EASING ACCESS TO FUNDS FOR SME BUSINESSES IN GHANA. CASE STUDY OF SELECTED SME BUSINESSES IN THE KUMASI METROPOLIS GHANA.
CHAPTER ONE INTRODUCTION
1.0 Background of the Study
For both developing and developed countries, entrepreneurial firms play important roles in the process of industrialization and economic growth. Even in advanced countries such as the USA and UK, the role of entrepreneurial businesses plays to economic development cannot be overemphasized. This means that any country that seeks to develop economically must give special attention to entrepreneurial businesses. Access to funds has been a major problem for most businesses in the world. This has been a major problem for many years. Many scholars have, therefore, tried to research why this is a problem. Most of these problems are faced by entrepreneurial businesses, Apart from increasing per capita income and output, entrepreneurial enterprises create employment opportunities, enhance regional economic balance through industrial dispersal and generally promote effective resource utilization considered critical to engineering economic growth and development. There is growing attention to the prominent role entrepreneurial business play in economic development. These entrepreneurial businesses, which are mostly SMEs, constitute about 90% of total business units in Ghana and account for 60% of Ghana's employed labor force (KDI, 2008). Entrepreneurs are often described as efficient and prolific job creators, the seeds of big businesses, and the fuel of national economic engines.
Even in the developed industrial economies, it is entrepreneurs rather than the multinationals that is the largest employer of workers (Mullineux, 1997). This is also supported by research done on small businesses in the United States by Dr. Charles Ou in June 2006, which indicated that U.S. small businesses numbered 23 million in 2003, and it employed about half of the private sector workforce, and also produces about half of the nation's private-sector output. In Ghana, entrepreneurial businesses play a meaningful role in the economic development of the country and will continue to do so if the government creates the necessary environment and support the needs of the sector.
According to Hug (1989), SMEs, which are mostly entrepreneurial businesses, provides the bulk of the people employed in manufacturing in developing countries. In Ghana, about 70% of the total manufacturing employment is provided by these entrepreneurial businesses. A recent nation-wide survey of all industrial establishments by the statistical Service in (2003) reveals that entrepreneurial businesses contribute about 97% and employ 46% of the total industrial labor force.
Despite their dominant numbers in job creation and the contributions the sector makes, entrepreneurial businesses are faced with many challenges. Every year several thousands of these enterprises collapse as a result of these challenges. Among these challenges are corruption, which is affecting the cost of doing business, and the inability to compete regularly, unregulated importation of goods that can be produced locally, which is killing the local industries, inadequate infrastructure, multiplicity of regulatory agencies, inadequate credit facilities, and the likes. Many believe that the single most important factor constraining the growth of the entrepreneurial business is the lack of finance. In a developing country like Ghana, lack of capital for entrepreneurial business has been considered as the most basic problem hampering the growth of the sector. They face difficulty in obtaining formal credit or equity. The maturity of commercial bank loans extended to entrepreneurial businesses is often limited to a period too short of paying off any sizeable investment. Access to competitive interest rates is reserved for only a few selected blue-chip companies whiles loan interest rates offered to entrepreneurial businesses remain high.
As a result, banks are generally biased towards large corporate borrowers, who provide better business plans, have credit ratings, more reliable financial information, better chances of success, and higher profitability for the banks. When banks do lend to entrepreneurial businesses, they turn to charge them a commission for assuming the higher risk and apply tougher measures that drive up cost on all sides. Banks in developing countries often prefer to lend to the government and thus the public-sector where small scale enterprises operate. Many governments and international financial institutions have tried to address the problems of high transaction costs and risks by creating subsidized credit programmers and/or providing loan guarantees. Such projects have often fostered a culture of non-repayment and failed to reach the target group or achieve financial self-sustainability. Well-functioning and sustainable mechanisms for entrepreneurial business financing require institution building and a market approach. Lending institutions must improve their ability to provide financial services to entrepreneurial businesses through commercial mechanisms that lower costs and minimize their risk exposure. Only in this way will financial institutions will find lending to entrepreneurial businesses to be more profitable and thus be encouraged to construct lending programs targeted at entrepreneurial businesses.
1.1 Statement of the Problem
Despite the role entrepreneurial business in the Ghanaian economy, the financial constraints they face in their operations are daunting, and this has hurt their development and also limited their potential to drive the national economy as expected. This is worrying for a developing economy without the requisite infrastructure and technology to attract big businesses in large numbers.
Most entrepreneurial businesses in the country lack the capacity in terms of qualified personnel to manage their activities. As a result, they are unable to publish the same quality of financial information as those big firms and, as such, are not able to provide audited financial statements, which is one of the essential requirements in accessing credit from the financial institution. This is buttressed by the statement that privately held firms do not publish the same quantity or quality of financial information that publicly held firms are required to produce. As a result, information on their financial condition, earnings, and earnings prospect may be incomplete or inaccurate. Faced with this type of uncertainty, a lender may deny credit, sometimes to the firms that are creditworthy but unable to report their results (Coleman, 2000).
Another issue has to do with the inadequate capital base of most entrepreneurial firms in the country to meet the collateral requirement by the banks before credit is given out. In the situation where some entrepreneurial businesses can provide collateral, they often end up being inadequate for the amount they needed to embark on their projects as entrepreneurial business assets- backed collateral is usually rated at 'carcass value' to ensure that the loan is realistically covered in the case of default due to the uncertainty surrounding the survival and growth of entrepreneurial firms (Binks et al., 1992).
