Small and Medium Enterprises Investment Readiness - Coursework Example

Running header: Investment readiness Student’s name: Instructor’s name: Subject code: Date of submission: SMEs investment readiness Growth SMEs (small and medium enterprises) are the most dynamic sector of our economy. As such their growth is of paramount importance to the overall economic well being. Whether an enterprise qualifies to be an SME is determined by the size of its balance sheet, headcount and turnover. SMEs usually have less than 250 workers and turnover less than 50 million dollars (Searle and Stensholt, 39). Majority of the companies in our country are hence SMEs and they produce more than half of the GDP. Due to their being small in size, they are potentially dynamic compared to big enterprises. This makes them ideal for job creation. However, they are more vulnerable often lacking access to capital as well as funding sources. Growth SMEs access to funding is constrained by the demand side weaknesses. Most of the SMEs are usually not investment ready. The owners of the SMEs are usually not willing to external funding while those that are willing fail to understand what investors are looking for. I.e. how to sell themselves and their businesses to these investors. This in turn compromises the supply side interventions effectiveness. This paper analyses the factors that determine investment readiness for growth SMEs and also describes the changes that could be undertaken to overcome the problems faced by SMEs in acquiring investment capital for growth Investment readiness Investment readiness is the capacity of a small business (SME) or an entrepreneur to know or understand the demands of external fund providers such as investors, banks or venture capital funds and hence be able to access the funds that the SME may be looking for. This may include the knowledge about effective communication with the fund providers and furnishing them with appropriately structured as well as relevant information, being credible and creating investor confidence so as to secure the external funding sort for (Lumme, 156). Investment readiness is therefore a key element in growth SMEs financing chain since it will increase the volume of fund flow to SMEs. In other words, there is need to improve investment readiness for the growth SMEs so that they can attract more external funding and hence make them better than they are at the moment. Factors that determine investment readiness of growth SMEs The following factors determine investment readiness for SMEs; a) Lack of knowledge about financing Lack of investment readiness by SMEs could largely be attributed to unavailability of market information as well as commitment by financial managers in accessing various sources of funding. In other words, many entrepreneurs are not aware of the available and suitable financing options including the sources that would be most suitable for their chosen business strategy. Research shows that the universal understanding of financial options available to SMEs is poor (Peacock, 75). For the majority, bank loans remain the preferred external financing source. The SMEs fail to realize the benefits accruing from a stronger capital structure for survivor as well as expansion. b) Need to retain control Investment readiness for SMEs is also determined by the owner’s willingness to fully remain in control of his enterprise. Research show that there is high external finance aversion by SMEs with most owners being reluctant to surrender ownership and control. This is in turn related to the owners’ lack of knowledge about the characteristics and availability of alternative sources of financing. Consequently, most investable projects are not brought forward as potential recipients of investment funds (National Investment Council Report, 17). Entrepreneurs also fail to understand that investors not only provide funding but can also provide knowledge and advice to the business. As such, they would rather keep their businesses small than take the external financing route despite the fact that it is a chance of owning a much larger enterprise. c) Invest-ability of the SMEs seeking external financing A growth SME will be said to be investment ready if it meets the requirements being sought by external investors. However, many SMEs usually fail to meet the external investors’ criteria. It should be noted that investment decision making involves two stages where the investment opportunity is assessed against the external investors’ investments parameters such as sector, size of investment, size of business as well as location. The biggest concern for external investors when doing investment opportunity appraisal is the goodness of fit between their own personal investment criteria and the investment opportunity (Hutchinson, 235). The concern here is whether the investor is interested or has any knowledge on the industry or market, the size of financing required as well as its location. External investors will usually reject investment opportunities that do not meet their investment criteria. Failure to have information or failing to seek out the information that actually exists is the reason why SMEs make approaches to inappropriate external financiers. In addition, investors screen the investment opportunities that meet their investment parameter. External investors reject investment opportunities from SMEs for many reasons that include weaknesses in the SMEs /entrepreneur management teams, marketing and marketing related factors such as flawed and incomplete marketing strategies and financial considerations such as flawed financial projections. SMEs are also considered as not investment ready due to lack of focus. This is where their business plans fail to offer comprehensive and credible market information (McKaskill, 81). Investors are interested in knowing how the product or service is superior to those of competitors and how the competitive advantage is to be sustained. Therefore, when proposals by SMEs contain unrealistic assumptions or information which is not credible and often containing insufficient information and business concepts that require further development as well as limited growth prospects for the business, they are considered not to be investment ready. Investment readiness for SMEs is also determined by the ability of the SME to demonstrate a credible revenue