Financing Sources for SMEs

There are several ways of raising finance for a business, depending on its nature. Large organisations are able to use a wider variety of finance sources than smaller ones.

Yet, an SME might raise new funds from the following sources:

Bank finance
Businesses require an adequate amount of capital to fund extra production expenses or pay for expansions. As such, companies take out business loans to gain the financial assistance they need. A business loan is a debt that the company is obliged to repay according to the loan’s terms and conditions.

Raising medium-term finance to fund operations is often more difficult for SMEs as banks are traditionally rather conservative. Hence, many SMEs end up financing medium-term, and potentially longer-term assets, with short-term finance such as an overdraft.

Moreover, banks will often require personal guarantees from the owner of the SME, which means the owner has to risk his personal wealth in order to fund the company.

Trade credit
SMEs, like any company, can take credit from their suppliers. However, this is only short-term and, indeed, if their suppliers are larger companies which have identified them as a potentially risky SME, the ability to stretch the credit period may be limited.

Leasing assets rather than buying them is often very useful for an SME as it avoids the need to raise the capital cost. However, leasing is only really possible on tangible assets such as cars, machines, etc.

Leasing might be attractive to the lessee:
i) if the lessee does not have enough cash to pay for the asset, and would have difficulty in obtaining a bank loan to buy it, and consequently the lessee will have to rent it in one way or another if he/she is to have the use of it at all; or
ii) if finance leasing is cheaper than a bank loan. The cost of payments under a loan might exceed the cost of a lease.

Operating leases have further advantages:
• The leased equipment does not need to be shown in the lessee's published balance sheet, and so the lessee's balance sheet shows no increase in its gearing ratio.
• The equipment is leased for a shorter period than its expected useful life. In the case of high-technology equipment, if the equipment becomes out-of-date before the end of its expected life, the lessee does not have to keep on using it, and it is the lessor who must bear the risk of having to sell obsolete equipment second-hand.


By achieving a listing on a stock exchange an SME would become a quoted company and, hence, raising finance would become less of an issue. However, before a listing can be con-sidered the company must grow to such a size that a listing is feasible. Many SMEs can hardly hope to achieve this.

Factoring and invoice discounting
Both of these sources of finance let a company raise finance against the security of their outstanding receivables. Again, this finance is only short-term and is often more expensive than an overdraft. Hence, factoring and invoice discounting are two of the very limited number of finance sources which grow in line with the business.

Own funds
This is a very good source of finance because investors as family and friends may be will-ing to accept a lower return than many other investors due to their motivation to invest, which is not purely financial. The key limitation is that the finance is often limited.

Business angel and venture capital
A business angel is a wealthy individual willing to take the risk of investing in SMEs. One limitation is that these individuals are not common and are very often quite particular about what they are prepared to invest in.
Another financing source for SME, not so common in our country, is venture capital, which is an investor who supports small and medium companies that wish to expand but do not have access to equities markets.
In order to attract venture capital funding an SME has to have a business idea that may create the high returns the venture capitalist is seeking. Venture capitalists are willing to in-vest in such companies because they can earn a massive return on their investments if these companies are a success.
Venture capitalists also experience major losses when their picks fail, but these investors are typically wealthy enough that they can afford to take the risks associated with funding young companies that appear to have a great idea and a great management team.

Providing grants
Grants are available most frequently nowadays. Most grants are made available for SMEs in case of extending their current activity, diversification of the production flow or the de-velopment of a product or service.
Governments are often keen to assist as to the extent that SMEs are unable to raise finance for their profitable projects and investment opportunities are potentially lost. Additionally, governments are keen to support innovation, which is one area where SMEs often excel, and are keen to support the growth of SMEs as this stimulates employment.