These are some of the factors already acknowledged by some researchers as blocking most entrepreneurial businesses from enhancing some of the financial channels that are available to them. But are these the case in Ghana? Entrepreneurial businesses in Ghana do not also have the luxury of picking a financing scheme that will be appropriate for their businesses. The major type of financing open to them is debt financing from the financial institutions, which most often comes with a long list of requirements that most of these entrepreneurial businesses find it so hard to meet or to provide. The other type that is Asset financing, aside from the long list of criteria, also requires operators of entrepreneurial businesses, which mostly are SMEs, to provide 50% of the funds and the financing institution providing the other half to fund the purchases of the assets. This type of financing does not allow for the growth of the entrepreneurial sector since they are all short term in nature.
1.2 Objective of the Study
Access to funds has been a major problem for most entrepreneurial businesses in Ghana, even though there exist several financial channels, some of which are family savings, personal savings, loans from banks and other financial institutions, grants, etc. The big question here is how we enhance the way with which we can access these funds. These ways to have access to funds are already there, but how do we enhance it. The general objective of the study is to found out how to enhance financial channels for entrepreneurial businesses in Ghana
Identify some of the financial channels for entrepreneurship businesses in Ghana
Which of these funds are easily accessible
Identify ways to improve the accessibility of these funds
1.3 Research Questions
What are some of the financial channels for entrepreneurship businesses?
What type of funds is most accessible?
What are some of the ways to improve the accessibility of these funds?
1.4 Research Hypothesis
Based on key factors that the researcher identified thus; human resource training, public education, reduction in loan repayment policies by banks, and encouragement of joint venture operations, the following hypothesis will be tested.
H1. Human resource training leads to enhancement of financial channels for small and medium scale enterprises
H2. Public education has a positive influence on enhancing financial channels for SME businesses
H3. Reduction in loan repayment policies by banks has got a positive influence with enhancing financial channels for SME businesses
H4. Encouragement of joint venture operations has got a positive influence on enhancing financial channels for SMEs
1.5 Organization of the Study
The study will be organized into five chapters. The first chapter will consist of the background which will introduce the topic and touch on some of the issues with regards to financial channels available for entrepreneurial businesses and ways with which entrepreneurial businesses can enhance access to financial channels that are available to them. The literature review that formed the second chapter will focus on the various financing schemes available to entrepreneurial businesses and the ways with which it can be enhanced. Thirdly, the method used in gathering data will form the third chapter. Chapter four will contain the data analysis, presentation, and discussion of the findings. The conclusion and recommendations will form the chapter five of this project.
1.6 Research Design
The descriptive research design will be used to analyze the data for this work. More precisely, the survey method of the descriptive research design will be used to analyze most of the data that will be obtained from most of the entrepreneurial businesses that will be selected. The sampling technique that will be used will be probability and non-probability. Under the non-probability sampling technique, the purposive sampling technique will be employed to select most of the respondents from entrepreneurial firms to have the right information about the financial channels that are available to them. Under the probability sampling, the simple random technique will be used to select respondents who own entrepreneurial businesses in the Ashanti region of Ghana.
A total of 400 entrepreneurial businesses will be selected from the Ashanti region of Ghana. Questionnaires will be issued to all the 400 entrepreneurial firms to get the right information about some of the financial channels that are available to them.
1.7 Significance of the Study
The development of entrepreneurial firms is very important to the overall economic and sustainable growth of any economy. This study will help draw the attention of institutions on activities of the entrepreneurial businesses, which are mostly small scale enterprises, and help modify the orientation of decision-makers towards entrepreneurial businesses about the provision of financial support and the creation of enabling environment for smooth business operations. The study will also assist operators of entrepreneurial businesses in knowing what sources of financing are available to them and what is required of them to have easy access to funding and to manage funds successfully to achieve business objectives. Finally, this study will help future academic researchers in the area of emphasis.
1.8 Limitations of the Study
The study could not cover all possible funding sources and all entrepreneurial firms in Ghana, mostly due to time and material resource constraints, so a limited number of questionnaires were given out. The study covered some entrepreneurial firms, which are mostly small and medium scale enterprises within the Kumasi Metropolis and its immediate environs. It was also very difficult in getting information from some selected entrepreneurial firms because of fear that the information is given would one way, or the other get to the tax authorities as most of them do not fulfill their tax obligation despite the assurance the researchers have given them
CHAPTER TWO LITERATURE REVIEW
2.0 Literature Review
2.1 Introduction
The literature review describes aspects connected to the study of the challenges faced by SMEs in obtaining credit in Ghana. It, therefore, follows a particular layout. First, some definitions relating to SMEs are given, which is followed by looking at the characteristics of the Ghanaian SMEs. This paves the way for the discussion of their contribution to economic development and growth and also looked at the literature on constraints SMEs faced in accessing credit. Attention will then be focused on the type of financing available to these SMEs without forgetting to also look at the sources of credit/finance for these SMEs.
Some SME Definitions
According to Ward (2005), there is no universal definition for SMEs since the definition depends on who is defining it and where it is being defined. For example, in Canada, SME is defined as an enterprise that has fewer than 500 employees and small enterprise as one that has less than 100 employees. On the other hand, the World Bank defines SMEs as having no more than 500 employees. SMEs can be defined in two ways: based on the number of employees in an enterprise and/or the enterprises' fixed assets. According to Boon (1989), the size of the enterprises' employment is the most important criterion used in Ghana. But one must be cautious when defining SMEs based on fixed assets because of the continuous depreciation in the exchange rates, which often makes such definition outdated. UNIDO defines SMEs in developing countries based on the number of employees in an enterprise.
