To Identify and Analysis the Financing Problem Within Small and Medium Enterprise in the UK - Dissertation Example

?Running Head:  Literature Review on SMEs in UK Literature Review on Small and Medium-sized Enterprise in UK [Institute’s Literature Review on SMEs in UK The study signifies the interrelation between the financial intermediaries and financing interventions between the small and medium enterprises. Matlay and Westhead (2005, p 279) noted that with the advent and uprising of the small and medium sized enterprises (SMEs) in UK, the social economic and political manifesto have contributed radically towards fostering healthy growth and competitive edge towards the businesses at national and international level. Alternatively, Harper (1988, p.17) also observed that once small businesses have expanded and grown enormously into mega businesses over the time span of last twenty years and it has also eradicated the hindrance of traditional obstacles in way of the businesses and turning it into a significant contribution to employment power and economical development. The boom of SMEs have integrated the vital portions of businesses sectors and have not only flourish different businesses at national level but have also contributed to highly skilled labor and creative ideas regardless of its business operations or services it caters. To grow and nourish any business, there has to be sufficient funds available for its going concern status and its stability to adhere economical turndowns especially any inflated market. According to Hussain and Matlay (2007, 1-5), a significant number of small firms and businesses milk their financial needs by family and friends loans, personal savings and belongings despite of structure and size, number of employees or the nature of business activity. This has also regarded as a safe and easy source of finance to cater the first building block of any business. The another striking feature identified by Mason and Harrison (2000, pp. 221-239), was the reliance of stable and potential growth fostering SMEs to fund their operations and businesses through medium or long term finances by financial loans, convertible bonds from bank, microfinance intermediaries, venture capitalist or angle financing etc. Manigart and Sapienza (2000, pp. 240-258) also highlighted that when the cost associated with the going concern status of the firm increased to significant heights to mark the survival of the businesses that the funding of the financial resources become a hardcore factor and is solely dependent on external finances or retained earnings of the business’s profits. The SMEs market in UK has flourished over decades and has an immense contribution to wealth maximization, employment turnover, and businesses transforming into mega giants with development of different sectors of businesses as a cash cow or moneymaker to the economy. Storey (1994), depicted that innovation and creativity, re engineering of the infrastructure and business operations in the SMEs have outward the economic turndown with stable growth and employment opportunities in public and private sector of UK economy. Poutziouris (2003, pp.185-214) found out that SMEs foreign and national level operations and trade have matured the economic market and have urged the government to intervene in the public sector SMEs specifically and foster their policies and interest to cater the important role of economic development. The results can be devastating noted by Deakins et al., (2000) that the government policies and agenda could not fulfill the demands and development opportunities for the SMEs in long run. It could further result in an adverse impact on the economic and social sectors as well as the competitive advantage of the country enjoyed over the number of years. Chami (2001) noted that adverse behavior in market for insufficient sources of finance for the SMEs have an interrelationship within different factors for not only the availability of the capital but also it is affected by the traditional trade practices, international business ventures and the significant contribution of e- businesses specifically in the SME market. The e-business internationally have given a significant competitive edge for reducing the cost of productions and adhered control over the overheads of the SMEs (e.g. Amazon UK) that has forfeit the funds for impetus growth for local businesses. The start up businesses is also adhered to the fuming industrialization and international operational trades, which have hit the soci0-economical coefficients, such as inflation, unemployment, and extensive capital requirement for start up businesses. The main allegations and problem area for the SMEs is the funding of extensive capital requirements and the working capital for smooth running of the businesses as well as the long term strategy for the businesses operations. Deakins and Hussain (1994, pp. 323-335) also noted that due to the structure, size and credibility of the SMEs the access to external finance for financing SMEs capacity has outwit the longer term strategic financing. Banks and other financial intermediaries would place a specific limit or agreement barriers for providing loans for a longer period. They are most likely to provide short term financing such as overdraft facility to the SMEs. Holmes and Kent (1991, pp. 141-154) also figured out that short-term financing is the favorite option to fund their operations rather than obtaining higher level of borrowings. The SMEs uses small term financing to operate their longer-term operations that sometimes also give rise to the short-termism of the businesses and firms operations. Another obstacle identified