Issues that Entrepreneurs Face in Raising Finance

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Table of Contents

Introduction
Issues
Addressing the Problems
Conclusion
References

Introduction

Entrepreneurs are key innovators in creative destruction in the entire world. Even though they play essential roles in growing the economy, the process of acquiring sufficient access to capital to start and grow businesses remains their biggest challenge (Legge & Hindle 2004).

In the U.K., for instance, the ability of small and medium-sized enterprises (SMEs) and entrepreneurs to gain access to adequate financial support has remained a great challenge amidst the interventions of the government and other financial institutions.

The tightening credit terms and the decrease in demand for products during the economic and financial crisis have been the main setbacks for SMEs and entrepreneurs in this century as these factors have affected the rates of cash flows (Kerr & Nanda 2009). The U.K. in a bid to counter these challenges, has set out policies that have assisted SMEs to gain access to favourable capital in order to start and grow their businesses.

These policies have assisted in reducing financial constraints that have been perennial among entrepreneurs. For example, the EU has made financial assistance for SMEs top among its agendas. The report critically evaluates the issues that SMEs and entrepreneurs in the U.K. have been facing in raising finance.

In addition, the report will analyse the extent at which public policies in the U.K. have handled the issues on financial access for entrepreneurs.

For example, U.K., which is a member of Organisation for Economic Co-operation and Development (OECD), has been working towards addressing the social, environmental and economic challenges that business enterprises are facing (OECD 2006). The organisation assists governments of member countries in designing policies that seek to address common issues that affect the business field.

Issues

Financial Market Development

In analysing the issues facing SMEs in raising finance in U.K., the report first discusses the impacts of financial market development on entrepreneurs and how banks’ competition levels and credit market relate to SMEs’ abilities to gain access to adequate capital. The inter-bank competition has improved the allocative efficiency since capital can flow freely to promising projects hence yielding highest returns (Marlow & Patton 2005).

Again, monopolist banks even subsidise their loans and charge favourable interest rates on their loans in order to remain operational in the market. Clearly, the competition has facilitated the provision of cheap credit to new projects thereby increasing SME start-ups.

This aspect lies on the capitalism style of development where financial market developers believe that large proportion of economic growth comes from setting up of new firms and closing firms that are unproductive instead of intensive margins where firms can become more productive from the internal aspect.

As a result, capital markets have found it tricky to fund the most promising SMEs given the cross-sectional differences (Carter & Jones-Evans 2000). This has made it impossible for new entrepreneurs to access adequate capital to implement their ideas in the market.

From this scenario, there are high chances of capital misallocation in funding unproductive business ideas thus impacting negatively on the overall economic growth of U.K. Clearly, the continuous friction in the capital market has affected SMEs in U.K. from raising adequate finance to support their projects.

Financial Market Depth

In a strong economy like U.K., some nations still lack financial market liquidities hence are not able to lend to SMEs. Entrepreneurs in the U.K. have low chances of getting credits for their projects since banks lack liquidities. Italy, which has a strong and integrated market, experiences disparity in loan acquisition among entrepreneurs since there are variations in financial depths across regions.

Explicitly, regions with low capital market do not support the entrance and development of new businesses thereby lowering the propensity of entrepreneurs from launching new projects. Local capital market is essential to the continuity of entrepreneurship as it can either alleviate or aggravate financing constraints for new projects in a region.

These moves in the market have reduced the demand for bank credit among entrepreneurs and SMEs in U.K. The Bank Lending Survey (BLS) method that banks use in Britain shows most entrepreneurs are frustrated in accessing credit for their start-ups.

According to the Federal Reserve Survey on Bank Lending Rates, almost 20% of British SMEs had problems on obtaining investment funding in 2008 (OECD 2009). Notably, over 70% of SMEs in Spain were facing difficulties with accessing credit for their businesses. Evidently, entrepreneurs have been unwilling to adjust their indebtedness upwards in spite of the decreased sales and increased delays in payments.

Tightened Credit Conditions

Moreover, there are tightened credit conditions that come in the form of commissions, loan periods, quantity of collateral needed and interest margins. The European Central Bank indicated that the inability of banks to access funds has increased the tightening of credit standards for SMEs (Pissarides 1999). In addition, banks face higher risks on security, un-expectations on the recession of 2008/2009 and have low liquidity position.

Even though this effect has immensely affected SMEs, large enterprises are not exempted either. In the U.K., banks adjusted their interest rates to high levels for small loans by the end of 2008. Banks were offering most small loans with short maturity as well as large loans (OECD 2009).

Unmistakably, most SMEs and entrepreneurs in the U.K. could not meet the conditions that the banks had set on the loans. The increased costs that accompany loans have posed challenges to entrepreneurs and SMEs in U.K. in raising finance for funding their projects. Other financial intermediaries are also reluctant to lend, as they are not sure of entrepreneurs’ repay-ability.

