FINANCING OPTIONS FOR SMALL AND MEDIUM SCALE ENTERPRISES IN NIGERIA

BY SAS ARUWA

BY

SAS ARUWA

Department of Economics and Management Sciences, Nigerian Defence Academy, Kaduna

Abstract

Government has identified the need for the development of Small and Medium Scale Enterprises (SME). One of such sectoral strategies is the introduction and pursuit of policies such as concessionary financing to encourage and strengthen the growth of SMEs in Nigeria. In this paper, a random sample of 10 formal/ informal finance sources and 20 SMEs in 6 selected Small and Medium industries in Kaduna and Abuja have been studied. We found that financing options for SMEs are numerous but access to these funds has been difficult inspite of several government initiatives. We also found that the Small and Medium Industries Equity Investments Scheme (SMIEIS) fund lacks standard guideline for fund disbursement, the unregulated informal finance institutions finance the SMEs much more than the formal sources and the informal sources make up more than half of the SMEs’ mix of funds. It is recommended that the informal source of financing is a potentially important source of micro financing. Savings in them should be further encouraged through regulation, government intervention by way of active participation of community and development banks in local business associations. SMEs should consider all financing options that maximize the value of the business enterprise.

1.1 INTRODUCTION

The significant role Small and Medium Scale Enterprises (SMEs) play in economic

development process has been well documented. Studies have been conducted on

SME management, business planning and to some extent on venture creation but

this paper focuses on financing options in Nigeria. This makes this paper imperative

as it re-evaluates the existing financing alternatives and the role government plays

in providing incentives for support from the formal and informal financial

institutions.

Financing has remained one of the key managerial problems decision that keep

confronting business enterprises in Nigeria today. For the SMEs, the accessibility to

funds and the cost of raising them have remained issues limiting the in-

capitalisation requirements leading to premature collapse of the enterprises.

Today, SMEs represent about 90 percent of firms in the Nigerian industrial sector on

numerical basis. Despite this dominance, however, they contribute as low as one

percent to GDP in contrast to countries like Indonesia, Thailand and India where

SMEs contribute almost 40 percent (HPAC, 2002:13).

Whilst SMEs are an important part of the business landscape in any country, they

are faced with significant challenges that compromise their ability to function and to

contribute optimally to the economy, especially lack of short, medium and long-term

capital – inadequate access to financial resources and credit facilities.

The objectives of this research paper shall specifically include the following:

i) To explore alternative source of financing small and medium-scale enter-

prises;

ii) to evaluate the abounding opportunities in micro finance, savings mobiliza-

tion and Small and Medium scale Industries Equity Investment Scheme

(SMIEIS);

iii) to ascertain the financing options available to the SME are practically obtain-

able to support the capital required for their operation;

iv) to identify the factors that contribute or mitigate the exploitation of these

sources;

v) and to finally suggest improvements on the design of SME financing policies

and regulations.

2.1 CONCEPT AND DEFINITION OF SMEs

SMEs are variously defined in Nigeria, as in other economies, on the basis of the size

or amount of investment in assets, total annual turnover, and the number of

employees. Within this framework, the classification of enterprises as 'medium' and

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'small' naturally varies from one economy to another and from one period to

another. In Nigeria, the National Council of Industry, under the Federal Ministry of

Industries, periodically revises the classification of SMEs. Other institutions, such as

the Central Bank of Nigeria and the Nigerian Association of Small Scale Industries

(NASSI), adopt classifications that vary from those of the Federal Ministry of

Industries. There is however, greater concurrence of opinion when it comes to

defining SMEs in terms of assets' value than on any other basis. Because in case of

an economic downturn, the impact on turnover and the number of people employed

is greater than the impact on assets' value.

