Corporate and Business Finance

Business finance involves raising and managing of funds by business organizations. Corporate finance includes planning, raising, investing and monitoring of finance in order to achieve the financial objectives of the company and add maximum value to the shareholders' wealth. To finance growth, any ongoing business must have sources of funds. Apart from bank and trade debt, the principal sources of Corporate funds include the under-listed.

Plowback

A significant source of new funds that corporations spend on capital projects is earnings. Rather than paying out earnings to shareholders, the corporation plows those earnings back into the business. It is an attractive source of capital because it is subject to managerial control. No approval by governmental agencies is necessary for its expenditure, as it is when a company seeks to sell securities, or stocks and bonds. Furthermore, stocks and bonds have costs associated with them, such as the interest payments on bonds while retaining profits avoids these costs.

Debt Securities

A second source of funds is borrowing through debt securities. A corporation may take out a debt security such as a loan, commonly evidenced by a note and providing security to the lender. A common type of corporate debt security is a bond, which is a promise to repay the face value of the bond at maturity and make periodic interest payments called the coupon rate. For example, a bond may have a face value of N1,000,000 (the amount to be repaid at maturity) and a coupon rate of 7 percent paid annually; the corporation pays 70,000 interest on such a bond each year.

Equity Securities

The third source of new capital funds is equity securities—namely, stock. Equity is an ownership interest in property or a business. Stock is the smallest source of new capital but is of critical importance to the corporation in launching the business and its initial operations. Stock gives the investor a bundle of legal rights—ownership, a share in earnings, transferability and, to some extent, the power to exercise control through voting.

SOURCES OF FUNDS FOR SMALL AND MEDIUM SCALE BUSINESSES

  1. Owner’s Equity: This is the owner’s fund contribution in business. It is also called risk capital. This is the most reliable source of funding in business. For it put less pressure on the entrepreneur even if the business failed. This money is raised from past savings of the entrepreneur. It may be contribution from friends, relations etc. The important thing is that there is no commitment of repayment on the entrepreneur.
  2. Loans: This is a facility given to the entrepreneur with obligation to pay the sum and accrued interest at an agreed date, This can be sourced from the private sources or financial institutions such as microfinance houses or commercial banks, It is not the best source of financing new business, because the payment put pressure on the entrepreneur and the business, Where it could not be totally avoided entrepreneur should be careful in taken it. As alternative to this option, a starter is advisee to take up apprenticeship to gather knowledge as well as money to start business,
  3. Types Of Loans And Facilities

    Short term loan: This is the type of loans with repayment period of less than six calendar months. This is the popular type offered by micro finance banks and venture capitalist. They are usually sourced to finance working capital and ventures with short term gestation. They usually attract payment of interest at high rate.

    Medium term loan: The duration of payment for this facility does not exceed twelve months. Both commercial banks and micro finance institutions are reluctant to grant this type of facility because they need fund to run their own businesses. They avoid anything that will tie down their article of trade (money).

    Long term loan: This type of facility is repaid after two years or more. It is sourced for capital projects, it is usually provided by specialized banks such as Bank of Industry, NEXIM etc; small scale business entrepreneur may not be able to access this type of loan because of stringent conditions attached to it.

    Overdraft: This is a facility that allows an entrepreneur to withdraw more than what he/she has in his account. It is an arrangement between the bank and its customers to withdraw above the balance in the account. It is approved from the appropriate authority in the bank. It is usually for few days or weeks. Micro finance and commercial banks offer this type of facility which is subject to renewal.

    Syndicated Loan: This is a practice whereby two or more lending financial institutions agree to provide funds to finance large project, usually a consortium of banks as creditors package such loan with one of the banks as the leading bank. Trade Credit: This refers to different trade arrangement between sellers and buyers whereby payment for goods purchased is postponed till agreed date.

    Loan from Credit/Thrift cooperative societies: These associations/organizations are formed to provide credit to their members at affordable/concessionary interest rate compared to what obtained at the money market. Small scale entrepreneurs are encouraged to belong to their associations to enjoy this facility.

    Equipment Leasing: This involves arrangement between the financial institution and its clients, whereby the institution agree to purchase fixed asset such as equipment/machine for its client who repay the cost of this equipment and interest accrued on it over an agreed period of time. This arrangement checkmate diversion of credit to other uses

  4. Grants: Government and non-government organizations sometimes give grants to potential entrepreneurs to start small businesses. This is an allowance that a government or an organization gives to support small business creation in the country. Examples include grants given by EcoBank, GTB, state and local governments through their different youth empowerment programmes.
  5. Private equity: This involves private investors providing funds to a company in exchange for an interest in the company. A private equity firm is a group of investors who pool their money together for investment purposes, usually to invest in other companies. Looking to private equity firms is an option for start-ups—companies newly formed or in the process of being formed—that cannot raise funds through the bond market or that wish to avoid debt or a public stock sale.

