Research: SMEs and financing difficulties

Updated: Apr 10, 2020

A lack of capital is frequently the main deterrent to the prospective entrepreneur with undercapitalisation recognised as a major weakness of many new and SMEs, often leading to their demise.

The structure of financial markets mitigates against equity fund provision for SMEs with internal sources of finance usually constituting the majority of working capital for the start-up firm.

The owner/manager generally has total control of resources determining resource allocation, with “the managerial ego dominating that of traditional accounting control”.

Typically SMEs will have higher levels of creditors relative to stocks and total assets and lower levels of retained profit than larger organisations.

As SME ventures are generally believed to be high-risk, with poor financial control contributing to business failure, high bank charges imposed by lending institutions (to compensate for the level of risk involved) add to the inherent problems faced by the smaller enterprise and may well lead to its premature death.

It is recognised that SMEs and banks, while important to each other, often experience difficulties in their relationship, with the relevant personalities involved from both organisations lacking empathy for the other.

“This is the situation in which, in order to obtain additional funding from the bank, the businessman agrees to provide regularly to the bank manager cash-flow forecasts, lists of outstanding debtors/ creditors and other means to evaluate assets and liabilities. The result is that valuable time must be spent with the bank manager (who probably has no hands-on experience of running a business like yours) while he tells you what you can and cannot do. The bank manager gains little from the success of the business but stands to lose a lot if it fails”.

Where uncertainty meets asymmetric information the bank has two main problems of adverse selection and moral hazard when dealing with small businesses.

The problem faced by entrepreneurial SME owner/managers is particularly acute as banks are

· concerned with short-term rather than long-term finance;

· are unable to accurately gauge risk assessment when dealing with new technologies;

· are staffed by generalists rather than specialists, resulting in a lack of understanding of the business itself, and

· have no mechanism for calculating the asset value of research and development.

Difficulty for the bank and the SMEs in building a sound and mutually satisfying relationship lies in fundamentally different characteristics, experiences, structure and behaviour.

Given that SMEs typically have limited (and usually internally funded) financial resources at start-up, high bank charges and the general unwillingness of banks to lend to SMEs without extensive security may well mitigate against adoption of creative marketing practice in the smaller firm, effectively stymieing the inherent creativity of such entities through emphasising risk reduction rather than expansion and growth.

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