From Table l, SMEs are divided into Medium Scale (MSE), Small Scale (SSE) and

Micro Enterprises (ME). The Federal Ministry of Industries defines a medium scale

enterprise as any company with operating assets less than =200 million, and

employing less than 300 persons. A small-scale enterprise, on the hand, is one that

has total assets less than =50 million, with less than 100 employees. Annual

turnover is not considered in its definition of an SME. The National Economic

Reconstruction Fund (NERFUND) defines a SSE as one whose total assets is less than

=10 million, but made no reference either to its annual turnover or the number of

employees. These and other definitions of NASSI, the National Association of Small

and Medium Enterprises (NASME), the Central Bank of Nigeria and other institutions

are indicated in Table l:

Table l: Definition of SME by Nigerian institutions

Asset Value (=’m) Annual Turnover y (=’m) No of Employees

Institution/Class. MSE SSE ME MSE SSE ME MSE SSE ME

Fed. Min. of

Industry

<200 <50 n.a. n.a. n.a. n.a. <300 <100 <10

Central Bank <150 <1 n.a. <150 <1 n.a. <100 <50 n.a.

NERFUND n.a. <10 n.a. n.a. n.a. n.a. n.a. n.a. n.a.

NASSI n.a. <40 <1 n.a. <40 n.a. n.a. 3 - 35 n.a.

NASME <150 <50 <1 <500 <100 <10 <100 <50 <10

Source: World Bank, SME Country Mapping 2001

The Committee for Economic Development of United States of America (1974:14)

identifies that if a business is characterized by two or more of the following four

features, it is a small business: the owners are also managers, the capital for

running the business is supplied, and one individual or a small group holds

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ownership, the area of business operations is mainly local; and when compared to

other businesses in the field, the business is small. In order to cover all classes of

SMEs, this paper will adopt the NASME definition.

2.2 GOVERNMENT INTERVENTIONIST POLICIES

SMEs have played important roles in the development process in most developed

economies, and have proved to be the most viable engines of economic growth and

development. The successes recorded by these countries were because of serious

consideration of the future rewards from sustained investment in this sector. Due to

their size and scope of operations, these enterprises require relatively small capital

investment to start, thereby offering a relatively high labour-to-capital ratio. They

also demand low technology and managerial skills, which are readily available within

the society.

The extent to which the opportunities offered by SMEs are exploited and their

contributions maximized in any economy depends on the enabling environment

created through the provision of requisite infrastructures. These include roads,

telecommunications, power, ports, finance facilities, and the introduction and

pursuit of policies such as concessionary financing to encourage and strengthen

their growth (HPACI, 2002:12).

The government has begun to address the constraints that impede their growth by

taking the following steps:

1. Merge all SME/Industry financing agencies comprising the Nigerian Bank for

Commerce and Industry (NBCI), NERFUND, and the Nigerian Industrial

Development Bank (NIDB) into one agency – The Bank of Industry - to administer

loan schemes to SMEs at lower than commercial rates.

2. Set up a Small and Medium Industries Development Agency (SMIDA), an umbrella

agency to coordinate the development of the SME sector.

3. Establish a National Credit Guarantee Scheme for SMEs to facilitate this access to

credit without stringent collateral requirenments.

4. Revive the Entrepreneurship Development Programme.

5. increased budgetary allocations for SMEs development.

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Furthermore, the government mandated banks to set aside 10 percent of their profit

before tax for equity financing in SMEs through the Small and Medium Scale

Industries Equity Investment (SMIEIS). The mandatory 10 percent has generated

tremendous interest for the following reasons (HPACI, 2002:25):

1. The value of funds that have been set aside by banks by the end of 2003

under the Small and Medium Industries Equity Investment Scheme (SMIEIS) is

in excess of =20 billion, and this is expected to rise to over =25 billion by the

end of 2004.

2. Private sector initiatives have historically been more succesful than

government ones.

3. Banks will be more discerning in their choice of SMEs they choose to finance

and will also demand better professional management of the SMEs and

transparency in their finances.

4. As at 2003, only about =8 billion have been disbursed, and the SMIEIS fund is

been envisaged to be invested in Central bank of Nigeria Traesury bills.

2.3 SOURCES/ACCESS TO FINANCE

A 2001 World Bank survey on Nigeria's firms showed that although 85 percent of the

firms had relationships with banks, not all of them had access to external credit.

