of capital and are not in a position of getting loans with security during the forming stage. Its advantages include: giving of long-term financing with less cash outflow as interest and assist in the strengthening of the credibility of the fresh companies (Beck, Thorsten, Asli Demirguc-Kunt and Maksimovic, 2008).

In the struggle through the raising of the finance to start or expand these SMEs, some drawbacks have been coming in action making the small companies unable to access the finance effectively. The companies may try to request fro finance from various sources but are not given due to various reasons. One of the reasons why these small organizations fails to access finance is the level of education of the person applying for the finance. The level education forms a major factor because most banks always value individuals who have achieved higher education since higher education depicts the owner-mangers to be more eloquent and are in a position to convince the bank that they had a feasible proposal. In a certain study carried out in the UK, only 8% of graduates in the survey had difficulties in raising finance as compared to as compared to the 19% from GCSE or O-level, and 23% owner-mangers who studied up to A-level (Irwin, David, and Jonathan, 2010).

In addition, the efficiency of the legal system that governs the accessibility to finance also forms the difficulties of the SMEs in accessing the capital. One study showed the legal system effectiveness to be positively connected to the size of the organization, an effect that is felt more in the areas dominated by proprietors. This shows that highly efficient legal system strengthens the investments by organizations owners through the reduction of individual risk owner face. The result of a positive connection between the law and financial development and the size of the organization constitute significance implications for the promotion of the policies of SMEs. Firms are limited to smaller sizes in the absence of financial institutions that are well- developed. Attempt to promote SMEs growth are thus limited unless the shortcomings of financial institutions are addressed (Laeven, Luc, and Christopher, 2004)

Ethnicity is another reason SMEs are faced with difficulties in accessing funds. Previous research has shown that ethnic minorities have issues in accessing the finance most so at the primary stages. The researches have shown that there are noticeably more difficulties than felt by the white capitalist. In the study in the UK, the problems are seen acuter in certain groups especially African Caribbean and Bangladeshis; however, there is a tough pressure of the business parts in which certain ethnic groups are concentrated. Another survey in the UK showed that ethnic minorities were faced with higher difficulties raising finance. According to the survey, about 13%of white respondents showed finance difficulties in comparison to 50% blacks, 22% Asians and 14% in other ethnicity groups like Chinese, etc. (Beck, Thorsten, and Demirguc-Kunt, 2006). This finding showed hesitantly as a confirmation of past studies. The lending infrastructure of the country also determines the credit availability of the SMEs.

The lending infrastructure defines the financial institutions rights and flexibility in funding the SMEs. The funding is done by use of lending technology that works best for the institution and the organization borrowing. The infrastructure involves the regulations of commercial and bankruptcy affecting the rights and legal enforcement of the creditors. The challenge thus comes when the rules that are applied by the financial institutions are not attractive to the SMEs. The regulations are usually applied on the level of interest or the security required for the borrower to have accessibility to finance. Firms are seen to be larger in nations with faster judicial conflict declaration systems and well-developed right protection. The results of a certain study showed that agency issues between foreign investors and corporate insiders limit firms to smaller sizes in nations that constitute a weak financial and lawful system (Ram and Monder, 2001). While concentrating on the large organizations they speculate that the finding applies to the entrepreneur world and may make programs to promote SME development inefficient and even counterproductive in nations poor financial and law systems, as small firms may decide to limit their size to be smaller rather than growing.

In my conclusion, looking into the sources of finances above available for the organizations, SMEs have been seen to have a variety of sources to choose. The firms should, therefore, be involved in choosing of a source that fits its objectives and mission. However, the firm is not restricted to only one financial source. It canactually get finance from various sources as long as it can repay the loan at the r...

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