A small enterprise has between 5 and 19 workers and takes the example of the ubiquitous small shops in the cities such as hairdressing salons and chop bars. A medium enterprise has 20 to 99 workers, and these include manufacturing firms and exporting companies. The Ghana Statistical Service, in their 1987 Ghana Industrial Consensus, considers firms employing between 5 and 29 employees and with fixed assets not exceeding $100,000 as small scale, while those employing between 30 and 99 employees medium scale category. The National Board of Small Scale Industries (NBSSI) defines SMEs as enterprises that employ no more than 29 workers, with investment in plant and machinery (excluding land and buildings) not exceeding the equivalent of $100,000. For this research, the Venture Capital Trust Fund (VCTF) Act 2004 (Act 680 section 28) definition of SMEs will be used since it's a more recent definition. SMEs are defined by the VCTF as "an industry, project, undertaking or economic activity which employs not more than 100 persons and whose total asset base, excluding land and building, does not exceed the cedi equivalent of US$1 million in value".
2.2 Characteristics of SMEs in Ghana
A distinguishing feature of SMEs from larger firms is that the latter has direct access to international and local capital markets, whereas the former is excluded because of the higher intermediation costs of smaller projects. Also, SMEs face the same fixed cost as Large Scale Enterprises in complying with regulations but have limited capacity to market products abroad (Kayanula & Quartey, 2000).
SMEs in Ghana can be categorized into urban and rural enterprises. The former can be subdivided into 'organized' and 'unorganized' enterprises. Organized ones tend to have employees with a registered office and are mostly solely owned by an individual, whereas the unorganized ones are mainly made up of artisans who work in open spaces, temporary wooden structures, or at home and employ little or in some case no salaried workers. They rely mostly on family members or apprentices. Rural enterprises are largely made up of family groups, individual artisans, women engaged in food production from local crops. The major activities within this sector include soap and detergents, fabrics, clothing and tailoring, textile and leather, village blacksmiths, timber and mining, bricks and cement, beverages, food processing, wood furniture, electronic assembly, agro-processing, chemical-based products and mechanics (Liedholm & Mead, 1987; Osei et al., 1993) as cited by (Kayanula & Quartey, 2000).
This sector is characterized by low levels of education and training of the self-employed. They are mostly family-owned businesses, and there is little separation of the business finances from that of the owners even to the point that the owners or operator's account is the same as that of the business.
SMEs in Ghana are heterogeneous groups- ranging from small workshops making furniture, metal parts, and clothing to medium-sized manufactures of machinery as well as service providers such as restaurants, consulting, and computer software firms. Some are traditional 'livelihood' enterprises that are satisfied to remain small; others are growth-oriented and innovative.
LENDING CYCLY OF SMEs AND CHALLENGES
Source: IFC enterprise finance gap database (2011)
2.3 SMEs Contribution to Economic Development and Growth
"The private sector is the engine of growth of the economy; therefore, they must be given the necessary tools to increase their growth." (Anyima-Ackah, 2006). Economic development is a process of economic transition involving the structural transformation of an economy through industrialization, rising GNP, and income per head. Economic growth, on the other hand, contributes to the prosperity of the economy and is desirable because it enables the economy to consume and contribute to more goods and services by increasing investment, increase in the labor force, efficient use of inputs to expand output, and technological progressiveness. Any nation that experiences economic development and growth will benefit from improvement in the living standards especially if the government can assist in growth by implementing complementary and growth-enhancing monetary and fiscal policies (Pass et al. 1993)
The SME sector is considered very important in many economies because they provide a job, pays taxes, is innovative, and very instrumental in countries participating in the global market. Beck and Kunt (2004) state that SME activity and economic growth are important because of the relatively large share of the SME sector in most developing nations and the substantial international resources from sources like the World Bank Group, that has been channeled into the SME sector of these nations. SMEs account for nearly 93% of the registered businesses in Ghana and therefore play an important role in economic development by providing employment opportunities, opening up new business opportunities, enhancing entrepreneurship, and fostering creativity, among many other things. Kayanula and Quartey (2000) recognize them as the engines through which the growth objectives of developing countries can be achieved and are potential sources of employment and income in many developing countries. Mensah (2005) makes the analogy that SMEs act like sponges by soaking up surplus labor to provide a large share of employment and income in Ghana.
Many researchers have observed that SMEs enhances competition and entrepreneurship; therefore, they suggest that direct government support can boost economic growth and development. Also, SMEs ' growth boosts employment more than a large firm because they are labor-intensive and make better use of scarce resources with a very small amount of capital. Hellberg (2000) also states that developing countries should be interested in SMEs because they account for a large share of firms and development in these countries. Young (1994) contended that SMEs are not only important because they are a source of employment but also because they are a source of efficiency, growth, and economic decentralization.
Finally, they are very important in the fight against poverty as they help in the poverty reduction strategy for most governments, especially those in developing countries where poverty is most severe. Since they employ poor and low-income workers and are sometimes the only source of employment in the rural area, their contribution cannot be overlooked.