by Mason and Harrison (1996, pp. 5-14) was the borrowing policies, agreements fostered by the government and the banks for scrutinizing control over lending decisions. The centralized banking has also given rise to more difficulties and have prevented smaller and medium sized businesses to access the longer-term debt. The approval of loans to SMEs have also been adhered to strict policies for personal banking and lending, which in turn could result in severe difficulties and most probably rejection for the proposal upheld by local SMEs and even start up businesses. The ethnic SMEs minority can also contribute to informal sources of finances due to significant relationship bonding for start up business especially, but the question with stand that external source of finance, such as bank loans is difficult to obtain without any prior creditability of the business operations in UK. Hussain and Matlay (2007) remarked over the imperfection in the capital market, which provokes the SMEs to rely on conventional sources of finances such as off-the-rack bank borrowings as pointed out by Walker (1987), and there is not a particular framework developed for the accountability of the SMEs financial statements. Holmes and Kent (1991); Mayers (1984) researchers explained that SME’s financing policies are usually dependent on the decision making of their owners or managers that intend to facilitate ‘ pecking order theory’ i.e. retained earnings are the foremost internal source of funding and are easily available without any restrictions or hurdles. The second most reliable source is short-term loans from either friends and family or any third party that wanted to invest in their enterprises. The middle-sized businesses also consider and have an access to business loans for longer-term debts at convertible bonds or irredeemable bonds at higher interest rates. The increase in interest payments might indicate towards the security of the bonds and continuous payment of the loan as well. Experts also (Graham, 2004, pp. 1-5) recommended the least preferred but optional equity finance in case of public sector SMEs for raising finance. This comes with a huge undue cost of listing and also affects the control and management of the businesses that SMEs are reluctant to adhered to as they are formally integrated into a limited number of employees and less complicated hierarchy. Peter and Schulman (1987) correlated the most important thing in choosing the right medium for financing their enterprise is the optimal level of capital structure of their businesses or firms e.g. debt to equity ratio that constitute the level of leverage the business can adhered to and the option of equity it could avail. The important thing is the control and accountability to the SMEs and it is highly regulated in UK that they prefer to keep that secure and choice for debt financing or bank borrowing as their secondary source of funding. Experts also (Graham, 2004, pp. 1-5) second the research of failure of SMEs due to strict financial implications and funding barriers or poor management control. The most popular funding options are the banking finance that has taken a wild run for SMEs funding as compared to the regulations of conventional banking. The condemnation of electrical credit rating scoring system in the financing business loans has jeopardized the objectivity of security or mortgage settlement, which is limited to loans less than insignificant amount of ?30,000. Graham (2004) highlighted the issue of collaterals, which are not required for borrowing to reduce the finance gap between the new start up businesses and the SMEs. The economical gap as suggested in previous studies by Berger and Udell (1998) relish on prototype financial growth depending on the capital structure. The debt financing is more reasonable for medium sized enterprises, which have sufficient mortgaged assets in place of loans. Another problem highlighted by Storey (1994, p. 250), Deakins (1996) also emphasis towards the lack of external funds available for SMEs especially private business which lacks integrity and revenue accumulation from the business operations. The level of risk raises more due to agency cost issues related with small firms and entrepreneurs high valued project assessments. The recent development in SMEs market is due to constant intervention by the government to raise external equity finance, which is an encouragement for enhancement and more advance-regulated source of continuous finance for the potential growth of SMEs. Apart from the credit rating of entrepreneurs and small businesses operations, Cole (1998) pointed out that interpersonal relationship and social fraternities contributes towards the lesser risk of credit rating on the borrowed debt. The business relationship can be straighten by sharing or resources as mentioned in earlier studies but it can only be applicable for business with potential growth who caters less for external finance as it would be unlikely that they could facilitate the approval of big loans. According to the statistical data as indicated by Carter, Mason, and Tagg (2004), there are more than a quarter representations of SMEs owners that are motivated for swift growth but does not have funds to accommodate the expansion. According to Small Businesses Survey (2003), the analysis of 5 years data shows striking results in relation to usage of funds by the SMEs owners. More than half of the population i.e. 50% relies on short-term finance (e.g. overdraft facilities); the other 30% uses the pecking order theory (e.g. retained earnings, savings). In addition, the long term financing such as bank loans that makes 28% almost quarter of the