model. The SME must show that it is in a position to attract sufficient customers so as to cover the costs of doing business. This includes the ability to demonstrate the business’ unique selling point – why customers would be interested in buying and how the product or service is to be delivered to the customer. In other words, the proposals must give considerations to cost of distribution, marketing as well as customer servicing. An SME will therefore be considered not to be independent ready if the entrepreneur lacks knowledge and expertise to turn the idea into a viable business, he gives unrealistic expectations and lacks good traits such as integrity, vision and commitment and has high need for control of the business (Howorth, 80). In addition, an SME that has poor management, poor profit potential for the level of risk to be undertaken, and provides insufficient information to the potential external investor is considered not to be investment ready. d) Quality of presentations The quality of presentations made to potential investors is another factor determining investment readiness for SMEs. Well presented proposals are in a better position to secure funding than those poorly presented. Although the underlying proposal may be sound, an SME may still not secure external funding if the business proposal/plan is poorly constructed or presented. As earlier stated, external investors will be frustrated by business proposals that lack sufficient information more so when this relates to the generic questions normally asked by the potential investors. Poor oral presentation also generates a negative reaction amongst the investors. Investors interpret poor oral presentation as a sign of lack of competence. In other words, SMEs owners who are unable to sell themselves as well as the substance of their investment opportunity will most likely fail to convince investors to consider their investment opportunity. Therefore, many growth SMEs fail to succeed in securing finance they require owing to their low quality of presentations. They do not understand the key factors which drive key investment decisions of external investors and they fail to answer this or their presentations lack some capabilities that the investors may be looking for. Although many management teams and business plans may have quality in them, they may be either inappropriately structured or insufficiently developed and fail to provide the assurance external investors need. As a result, this reflects badly on the capability of the team seeking finance since it shows lack of understanding in finance and business too. Such SMEs are therefore not considered to be investment ready. e) Market and technology Most SMEs fail to enjoy the opportunity of accessing different markets. In other words, they fail to fully utilize their existing market opportunities for their products or services. For this reason, they lack sufficient market information, poor research of the markets, they have poorly developed products/ services and lack efficient promotional tools for the products hence costing them dearly such that they lack the opportunity of accessing external financing from potential investors or financial institutions. This is what has caused many SMEs to fail to take advantage of globalization and hence their reduced competitiveness and poor access to international markets which has in turn caused them not to be investment ready (May, 32). Technology changes in their respective industries also greatly determine investment readiness for SMEs. SMEs inability to cope with new innovations has greatly cost them in terms of market share and hence reduction in their overall performance. Owing to globalization, technological changes have flooded the market and financial managers have to make use of such technologies so as to remain competitive and gain international scope. This will in turn lead to increased profits hence making the SMEs gain access to sustainable external funding. f) Financial forecasting and financial decisions made The financial forecasting aspect of management in SMEs is another determinant of investment readiness. This involves prediction by financial managers of the organizations’ future revenues using the available current financial information. Using reliable forecasting techniques greatly boosts the SMEs investment opportunities as they are able to know the amount of funding they need in future to run their businesses. With proper forecasting, SMEs are able to access external financing as they will be able to convince the financiers/ investors on their ability to get substantial returns form the investments undertaken. With financial forecasting, the SMEs will achieve their targets for profitability which will foster their investment readiness. In addition, the financial decisions made by financial managers greatly influence SMEs investment readiness. Financial managers make four types of financial decisions including financing decisions where financial manager determines the best sources of funding for the business (Nielsen, Trayler and Brown, 70). They indentify cheap sources of financing which will not strain the financial capability of the SME in terms of financial obligations that arise. The managers also make investment decisions by identifying viable investment opportunities. Therefore, the ability of SMEs to determine in advance the risk involved and returns expected from the chosen investments also determine the investment readiness of the SME. Changes that could be undertaken to improve SMEs investment readiness As seen from above, investment readiness has to be addressed if SMEs are to appreciate and take advantage of external financing so that they can continuously pay the important role they play in the economy. It is for this reason that government in conjunction with the investors should come up with investment readiness programs aimed at raising investment readiness of the SMEs. The programs should address all the factors that affect investment readiness for SMEs especially equity aversion, investability as well as presentational issues (Ernst and young/ centre for innovation and enterprise, 70). There should be introduction of information presentation seminars specifically designed for SMEs that do not know the existence and advantages of external financing, what the requirements for attracting external financing are, the