Survey: Entrepreneurs opt for savings rather than loans to grow investments

Firm owners apprehensive about loans have reservations about the payment modalities and concerns in case of default. [iStockphoto]

Entrepreneurs seem to be shunning loans from mainstream financial institutions in favour of family and friends, according to a new report.

The report, titled Financial Services: How Small Firms Manage their Finances, which is part of a series dubbed Small Firm Diaries published by Financial Sector Deepening –Kenya, lists bank loans as the third source of funding for those starting businesses.

It also documents 19 per cent of surveyed businesses saying they do not want a loan.

This was the response when asked owners of firms what they use or would want to use a loan for.

The survey covered firms in agro-processing, light industry and services sector. The Small Firm Diaries covers seven countries namely: Kenya, Ethiopia, Fiji, Indonesia, Columbia, Nigeria and Uganda.

It ran from 2012 to 2023.

In Kenya, the project followed more than 155 small firms from November 2021 to November 2022. The firms were spread roughly evenly between Nairobi, Kisumu, and Kwale.

Starting capital

The May 23, 2023 report notes that regardless of the level of financial integration, the majority of firm owners used their own savings for start-up capital.

Personal savings scored high as the source of capital across the level of banking of the business owners listed as high, partial, marginal or unbanked. For high, it was 100 per cent.

The second source of capital was family members at 33 per cent followed by bank loans at 11 per cent.

“Most firms report a relatively low desire to actively use credit, noting only an occasional, rare, or non-existent need for a loan,” the report says.

The report states that a quarter of agri-processing firms report never needed a loan and a further 30 per cent say they rarely need a loan. Light manufacturing firms need loans rarely, the report says, while 70 per cent of service firms need a loan only occasionally or rarely.

“Overall, very few firms across both genders report needing loans constantly or often,” it says.


When the desire for loans is explored across the three surveyed industries, 24 per cent of firm owners in the agri-processing say they never need a loan, similar to 20 per cent in light manufacturing and 12 per cent in services.

The report, however, notes some mismatch between the desire for credit and the reported use of credit.  It notes that about 15 per cent of firms with a formal loan say they never need a loan meanwhile, of firms that do not report a current loan, one-fifth report occasionally needing a loan.

“It is very possible that this pattern is explained best by lenders making accurate judgments of the firms’ credit risk—the firms that constantly need loans are firms that are riskier and find it harder to be approved; while the firms that “never” need a loan, don’t need a loan because they can generally self-finance, which makes them more attractive customers for lenders,” the report explains.

It adds: “This interpretation is supported by the fact that there isn’t a correlation between “constantly needing” loans with firms that are growers; in other words, the firms that constantly need loans don’t need them to fund rapid growth (which would make them more attractive to lenders).”

When asked separately about their future desires, the majority, 45 per cent, report wanting to invest in expanding stock compared to 35 per cent who would put in a productive machine.

Yet when asked what was preventing the firms from making these future investments, lack of capital was the predominant answer.

“Of the 55 firms that reported wanting to invest in productive machines, 75 per cent of them reported lack of capital as a barrier. However, of those 41 firms, only 21 reported constantly or even occasionally needing a loan,” the report explains.

Cost, approval time, and lack of collateral are the leading three perceived barriers to accessing credit documented in the report at 49 per cent, 25 per cent and 22 per cent respectively.


Others are paperwork, availability and design.

The report notes that perhaps the most important finding from the Small Firm Diaries in terms of credit access is that working capital, or liquidity management credit is the most pressing need for many firms.

“So while we see firms saying they want credit to “invest” we most commonly see large purchases being raw materials, which we consider a liquidity need as opposed to an investment in increased productivity, such as more sophisticated equipment,” the report says. It also found that firms note access to finance is a barrier to their success, but there are still many of them who also say they rarely or never need loans.

“We interpret this mismatch generally as a statement about the need for tools specifically designed to manage liquidity rather than a need for the types and cost of loan products currently available in the market,” it adds.

From the report, firm owners apprehensive about loans have reservations about the payment modalities and concerns in case of default.

“When asked about their experiences with loans, respondents most consistently mentioned concern about the cost of a loan and apprehension that if they did get a loan they might not be able to keep up with the payments—they might be digging themselves into a financial hole too deep to dig out of—a very valid concern given the volatility we observe,” says the report.

High-interest rates 

High-interest rates and payback periods are also listed as primary reasons that some firm owners tend towards informal loans yet there are options.

The report documents that during the study, a female couch manufacturer shared that she had borrowed Sh10,000 from a family member with zero interest.

“Even though she planned to pay back the loan quickly (and she did), she felt more comfortable knowing that her family member was more patient and would not penalise her if she needed to defer payments,” the report says.

“However, later in the study she needed a larger loan of Sh80,000 and her family was unable to loan that amount. This pushed her to approach a formal bank for a loan, which she got for one year at 13 per cent interest.”

The report, while surveying usage of credit, found that based on a firm’s perceived level of formality, 48 per cent of informal firms have no loans, compared to 56 per cent of formal and 49 per cent of semiformal firms.

It adds that between perceived formal and semi-formal firms, there were few differences in the usage rate of “informal loans”; 41 per cent and 35 per cent of informal and semi-formal firms, respectively, took an informal loan during the study, compared to 38 per cent of formal firms.

“This suggests that formal firms that may have access to institutional sources of credit still rely on informal credit due to issues with credit product design, cost or other barriers noted above,” the report says.


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