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Why alternative funding model is key to SMEs growth

OPINION
By Otieno Odhiambo | January 28th 2020

Small and Medium Enterprises (SMEs) are key to the economy.

This explains why the government recently announced a new fund to cater for them. This is encouraging as it’s different from the Youth Fund or Women Fund. It will be a kitty meant to benefit businesses with viable ideas. The problem that the State faces now is how to remodel the fund so that it becomes self-propelling and in future rely less on taxpayers.

This requires a well-thought-out funding model. The model used in the past entailed handing over the money to a large financial institution, in most cases, commercial banks.

The shortcoming of such an approach was that commercial banks take too long to process a loan. Also, the approach exposes the fund to pilferage in that management fee chargeable by the financial institution significantly reduces the amount available to SMEs.

Organisational structures

The State should seek an alternative model in which private investors make capital available to SMEs, while the government gives tax concessions to those lending to fund SMEs. The advantage of such a model is that private investors will keenly monitor SMEs.

Alternatively, the government can pay interest to private investors to lend to SMEs, providing them with cheaper capital.

Such a model will encourage savings. The point is that private investors create the fund, but the government encourages them by offering incentives.

Funding is not the only challenge to SMEs. Various SMEs lack ideas that can transform a strategy into marketable products and services.

They are not grounded on the necessary product and service processes. Their organisational structures goes to show the lack of depth in ideas. However, such concerns are lacking in terms of risk-sharing and capital required for large projects that derive economies of scale.

The next type of organisation structure is a partnership, but we do not see much of this because our attitude and lack of trust pushes up towards sole proprietorship.

This is because many of us feel good when identified with an asset such as matatus, salons, or hotels.

SMEs must be aware that as long as they are owed by individuals or partners, they might not be able to raise enough capital to support the project that accrues economies of scale.

Sole proprietorship and partnership do not help much in terms of taming risk exposure.

Unless stated otherwise, all partners have unlimited liability as in the sole proprietorship.

It is risk sharing, access to capital and the capacity to hire professional managers that explain why in developed economies corporate form of business organisations is preferred.

In a company, ownership shares can be transferred without disrupting the business and this supports continuity.

Besides, limited liability makes a corporate form of ownership preferable. Limited liability means that if a company fails to pay its debts, the creditors cannot recover the debt out of the personal assets of the shareholders, thus exposing the owners to ruin.

Financial institutions

Before the State finances SMEs, it must ensure that the organisational structures of these firms are corporate.

The State and financial institutions must only give money to projects and not individuals.

The emphasis on the project ensures it is adequately financed. Let us avoid this practice of getting the cash then look for a project to invest in.

Reasons explaining the high failure rate in SMEs include absence from the market of products and services they offer and poor daily management.

The solution is that either the government develops a shared advisory management unit for SMEs or encourages investors to develop training models on managing the SME projects.

Money is always available for productive firms. However, many of us lack business ideas.

When it comes to accessing bank capital, most SMEs face hurdles such as high-interest rates and lack of collateral.

Some cannot take a loan or lack relationship with the banker. This is why SMEs need State support.

It is expected that when the government releases these funds, the major critereon will be the viability of the project or else the cash will be lost.

Successful firms tend to have a clear strategy, yet several SMEs lack resources to hire professionals to do strategic planning. Most SMEs tend to fail within the first three years into their operation.

Always remember that the worst reason for getting into business is to make a lot of money.

-The writer teaches at the University of Nairobi  

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