Poor Economic Prospects

Banks have been shying away from lending to SMEs in the U.K. given their poor economic prospects, the raised cost of capital and restrictions on the balance sheets. For instance, banks and other financial institutions in Scotland have been under immense pressure to protect and fasten their capital base hence they have been minimising the use of their economic capital by avoiding lending to SMEs with poor credit rating.

As a result, these institutions are lending highly to blue chip SMEs as compared to SMEs that require funds for start-ups. Further, the expensive rates on inter-bank funding have made these financial institutions reduce lending to entrepreneurs. The high rates have made it difficult for banks to raise new funds overseas thus deteriorating their confidence of loaning to non-blue chip SMEs.

For example, the EU has made financial assistance for SMEs top among its agendas. The report critically evaluates the issues that SMEs and entrepreneurs in the U.K. have been facing in raising finance. In addition, the report will analyse the extent at which public policies in the U.K. have handled the issues on financial access for entrepreneurs.

For example, the U.K., which is a member of Organisation for Economic Co-operation and Development (OECD), has been working towards addressing the social, environmental and economic challenges that business enterprises are facing (OECD 2006). The organisation assists governments of member countries in designing policies that seek to address common issues that affect the business field.

Increased Payment Delays

According to the OECD report of 2009, the U.K. has registered decreased demand for finance from key financial institutions, and there have been increased payment delays and insolvencies among banks and other financial institutions. Most entrepreneurs have been going for short-term loans but not at a high rate while there has been a massive decrease on the demand for long-term funding.

Therefore, the credit market crisis has affected the rates at which SMEs and entrepreneurs in the U.K. raise finance to support their projects. Moreover, large financial institutions have centralised their loan decision-making process and automated their credit assessment arrangement thus increasing the complexity within these institutions.

As a result, entrepreneurs and SMEs lack direct contact with the managers in these financial institutions hence cannot explain the nature of their businesses to them. Even though local branch banking might see the viability of the projects, a lack of face-to-face communication with bank managers have lowered the lending of working capital to entrepreneurs.

For example, in the United Kingdom, there are close 2,000 small commercial banks that still lend to SMEs since the collapse in the credit market has not affected their capital bases (Market Failure in the Provision of Equity to SMEs n.d.). The stiff competition among these banks in providing lending services to SMEs and small enterprises made SMEs not experience freezing up of capital flows in 2008.

Capital Market Crisis

The crisis has also led to demand slump for goods and services among consumers. According to the British Chambers of Commerce Economic Survey, demand in the last quarter of 2008 down-turned at the fastest rate since 1991. During this period, 54% of SMEs registered demand slump on their new orders in comparison to an increase of 13%. Markedly, demand for goods and services are the key factors that constrain output.

Consequently, the crisis led to a decline in the level of demand for products as well as decline for entrepreneurs in the service segment. The crisis also increased the payment delays on receivables during the low sales period and even led to exhaustion of the working capital. In the U.K., 50% of SMEs had to delay their own payment and experienced massive delays in their receivables.

The depletion of working capital among small firms has increased the bankruptcy rate among SMEs, as they cannot access short-term funding.

The 2008/2009 financial crisis increased the insolvency rate by 11% across Europe. According to “Insolvencies in Europe 2008/2009” (Credit reform), the insolvency highly affected medium-sized enterprises as compared to other enterprises since they lacked working capital to continue operating their businesses.

Lack of Verifiable Data

SMEs go through a high potential life cycle where they posses little data that financial institutions can use to verify their characteristics, credit worthiness and financial strengths. Therefore, at start-ups, entrepreneurs rely on internal sources of finance such as family and friends contributions, properties, trade credits, and personal savings (Market Failure in the Provision of Equity to SMEs n.d.).

Afterwards, SMEs move to acquire external equity, which is in the form of venturing capital, bank debt, angel finance, and corporate investment. The market failure in the “equity gap” represents a variance between the needs of SMEs and the supply of investments like venture capital.

For example, there is underdevelopment of angel finance and the large size of venture capital. Venture capital largely fixed its operations and transactions on their funds irrespective of the required equity (Hackner & Hisrich 2001). This has made it difficult for SMEs to request for funds from such institutions. The financial strengths or resources of individuals affect their propensity of becoming new entrepreneurs.

Kerr and Nanda 2009 argue that entrepreneurs are more financially stable than their counterparts who are in paid employment. The constraint comes in when they want to borrow funds from financial institutions.

Since they are accountable to their own activities and personal wealth, banks tend not to lend them more funds than they can borrow to support their innovative ideas. As a result, a profitable project may become unprofitable to a constrained entrepreneur. From this dimension, creative but poor individuals are less likely to realise profits on their projects as they are credit constrained.