population. Other sources make up 11% for financial lease, an insignificant proportion of 3% on factoring and 0.8% on venture capitalist. This also indicates that personal contacts and social networking might give a wider pool of finance to invest in the expansion of SMEs in UK or Mutual Investment funds (MIF) that would be another option due to personal credibility of the owner and the reputation of the firm to repay the loan. Carter et al., (2004) indicated that entrepreneur with stable financial background and management experience are more likely to get access to wider sources of personal finance through personal and business peer groups. The structure and size of the SMEs is an important factor when considering available sources of finance. A small business with few employees will consider funding through overdraft or personal savings rather than long-term finance as compared to a medium sized enterprise. The feature of business operations is also a correlated variable when considering financing options. The startup businesses will more likely rely on family and friends loans or savings, the more experienced firms or businesses will cater towards overdraft facility or short term finances while businesses over 10 years or potential to expand in national horizons will facilitate its working capital through long term debt finance or equity finance. The literature also reveals striking features regarding the choice of funds according to industry. The agriculture, manufacturing, construction and fishing makes up a bigger proportion of the private sector SME and rely mostly over debt finance as compared to the old school of retained earnings. The main aim of this study is to emphasis on the resolution of the finance gap that had led the SMEs market in awe of equity and finance lending. Cruickshank (2000) noted that the gap filled with the suitable mode of finance depending upon the demand and requirement of SMEs operations. The most striking solution to funds for SMEs in UK is either bank financing short term or longer term that anticipates the problem areas and financial gaps in the market. Storey (1994, p. 146) suggested that only few firms expand and grow in a big fish and usually the firm owners do not want to increase the size of the business by number of employees. This evidence gives light to the fact that SME financing is more suitable as debt financing and unwilling to raise equity share by dividing the managerial control to the stakeholders. Holmes and Kent (1991) indicated that almost 80% of the population of SME market in UK is motivated to finance their day-to-day operations through bank overdraft. The bank is keen to do business with SMEs on short term but also willing to get their share on timely basis. It is difficult to retrieve collateral on long-term assets and the SMEs are less enthusiastic to mortgage their assets to the bank. This was explained earlier by Chittenden, Hall et al.,(1996) and indicated further than only tangible assets can be held up for collateral to long term debt finance whereas intangible assets cannot be assessed for SMEs in short term. The studies also revealed that SME owners are reluctant to invest in venture capitalist companies due to share of experience in management and level of capital-intensive investments. Their decision making power and running of operations with ventures lacks distinctive control, and they are more likely to turn their heads over debt financing, as this is more suitable and carry little or no investments. As compared to other large enterprises the ownership and management in SME is a vital part of the business and sharing the control in case of venture capitalist market is a drawback of its utilization for SMEs in UK. Another problem that have been anticipated in this accord is the amount of collateral provided to secure the long term borrowing against the non current assets of the business. Berger and Udell (1998) noted that over the time span of business operations, the credit worthiness of the owner/ manager is assessed by banks or financial institution to give debt for more years but if the mortgage is not sufficient as compared to the amount of borrowing than there is an anticipated danger. The owner had to bring in personal assets to secure the debt against the collateral which can be a high-risk area incase the business fails to provide the repayment of loans to the bank. The lack of available funds may also indicate that projects with higher positive NPV than rejected eventually. To reduce the finance gap of equity in the market, government intervention can project solutions for SME financing. Bank of England (2001), and Basham and Pickering (1999) illustrated the idea of angel financing. The network comprised of individuals or group of individuals working together to invest in SME business in long run for their survival and eliminate the finance gap that had been a big hurdle in the past. The birth of Alternate Investment Market (1995) also gave rise to new equity funding as it is not as highly regulated like the London Stock Market and comes with a one time bearable listing fees. AIM is urged to foster the needs of potential growth oriented SMEs. The further enhancement in tax favorable share options and employee benefit schemes are also encouraged to raise equity finance for the survival of the fittest of SMEs. Joseph (1999) illustrated the idea along with British Venture Capital Association (1999) for bridge financing or short term floating for SMEs who tend to buy out arrangement or needs funds for the survival. The management buy out is also an issue addressed with deep concern, when venture capitalist funds to reengineer or restructuring