Sources of finance Essay Sample
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Sources of finance Essay Sample
Abstract: This article examines which types of finance are more suitable for the SMEs, also analysing the disadvantages on them when raising finance. Unlike the large companies, SMEs have difficulties in getting enough money to develop. SMEs are more likely focused on the Venture Capital and some informal finance, such as Business Angel Financing and relationship lending. Also the special tools, like leasing and factoring, are quite useful when they suffering financial troubles. Difficulties in raising finance are numerous, for instance, the policy of the government and legal protections, but sometimes ownership might be a barrier, as well as the credit information sharing. Key words: SMEs, Raising Finance, Venture Capital, Barriers
For a long time, small or medium-sized enterprises(SMEs) have played important roles in the development of national economy construction. And lots of research have been set up to look for the solution for the SMEs in raising finance. Putting so much efforts on SMEs based on two reasons: on one hand, SMEs are the engine of economic development; on the other hand, banks and some institutions fail to invest SMEs which will impede their growth in the society, and will constrain the development of society.(Beck, 2006) SMEs have been defined in various ways, and lots of the definitions include the number of employees, the investors, the suppliers and most importantly the assets they have. The Journal Of Enterprising Culture (2003: 174)said SMEs should be less than 100 employees, including the managers.
But no matter how many people they have, the point of the SMEs is they are not large, which should be the main feature of SMEs. Because they are not big enough, they have less credit information to the bank, so it is hard for them to get a large amount of money from the banks.(Ptacek, 2012) In this situation, they will definitely suffer from a short of capital. Additionally, constrains that keep SMEs from developing are numerous. Most important and existing in almost every SME is the problem of credit. Considering credit issue, the better way for SMEs si providing the hard information, but unfortunately most of them can only give soft information. Hard information refers to the quantitive, and soft information refers to credit which cannot be counted.(Petersen, 2004).
The following section shows the stages of raising finance, from the start-ups to become large companies, and discusses what finance sources should be used in different stages. After that, venture capital, angel financing, relationship lending, and the specific financing tools like leasing and factoring will be highlighting. The second section illustrates some barriers SMEs will face, and the most significant would be credits or reputations. Sometimes SMEs might suffer from bad educational owner-managers, and maybe the ethnic has some influences. The third section offers conclusions and recommendations.
1 Some important financing sources for SMEs
1.1 Different stages in raising finance
Lots of choices allow the companies to raise money, but it is extremely significant for the companies pick the right financing. The following is showing the different stages when raise funds. Firstly, self-raised funds. At the beginning of the SMEs, it is an effective step to use venture capital, leasing and factoring. In most case, the start-up fund is far from enough.(Badulescu, 2012) That why SMEs need to raise funds by themselves.
Secondly, direct financing. Next step of the SMEs may be looking for the bond and stock market, which are mainly focus on the equity financing.(Carmen, 2013) In this stage, companies should already have some hard information, as well as have some valuable trust records in banks. Thridly, indirect financing. This kind of financing is not welcome for the SMEs, for most of them are short-term and long-term loan, and the ways of loan are contained mortgage loan, guaranteed loan, unsecured loan and et at. 1.2 Venture Capital: a light of hope for the SMEs
Venture capital(VC), which is known as the risk investment, shows significant role in promoting the SMEs in raising finance. VC includes business angel financing, relationship lending and so on. All of them are good choices for SMEs, specifically for the small and medium companies which are just starting up.(Dagogo, 2009) “Venture capital is the fuel for high potential growth firms, especially in the United States. New venture survival is tenuous at best, but those backed by venture capitalists tend to achieve a higher survival rate than those that are not.” said by Robert(2010), moreover, in his study shows “ survival for venture capitalists backed ventures range from around 65 percent to 85 percent of the venture capitalists’ portfolio.” If SMEs managers can get help like this, they would have more chances to develope.