PROBLEMS FACING THE POTENTIAL SMALL SCALE BUSINESS OWNER IN OBTAINING FINANCE

High cost of capital

A very important element in decisions about the use of any resource is the cost of that resource. The cost of capital is the rate which a company has to pay for its finance. In recent years, most financiers in Nigerian money market have raised the cost of their finance with the sole intention of scaring away not-too-stable borrowers. It will be meaningless for a small business owner to borrow at a high cost especially when this cost exceeds the return he expects from the business. He should maximize his returns by avoiding expensive finance. He should evaluate available financing options and choose only those sources that will maximize the returns accruing to the business.

Inability to raise equity finance

Equity finance is the type of finance available to companies through the sale of part of the ownership of the company. This finance method is only available to publicly quoted companies who can sell their shares to raise money in the open market. The inability of small scale businesses to raise money through equity finance compounds their finance problems as they are left with one or two viable options.

Unusual Collateral

The Nigerian small scale business owners have in the past found it difficult to raise finance or to borrow money from the banks and other financial institutions as the terms stipulated by these financiers cannot be met by the borrowers. In some cases it had been found that some of the unusual collateral required do not apply to all prospective borrowers but only to those without strong financial background like the small business person.

How does an Entrepreneur Access Institutional Loan Facility?

Since loan is to be repaid, financial institutions are very careful to part with the fund put in their trust by the shareholders. The prospective borrower is expected to come up with convincing business plan or feasibility plan. This is a comprehensive, detailed document that will show the viability of the project for which the loan is being sourced for. The document will show among other things.

  1. The profile of the entrepreneur
  2. Description of the product or services being rendered
  3. Technical profile of the business
  4. Marketing profile
  5. Manpower Structure/Organogram
  6. Accounting/profitability index etc.

Our Thoughts

Corporate and Business Finance for SMEs

Corporate finance is the area of finance dealing with the sources of funding and the capital structure of corporations and the actions that managers take to increase the value of the firm to the shareholders, as well as the tools and analysis used to allocate financial resources.

Financial review

A financial review would probably focus on the profit and loss account, or tax, and how you can thereby save money. But the central focus of corporate finance is much more on the balance sheet. For example, an acquisition needs financing, either by debt or equity, or by both. Both need to be seen in the context of and integrated into the existing financial structure of the balance sheet.

Financial review and Business review

A thorough financial review should ideally begin with a thorough business review. Every financial transaction is the consequence of a business decision. The business review starts with a review of strategy—especially the marketing strategy. It can go all the way through to the business processes and the systems that support them. It’s rather too simplistic to think that corporate finance transactions result solely from a need such as raising more working capital, financing capital expenditure, saving tax, selling or passing the business on, etc. Even if these are the circumstances that trigger a corporate finance transaction, each transaction should still be preceded by a thorough business and balance sheet review to see how it fits into the whole and ensure that the overall goal of maximizing the return on the balance sheet at a managed level of risk can be achieved.

Corporate Finance in a Credit Crunch for SMEs

Credit shortages and squeezes are not unusual; they typically follow a credit “bubble,” where credit has grown so fast that it necessitates an economic readjustment. More importantly, the recent credit crunch has actually been a liquidity shortage. Funds have been scarce and the cost of borrowing has gone higher because the banks could not raise sufficient, or even any, longer-term funds to lend to business.

The smaller the enterprise, the harder it is to raise sufficient funds and the higher the likely cost. It’s hard enough that the economic slowdown has squeezed financial performance. Being unable to find additional funds readily when they are most needed can all too often lead to business failure. It’s not lack of capital but lack of cash that busts businesses. So creativity in corporate finance becomes even more important.

For SMEs and family owned businesses, the initial cost of implementation is relatively high as it involves the setting up of a set of corporate governance practice guidelines and to a larger extent, possibly some restructuring at the board of directors, for instance, segregation of duties between the Chairman and CEO, and introducing independent non-executive director or advisors to the board.

So What Can SMEs Do?

Few SMEs have the opportunity to float via Stock Exchange; most corporate finance transactions for SMEs involve rather less finance than might be raised through an IPO (initial public offering, or flotation). One factor that unites all SMEs is the need to find and manage working capital. Many are wedded to the idea of unsecured debt—usually an overdraft. Some will even resort to moving banks just to get a bigger unsecured overdraft facility. This may not be the most efficient or, especially, the cheapest means, however. The credit crunch produced some fundamental changes in the commercial and corporate banking markets. First, it accelerated the transition from overdraft finance to invoice discounting. One of the key reasons for this was because in most cases banks wanted security for the debt. This security can take many forms. The most common is assets—property, machinery, other capital assets, cash, stock, receivables, etc. The practice of taking unsecured personal guarantees has decreased, but banks may routinely ask for a statement of personal assets and liabilities. Ideally, they prefer to take a charge on personal assets, such as the owner’s or director’s house. So unsecured overdrafts became relatively dearer and invoice discounting relatively cheaper.

The Cheapest Form of Working Capital for SMEs

The cheapest form is that generated by the business itself, i.e. from sales. It is amazing how many SMEs approach their advisers or bankers seeking to borrow more money for working capital purposes when they could devote more time to selling and less to administration. This is the principle of working in the business rather than on the business. Sir Alan Sugar, the British entrepreneur and businessman, is not alone in referring to the concept of the “busy fool”—someone who works long hours and makes little or no profit.