the entire operations. The ventures are only interested in profitable SMEs that have potential to grow further; they do not touch the toddlers or the early growth seekers. The venture capitalists are only favorable for public sector SMEs and not respondent to the private sector at large due to the clause of share of management, expertise, and employees, which is a big barrier for growth in terms. Poutziouris (2000) identified and explained the rational approaches by family based small businesses in their financing operations. Almost 61% of SMEs in UK, operated by family owned businesses and they tend to be more respectable and emotional to their independence and control. They are likely to finance their funds through angel financing, venture capitalist, or even long-term debts, as they do not intend to commit their small business to bank mortgage. The generations owned businesses are more stimulated towards personal bread earnings and subjected to moderate structure and size for years. Another group of owner based small businesses that constituted almost 21% of family or friends based startups wants to expand for potential growth and are willing to take risk with venture capitalist management experience, angel financing and long term debts. They usually float in the market to catch an eye for ventures so to raise equity finance. This highlights the approach of funding choice and business operations in SMEs owners. The introvert approach of taking less risk and close family control are unlikely to raise equity funds rather they persuade towards internal funds. The extrovert approach wants to grow and expand its horizons and are subjected to take risk over management control on the expensed of increasing the business operations through excellent management experiences. Michaelas (1998) noted that SME in private sector subjected to short term financing as compared to long term or equity financing. The behavioral implications of SMEs owners also facilitates the choice of funds they choose and the willing to grow or expand their business or remain intact to their size in order to earn their bread living. Poutziouris et al., (2000) indicated that SMEs especially family based businesses generates equity financing through withholding retained earnings over the span of the business operations. Some private SMEs do not integrate any outsider mergers and though have strengthened the internally regulated equity base from the social and family fraternity. Privately owned SMEs have a trend of generating internal funds i.e. somewhat similar to the pecking order theory or utilising the retained profits or short term financing through mutual funds or overdraft bank finance. The emphasis was further enhanced by Astrachan and Tutterow, (1996) that equity finance is a difficult source for privately owned business and is not favourable in long term investments. Cressy and Olofsson (1997) argued that long term financing depends upon the asset structure of the company and SMEs are more often secured when they have enough collateral for debt financing. The interest payments are tax allowable and therefore it would be rather cheaper form of financing and it could also be second with invoice discounting especially in case of long term creditors. It is also important to know that management decision is important when exercising equity finance as it is a costly and risky matter that is also related to the asset structure of the firm. This also indicated towards a life cycle model that illustrates that when the firm has a higher growth potential it is likely to invest by raising equity finance but later on secure over debt finance. Myers (1984) also revealed that trade credit can also be used an important source of finance and can be repayable at a premium rate. It can be an important factor for raising short term financing and even longer term that should be taken into account by the SME owners. The choice of correct source of funds vary by different factors and it covered in course through a life cycle that relish the owners to set apart modes of finance over the current demands of the firm. The rationalism of credit terms and the owner’s personal wealth has also a deep effect on the mode of funding to day to day activities. Holmes and Kent (1991) have emphasized on the rationalism of equity finance for the SME owners. The relationship between the ownership and management is crucial in case of SMEs and by raising equity at an early stage there is a risk involved of parting with their business or dilution of control. The most common example found in SME industry is the retail and wholesale stores, hotels and restaurants owners are more prone to retain their existing control rather than sharing a partnership. Factoring is also another source of financing the working capital at SMEs. It can be regarded as another short term financing that can also be related to SMEs with a mature accounts department. The outsourcing of skills from an experienced and highly qualified administration can not only control the potential bad debts but also it gives a wider variety of expertise and skill that SME management might lack due to its small structure and size. It is less risky as compared to bank draft financing and there is no collateral involved. References Astrachan, J. H., & Tutterow, R. 1996. ‘The effect ofestate taxes on family business: Survey results.’ Family Business Review. Volume 93, pp. 303-314. Bank of England. 2001. Finance for small firms: Eighth report. London: Bank of England. Basham, B., & Pickering, C. 1999. Tomorrow’s Giants. London: Equity Development. Berger, A. N. and Udell, G. F. 1998. 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