Diversifying Sources of SME Funding
Facilitating SME Financing: New Avenues Of Diversification
You probably know the saying, “don’t put all your eggs in one basket”. Did you know it also applies to your business strategy? Diversification: it makes it possible to accompany the growth of the company.
But is such a project not fraught with danger?
The concept of diversification is an important consideration for small and medium-sized enterprises wishing to expand their business overseas. Adopting a diversification strategy will promote the stability and growth of your business over the long term.
What is Diversification?
Diversification is a strategy adopted by many firms. It can take several forms, and it differs according to the objectives of the company. This strategy can give an advantage to firms by reducing their risk. Diversification allows the company to generate additional cash and better spread the risks associated with these activities.
A fundamental element of effective risk management is diversifying one’s funding, which enables to perform better while maintaining one’s own governance philosophy. Indeed, this diversification of sources of financing allows the business manager to arbitrate between different equity instruments, such as stocks, bonds and loans, with different rates and maturities.
Crowdfunding helps the business achieve this financial independence since it disintermediates the banking system. It provides SMEs with instruments adapted to each stage of their development.
A Problem with SME’s Growth and Valuation
For a long time, there has been agreement on the fact that SMEs lack sufficient equity capital. Their progress is obviously constrained by these factors: weak balance sheet, export barrier, etc. Due to their small size and the difficulties associated with approaching and processing applications, investment funds are still mostly uncommitted to this business sector. When financing is accessible, they usually require shareholder control of the company in exchange for their assistance.
Don’t Only Rely on Conventional Bank Loans
Bank loans are the main mode of financing for SMEs. Banks offer different benefits, such as personalized service or flexible repayment terms. Compare to find the bank that can meet your specific needs.
Banks generally target companies that have a proven track record and excellent credit history. A good idea is not enough. It must be supported by an effective business plan. Additionally, start-up business loans normally require entrepreneurs to provide a personal guarantee.
The actual demands of SMEs can only be partially met by traditional funding. Contrary to a commonly held belief, the financial markets’ excess liquidity does not succeed in penetrating into the architecture of local SMEs. These are generally unwilling to take development steps that include building equity because their historic bankers have frequently exhausted their borrowing capability.
Other Funding Sources for SMEs
Venture Capital
First of all, it should be remembered that venture capital is not intended for all business owners. Indeed, venture capitalists seek to invest in high-potential companies in sectors such as information technology, communications and biotechnology.
These investors also take a stake in the companies they finance in order to help them carry out a promising project that entails greater risk. This means that the business owner must transfer part of his business to a third party.
Venture capitalists also want a good return on investment, which usually comes when the company begins to sell shares to the public. Look for investors who have relevant experience and whose knowledge will benefit your business.
Financial Angels
Financial angels are usually people with lots of money or retired corporate executives who invest directly in SMEs owned by others. They are often important people in their field. They give the company the benefit of their experience and their network of relations, but also of their technical knowledge or their management know-how.
Financial angels tend to finance companies in the early stages of development, and the amount invested ranges between 25,000 and 100,000 dollars. Venture capital companies prefer to invest large amounts, in the order of a million dollars.
In return for the risk they run by investing their money, the financial angels reserve the right to supervise the management of the company. This often means that they sit on the board of directors and demand an assurance of transparency.
Business Incubators
Business incubators usually target high-tech start-ups at various stages of development. There are also local economic development incubators, which focus on job creation, revitalization, and the provision and sharing of services.
Incubators often invite fledgling or emerging businesses to share their premises and their administrative, logistical and technical resources. For example, an incubator can make its laboratories available to a new company to enable it to develop and test its products at a lower cost before starting production.
Incubator companies often belong to cutting-edge sectors such as biotechnology, information technology, multimedia, or industrial technology.
Conclusion
Faced with the evolution of the professional loan system, companies have understood that it is essential to diversify financing and no longer rely exclusively on the banking partner. To maintain a growing economy, companies have chosen to diversify their sources of financing.
Undoubtedly, bank financing will remain a vital source of capital for the SME market. However, having a diversity of solutions can help your long-term goals and lessen the sensitivity of the larger SME sector to changes in the loan market.
