FINANCING YOUR BUSINESS
WHO SHOULD ENTREPRENEURS TARGET FOR CASH?
Renee Horne –London 13 July 2011
Bolstering your business takes cash so to whom or where should an entrepreneur look to obtain that money? Can one turn to government, banks, venture capitalists, micro-financiers, or just the good old fashion way of family and friends? The lending list is long, and the debate will never cease to exist as to whom or what are the better lenders for small and medium enterprises (SMEs). SMs have become the global trend, with many pundits arguing that it has become the backbone of the global economy; the contradiction is that SMEs are seen as a high risk factor. “SME is a buzzword these days with all the baggage comes along with it that they don’t have the support for. Also, there are still issues with financing. There are actually a lot more SME’s than it first appears. It’s just that the official numbers don’t capture them. They are not captured in the country records or tax records because they are created in the unofficial economy, with little in the way of forms, so at times you can’t regulate its existence.” These are the words from China Onyemelukwe, Managing Director of Goldman Sachs who spoke to the World Entrepreneur Society (WES) exclusively about financing SMEs. This is part of the WES “MD’s SPEAK OUT SERIES”.
THE RISK FACTOR
“SMEs by nature are riskier to lend to than lending to a large size corporation that has been around for many years”, said Onyemelukwe. Indeed SMEs by their nature often have a relatively shaky shelf life and there are additional difficulties as many lack basic business skills such as record keeping, accounting, financial management and business planning which affects profitability. Is it true that in most cases SMEs have no collateral, that their financial statements are generally not reliable and that there are virtually no credit bureaus to rate them, and so the traditional response has been to over-guarantee the loans, hence reducing profit margins, as the costs related to seizure and liquidation are too heavy a price to pay. “ Now the way that problem is solved in some developing countries is that it is not done through the banks but through micro-finance or it is done through money lenders. The reality is to lend to an SME you need to lend at a very high interest rate and a lot of the times banks are very uncomfortable with lending at a high interest rate because then they get accused of extortion,” argues Onyemelukwe.
THE BIG LENDERS
There are several big players that SMEs could look to when thinking about finance. Banks, Venture Capitalists, Micro-Financiers and Government all lend but what is the cost of borrowing to your business? Onyemelukwe said, “When you look at micro-finance companies, they lend at sixty –seventy percent per annum. If you look at money lenders the rates are as high as 200% per annum, these rates per annum are exorbitant. Banks are just not set up to lending to companies at those rates. Given the amount of small companies that fail, personally I would argue that those are the high rates you need. However, the other people who provide finance are venture capitalists who provide equity and this is pure risk venture capital which is not as established in Africa, as it is in the United States, even in Europe venture capital is not that strong or nowhere near as strong as it is in the US”. Last week, WES questioned whether government lending a helping hand was too much of help for SME’s? What is government’s role in relation to SME’s? Onyemelukwe argues, “It is a bit of a chicken and egg scenario, to raise the financing is difficult, the SME’s themselves lack the team or the knowledge to know where to go for financing. The government has a role to play not by giving out subsidised loans but by making sure that information is more readily available and also being sure that when they push banks to lending to SMEs, they allow them to lend at appropriate rates”. You can’t force a bank to lend to a small company when a bank is not sure the company has an ability to pay. Then SMEs complain when they are hit with high interest rates, it is the risk adjusted rate of return as the company grows and becomes successful, they will drop their rate of lending, because there will be more competition for people to lend to that company”.
THE SOLUTION?
So, what is the next step in this SME funding debate? What are the solutions? Could the solution be government forcing the banks to fund SMEs more? “Nigeria in 2005/2006, the government said to the banks that they should invest a certain amount of their profits to SMEs but it didn’t happen. As stated before, you cannot compel banks to give money to a company it does not work. You can’t compel people to invest. You can’t say to banks you must lend, it is happening in the UK right now, you see people saying you must lend to small business. The banks are happy to lend to small business, but they are not going to lend money to people or business where they think they stand a good chance of losing their money”. Indeed why should one face losses for another, but there is still no solution as to how one should fund SME’s? “In respect of government funding of SMEs I have no problem with it as far as it is done on commercial terms because if you just give people money, you not really helping them. What government should be doing is providing those funds on commercial terms with the same stringent guidelines that an equity investor or a bank would do because at the end of the day it is best for the company as well.
Government’s face difficulties with this. The US has done well with this where small business administration is tasked to guarantee loans, so what that does is the bank is lending the money, the small business administration will give a guarantee which is a certain portion. You see this with the World Bank, partial risk guarantee and that means they leave some of the risk with you, so everyone is on commercial terms. So there is a role to play for government in terms of partial guarantees and regulation but at the end of the day the private sector will still need to drive it”. So government, the private sector and SME’s all working hand in hand for the benefit of the entrepreneur. Sounds good but whether this is realistic is debatable? Can one think of another way of financing of SMEs? “Using family and friends has always been good for businesses. For example, China has a more complex way; the family business system. They have a lot of town associations, a sort of cooperative that then provides financing to that town or even to a subsection of the town, so there is a sort of a developed system of this sort of quasi family financing of businesses” said Onyemelukwe. While family business may very well be the key to success in various parts of the world, can it work in a world where more and more people are migrating; intimate villages/towns are shrinking only to be replaced by the grandeur of city life? Have your say…