Banks have experienced several challenges in lending to MSMEs (Micro, Small and Medium Enterprises). ‘Perceived risk’, alongside lack of specialization and understanding of unique sector characteristics have generally discouraged risk appetites. The CBN classifies MSMEs as entities with turnover of less than N500m (excluding land and buildings) and labour force (employees) from 1-200. Due to the nature of their businesses MSMEs do not possess tangible assets that can be used as security for lending. For example, creative businesses tend to be IP (Intellectual Property) based, and have an abundance of intangible assets, which some banks may have less experience and confidence in lending against. Furthermore, over 70% of the entrepreneurs in Nigeria do not hold patent rights, hence increasing the riskiness of their business profile.
The interests of lenders will always revolve around being able to establish a correlating relationship between risk and return. Although every business would naturally vary in size, scale, model and output, the more sizeable and established a business is, the more attractive it would become to potential lenders. Unfortunately, a majority of MSMEs in Nigeria have struggled to provide the requisite evidence to validate both the business (financial records, operating history, business plans etc.) and the individual (professional history, experience, and guarantees).
The combination of these factors has resulted in a structural financing challenge for the MSME sector, which has caused many businesses to migrate towards more informal sources of funding to suit the correlating risk profile of the business.
1. Concept Stage (high-risk level)
Businesses in this stage would usually require some proof of concept, which signifies a considerable level of risk. The support of those who believe in your idea is the first stage to validating the individual and the idea. It is also important to note that future risk-takers in your business will use this early funding track record to gauge the level of investments to make in your business. Funding here comes from Self (personal savings), friends and family.
2. Start-up Stage (medium/high-risk level)
By the startup phase, your business idea has been tested and proven to be feasibly attractive to a desired target audience. Although revenue might be minimal at this stage, a reasonable amount of demand can be established to project a positive growth trend. More importantly, risk factors can now be appropriately identified, measured and mitigated. Funding options here include grants, seed funding, crowd funding, angel investors, domestic and international institutions like the Central
Bank of Nigeria (CBN), IFC (International Finance Corporation) and ADB (African Development Bank).
3. Growth Stage (medium-risk level)
By the growth stage, the business should have created an established brand with market share. Emphasis is now centered on sales growth and product diversification. As we all know, banks would most often grant loans to businesses with established and successful operating records and histories. The funding options at this stage are bank loans, venture capital and investments.
4. Maturity/Expansion Stage (low/medium-risk level)
At maturity, businesses tend to experience sales stabilization, however challenges include maintaining market share, profit maximization, and structural efficiencies. The funding options available are the Public Markets, International Funding.
With your knowledge of these alternative options, you now understand what stage your business falls into and the various funding options available for you to finance it.