Small and micro business enterprises face a lot of problems when it comes to accessing loans to expand their operations. According to Jonsson and Lindbergh (2013, p. 685), unlike the large business entities that have formed trust with financial institutions, the small business entities lack the trust of the lending institutions. They also lack the collateral that may act as a security when they go for loans. Financial institutions, just like any other business entity, would like to avoid any bad debts because this may hurt their profitability. They prefer lending money to institutions and individuals who have the potential to pay it back. Most of the small enterprises lack the potential to pay back the loans they borrow from these financial institutions. Lynch (2012, p. 46) says that most of these businesses fail to celebrate their first anniversaries. The high rates at which these businesses fail has made many financial institutions to avoid extending their loans to them. Although some of the reservations these financial institutions have towards the small enterprises have been criticised, they are justified to demand for stronger collaterals from these small and micro businesses. When these businesses stop operating, it becomes almost impossible to trace the owners who took the loan. Some of them fail to see the rationale of paying loans after their businesses have failed. To achieve prosperity, a business entity needs financial support from the financial institutions. In this paper, the researcher will conduct an analysis of how to raise finances for small business entities.
Problems Small Firms Face When Trying To Obtain Long-Term Finances
According to Hisrich and Peters (2009, p. 29), almost all successful business entities in the world today started operations from a humble background. They did not start as large institutions with large financial bases. However, out of commitment and dedication of the owner and the stakeholders responsible for various activities, such businesses have been able to expand to the global market. One of the instruments that have enabled these firms achieve success from a humble beginning is the availability of finances to support their operations. Mouer (2012, p. 77) says that many business entities need financial supports when planning to expand their growth, irrespective of their size. However, the large business entities do not strain much in accessing loans from the banks because of the goodwill they have. On the other hand, small enterprises face numerous challenges when looking for financial support. In this section, the researcher will look at the specific problems that small business entities face when looking for financial assistance.
Lack of collaterals
According to Moyer, Mcguigan and Kretlow (2009, p. 47), one of the major challenges that many small businesses face when looking for sources of finance is the need for of collaterals that may act as security when going for a loan. Banks are always willing to give loans to individuals and business entities. They earn their profits from the loans they extend to their clients. However, no lender would want to give out a loan when there is no assurance that the person borrowing the loan will pay back the loan, including the accumulated interests. That is why they ask for collateral. Once the owner of such a business entity is able to extend collateral whose value matches the amount of money being borrowed, then it becomes easy for the banks to release the money. This is where the small businesses face their first challenge. As Young (2013, p. 221) observes, most of the owners of these small businesses lack tangible collaterals they can present to the bank. Without collateral and a proper proof of the ability to refund the loan taken, it becomes impossible to get the much needed financial support from the financial institutions.
A good example of a firm that faced many challenges when sourcing for financial support from one of the leading banks in the country is Cloudreach. This firm suffered a lot in getting finances when it was planning to commercialise its products in the market for the first time. According to the statements from the owner of this entity, the firm found it difficult to get the financial support from a number of financial institutions. However, many of these institutions could not understand the concept that this business was explaining to them in terms of its operations. It was not easy to explain how a firm without tangible assets would offer an assurance that the borrowed money would be refunded. The owner had to rely on other sources to finance its activities. After a lot of struggle, the firm became successful in the cloud computing industry. Atrill (2014, p. 80) notes that the firm was voted the best small company to work for in the United Kingdom in 2013. This is a clear demonstration that although financial institutions are always quick to dismiss these firms, they have a great potential that can be tapped for the benefit of its stakeholders.
Poorly known business entity
Tuller (2012, p. 73) notes that brand name alone is strong enough to help a business entity to get financial supports from banks even without having the collateral. A brand such as Apple Inc or Coca Cola are estimated to be worth billions of dollars. They are known and valued in the global market. To these firms, financial institutions are always willing to offer them the financial support. However, the small business entities lack this strong brand power that can help them access loans from banks. Foley (2004, p. 40) notes that very few banks may be willing to offer loans to small start-ups without any strong brand in the market, even when they can give a collateral. This is another challenge that limits the sources of finances for the small and micro enterprises.