2.4 Types of Financing Available to SMEs
Boom et al. (1983) and Longenecker et al. (1994), like most writers on the subject of SME financing, describe two basic types of financing, namely debt and equity. Hisrich and Peters (1995) and Anderson and Dunkelberg (1993) describe debt as funds borrowed to be paid at a future date and a fee, referred to as interest to be paid an at an agreed schedule. The payments of interest are supposed to be done regardless of whether the firm makes a profit or loss. Equity, on the other hand, is defined as funds contributed by entrepreneurs or investors who become owners or part owners of the firm and whose returns are primarily based on the profits. This implies that if a firm fails to make profits, its owners do not get any returns.
Generally, equity funds are long-term funds, but the debt may be short to medium or long-term. Hisrich and Peters (1995) mention another basic classification of funds: internal and external funds. Internally generated funds come from several sources within a company and are more frequently employed. They include operational and investment profits, sales of assets, extended payment terms, reduction in working capital, and accounts receivable. Another important source of internally generated funds is expediting the collection of receivable accounts. This releases funds that may be locked up with suppliers and distributors for the firm's use. Sources that are external to a firm include owners, friends and relatives, commercial banks suppliers and distributors, government, and non-government agencies.
Equity versus Debt
It is very important to carefully evaluate the reasons for the choice of one form of funding against another or a particular mix. Several factors must be considered, and they include the following:
Purpose of Funds
The choice of the type of financing that is, whether to use equity or debt depends on several factors, and one such important factor is the intended purpose of the funds. Wert and Henderson (1979) note that the suitability of funds obtained and the project for which funds are obtained is very important. Long-term funds as long-term debt may not be suitable for short term projects. This will burden the firm with the cost of servicing an unnecessary debt. Similarly, short-term debts are not appropriate for financing long-term projects since the loan may have to be repaid before the end of the project. Wert and Henderson (1979) concluded that a more flexible short-term debt is more suitable for short-term projects, whereas long-term funds such as long-term debt or equity are more suitable for long-term financings such as the acquisition of equipment or the construction of a new plant. The phenomenon is described by Brealey and Myers (1996) as "matching maturities."
Leverage and Owner's Equity
Borrowing creates financial leverage since payments of interests add to financing costs. Thus a percentage of increase in the earnings before interest and tax of a firm will result in a higher percentage increase in the net earnings of the firm. Consequently, the value of the owner's equity will appreciate. Similarly, a percentage reduction in net earnings before interest and tax will lead to a greater percentage reduction in net earnings, and consequently, the depreciation of owner's equity. Therefore the use of debt results in higher earnings volatility and increases the risk to the owner's equity. Equity capital does not result in financial leverage (Brealey and Myers, 1996; Wert and Henderson, 1979).
Riskiness
Apart from the increased risk to earnings and the owner's equity, debt financing poses another risk. When a firm has to honor its debt obligations with difficulty or is unable to honor the obligation at all, then it is said to be in financial distress—the probability of financial distress increase as a firm's debt-to-equity ratio increases. So to avoid financial distress, a firm must guard against excessive debt. Investors take the potential for financial distress in the future into consideration in the valuation of firms. The attitude of suppliers towards a firm may change when a firm becomes financially distressed. Also, valuable management time will be lost to the firm. Financial distress may result in bankruptcy. Filing for bankruptcy involves heavy legal fees, which come from the remaining value of the firm's assets. So the costs of financial distress and bankruptcy must be considered carefully. (Wert and Henderson, 1979).
Flexibility
A firm's ability to adapt to a changing economic environment, particularly concerning its future financing decisions, is very important. According to Wert and Henderson (1979), if a company takes on too much debt, it may be forced to use equity financing at a time that the market for equity may be unattractive. Alternative options under such circumstances may be equally unattractive. For instance, a firm may be forced to take more debt at very high-interest rates, since lenders will demand higher returns from a firm that already has high levels of debt. Otherwise, the firm may have to forego very attractive business opportunities due to major cuts in capital expenditures. On the other hand, too much equity can give rise to a similar problem. In this case, the problem arises if a company decides to contract operations. Wert and Henderson (1979) recommend that to be truly flexible, a company must maintain its options by maintaining a good balance of the capital mix. This will allow an easier choice of expansion or contraction as and when necessary.
2.5 Sources of Financing for SMEs
Several sources of capital exist, but many of them may not be accessible to companies of small and medium sizes.
Debt
Friends and Relatives.
Loans and contributions from friends and relatives are a common source of funds, especially for new business since the financial institutions are reluctant to providing funding for start-up business because of the risk involved. This source of funds, however, bears a potentially dangerous price. Many friends' relatives find it very difficult to stay as passive creditors or investors. They usually try to interfere with policy and operational issues (Kuriloff et al. 1993; Longenecker et al. 1994). As a remedy to this problem, Kuriloff et al. (1993) recommended the treatment of such loans as bank loans by putting in writing all the terms, including interest rates and payment schedules.
Commercial Banks
Hisrich and Peters (1995) assert that commercial banks constitute the most widely used source of debt financing for small companies. This assertion is also supported by Longenecker et al. (1994). Again Longenecker et al. (1994) claim that commercial bank loans to small companies are mostly short-term loans, though some do offer long-term loans to small and medium-sized companies. According to Kuriloff et al. (1993), commercial banks usually provide loans for working capital or the purchase of fixed assets. They demand evidence of a company's ability to pay the interest and principal as scheduled. This evidence is usually in the form of cash flow statements. They also demand some form of security. Collaterals are the most widely used form of security demanded by commercial banks. Longnecker et al. (1994) classify commercial bank loans as a line of credit and term loans.