criteria used by the investors in assessing investment opportunities as well as how to sell their investment proposals to the potential investors. Investment conferences, workshops or seminars should also be introduced to help SMEs meet the standards required by the investors. This should involve such elements as information seminar, investment readiness review, investment readiness development programs, investment readiness presentation reviews as well as investment networking programs. The information seminars/ workshops should be designed so as to fill the knowledge gap existing about external financing for SMEs. This should address such issues as the definition of external financing as well as its benefits, the circumstances when external financing is most appropriate, the different sources of external financing available in the market, how the SMEs can access the right investors, the evaluation criteria employed by the investors as well as how to successfully present the investment opportunity to potential investors among other issues (Golis, 65). Investment readiness review programs should also be introduced for the SMEs who are ready to take up external financing. These programs should be aimed at reviewing the ability of such SMEs to access financing. The issues raised in the review programs should be addressed in an investment readiness development programs. This should be aimed at accelerating the SMEs to the stage of positive cash flows soonest possible since such SMEs will then be easier to sell to potential investors than those at the ideas stage. The program should cover such issues as management, products and services, competition, differentiation and barriers to entry as well as SMEs financial management (McKaskill, 59). Networking programs should also be designed so as to link the SMEs that become investment ready with the potential investors the government in conjunction with the investors should come up with incentives aimed at increasing the number of angel networks. This way, the level of investment readiness for SMEs will increase significantly. In a bid to increase investment readiness even among new SMEs, the government through the relevant departments should also come with curriculum changes aimed at increasing investment readiness among new SMEs in various levels of education. This is owing to the fact that SMEs play a very great role in the growth of our country (Douglas, and Shepherd, 230). Ensuring that students leave school when they already have adequate knowledge on external financing will ensure that the SMEs they start become investment ready. There should also be an increase in media campaigns aimed at informing the SMEs of existence of other sources of financing other than the internal sources. The adverts should also give enough information on steps that could be taken to become investment ready. This way, the knowledge of external financing will increase amongst SMEs hence increasing investment readiness. The government through the relevant department should also come up with legislation aimed at supporting investment readiness by SMEs (Meredith, G and Williams, 103). For example, there could be introduction of tax subsidies for SMEs that become successful in seeking external financing. This way, the SMEs will be motivated to become investment ready and hence have an even greater impact on our economy. Conclusion The above discussion confirms that there is a growing recognition that improvement of SMEs access to external financing should not be left to external financiers only. The increased supply of external financing will not achieve the intended impact owing to the fact that many business proposals by the SMEs are always not investment ready. As a result, the external investors will be unable to make as many investments as they would intend and if they actually invest owing to pressure to invest, they will end up investing in poor quality business. It is for this that the government should develop investment readiness schemes or programs (Pittwood, 75). The programs should comprise such elements as seminars aimed at providing information regarding financing, how to get investment ready as well as finding attracting and winning external investors to invest in the SMEs. As such, the government should allocate fund which (with the support of investors) will establish independently run investment readiness programs. This way, the level of investment readiness among SMEs will greatly increase. As a result, external financing uptake among SMEs will also increase. This in turn will greatly enhance economic growth in our country. Works cited: Searle, Joane and Stensholt, John. ‘Big play for small end’. BRW, 29.4(2007):38-41. Lumme, Mason, C. Informal venture capital: investors, investments and policy issues. Dordrecht: Kluwer academic publishers, 1998. Peacock, R W. Understanding small business: practice, theory and research. 2nd ed. Adelaide: Scarman Publishing, 2004. National Investment Council Report. Financing growth: policy options to improve the flow of capital to Australia’s small and medium enterprise, 1995. Hutchinson, R W. The capital structure and investment decisions of small owner managed firm, Some exploratory issues. Small business economics 7.3 (2005): 231-239. McKaskill, Tom. Discover hidden growth capital’. BRW 28.23 (2006): 81. Howorth, C. Small firms’ demand for finance, A research note. International small business journal 19.4(2001):78-86. May, Julie. ‘New ventures go begging’. BRW 28.24(2006) :32-33. Nielsen, J F; Trayler, R M and Brown, B M. ‘Banking expectations: do bankers really understand the needs of the small business customer?’ Journal of Small Business Finance 4 (1995). Ernst and young/ centre for innovation and enterprise. Investment readiness study. Department of industry, science and tourism, Canberra, 1997. Golis, C. Enterprise and venture capital. Sydney: Allen & Unwin,1998. McKaskill, Tom. ‘Fast growth factors’. BRW 28.17(2006):59. Douglas, E and Shepherd, D. Exploring investors’ readiness: assessments by entrepreneurs and investors in Australia, Venture capital. An International journal of enterprise finance 4(2002):219-236. Meredith, G and Williams, B. Managing finance—essential skills for managers. Sydney: McGraw-Hill, 1999. Pittwood, Elaine. Business finance: small business management series 2002. Adelaide: Institute of TAFE, 2002. Read More