THE IMPACT OF VENTURE CAPITAL FINANCING ON SMALL AND MEDIUM ENTERPRISES

CHAPTER ONE

INTRODUCTION

1.1 Background

Data from the International Finance Corp developing world the private economy is almost entirely comprised of SMEs' and

that „they are the portunityonlyfor realisticmillionsofpoorpeople employ throughout the world'

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9%

3

21%

1

55%

2

15%

Figure 1: Fiscal Year 2004                        Approvals in USD

Source: 2004 Annual Review Small Business Activities

1. International Finance Corporation (IFC) $ 820 million

1. Multilateral Investment Guarantee Agency (MIGA) $ 219 million

1. International Bank for Reconstruction and Development (IBRD) $ 317 million

1. International Development Association (IDA) $ 141 million

Small and medium-sized enterprises (SMEs) are the backbone of all economies and are a key source of economic growth, dynamism and flexibility in emerging and

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developing economies. In Nigeria, the total economic output of SMEs is about 50 per cent of gross domestic product (GDP), and this sector employs in excess of 60 per cent of the total labour force (ISSER, 1999). Thus, SMEs form a large proportion of the firm tissue in Nigeria. One of the most important problems confronting SMEs concerns the issue of financing.

Financing is necessary to help SMEs set up and expand their operations, develop new products, and invest in new staff or production facilities. Many small businesses start out as an idea from one or two people, who invest their own money and probably turn to family and friends for financial help in return for a share in the business. But if they are successful, there comes a time when they need further funds to expand or innovate further. Some SMEs often run into problems, because they find it much harder to obtain financing from banks, capital markets or other suppliers of credit.

Almost every company we know of began as an SME. Vodafone as we know it today was once a little spin-off from Racal; Hewlett-Packard started in a little wood shack; Google was begun by a couple of young kids who thought they had a good idea; even Volkswagen at one point was just a little car maker in Germany (as opposed to being a giant small car maker globally) (Lukacs, 2005)

Microsoft may be a software giant today, but it started off in typical SME fashion, as a dream developed by a young student with the help of family and friends. Only when Bill Gates and his colleagues had a saleable product were they able to take it to the marketplace and look for investment from more traditional sources (Amissah, 2009).

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The growth of SMEs has been hampered by the lack of adequate knowledge and a well structured financial market for the mobilization of capital. The role of finance has been viewed as a critical element for the development of SMEs (Cook and Nixson, 2000).

Recently, various funds have been setup to benefit SMEs but statistics provided by fund managers show that a disproportionate number of applicants have not been successful at accessing funding (Boateng, 2010).The need to explore alternative means of raising capital for business growth cannot be over emphasized. One of the innovative ways to raise funds for the growth of SMEs is venture capital.

Venture capital is an investment in a start-up or growing SME that is perceived to have excellent growth prospects. Venture capitalists raise and manage funds which are a pool of money raised from both public and private investors. Venture capitalists identify entrepreneurs with promising new ideas and assist with funding and professional management.

Venture capital investments provide the needed cash in form of equity for companies to develop technologies and products which, in turn, generate jobs and taxes that keep Nigeria competitive. The objective is to generate sufficient long-term capital gains from the investors and the venture capitalists. Venture capital assists investors to access equity capital to finance expansion of business while maintaining control. The expertise and extensive relationships of the venture capitalist through its network add value to the company and increase credibility with customers, and finally, the company gain access to the venture capitalist knowledge in accounting, budgeting, computer systems, and back-office operations. (Amissah, 2009)

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In venture capital financing agreement the venture capital firm will provide financing to enable a business to undertake a project and in return the venture capital company gets an ownership stake in the business (Boateng, 2010)

Limited data exist on venture capital as an alternative source for funds for SMEs.

Therefore a research was made to gather inform the SME sector to know about the impact of venture capital in the growth of its

business.

1.2 Statement of the Problem

The SME sector constitutes in excess of 90% of the economy of the country. The need to provide affordable credit over a reasonable period for this sector cannot be over emphasized. SMEs, if properly structured and capitalized have the potential to grow and spearhead accelerated growth of this economy into a middle income status (Venture Capital Nigeria, 2008)

SMEs still in Nigeria have been faced with liquidity and financing challenges leading to business failures under production Industrial disputes and sometimes closures by regulatory authorities.

Just as it has been a great concern to all and sundry to promote the welfare

of SMEs, it has also been a great cause of concern to all, the fact that the vital sub-sector has fallen short of expectation. The situation is more disturbing and worrying when compared with what other developing and developed countries have been able to achieve with their SMEs.

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Their success is determined by their financing needs and the action of investors. SME financing needs reflect their operational requirements, while the action of investors depends on their risk perception and the attractiveness of alternative investment (which affects their willingness to invest). Government borrowing, the general economic climate, availability of collateral, quality of SME record keeping, and SME investor relations skills affect the way in which this challenge is managed

Additionally many non-financial constraints inhibit the success of such enterprises. SME owners are reluctant to be transparent or open up involvement of their businesses to outsiders. They seem to be unaware of or oblivious to the obligations and responsibilities they have toward capital providers, and the need to acquire or seek support for technical services like accounting, management, marketing, strategy development and establishment of business linkages. Management and support services are perceived to be cost prohibitive and non-value adding

Unfortunately since there is a dearth of long term investment funds for SMEs (as a consequence of the banks and securities markets shying away from the high risk investments in these sectors, it has became imperative for the Government to set up a scheme that will provide long term funding for the high risk investment needs of the SME sector. This has led to the establishment of Venture capital fund under the Venture Capital Trust Fund Act, 2004 (Act 680), to provide capital to Small and Medium Enterprises (SMEs) and to promote Venture Capital industry in Nigeria.(Venture Capital Nigeria,2008)

Does Elsa Foods know of venture capital funds? Has it ever applied for funding from Venture Capital organisations? What motivated the organisation to go for venture 5

capital funds? What benefits have choked from sourcing funds from venture capital managers? This study seeks to provide answers to these questions.

1.3 Aim/Objectives

The main objective of this research is to examine the impact of Venture Capital

Financing on SME‟s. The study will be objectives:

1. To determine SMEs alternative sources of funding.

1. To determine the SMEs Owner Manager‟s perception o funding.

1. To determine the impact of Venture Capital Financing in small business activities

1. Research Questions

The study addresses the following research questions:

1. What are the alternative sources of funding to SMEs?

1. What   is   the   SMEs   Owner   Manager‟s   perc

1. What is the impact of Venture Capital Financing on small business activities?

1. Significance of the Study