Business Suppliers
Companies can enjoy some form of credit from their business suppliers. This is a very important source of credit, especially for SMEs. The suppliers allow the company some time to pay for the supplies. The credit periods vary from a few days to several years, according to Broom et al. (1983). Credit from business suppliers may be trade credit or equipment loans and leases.
Trade Credit: It involves the purchase of goods and services from a supplier on credit. The purchasing firm is given a few days, usually between 30 and 120 days, to settle the debt (Broom et al. 1983). This type of credit is very important to SMEs for several reasons:
1. Broom et al. (1983) and Moyer et al. (1992) assert that suppliers are more flexible in dealing with SMEs than the banks. Suppliers may only check the credit standing of an SME, whereas a bank is likely to demand financial statements and cash flow budgets before extending a credit facility. Generally, suppliers are very eager to add to their customers (irrespective of the size of the firm) and thereby increase their sales; hence they are more willing to assume greater risk.
2. Suppliers are more flexible regarding adherence to terms of credit. Banks required strict adherence to loan terms and monitor borrowers more closely than suppliers do.
3. The amount of trade credit granted may be readily increased just as the volume of a company's purchases increases. It may not take a lot of negotiations to make this possible. Banks are less willing to substantially increase the amount of credit they grant to customers, especially small and medium scale companies (Peirson et al., 1990)
Trade credit, however, is not cost-free. The cost associated with trade credit may not be explicit as interest on bank loans, for instance, suppliers incur costs by supplying goods on credit, and they must recover the cost. They usually pass the costs on implicitly as part of the purchase price of the merchandise.
Trade credit may come with an offer of a cash discount. A cash discount may be quoted as 3/12 net 40. This means that the customer has 40 days to pay the full amount but can enjoy a 3 percent discount if payment is made within 12 days. Failing to take a cash discount may constitute an opportunity cost of a trade. In the above quote, for example, failing to utilize such a discount implies borrowing the amount for 28 days (i.e., 40-12) days at 3 percent. Therefore it is important to compare the cost of forgoing a trade discount and the cost of other available short-term credit facilities before a decision is made (Moyer et al., 1992; Brealey et al., 2001).
Equipment Loans and Leases: Many SMEs find it very difficult to raise funds for the outright purchase of certain equipment and machinery. They resort to purchasing such equipment on an installment basis. Longenecker et al. (1994) noted that down payment of about 25 to 30 percent of the price of the respective equipment is usually made initially. The remainder may be amortized over 3 to 5 years. This practice is referred to as equipment loans. An alternative to this is equipment leasing. This arrangement allows firms greater investment flexibility, and smaller amounts of capital are required by the firm at any given time. However, the total cost involved in equipment leasing is usually higher than the cost of outright purchase. On the other hand, in a situation where continuous specialized maintenance and protection against obsolescence are required, leasing may be more suitable (Broom et al., 1983)
Equity
Personal Resources
Again Longenecker et al. (1994) observe that personal savings of the owners and partners of businesses constitute an important source of funds, particularly in the formative stages of a firm. Personal contributions also help to raise additional funds from other sources.
Significant financial commitments made by owners of a company tend to build a lot of confidence among potential investors. Kuriloff et al. (1993) also note other personal resources apart from personal savings. These include borrowing using one's personal assets such as house and bonds as collateral.
Other Individuals (Business Angels)
There is a category of private individuals who invest in business ventures. These individuals are referred to as 'business angels.' Many of such individual investors tend to have some experience in business and/or are affluent professionals, who may have a lot of money to invest. Business angels constitute the informal capital source. They are said to represent the informal capital because there is no formal market place where their investment transactions are carried out. They are usually contacted through dealmakers such as business associates, accountants, and lawyers (Longenecker et al. 1994).
Venture capital
Venture capital, according to Stevenson et al., (1999), is a pool of equity capital contributed by wealthy individuals, as limited partners, and professionally managed by general partners for a fee and a percentage of the gain on investments. Thus venture capital firms are investment firms. Owing to the highly risky nature of the investments they undertake, venture capitalists demand very high returns on their investments, with target returns of about 50 percent or 60 percent being considered normal ( Stevenson et al., .1999). Tuller (1994) notes that owing to their high expected returns, venture capital companies usually target companies that have prospects of rapid growth and above-average profitability. The targeted companies must also have the prospect of going public in the foreseeable future –usually within five to seven years. Venture capital firms aim to capitalize on initial public offerings (IPOs) and cash in on their investments if prices are substantially above their initial investments in the respective companies.
Apart from the provision of capital for very promising business ventures, venture capital firms also provide useful advice to these young enterprises, having acquired much more experience in the business. They also provide additional financial assistance in the future if a firm they have invested in runs into financial difficulties. It will not be considered prudent to stand aside and watch their investments go to waste with a firm for lack of cash provided throwing in more cash will not amount to reckless investment. (Tuller, 1994; Longenecker et al., .1994). Tuller (1994) summarizes this as "future availability of funds can be an enormous boost to achieving long-term strategic goals." One of the clear weaknesses in the Ghanaian financial system is the limited medium and long-term financing available to the private sector in the market place (Morse et al., 1996).
While commercial banks are the major source of loanable funds in the market, they focus on providing only short-term financing for their clients. As a consequence, many companies inappropriately use short –term funds to finance the long-term project (Morse et al., 1996). The short–term nature of the loans from the banks does not support the expansion programs of SMEs.