A good example of a firm that went through hardships to get financial support at an infancy stage was the Virgin Group. When Richard Branson started his printing company at a tender age while still in high school, no one could have predicted that he would rise to become one of the most successful businessmen in the world. He and his business were rarely known during this period. Peirson (2012, p. 50) says that Branson faced many financial problems with his small business because many financial institutions did not consider him to be in a position to refund the loan. Moreover, his business was hardly known outside his immediate market where he operated. He had to use his savings and funds from friends to push through the firms’ operations at its initial stages (Beck & Levine 2012, p. 118). At the moment, Virgin Group is one of the most successful firms in the global market, especially in the transport sector and banking. Were it not for the skills of Branson in getting the financial support from other sources, this firm would have failed to take off to become what it is today.
Poor financial background
According to Broom and Longenecker (2011, p. 59), before banks can offer a loan to an individual, they always look at the financial history of a person or an entity. They look at the inflow and outflows of such businesses. This analysis helps them to predict the capacity of such an individual or entity to pay back the loan within a given period. This is another challenge that some small enterprises face. They have unattractive financial flow into and out of their bank accounts. To many bankers, such unattractive flows always demonstrate that a business entity lacks the capacity to pay back a given loan, especially if it does not match the financial history of the bank account. As Burton (2006, p. 80) says, many banks assume that the loans they are extending to their clients will not work magic. This means that such loans do not have the capacity to significantly change the cash flow into the account. They want other assurances that can prove to them that a business entity is able to give returns based on its historical records.
Creditworthiness of the business owner
Creditworthiness of a business owner is another issue that may limit a firm from accessing loans from the financial institutions. According to Dilger and Gonzales (2010, p. 53), some of the entrepreneurs that start small businesses are beneficiaries of the student loans offered by the government. Some financial institutions would look at the trends taken by the student to repay the loan in order to determine if they have the capacity and willingness to pay back their debts. Gerschenkron (2012, p. 90) says that this is a wrong measure because some of these entrepreneurs start businesses using donations or small loans from the family and friends. It may take a while before they can be in a position to start repaying such loans. However, such issues may limit the ability of the small business they own from getting reliable sources of finance. Solutions Ltd, industrial automation specialists, faced challenges of getting finances at its earlier stages of development. This is so because the financial institutions doubted the creditworthiness of the owner. It took time and experience in the financial market for the management to know the alternative methods of accessing the financial support.
How Small Businesses May Gain Access to Long-Term Finances
The sections above have discussed the factors that make it difficult for small firms to access loans from financial institutions. In this section, the researcher will look at how small businesses can gain access to long-term finances. According to Stevenson, Roberts and Grousbeck (2013, p. 77), getting financial support for small and micro business in our society today has become easier than it was some years ago. However, Smith (2015, p. 48) warns that an entrepreneur must understand the nature of each source of money before going for it. The following are the major sources of finance that small business entities can use when planning to expand their operations.
Raising money from friends and families
One of the most common sources of funds available to business entities is soft loans and gifts from friends and family members. According to Morrisson and Oudin (211, p. 135), some of the leading corporate organisations in the world sourced for funds from friends and family members in order to start their operations. A good example is the Microsoft Corporation, the world’s leading provider of software solutions. Bills Gates had to rely on the pocket money from the parents to finance the initial operational activities of their newly found business. Before the firm could become profitable, Gates and his friend had to rely on the grants from their family members to support their operations. One of the biggest advantages of raising money from friends and family members is that the money given does not have interests. It is a grant. Sometimes it is given out as a gift, and this means that it is not expected back.
Armstrong and Botzler (2007, p. 56) say that new start-ups and small businesses should not disregard this source of funds. It may be the key to success and greater sources of finance. However, Strauss (2012, p. 27) warns that a business entity should not look at this as the only source of funds because sometimes it may be limited. It also relies heavily on the financial strength of the family members and friends. When these people lack strong a financial base, then they may not be of use as a reliable source of fund.