Having a overview on the SMEs, they have nothing but the companies, without large amount of capital or collaterals.VC might be a better method of gaining funds from the external, they do not need the credits of the companies or mortgages, and they might offer some useful advice for SMEs. Angel financing, the other venture capital, acts as one of the most important way of obtaining capital for SMEs. It has the ability to turn the entrepreneur’s idea into reality. Some small firms have failed before they actually into the market. In this case, the informal venture capital, known as angel financing, may be able to generate capital for SMEs. Not very famous in some developing countries but still as important as other financing, using as the start-up capital for the SMEs in the informal venture capital market. In the UK, Mason and Harrison(1990) find “angel investors finance at least five times as many small firms as venture capitalists.” Relationship lending, also parts of venture capital, would bring lots of benefits for the SMEs in their earlier stage.(Hernández-Cánovas, 2010)
In some ways, it can be the best choice for some specific small and medium enterprises, based on the costs as well as
profits. Investment from the partnership can get lower interest rates, also some banks can offer low interest rates for the companies which they trust.(Beck, 2011) That makes most of the SMEs trying to building good relationship with more than one bank, and comparing which one would be more beneficial to the companies. Companies might get in a dilemma that none banks would like to build up more closer relationship with them, because of their bad behaviors.(Steijvers, 2010) On the contrary, banks are happier to trust the companies which are more concentrated. In return, companies need more pledge for guarantee. 1.3 Leasing and Factoring: special survival skills
“Leasing is a activity that fixed-assets are purchased by the lender, also called lessor.”said by Berger and Udell(2006). It is very common in raising finance in the areas of motor vehicles, (Martin, 1983) real estate and restaurant.(Rentas-Giusti, 2002) In most cases, lessor buys the fixed-assets and make the rental contract with lessee, the borrower, then make the payment plan. Leasing is based on the hard information, the fixed-assets. Credit records are not necessary in leasing. Small firms can get lots of benefits from leasing, for it allows the companies to have more free cash contributing to other functions.(Bova, 2007) Instead of having hundreds of cars without any cash flow, renting cars from the lessor can give companies the opportunities on both having cars and cash in the same time.
As long as having proper management, paying rental fee before the end of leasing should not be too hard. The definition of factoring is “Factoring is a financial transaction in which a business sells its accounts receivable, that is invoice, to a third party (called a factor) at a discount”, explained by Investopedia(2013). Factor sometimes will charge companies for a large amount of money, even so more and more SMEs are willing to do that. The explanation for this situation is that factoring keep companies away from bankrupting.(Dresser, 1997) In return, most of the invoices will become cash back to the companies, which will save the waiting. Seeing so many companies suffering from insolvent, SMEs would rather pay for the factor than end up nothing. Receiving the money back earlier, companies would have more opportunities to invest in other businesses. “Factoring’s major benefit is an immediate injection of cashflow” said by Charlwood (Manufacturers’ Monthly, 2003).
2 Difficulties for SMEs in raising finance
2.1 Biggest trouble: lack of credit records
Small and medium-sized enterprises are one of the most important part of the economic all over the world.(Badulescu, 2010) But based on their size, less capital and low level of credit, they will encounter funds insufficiency. Banks and other large institutions will not invest a great deal of money to the firms without many credit records, due to there are too much ventures. Only by providing hard information will the SMEs earn the chances of receiving investment. So it is the biggest trouble for SMEs, who cannot offer the credit records for the investors, that a small amount of money they receive from the banks or may be the government would not allow them to develop. Some countries have already face this situation that having a large SMEs group for a long period, and few of them got chances to develop. Old and ineffective firms will constrain the development of society.(Beck, 2006) 2.2 Capital constraints
Not surprisingly, SMEs are not having too much capital from the beginning, and not having valuable fixed-assets, either. No money into the companies’ projects, no profits they can get. Also more than that, even if there are lenders who willing to pay, SMEs might not be confident enough to accept the loans with expensive premiums.(Kirschenmann, 2012) As a small scale company, less trust will get from others. Considered with the information asymmetry, investor will hesitate about the investment. Because of capital limitation, helps from external are handful. 2.3 Other barriers
Cases are a bit different in some countries, such as UK. Taking loans from banks is acted as the main financing method among SMEs in UK.(Irwin, 2010) But if suffering the finance constraints they are likely to fail the business. That is to say, the management of the companies matters. Consider that failure might happen, some owner-managers have just make some terrible decision which will result in failure. On the other hand, some characteristics of the managers are impeded companies in raising finance. For instance, Irwin(2010) finds out that women show good abilities in raising finance. Regardless of the credit issue, the education maybe the major element in the lending progress. Moreover, even though the managers have got the university degree, the ethnic might be another constraint for them, such as a black owner-manager with a A-level degree will get more troubles in raising capital.(Irwin, 2010) it suggests that the personal characteristic can be an important factor in raising money. 3 Conclusion
We found that financing choices are numerous, but limited in SMEs. After comparing with the different stages in raising finance. Self-raised fund seems to be a viable solution, especially by using the venture capital, angel financing, relationship lending. Leasing and factoring are in a different way of raising finance. As for leasing, it allows the companies to get some fixed-assets without paying all at one time. More cash will be available for the companies. Referring to factoring, it protects the companies from closing door. Because companies will not need to wait for a long time to get their money back, factors will buy the invoices and pay them cash almost immediately. Due to immature, SMEs are likely to suffer from credit problems and capital insufficiency. Unprofessional managers can be problems, too.
“Factor”. Investopedia. Retrieved 27 July 2013.
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