Capital is key to scale-up success, yet access to financing is one of the greatest challenges for SMEs today. The reasons are numerous: they are inherently more vulnerable investments—often not rated and with more fickle financing than larger organisations.
During the 2009 economic crisis for example, SMEs were the first to suffer. They are also more likely than larger established businesses to bootstrap their operation, or seek loans from banks.
However, on a global scale, approximately half of all SMEs lack access to credit according to the World Bank. This discrepancy between current supply and potential demand for credit is called the financing gap. If left unreconciled, this phenomenon can lead to decreased growth, so ensuring SMEs have access to sufficient funding is essential.
The different financing options
Financing options can generally be broken down into two categories: equity and debt, raising money by selling company shares vs borrowing funds to be repaid over time with interest.
The best option often is a healthy balance of both, depending on your stage of growth and financing needs. Equity often comes into play in the early stages of a business and provides a substantial cash injection, while debt is more tailored to a company with a track record and investment amounts can vary greatly.
Venture capital (VC) firms and angel investors are two common sources of equity financing. Both provide an injection of capital in exchange for equity in the company.
VC and angel investors provide funding at an early stage and accommodate high levels of risk, an attractive arrangement for many SMEs.
Private equity typically focuses on more mature businesses and seeks high returns and lower levels of risk than Venture Capitalists or Angel Investors.
Bank credit lines and loans are the most common sources of debt funding for SMEs. They are familiar, straightforward and often have low interest rates. The downside is that businesses have to qualify. Banks want to ensure a return on their investment and smaller businesses pose a greater risk.
As such, financial institutions often require proof of success and/or collateral, which can be a challenging requirement to meet for smaller businesses.
Institutional financing options
In many countries, governmental and institutional financing options are another popular source of funding. These vary greatly depending on the market but generally come in the form of subsidised grants or loans.
One of the best ways SMEs can enhance their attractiveness to lenders is by taking out trade credit insurance. If your collateral is secure, you can obtain more working capital and often at more favourable rates.