Table II: Percentage of Firms Having Access to External Credit

Group Percentage

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Constrained

Full Sample 80.3

Micro (20-49)

Small (50-99)

Medium (100-199)

Large (200-499)

Very Large (over 500)

51.7

81.8

89.8

100.0

93.1

Foreign Owned

Indigenous

93.6

70.2

Source: World Bank, Nigeria Firm Survey, 2001

In Table II, the larger a firm, the more likely it is to have access to external sources

of credit. Almost 100 percent of firms with more than 250 employees have access to

credit compared to only 52 percent of micro-enterprises and 80 percent of small

firms. Interestingly, over 90 percent of foreign firms have access while just over 70

percent of indigenous firms do.

Secondary financing sources are another alternative. Unfortunately, there are few

domestic equity sources, as well as limited sources of export finance, and SMEs’

participation in the stock market (Second-tier Security market) is minimal. This is

due to their inability to meet the listing requirements as well as their persistent

tendency to operate as much as possible in the informal sector. They are also

unaware of the advantages of using the stock market as a source of financing. The

newly incorporated Bank of Industry is expected to play a very important role in

addressing SME financing, monitoring and advisory issues.

The commercial banks remain the formal source of finance for enterprises. Banks

have three social and economic functions: to collect and secure savings and other

deposits; to finance the economy by handing out credits; and to facilitate payments

and to transfer funds. Their role is to reduce the gap between supply (the money

deposited and potentially available) and demand (the money needed for

investment) that exists between idle money and productive investment.

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The financial intermediation role of financial institutions has been faulty for a

number of reasons (Gelinas, 1998:108): Inadequacy in building up and securing

national savings; bureaucratic obstacles to the financing of small and medium-sized

enterprises, inability to establish positive relationships between lenders and

borrowers; and absence of risk sharing. Otherwise, the banks offer loans, either by

way of term loan or an overdraft. An overdraft is essentially a short-term finance to

meet working capital requirement over a few months and can not be used for long-

term investment purposes.

In Nigeria, the formal financial institutions have been organised to finance SMEs

through venture capital financing; in the form of a SMIEIS fund. Venture capital

financing supplements or takes the place of credit facilities that the conventional

banks are unwilling to give. The provider of the funds may initially part with the

funds as a loan, but specifically with the idea of converting the debt capital into

equity at some future period in the enterprise. The return from such investment

should be high to compensate for the high risk. Venture capital may be regarded as

an equity investment where investors expect significant capital gains in return for

accepting the risk they may lose all their equity (Golis, 1998:xxv).

The Nigerian government’s version of venture capital financing of SMEs -SMIEIS,

requires all licensed banks in Nigeria to set aside 10 percent of their pre-tax profit

for equity investment and to promotion of small and medium-scale enterprises. The

goal is to reduce interest rate burden and other financial service charges imposed

under normal bank lending. However, SMIEIS’s fund has been reported to have

attained 20 billion naira but only 8 billion naira disbursed. The reason for the

inability of the SMEs to avail themselves of this fund is yet unconfirmed. The

apparent lack of investment in the micro-enterprises sub-sector could be informed

by the absence of approved guidelines which is still being finalized (Osagie,

2004:25).

According to Sanusi (2004:25), a break down of the SMIEIS fund investment by

sectoral distribution, 68.82 percent went to the real sector while service related

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investment accounted for only 31.18 percent. This he noted is a sharp reversal from

the initial trend recorded under the scheme. The Bankers Committee have allocated

the investment of banks with respect to the fund as 60, 30, and 10 percent of their

fund in core real sector, service-related and micro-enterprises respectively.

Analyzing the geographical spread of the SMIEIS fund, Sanusi (2004:25) reports that

Lagos-based investments have gulped 56.63 percent of the fund, and Abuja and 18

states received the balance 43.47 percent.

Since the banks have demonstrated their inability to assume and manage the

interest of small and medium-scale Enterprises (SMEs); the informal savings, not

only do they fill the vacuum created by the official financing system’s failure to

adapt to the SMEs needs, but they also prepare for new forms of capital

accumulation based on solidarity and co-operation.