Joint Venture
Various forms of strategic alliances have become important and common practice in business today. One such important form of strategic alliances is joint ventures. A joint venture typically involves two or more companies coming together to form a new entity. The main objective of joint venture formation is to gain a competitive advantage and become more profitable. Combining the resources of the firms involved in a joint venture most often leads to the attainment of synergy. The new company may be able to perform a service more efficiently, produce a product at a less cost, or utilize a facility or funds more effectively. This ultimately results in greater profits for the firms involved than they would have achieved as separate business entities. Financing is also a common goal of the joint venture. Smaller firms, in particular, tend to benefit from the usually better financial positions of larger firms. Also, the joint venture stands a better chance of obtaining credit or raising more equity as creditors and investors' confidence in the new firm is often greater. As a joint entity, they provide a better guarantee for creditor's fund as their assets base is widened.
2.6 Other Sources of Financing SMEs
There are several institutions, programs, and government agencies that aim at promoting SME development. These were created to help SMEs in various ways, such as access to finance, training programs, and technological development. These are discussed briefly below.
Government Institution
The government has implemented several programs to benefit the SME sector in Ghana. This started in 1969 with the establishment of the Credit Guarantee Scheme, which was administered by the Bank of Ghana (BoG) to assist entrepreneurs in obtaining bank credit. Shortly after this, in 1970, the Ghana Business Promotion Programme was established to provide financial assistance to newly establish SMEs. Unfortunately, these schemes did not have the intended impact because of low loans repayment rates and the fact that beneficiaries were politically connected to former managers of foreign-owned enterprises (BoG Policy Brief, 2006)
Under an Act of Parliament in 1981, Act 434, The National Board for Small Scale Industries (NBSSI) was established to promote and develop the small-scale industrial sector because of their importance and contribution to the economic development of Ghana. The NBSSI also has a revolving loan scheme that is intended for working capital and fixed assets acquisition by enterprises in selected sectors. It collaborates with and receives support from several NGOs and international organizations such as the Friedrich Ebert Foundation, World Bank, and UNDP. Unfortunately, according to Adu-Amankwah (1999), this institution is poorly funded, thus limiting the assistance that they can offer to help SMEs develop and grow in the economy.
GRATIS is another organization that was established by the Government of Ghana to promote small and medium scale industrialization, provide employment opportunities, improve incomes, and enhances the development of Ghana. This is accomplished through the dissemination of appropriate technologies by developing and demonstrating marketable products and processes for small and medium enterprises.
The Ministry of Private Sector Development (MPSD) was also established to coordinate and harmonize inter-sectorial efforts to propel the development of the private sector as an engine of growth and poverty reduction. With a majority of the working population in this sector, the government is aiming at a successful reform that will have a major effect on the development of society and the economy.
Within the MPSD is the Business Development Unit, which aims to facilitate business support services targeted, especially in the informal sector and access to credit for micro and SMEs. Some of these services are the African Development Fund (ADF) and Ghana Government providing between 5 to 8 SMEs with up to US$500,000 each for the next five years; the Italian Credit Facility of 10 million Euros; the Danish Government's contribution of US$30 million for the Business Sector Programs Support; and the Swiss Government support of US$5 million which is being administered by The Trust Bank Limited. Also, in addition to a US$40m HSBC credit, MPSD has arranged for the SOFITEL Bank of USA to approve a release of a US$17m facility to the Ghana Commercial Bank (GCB) to enable the bank to provide long-term project credit to SMEs.
The government has also issued several policy papers to support SMEs. These include the Investment Code 1985 (PNDC Law 116), Draft Policy Paper on Micro and Small Enterprise Development (May 2002), MPSDs Policies, Strategies, and Action Plan: 2002-2004, Ghana Poverty Reduction Strategy Paper (2002-2004), and the National Medium-Term Private Sector Development Strategy (2004-20008), which articulates government's commitment to facilitate private sector-led growth. There have also been various programs and initiatives over the past ten years to support the sector, such as Vision 2020 and the Fund for Small and Medium Enterprise Development (FUSMED).
Non-Governmental Organizations (NGOs)
As a result of the unsuccessful nature of direct lending by the government in the recent past, more donor interventions in SME finance have recently used existing financial institutions to channel funds to SMEs. Examples of some of the available credit facilities are Trade and Investment program created by USAID to assist SMEs in the non-traditional export sector, African Management Services Company funded by UNDP to assist SMEs (training and secondment) (Mensah, 2004).
EMPRETEC Ghana and TECHNOSERVE are other NGOs in Ghana established to offer assistance to SMEs. The former raises funds for SMEs through venture forums where entrepreneurs are linked with potential investors. The latter, on the other hand, helps entrepreneurs to build businesses that create income, employment opportunities, and economic growth for the nation. They train and mentor the entrepreneurs to identify customers' needs, employ capable managers, and act strategically.
2.7 Challenges Faced by SMEs in Accessing Fund
Cuevas et al. (1993) indicate that access to bank credit by SMEs has been an issue repeatedly raised by numerous studies as a major constraint to industrial growth. A common explanation for the alleged lack of access to bank loans by SMEs is their inability to pledge acceptable collateral.
