Sources of Finance for Smaller Firms


Capital is considered the inevitable part of any kind of business. Without capital, the running and survival of a business unit are very difficult. It is the cornerstone of a business. Whatever be the nature of the business organization, that is, be it a big or a small organization, capital is essential for its day-to-day operation. A business organization can acquire the required capital from different sources. If the sources of capital are less in a country it will affect the starting up of new ventures and the development of the existing ventures.

Sources of finance for small firms

There are different sources of financing the capital requirement of small business firms. The selection of sources depends on the capital requirement of the business organizations. It is a known fact that big firms will get capital more easily than smaller firms. The financial organizations and banks will provide finance to the smaller firms after checking out the ability of these firms to repay such money. Therefore, for availing the required finance the smaller firms should make the finance providers confident of getting back the lent money. The different sources of finance of smaller firms are present shareholders, overdraft facilities provided by banks, trade credit, equity and venture capital, merchant banks, hire purchase and other financial organizations, etc.

Existing shareholders

Existing shareholders are one of the main sources of finance for small firms. Small firms can raise required finance by way of issuing new shares to the existing shareholders. Issue of shares to existing shareholders is an easier task compared to issuing shares to outsiders. The companies issue shares to existing shareholders through a rights issue. Rights issue can be defined as a “new stock (share) issue offered to exist stockholders (shareholders) in proportion to their current stock/shareholding, for a specified period and at a specified (usually discounted) price. Its objective is to allow them to maintain their percentage of ownership of the firm. See also scrip issue.” (Rights issue 2009).


Overdraft is another source of finance for smaller firms. An overdraft can be defined as “a short-term form of finance obtained normally from a commercial bank that allows customers to spend more money than there is in their account.” (Glossary 2004). Small firms can make use of this facility provided by banks for withdrawing an amount over and above their original account balance.

Trade credit

Small firms make use of the trade credit facility offered by the suppliers of the goods. It is finance received by way of getting some extension of time for making the payment to the suppliers. Trade credit can be defined as “an arrangement to buy goods or services on account, that is, without making immediate cash payment.” (Glossary of business terms n.d.).

Equity and venture capital

Equity capital and venture capital forms a substantial part of the total finance of a small business organization. Equity capital can be defined as “the sum of capital from retained earnings and the issuance of stocks.” (Glossary of energy terms-E 2009).

As equity capital does not bear a fixed rate of interest; it is a risk-less source of finance. Small firms can also make use of venture capital for financing the capital requirement. Venture capital is provided by parties namely venture capitalists. Venture capitalists invest in companies where there is high risk in the investment. Small firms can contact venture capitalists for financial requirements, as banks may not always be ready to lend them money to small firms. (Long term sources of finance 2009).

Merchant banks

Merchant banks assist in financing the capital requirement of the small business firms by way of lending money to them. Merchant banks can be defined as the “banks that provide merchant accounts to merchants, thereby giving the merchants the ability to accept credit cards.” (Glossary of terms n.d.).

Hire purchase

Hire purchase is yet another option as a good source of finance for smaller business firms. It can be defined as a “way of obtaining the use of an asset before payment is completed.” (Glossary n.d.).

It is a solution for the small business firms for the immediate requirement of the finance for the purchase of machinery and equipment.

Other financial institutions

Some other local financial institutions also help in fulfilling the financial requirements of small firms.

Lack of access to capital; the real obstacle

If business firms are facing the problem of lack of access to capital, it will affect the starting or functioning of business firms. Compared to bigger business organizations, small firms are finding it difficult to get easy access to the capital. Financial institutions are denying a loan to small firms. This will affect the economy as a whole as the growth of the economy depends on both large firms as well as smaller firms. “After plowing through reams of data on some 8,500 small businesses compiled by the Federal Reserve and the University of Michigan in the late ’80s and early ’90s,

Hurst rejects the notion that, for the most part, limited access to capital is constraining would-be entrepreneurs.” (A chat with…capital is no constraint 2006).

If the promoters or entrepreneurs of new small business firms face the problem of lack of capital, it will affect their confidence and may sometimes force them to cancel the decision of starting the venture. Therefore, it can be said that lack of access to capital will ultimately affect the growth of the country’s economy as it is largely dependant on the growth of the business firms.


  1. A chat with… capital is no constraint 2006. Brett Nelson (Ed.), Forbes. Web.
  2. Glossary: bank overdraft. 2004. Web.
  3. Glossary of business terms: trade credit n.d., NSW: Department of state and Regional Development.
  4. Glossary of energy terms-E: equity capital. 2009. Spectra Energy.
  5. Glossary of terms: credit card processing industry: Merchant Bank n.d., E-Commerce Exchange.
  6. Glossary: hire purchase (HP) n.d. FIAT.
  7. Long term sources of finance 2009. Biz/ed.
  8. Rights issue: definition 2009. Business Dictionary. Web.

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