High Costs of Information Acquisition

Additionally, financial intermediaries have met difficulties in finding credible information about borrowers given the increased costs of acquiring such information. This occurrence results in an inadequate funding for reputable and profitable SME projects.

SMEs and entrepreneurs are also disadvantaged in the sense that they lack history of audited financial accounts, less or no collateral to pledge for loans and inability to fund partially their expansion since most of them lack retained earnings (McGlue 2002).

Consequently, lucrative and profitable entrepreneurial projects go unfunded. In respect to this scenario, banks often adopt credit rationing without raising interests on loans. Such approaches by banks put off potential entrepreneurs thus making them face financial constraints.

In fact, raising interest rates does not lower the costs of acquiring information for start-ups since the move may result to adverse selection where SMEs that plan to launch risky projects would consent to the bank’s loaning terms.

Effective innovations within the financial sector can assist in minimising the large costs that financial intermediaries require to screen and monitor start-ups in order to reduce challenges that SMEs face while raising funds for their projects. Information asymmetry cannot only lead to adverse selection but also lead to moral hazard.

Addressing the Problems

The macroeconomic policy

Since SMEs faces numerous challenges in raising finance, the U.K. has initiated policies that seek to assist entrepreneurs to access finance in various aspects of their operations. The U.K. believes that the increasing importance of SMEs makes their policies be included in other economic policies. Moreover, the U.K. views the fast-growing businesses as the key players in recovering the economy.

Some of the moves towards encouraging entrepreneurs to access credit in the U.K. include market deregulation, developments in the ICT field, rise in affluence, and growth of niche markets (Wang et al. 2004). The macroeconomic policy helps SMEs and entrepreneurs by providing a framework that favours economic flourishing to the enterprises.

Under the macroeconomic objectives, the U.K. has focused on creating employment (Harvie & Lee 2003). In this option, the U.K.’s government offers grant to SMEs that are not able to raise adequate capital for start-ups. On the social aspect, the U.K. has initiated income transfers as a way of achieving income redistribution target.

National Loan Guarantee Scheme

Additionally, there is the National Loan Guarantee Scheme (NLGS) that targets small businesses. Chancellor George Osborne included a 20 billion Government-backed loan in this year’s financial plan. In this scheme, the government has liaised with the Royal Bank of Scotland, Lloyds, and Santander in lending the loans to small businesses. Markedly, the government lowered the lending rates by 1% with turnovers of 50 billion.

The government targets high street lenders as they can easily interact with local entrepreneurs. The participating banks have also been awarded 5 billion to underwrite the unsecured loans so that they can be able to lend at cheaper rates. The strategy has also put aside 20 billion to support SMEs in case the initial scheme receives sufficient demand from small businesses across the U.K.

In Addition, the U.K. Department of Business Innovation & Skills (BIS) has taken positive steps towards providing funds for innovation and research. In December 2012, BIS set aside 75 million to give SMEs better access to financial supports with the intention that they can come up with new products (Harvie & Lee 2003).

Moreover, BIS in collaboration with the National Endowment for Science Technology and the Arts (NESTA) plans to set up an innovation awards centre and an additional 250,000 prize fund that NESTA manages. There is also the coaching programme where BIS trains over 10,000 SMEs on strategic growth options.

Collaboration with the Bank of England

The U.K. has also supported SMEs in accessing finance by collaborating with the Bank of England in launching a funding scheme where other banks can borrow funds from the Bank of England at low rates for up to 4 years. This scheme has made banks adjust upwards their loaning to the U.K. households. The decreased lending rates have increased SMEs access to funding.

The local banks are also assured of repayment in case some entrepreneurs fail to repay the loans as the government has included the repayment scheme to assist such SMEs. The new business bank plans to unify all government schemes that aim at supporting SMEs to access finance. The institution offers different financial support and high amount of loans to entrepreneurs.

The Enterprise Finance Guarantee

The Enterprise Finance Guarantee (EFG) is a beneficial scheme that lends to SMEs with no proven history of their financial statements or lack collateral to secure loans from banks.

From the first part of this report, most entrepreneurs who require funds for start-ups lack collateral and proven record of accomplishment to secure normal commercial loans; therefore, this initiative has eliminated cases where profitable projects fail to get adequate funding. However, this scheme does not fully replace the commercial products as it accounts for 1% to 2% of total loaning to entrepreneurs (Gibb & Webb 1980).

Presently, 46 financial institutions lend to businesses through the EFG scheme. In 2012, EFG replaced the maximum 1 million loan limit with a progressing 1 million limit so that many SMEs could access the funding. Again, the scheme increased sets the level of lenders from the initial 13% to 20% for the 2013 fiscal year.

The government of the U.K. is also partnering with the British Bankers’ Association to alter numerous issues that have acted as barriers to entrepreneurs from accessing funds for their businesses.