In their view, the current system of land ownership and transfer regulations retards and, to some extent, limits access to formal credit. First, due to the lack of clear title to much usable land in Ghana, there is a limited amount of real property that can be put up as collateral. Second, a Government embargo on the transfer of stool and family land has further restricted land availability for collateral. Finally, where title or lease is clear and alienable, transfer regulation needlessly delays the finalization of mortgages and consequently access to borrowed capital (p 24). Aryeetey et al. (1993) supported the view of Cuevas et al. (1993) that from the viewpoint of the private sector, problems related to finance dominate all other constraints to expansion (p 50).
They claimed that the availability of collateral plays a significant role in the readiness of banks to meet the demand of the private sector. Collateral provides an incentive to repay and offset losses in case of default. Thus collateral was required of nearly 75 percent of sample firms that need loans under a study, which they conducted on the demand-supply of finance for small enterprises in Ghana (p 19). The study also indicated that 65 percent of the total sample firm had at various times applied for bank loans for their business. Nevertheless, a large proportion of the firm had its application rejected by banks. For firms that put in loan applications, there was an almost 2:1 probability that the application would be rejected. Firms receive loans for much less than they requested. Among firms that had their applications rejected, lack of adequate collateral (usually in the form of landed property) was the main reason given by banks. Aryeetey et al. (1994) suggest that banks can offer an alternative to the property as collateral such as guarantors, sales contracts, and liens on equipment financed.
The above was also corroborated by Dr.Ansah-Ofei (1989). In his view, small and medium enterprises are unable to assess loans because of the conditions attached to the banking methodologies. This he grouped into two:
Formal bank methodologies: These consist of several techniques to pre-screen clients and concentrate on relatively few large transactions. They include; feasibility studies, collateral, track record, and minimum deposits.
Informal banking methodologies include personal relations family connections and knowledge business relations. Also, it is contained in Dr. Ansah-Ofei (1989) that the fear of risk, especially the loss of their (SME operators) wealth prevented them from pursuing a loan. SMEs face more challenges in doing business than large enterprises because of the difficulties in financing start-up and expansion. Schiffer and Weder (1991) found that small firms tend to experience more difficulties than medium-sized firms, which also experience more difficulties than large firms. In most countries, especially developing nations, lending to small businesses and entrepreneurs remain limited because financial intermediaries are apprehensive about supplying credit to businesses due to their high risk, small portfolios, and high transaction cost.
According to Cuevas et al.,(1993), the cost of transactions contributes to the inability of SMEs to access finance. They think that "if transaction cost of lending is high, the net margin banks expect from loan operation do not compare favorably against safe investment represented by treasury bonds" (p 30). Aryeetey et al. (1993) also share the same view that if a lender faces information asymmetry, the issue often becomes somewhat persuasive authority he or she holds in ensuring repayment. These push up transaction cost as the probability of default is assumed to be high and has to be contained. Thus lenders may avoid lending to smaller or lesser-known clients or impose strict collateral requirements when they do. They may perceive clients in ways that would overcome their own latter perception of the difficulty in obtaining formal finance.
In investigating "whether lending to SMEs in Ghana was more expensive than lending to larger enterprise in terms of loan screening, loan monitoring, and contract enforcement, banks estimate that screening to gather information about the applicant and project, review the feasibility study, do the credit analysis and make a decision, an average of 16 man-days for large scale applicant and that of small scale applicants takes 24 man-days.
Similar results obtained for loan monitoring and contract enforcement suggest that the transaction cost of SME lending were higher than those for a large enterprise per loan though a similar study undertaken in 1992 by Aryeetey and Seini on the transaction cost of covering sixty bank branches in Ghana suggested that there was no statistically significant difference in the cost of administering loans to smaller and larger enterprises".
They further state that the internal organization of most banks is such that SMEs applying for loans deal with branch staffs that have little say in the decision, whereas major decisions are taken at the head office of the official who knows little about the enterprise. This arrangement ensures that many potential SME borrowers do not have the chance to interact with the few trained project personnel before applications are made. There is a high probability that many potential good projects are turned down because distant credit officers lack enough undocumented information to form an opinion on the projects and especially on entrepreneurs.
Despite SME's strong interest in credit, commercial banks' profits orientation may deter them from supplying credit to SMEs because of the higher transaction cost and risk involved. First, SME's loan requirement is small, so the cost of processing the loan tends to be high relative to the loan amounts. Second, it is difficult for financial institutions to obtain the information necessary to assess the risk of new, unproven ventures especially because of the success of small firms often depends heavily on the ability of the entrepreneur. Third, the probability of failure for new small ventures is considered to be high (Ibid pp. 24-27)
Cuevas et al., (1993), however, indicate that other alternatives to loans secured by real and movable property have practical constraints. For example, it is possible to take a security interest in liquid assets, the foreclosure upon which is much quicker than that for real and movable property. However, many debtors, especially traders, are not in the habit of saving money in liquid accounts; rather, they turn to either move it into the informal economy or reinvest in their business. Another alternative would be for the banks to accept the assignment of contractual benefits from borrowers. Though this arrangement is known in Ghana, it is not chosen by banks as they prefer to stay out of other contracts. Cuevas et al. (1993).
2.8 ENHANCING FINANCIAL CHANNELS
Enhancing financial channels is one of the key issues that need to be addressed when thinking about enterprise development. Many researchers have researched how to have easy access to finance, which will enable them to get the required knowledge on how to enhance the operation of their businesses, most of which are SME businesses. Financial access is critical for the growth of small and medium-sized enterprises (SMEs). It allows entrepreneurs to innovate, improve efficiency, expand to new markets, and provide millions of jobs. Yet, in developing countries, the majority of SMEs are unable to acquire the financing they need to reach their potential. Financing SMEs in the developing world can be risky and expensive for lenders, leading to an estimated financing gap of one trillion USD (International Finance Corporation, 2011).