How will the SMEs utilize the abundant financing options in the informal institutions?

SMEs in most developing countries, like Nigeria, have found relief in the traditional

Rotating Savings and Credit Associations (ROSCA). This mechanism has survived in

many societies where it is nothing less than an institution, known under different

names depending on the ethnic group in Nigeria: Esusu (Yoruba), Oja (Igala), Adache

(Hausa), etc. Effective examples have been reported in Benin, Tanzania, Cameroon

and other African countries.

This source of micro finance (ROSCA) is a simple and flexible source of financial

intermediation. According to Aruwa (2003:58) “A group of people with common

interest forms a co-operative with each member depositing a given amount in the

kitty at regular interval, for a specified time. The total amount is given in turn to one

of the group’s members. The first round lucky winner will continue to contribute

faithfully until the end.” Apart from the ordinary ROSCA that brings together

depositors in need of money for a social purpose or to buy a house, the rapidly

evolving business ROSCA is designed for SMEs with a more substantial need for

capital. Gelinas (1998:111) grouped this type of ROSCA under three headings:

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1. The Investment ROSCA, in which the participants are SMEs who have to

submit a private or co-operative investment project; the deposits are relatively

high.

2. The modern commercial ROSCA, which is periodically auctioned off to

participants; the bidder offering the highest interest rate on the deposits wins

priority access to the kitty’ and so on down the line; each interest payment is

distributed among the other members.

3. The market place (or mobile banker) ROSCA, organized by a professional

ROSCA promoter who collects contributions in the market place; he then

auctions off the kitty, reserving a commission for his services before

redistributing the proceeds from the sale among the participants.

The lesson derived from micro-finance experiences is that through user-ownership

and vigorous savings mobilization, unsustainable credit programmes can be

transformed into networks of viable local financial intermediaries. While the informal

micro finance is advisable to be exploited, SMEs can avail themselves with

government development banks and funding institutions for credit facilities with

minimum guarantees, e.g. the Central Bank of Nigeria and World Bank small and

medium enterprises development project loan scheme- a World Bank loan of $270

million to existing and new enterprises.

Other sources of funds are the Central Bank of Nigeria Agricultural Credit Scheme,

Microstat programme by United Nations Development Project (UNDP) with City

Express Bank, the African Enterprise Fund (AEF-IFC), special funds for oil and gas

contractors (an initiative of the International Finance Corporation using some banks

for delivery), and many foreign Development Institutions (DFIs) especially in Europe

e.g. commonwealth are focused on Nigeria Small-scale enterprises, trade credits,

and equipment leasing.

Leasing becomes a good alternative, with the difficulty involved to scale through

collateral or security for loan facilities from banks; as the leased equipment is the

collateral in a leased contract; and it provides a flexible payment plan from the

onset of the contract, reducing cash flow pressure on working capital, which is

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needed for operation or production. It provides technological hedge for SMEs thus

making it possible to avoid ownership risk (Aruwa, 2003:60).

The point is about the model of growth of SMEs and financing options available.

Allen (2001:50) and Golis (1998:47) submits that venture capitalists do not seek

enterprises on the start-up and survival stage but only in the stability and rapid

growth stages did the venture capitalists appear. It is at these stages when there

are multiple fundraisings from venture capitalists. Yet the method of financing

remains a critical success factor of SMEs.

How will the Nigerian SMEs in their start-up and survival stages benefit from these

financing options, especially from the SMIEIS fund? Is the venture capital fund

structured to contain the inherent high risks at these stages of SMEs? What about

existence of good investments or good business plans to secure finances!

3.1 METHODOLOGY

Questionnaires were used to collect data on formal and informal financial

institutions and SMEs. Ten each of commercial banks and informal micro-finance

institutions were randomly selected and twenty SMEs in Kaduna and Abuja for this

study. The questionnaire for commercial banks and informal institutions was

designed to collect data showing the attitude of these financial institutions towards

financing SMEs. The SMEs’ questionnaire was designed to provide data that will

assist in determining the SMEs schedule of fund acquisition and the mix accessed by

the SMEs.