The Business Finance Task-force aims at improving standards that SMEs can anticipate from their banks (Gibbs 1994). The Task-force can appeal directly for SMEs in case a bank denies them loans. In this approach, the government policy has aided the process by which SMEs access credit in the UK.

Funding Entrepreneurs and Awards

The government has also started promoting enterprise by funding awards and key events like the Queen’s Awards for Enterprise, Enterprising Britain, and Global Entrepreneurship Week (GEW) (Jackson n.d.). In addition, it has established Enterprise Zones to assist in generating jobs, assist in driving both the local and the national economy.

The government is collaborating with other financial departments in order to support the expansion of Enterprise Zones across England and even offer them with necessary incentives for doing business. The government is also helping young entrepreneurs through the Start-Up Loans scheme that offers funds and mentoring services to young entrepreneurs between the age of 18 and 30 (Denis 2004).

Information imperfection has been a key issue that faces SMEs. Most entrepreneurs lack essential information on how to access funds. Presently, the government has created a well-guarded distribution network that SMEs use in exporting their products.

The initiative has tremendously reduced the costs of operations for SMEs hence increasing savings for operating their businesses. Clearly, the U.K. has strived towards solving challenges that have been facing entrepreneurs and SMEs in accessing financial support for their businesses.

Conclusion

Entrepreneurs have been facing several issues in order to access funding for their businesses. For instance, some banks have loan requirements that are beyond the reach for most SMEs. Some financial institutions required proven record of accomplishment of businesses, yet most entrepreneurs require funds for start-ups only (Burns & Dewhurst 1996).

This reveals that most SMEs fail to move to the next level of growth. The policies that the U.K. has adopted have indeed assisted to eliminate some of the challenges that SMEs have been facing. For example, the launch of EPG where entrepreneurs can access loans without collaterals has made it possible for many entrepreneurs to access funding.

References

Burns, P & Dewhurst, J 1996, Small Business & Entrepreneurship, MacMillan, Basingstoke.

Carter, S & Jones-Evans, D 2000, Enterprise and small business: principles, practice, and policy, FT Prentice Hall, Harlow.

Denis, D. J 2004, ‘Entrepreneurial Finance: An Overview of the Issues and Evidence’, Journal of Corporate Finance, vol. 10. no. 2, pp. 301-326.

Gibb, P & Webb, A 1980, Policy issues in small business research, Saxon House, Farnborough, Hants.

Gibbs, P 1994, Doing business in the European Community (3rd edn.), Kogan Page Ltd, London.

Hackner, E & Hisrich, R. D 2001, Editorial: A golden era for entrepreneurship and entrepreneurial finance research, Venture Capital, vol. 3. no. 2, pp. 85-89.

Harvie, C & Lee, C 2003, Public Policy and SME Development. University of Wollongong, https://ro.uow.edu.au/cgi/viewcontent.cgi?article=1085&context=commwkpapers

Jackson, W n.d., UK Government action to support SME access to finance, European Commission, https://ec.europa.eu/search/?QueryText=UK+Government+action+to+support+SME+access+to+finance&op=Search&swlang=en&form_build_id=form-B0_MfSTxkUK0IPJJ7NAdOJ5YfDkO3l0exTeY6Xp8M70&form_id=nexteuropa_europa_search_search_form

Kerr, W. R & Nanda, R 2009, Financing Constraints and Entrepreneurship, Harvard Business School, https://hbswk.hbs.edu/item/financing-constraints-and-entrepreneurship

Legge, J. M & Hindle, K 2004, Entrepreneurship: context, vision and planning. Palgrave, Basingstoke.

Market Failure in the Provision of Equity to SMEs n.d., HM Treasury. Web.

Marlow, S & Patton, D 2005, All credit to men? Entrepreneurship, finance, and gender. Entrepreneurship: Theory and Practice, vol. 29. no. 6, pp. 717-735.

McGlue, D 2002, ‘The funding of venture capital in Europe: issues for public policy’, Venture Capital, vol. 4. no. 1, pp. 45-58.

OECD 2006, Financing and Policy Responses, Organisation for Economic Co-operation and Development, http://www.oecd.org/

OECD 2009,The Impact of the Global Crisis on SME and Entrepreneurship Financing and Policy Responses, Organisation for Economic Co-operation and Development, http://www.oecd.org/industry/smes/43183090.pdf

Pissarides, F 1999, ‘Is lack of funds the main obstacle to growth? EBRD’s experience with small-and medium-sized businesses in Central and Eastern Europe’, Journal of Business Venturing, vol. 14. pp. 519-539.

Wang, Y, Watkins, D, Harris, N, & Spicer, K 2004, ‘The relationship between succession issues and business performance: evidence from UK family SMEs’, International Journal of Entrepreneurial Behaviour and Research, vol. 10. no. 12, pp. 59-84.

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