According to Prather and Wert (2011, p. 73), one of the sources of funds that have become very popular in the current society is crowd-funding. The government of the United Kingdom has been encouraging this approach of raising funds for small businesses. The reason why this approach has become very popular in this society is that it does not have the rigorous and discriminatory procedures in the conventional banks. As Asif and Ahmad (2011, p. 30) explain, to get financial support through this approach, a firm will need to trade its equity for cash. As long as the money is not paid back, the firm will acknowledge that the lender is a legal owner of a given percentage of the business. This gives the lender the legal right to be engaged in the operations of the firm for the period that the owner of the business will be indebted to the firm. One of the main benefits of this approach of getting finances is that it is a much simpler process compared to getting loans from banks. The fact that the lender may be involved in the operations increases the chances of success to these small and inexperienced firms. The lender does not only come with the much needed money, but also knowledge on how to manage the market forces. London Co-Investment Fund is one of the leading crowd funding institutions that are available to small and medium enterprises.
A merger is another option that a firm may use to expand its operations. When two firms which operate in the same industry find out that they have a common interest, they can form a merger as a way of expanding their operations. According to Brealey and Marcus (2011, p. 58), one advantage of a merger is that it allows a firm to expand its operations and assets without borrowing funds from the financial institutions. However, one must be ready to share the benefits and challenges expected in the management of the larger firm. Brealey and Myers (2009, p. 45) say that this method may not be appropriate for a firm that has just gotten into a given industry. The owner of the business must also be ready to comply with the management demands of the partner. It means that the control of the firm will be taken away from the owner. The decisions must be based on the consensus of the new owners.
Home equity financing
Home equity financing is also available to home owners. This type of loan is offered by many financial institutions. Under this context, a business owner will pledge his home as collateral to the loan being taken. The loan will be issued against the house. Although this method has been used by many firms in the past, it is not the best approach because there is a risk of losing the home. In case the loan is not delivered in time, then one may lose his home to the lender.
Loans from financial institutions
According to Harper and Ramachandran (2013, p. 88), financial institutions still remain the best sources of finance to business entities. They are reliable and have a conventional approach of lending and recovering their money. Grant (2013, p. 72) observes that numerous microfinance institutions have emerged in this society, giving an opportunity to small business owners easy access to loans. A firm can start by taking small loans. If trust is built between the business owner and the bank, the amount of loan can be increased to meet the increasing needs of the firm.
Effect of Sources of Finance on Small Business’ Strategy Formulation
The type of finance that is available for a business entity will affect its business strategy formulation. When a firm relies on donations from family members, Sampson and Norris (2012, p. 52) say that this may affect the ability of a firm to set its strategic objectives. One is not sure if the promises made by the financiers will be honored. Crowd-sourcing is a good option, but sometimes the need for the third party to play part in strategic decision making means that full control of the firm’s operation is taken away from the owner. However, Longenecker, Moore & Petty 2003, p. 148) says that it is the best option for small firms. It is reliable, which means that the business owner will be assured that his plans will not be disrupted due to last minute disappointment by would be financier.
Many mid-sized companies have used mergers in order to boost their positions in the market. This method is good because other than the resources that will be shared, the two entities will also share their knowledge in the market (Otero & Rhyne 2011, p. 113). However, a business must be ready to redefine its strategic objectives, and sometimes even the vision statement, to accommodate the new partner. Home equity funding may be another good source for small firms because it may not have major impacts on the business strategy of a firm. However, its associated risks may affect the ability of the business owner to focus on achieving success for the business. The focus will be on how the loan can be paid to avoid the consequence of losing the home (Kuriloff & Hemphill 2013, p. 88). Loans from financial institutions are good for a firm that has stabilised. Its consequences on business strategies are negligible.
This research has revealed that small and micro enterprises face numerous challenges in accessing finance to expand their operations. Many players in the financial market do not trust their ability to repay such loans. However, the study shows that there are options that these small businesses can go for. A business owner should choose the option that suits his business model and needs in the best way possible.
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