Simple Chi-square analysis and correlation coefficient analysis were employed as

the statistical tool, to show the degree to which the disbursement of Bank credit

facilities is associated or related with SMIEIS fund.

4.1 RESULTS AND FINDINGS

The responses from questionnaires administered to formal and informal financial

institution and SMEs are presented and analyzed as follows:

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Table lll Ratio of loans to SMEs to Commercial Banks and Merchant Banks Total Credit

Year/Quarter Commercial banks

loans to SMEs as % of total credit (N’ M)

Merchant banks loans to SMEs as % of total

credit (N’ M)

%

1992 20, 400 48.8% 3, 493.9 31.2% 541993 15,462.9 32.2% 4, 900.0 19.5% 461994 20, 552.5 22.2% 5, 489.3 18.2%1995 32. 374.5 22.9% 9, 159.6 29.9%1996 42, 302.1 25.0% 5, 595.8 13.6%1997 40, 844.3 17.0% 7, 137.9 13.0%1998 42, 260.7 15.5% 7, 800.8 12.9%1999 46, 824.0 13.35 30, 149.9 51.7%2000 44, 542.3 9.7% 71, 599.2 40.7%2001 231, 044.8 31.0% - -2002 296, 711.8 32.9% - -Source: Central bank of Nigeria Statistical Bulletin “Financial Statistics” Vol. 13,

December, 2002

Note: with effect from year 2001, universal banking commenced and hence Merchant Banking activities were abolished.

Table lll depicts that the commercial and merchant banks’ total credit to SMEs in the

period 1992 to 2002 has been below average. The average total credit to SME sector

for the eleven years (1992-2002) stood at 144.8% for commercial banks and 25.6%

for merchant banks within a ten-year period (1992-2000). The standard deviation for

commercial banks and merchant banks were 3.9 and 0.1, respectively.

With the abolition of mandatory banks’ allocations of 20% of its total credit to SMEs

wholly owned by Nigerians which took effect from October 1, 1996, the banks total

credits to SMEs significantly reduced up till the inception of SMIEIS fund

disbursement in 2001.

The disbursement of SMIEIS fund have significantly improved the portfolio of funds

to SMEs as signified by absolute increase in total credit by commercial banks from

9.7% (2000) to 32.9% in 2002.

Table lV: SME Financing by Formal Finance and Micro-informal Finance Institutions

Institutions Formal Informal %

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Approval 16 32% 38 76% 54Disapproval 34 68% 12 24% 46Marginal 50 100% 50 100% 100Source: Field data (March, 2004)

From table lV, 54 percent of SMEs proposals for financing were approved in both

formal and informal financial institutions. If we look much closely, the analysis shows

that 76% of SME financing is created through informal finance institutions, while

68% of SME proposals to formal finance institutions were disapproved. In table lV,

there is significant difference between the attitude of formal financial institutions

and informal financial institutions towards SME financing. The contingency

coefficient is 0.28, which shows very low association between the approval rate of

both institutions.

Table lV: Bank Credit/SMIEIS Fund Disbursement to SMEs

Institutio

ns

Disbursements

(%) Bank

Credit

SMI

EISUBA Plc 39 28UBN Plc 35 38STB Plc 31 33Omega 30 48GTB 45 43Citibank 50 30Intercity

Plc

48 20Lion Bank 33 23First Bank 51 34Reliance 30 27

Source: Field data (January, 2004)

The Pearson correlation (r) of -0.1751 indicates a negative and low relationship in

the sample means of 39.2% and 32.4% computed for bank credit and SMIEIS fund ,

respectively. It means that the banks that provide bank credit for SME financing do

not provide as much under SMIEIS fund financing.

