How Government Can Finance SMEs

How Government Can Finance SMEs

Friday, August 21, 2015 6:38 pm

Dada Adefolami

Dada Adefolami

Dada Adefolami.

Small and medium-sized enterprises or small and medium-sized businesses are businesses whose personnel numbers fall below certain limits. The abbreviation “SME” is used in the European Union and by international organisations such as the World Bank, the United Nations and the World Trade Organization. Small enterprises outnumber large companies by a wide margin and also employ many more people. SME are said to be responsible for driving innovation and competition in many Economic sectors.

Small businesses are normally privately owned corporations, partnerships, or sole proprietorships. What businesses are defined as “small” in terms of government support and tax policy varies depending on the country and industry.

Issues that SMEs face with regard to raising finance
Prior to considering some of the finance sources available to small and medium-sized enterprises (SMEs) we should first consider what we mean by SMEs, why they are important, and why they often find rising finance difficult, the potential finance sources that an SME could use. There will be a particular focus on the more modern sources of crowd funding and supply chain financing, consider how, and why, governments often try to assist the SME sector in Nigeria.

It is generally accepted that an SME is something larger than those businesses that are fundamentally a self-employment of their owner. Equally an SME is unlikely to be listed on any stock exchange and is likely to be owned by a relatively small number of shareholders. Indeed, very often the majority of the shareholders come from one extended family. Hence the term SME covers a very wide range of businesses.

The term SME covers a very wide range of businesses; as a result, SME sector as a whole is very important to the economy of our country (Nigeria). In advance countries, SMEs estimate for about half of employment and half of national income hence are of great importance.

As SMEs are relatively small they are often more flexible and quicker to innovate than larger companies. Indeed, SMEs are often thought to be better at embracing new trends and technologies. Obviously it is important to any economy that this occurs. One consequence for some successful SMEs is that they are acquired by a larger company with the financial resources to fully exploit the potential of what the SME has developed. When this happens the SME sector has provided a useful service as it has helped a larger company to innovate and continue its success into the future.

In economies, such as the Nigeria, where manufacturing industry has declined as a proportion of total economic activity and the service sector has become increasingly important, the SME sector will need to grow. This is because, in the service sector, economies of scale are normally less important than they are in manufacturing. Hence, within the growing service sector it is easier for SMEs to survive and flourish.

Finally, it is important that SMEs can flourish as potentially a number of the SMEs of today could be the bigger companies of tomorrow.

The directors of SMEs often complain that the lack of finance stops them growing and fully exploiting profitable investment opportunities. This gap between the finance available to SMEs and the finance that they could productively use is often known as the ‘funding or financing gap’. As Finance / Management consultant to SMEs it is important that we understand why this gap occurs.

The first thing to understand is that there is a limited supply of funds from investors. Once potential investors have satisfied their need and desire to spend and have paid their tax there is often little left over to be invested An additional issue at the current time in Nigeria is that the returns available to investors on a typical deposit account are so low if at all , that investment does not seem attractive.

Equally there is a competitive market for the limited supply of investors’ funds. Governments and larger companies have a great appetite for the funds available and, hence, the SME sector can be squeezed out. The SME sector tends to suffer because SMEs are viewed as a less attractive investment opportunity than many others due to the high levels of uncertainty and risk they are perceived to have. This perception of risk is due to a number of reasons including:

1.SMEs often have few tangible assets to offer as security.
2.SMEs often have a limited track record in raising investment and providing suitable returns to their investors
3.SMEs often have one dominant owner-manager whose decisions may face little questioning
4.SMEs often have non-existent or very limited internal controls
5.SMEs often have few external controls. For instance they are unlikely to be abiding by the rules of any stock exchange and due to their size they are unlikely to attract much press scrutiny. Indeed, in the UK many SMEs are no longer required to have their annual accounts audited

As a result of the above, investors are nervous of investing in SMEs as they are concerned about how their funds might be used and the returns that they might get. Hence, the easiest thing for an investor is to decline any opportunity to invest in an SME, especially when there are so many other investment opportunities available to them.

Finance Manager can do little to alter the supply of funds or the competitive market for those funds, but can assist by showing how an SME could reduce the level of risk it is perceived to have, thereby improving its ability to raise finance. For instance, SMEs that can show that they have treated earlier investors well, have adopted some key internal controls, and have a rigorous and documented approach to decision making are more likely to be attractive to investors.

There are quite a few potential sources of finance for SMEs. However, many of them have practical problems that may limit their usefulness. Some key sources and their limitations are briefly described below. Crowdfunding and supply chain financing are then considered in more detail.

The SME owners,
This is potentially a very good source of finance because these investors may bewilling to accept a lower return than many other investors as their motivation to invest is not purely financial. The key limitation is that, the finance that we can raise personally, and from friends and family, is somewhat limited.

The business angel
A business angel is a wealthy individual willing to take the risk of investing in SMEs. One limitation is that these individuals are not common and are very often quite particular about what they are prepared to invest in. Once a business angel is interested they can become very useful to the SME, as they will often have great business acumen themselves and are likely to have many useful contacts.

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