Debt financing for small and medium agri-business

Naira notes

Agosile Akinjide Dickson

1.0 Leveraging Customer Money: Strategic Offtaker Advances

In certain agricultural sectors, such as the cocoa industry, a unique financial collaboration takes center stage: customers providing upfront funding to suppliers. This strategic move is particularly prominent in industries where suppliers source essential resources, like cocoa beans, on behalf of their customers. What makes this collaboration noteworthy is that it involves significant funding without the burden of interest rates. Consider the cocoa industry in Nigeria where smaller players often turn to their customers for funding. Why? It’s simple: this approach is cost-effective and easy to arrange, primarily due to the established trust and longstanding relationships between the suppliers and their customers. Unlike traditional banking processes that involve valuations and extensive paperwork, this direct funding streamlines the financial process, allowing for quicker access to the necessary capital.

This model, where customers essentially finance the procurement of goods from suppliers, is a testament to the level of trust and reliability established between the parties involved. For small players in Nigeria’s cocoa sector, this funding becomes a crucial avenue for growth. It’s not just about the money; it’s about leveraging these established relationships to scale operations and boost annual output. The absence of interest rates is a significant allure. It’s a cost-effective means for smaller players to expand their operations, meet growing market demands, and navigate the volatile market landscape. This direct funding facilitates operational growth, allowing these smaller players to remain competitive in the market without being burdened by interest-bearing loans.

What makes this form of funding truly strategic is its ability to nurture growth while reinforcing trust and reliability. The financial support from customers isn’t just a transaction; it’s a testament to the robust partnership between suppliers and their customers. It enables operational enhancements, powering sustainable growth within Nigeria’s cocoa industry. This financial strategy isn’t isolated to cocoa; it’s a prime example of how innovative financing models can drive growth in various agricultural sectors. Looking ahead, exploring and embracing alternative financing approaches will continue to be vital for agri-businesses seeking sustainable growth and resilience in dynamic markets.

2.0 Explore Subsidised Funding
In addition to customer-funded advances, institutions like NEXIM (Nigerian Export-Import Bank) play a pivotal role in supporting agri-businesses, particularly those with exporting records or aspirations. NEXIM offers significantly cheaper funding compared to conventional bank loans, presenting a substantial advantage for agricultural enterprises. During the COVID-19 pandemic, NEXIM provided funds at a remarkable 5% interest rate, recently adjusted to 9%, still notably lower than the prevailing commercial rates, which hover around 30%. To access these funds after approval by NEXIM, agri-businesses must obtain bank guarantees from commercial banks which is a crucial step in securing disbursement.

However, a common challenge faced by agri-businesses is the requirement for sufficient collateral to access these loans. Here’s where the federal government’s institution, NIRSAL (Nigeria Incentive-Based Risk Sharing System for Agricultural Lending), steps in. NIRSAL’s primary aim is to de-risk agricultural businesses. For instance, if an agri-business seeks 100 million but only possesses collateral worth 70 million, NIRSAL can cover up to 50% of the facility value (50 million) alongside the business’s existing collateral, enabling the company to meet the required 120% collateral coverage rate demanded by many banks. NIRSAL charges a fee of about 1% of the facility value (equivalent to 1 million naira). Consequently, even with this fee factored in, the effective interest rate amounts to approximately 11% (including 1% charged by banks for processing bank guarantees, significantly lower than the commercial banks’ nearly 30%.

This strategic collaboration between NEXIM and NIRSAL exemplifies how government initiatives aim to support agri-businesses by providing cheaper funding options and addressing the collateral gap. It’s a critical avenue that aids in fostering growth, competitiveness, and sustainability within Nigeria’s agricultural landscape. This multi-layered financial support system, combining the reduced interest rates from NEXIM and the collateral coverage by NIRSAL, significantly alleviates the financial burden on agri-businesses. It ensures their continued growth and contribution to the flourishing agricultural sector.

Such initiatives underscore the importance of tailored financial assistance for agri-businesses and further emphasize the significance of exploring and tapping into government-backed funding opportunities for sustained growth and resilience within the industry. Other government agencies like BOI (Bank of Industry) also provide these subsidized loans, especially for agri-businesses who are looking to purchase significant types of machinery needed to add value to agricultural produce.

3.0 Conventional Bank Loans
When exploring financing options for agri-businesses, conventional bank loans often serve as a fallback option if the first two avenues—off-taker advances and subsidized loans—are inaccessible. However, it’s crucial to note that conventional bank loans come with significant drawbacks, primarily their expense compared to the more cost-effective options of off-taker advances and subsidized funding.

The main advantage of turning to conventional banks lies in their faster processing times, attributed to the banks’ well-established relationships and extensive experience in the financial sector. Also, agri-businesses that require urgent funding and do not meet the requirements of NEXIM and BOI could easily approach commercial banks. However, this convenience comes at a substantial cost, as interest rates for these loans can soar to almost 30%, making them an expensive choice for agri-businesses.

Despite the high cost, there are inherent benefits to acquiring debt through conventional bank loans. Interest payments are tax-deductible, which aids in reducing tax liabilities for the agri-business, presenting a potential financial benefit. Additionally, these loans can be instrumental in scaling up operations and providing the necessary capital to invest in infrastructure, technology, and human resources.

Agri-businesses seeking this funding option must be meticulous and objective in their projections. Given the exorbitant interest rates, detailed financial planning and stringent adherence to projected outcomes become paramount. Thorough and transparent business plans are crucial when approaching banks for loans, as they seek assurance and feasibility in the investment. Debt, when managed prudently, can be a beneficial financial tool. While conventional bank loans might not be the most cost-effective, they can still serve as a viable option if the first two funding sources are unavailable. However, agri-businesses must approach these loans cautiously, fully understanding the high interest burden and ensuring their financial projections are realistic and achievable.
In summary, while conventional bank loans offer faster processing times and accessibility, they come with a considerable cost. Agri-businesses should consider these loans as a last resort, emphasizing detailed financial planning and stringent business projections due to the substantial interest rates involved. Properly managed debt can aid in growth, but meticulous assessment and caution are necessary when opting for this expensive financing route.

4.0 Conclusion
In conclusion, Minsky’s financial stages provide a valuable framework for debt financing which could be useful for agri-businesses. He delineates three critical stages: the hedging stage, where operating profits robustly cover interest expenses; the speculative stage, where profits barely cover payments, risking erosion of capital; and the Ponzi-scheme stage, where profits fail to cover liabilities, necessitating further debt to repay existing obligations.

Agri-businesses must assess their position within Minsky’s framework before pursuing substantial debts. Operating within manageable debt levels is crucial to avoid situations where businesses become beholden to creditors, potentially leading to asset liquidation. Careful consideration is vital, ensuring that debt doesn’t overshadow profitability and growth prospects.

For agri-businesses, the prudent approach involves not immediately resorting to conventional commercial loans. Instead, exploring subsidized rates from government initiatives or funding from off-takers for their agricultural produce should be the initial focus. This strategic manoeuvre ensures cost-effective financing options, reducing reliance on high-interest conventional loans.

By leveraging Minsky’s financial stages and choosing financing avenues wisely, agri-businesses can avoid becoming entrapped by debt, securing sustainable growth and resilience within the dynamic agricultural sector. Strategic financial planning and prudent decision-making stand as fundamental pillars for ensuring long-term success and mitigating the risks associated with excessive debt accumulation.

Financial Analyst, Vicago Nigeria Limited