Table V SMEs Mix of Funds

SME Mix of Funds (%)SMIEIS

Fund

Bank

Credit

ROSC

A

12

Trading 16 21 63Food processing 28 27 45Business Centres Services 9 22 69Textiles & Clothing 19 47 34Metallic fabrication 13 32 55Timber & Wood processing 11 36 53Mean (%) 16.0 30.8 53.2S.D. 6.9 9.8 12.5Correlation Co: SMIEIS & Bank

Credit

0.1041Correlation Co: SMIEIS & ROSCA -0.6297Correlation Co: ROSCA & Bank

Credit

-0.8382Source: Field data (December, 2003)

The pearson correlation (r) of -0.6297 and -0.8382 indicates a negative and low

relationship in the mix of funds available to SMEs, while a positive but not high

relationship exist between SMIEIS fund and Bank credit. It means that in the

schedule of finances of SMEs, ROSCA substantially make up the mix of funds in

relation to SMIEIS fund and Bank credit.

5.1 CONCLUSION AND RECOMMENDATIONS

From the foregoing analysis and findings, we can derive empirical conclusions with

respect to financing options available to SMEs and that adequate capital and credit

have remained a key success factor for SMEs.

The ranges of finance available are numerous, but there are no easy accesses to

these funds. Inadequate access to financial resources and credit facilities in formal

financial institutions continued to persist because there are more discerning in their

choice of SMEs they choose to finance. These institutions grant more short term

commercial credit to SMEs because of higher interest charges than disbursement

from SMIEIS fund. The conditions for accessing SMIEIS fund are stiff and unrealistic-

there is no clear standard guideline for all banks to comply.

The un-regulated informal financial intermediaries provide substantial and effective

access to credit facilities through savings mobilisation The downside is that their

portfolio does not address the problems of micro-enterprises whose level of financial

need is still too low to meet the Fund’s optimal scale of investment.

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They are also unaware of the advantages of using the stock market as a source of

financing. The relaxed listing requirements of second-tier security market have not

been fully exploited. Among the sampled SMEs, none accessed the funds in the

second-tier security market.

To address the financing needs of these SMEs, the following recommendations are

put forward:

1. It is important for the SMEs to consider all alternative financing options,

probably through professional advice, to select an appropriate financing

mix that maximizes the value of the business enterprise.

2. The SMEs should be enlightened on the advantages of using the stock

market as a source of financing.

3. For the SMIEIS fund to create expected impact on SMEs, they have to be an

approved guideline for all banks to comply in the administration of the

fund. The fund should be given a specific mandate to fund start-up and

survival stages of SMEs that are mostly denied financing opportunities

4. Community Banks and development banks are a potentially important

source of micro financing. Savings in them should be further encouraged,

and their active participation in local business associations encouraged.

The informal savings should be given a legal backing.

5. Private leasing – there are some specialized leasing companies, and some

Banks are developing leasing services for selected clients. They should be

encouraged by government to provide cost-effective services to SMEs in

view of the advantages of equipment leasing.

References

Aruwa, S.A.S (2004), The Business Entrepreneur: A Guide to Entrepreneurial Development, Scopy Press, Kaduna.

Central Bank of Nigeria (various issues), Statistical Bulletins and Financial Reviews Lagos.

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Commercial Banks’ Financial Reports

Committee for Economic Development (1974) ‘Meeting the special problems of small Business’. New York.

Golis, C. (1998) Enterprise and Venture Capital: A Business Builder and Investment Handbook, 3rd edition. Allen and Urwin Business/Finance, Australia.

Honourary Presidential Advisory Council on Investment In Nigeria (HPACI, 2002), "Sectoral Profiles on Small and Medium Scale Enterprises". Vol. 1 and 2, May.

Gelina, J.B. (1998). Freedom from Debt: The re-appropriation of development through financial self-reliance. University Press, Dhaka-Ottawa

Osagie, C. (2004), “SMIES mostly Targeted at Real Sector- Sanusi”, Industry Column, Thisday, Vol. 10, No. 3243, Page 25

Sanusi, J. (2004), Paper presentation at the National Summit on Revamping Small and Medium Industries, Thisday, Vol. 10 No. 3243, page 25

World Bank (2001) Nigeria Firm Survey

World Bank (2001), Small and Medium Scale Enterprises Country Mapping

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