Small and Medium Enterprises (SMEs) are entities with asset base of N5 million and not more than N500 million excluding land and buildings with employees between 11 and 200. Many SMEs face several business challenges which have resulted in their extinction. These challenges include skills shortage, lack of funding, high interest rate, access to markets, poor infrastructure, tax regimes and many more.
There are several funding institutions in Nigeria that offer several forms of business funding to SMEs. Funding institutions include Microfinance Banks, Commercial banks, Merchant banks, Development banks, Venture Capital Firms, Private Equity, Angel investors and Development Finance Institutions (DFIs).
However, SMEs must have the understanding that there are several stages of funding a business. A business at its earliest stages of growth with no track record or market share and very limited assets will find it very difficult to raise funds from formal financial institutions.
SME typically grow in stages which include; early stage, expansion stage and later stage. In the early stage it is best to restrict funding sources to the following:
“3F” – Friends, Family and Fools
Personal Credit Card and other personal borrowings
These sources are usually willing to lend small amounts of money without asking for a business track record, market share or collateral. They lend based on their personal relationship with the business owner and their informal assessment of the owner’s ability to pay back the loan.
Once the SME has reached the Expansion stage, they would have gained some market share and have started to make profit. The additional funds are usually needed to expand capacity, distribution outlets or buy additional equipment. At this stage there are several funding options that can be explored by the SME such as; Venture capital, Equipment leasing, corporate debt, mezzanine finance, private placement. All these options can be offered by large financial institutions, once an SME is able to prove credibility and for corporate debt provide collateral.
As the SME continues to grow, it gains stability and profit margins continue to increase, it moves to the later stage. At this stage SMEs can raise very large long term equity funds from several sources including IPO (Initial Public Offering) on the stock market, private equity firms, corporate debt, mezzanine finance and more
Note that these types of fund providers require the SME submits very detailed documentation, has significant market share, revenues and profits and is transitioning to become a large enterprise. For corporate debt the SME has to provide collateral in some instances, but the collateral requirement is de-emphasized if the SME has transitioned to become a large enterprise with dominant market share, valuable fixed assets and relatively low borrowing levels. In such cases the borrower might accept a negative pledge from the company which means it has not and will not pledge its assets as collateral to any borrower to ensure that all borrowers have equal rights to its assets in the event of a loan default.
In conclusion it is easier for SMEs at the expansion or later stages of growth to meet the requirements of financial institutions.