To reduce the credit gap, financial institutions, governments, and donors invest in lending products and policies designed to provide SMEs with the financing they need to grow and innovate. However, the extent to which such programs effectively reduce the barriers to SME financing has generally not been rigorously measured.
Source: IFC enterprise finance gap database (2011)
Upon reading and analyzing most literature, some of the following key factors need to be addressed well to be able to ease the way with which funds can be acquired.
Public education
Reduction in loan repayment policies by banks
Human resource training and development
When these issues are addressed well, it will help lead to easy enhancement of credit by SME businesses.
2.9 THEORY ANALYSIS
Rational choice theory
Attempts to explain all conforming and deviant social phenomenon in terms of how self-interested individuals make choices under the influence of their preferences. It treats social exchange as similar to an economic exchange where all parties try to maximize their advantage or gain and to minimize their disadvantage or loss. RCT's basic premises are that
Human beings base their behavior on rational calculations,
They act with rationality when making choices,
Their choices are aimed at optimization of their pleasure or profit.
This concept has applications in economics and marketing, and in criminology and international relations, RCT, however, cannot explain the existence of certain social phenomena such as altruism, reciprocity, and trust, and why individuals voluntarily join associations and groups where collective and not individual benefits are pursued. Not to be confused with the theory of rational expectations. Also called the theory of reasoned action.
Modern Portfolio Theory
The modern portfolio theory deals with the measures to be taken to optimize the investors' portfolios. The theory proposes how an intelligent investor should use diversification to optimize his or her portfolio returns. The theory also discusses how those assets that are risky should be priced in the portfolio. The basic concepts of the Modern Portfolio Theory are Markowitz diversification, capital asset pricing model, the efficient frontier, the Capital Market Line, the Securities Market Line, and the alpha and beta coefficients. It was Harry Markowitz who developed the basics and built much of the structure of Modern Portfolio Theory. The greatest contribution of the theory is believed to be the introduction and establishment of the risk-return framework while making decisions for investments. The theory provided investors with a mathematical approach to portfolio management and asset selection.
Modern Portfolio Theory is also popularly known as the MPT model. The MPT of economic theory considers the return of an asset as a random variable and considers the portfolio as the weighted combination of assets. Hence the return of a portfolio, according to Modern Portfolio Theory, is defined as the weighted combination of the returns of the assets. The random variable taking the portfolio's return has an expected value and a variance also. According to this model, the risk is defined as the standard deviation of the return of the portfolio. According to the MPT model hypotheses, it is assumed that – when the investors are given the choice of two assets, they will prefer to have less risky ones. Hence it can be said that the investor will take an asset with higher risk only if he is assured of getting compensation through high returns. Thus it can be implicated that an intelligent investor will never invest in a portfolio if there is a second portfolio providing more favorable risk-return profile features. The investors will always go for a portfolio that offers better-expected returns.
According to Modern Portfolio Theory, a quadratic utility function describes the investor's risk and reward preference. This theory assumes that only the volatility and expected return of the portfolios matter to the investors. It has been seen that the investors are indifferent about the skew and kurtosis of the returns. In this theory, the volatility is considered as the proxy for risk, and the return is the expectation of the future.
CONCEPTUAL MODEL
The researcher used this model to identify how to enhance financial channels for SME businesses in Ghana. A case study of the Ashanti region. This model was developed by the researcher. Through the development of this model, the researcher was able to find out some of the key factors that need to be addressed to help in the enhancement of financial channels for SME businesses in Ghana. These key factors are public education, reduction in loan repayment by banks, encouragement of joint venture operations, and human resource training. When these issues are well attended to it will lead to the enhancement of financial channels for SME businesses in Ghana, Which in the long run, will lead to SME growth and development.
Source: The Author
CHAPTER THREE METHODOLOGY
3.0 Introduction
This chapter will look at how data of the research is going to be gathered, the research method employed in the study, the data collection techniques used and the target population, the sample size and sampling techniques as well as the data analysis method to be employed. It will finally look at the procedures and the limitations faced in gathering this evidence. The reason behind this chapter will be to help us obtain the sources of funds available to SMEs, Challenges facing SMEs in accessing funds, which of these funds is easily accessible, and how to enhance the accessibility of these funds.
3.1 Research Design
The questionnaires will be administered to four hundred SMEs in the Kumasi metropolis of Ghana. The respondents will be briefed first about the purpose of the study, and the instructions will be explained. Written instruction will also be at the beginning of the questionnaire. The respondents will be informed that they are free to ask any questions if they do not understand something in the questionnaire. Questionnaires will be completed within 25 to 30 minutes.
3.2 Sources of Data
Primary Data
Primary data is the original data collected by the researcher for the research problem at hand. The study will focus on primary data. This will be collected through interviews and the use of questionnaires. According to Yin (2003), interviews are the most important sources of case study information. This is because they can provide exact answers to the research questions. Again questionnaires will be used as a gathering process for this work.
Secondary Data
This is data that is collected by someone other than the user. Secondary data will also be obtained from reviewing journals and literature relevant to the subject matter of this research. Newspaper sources and official policy documents of the government of Ghana with relevance to the subject will also be consulted. The electronic search site: www.google.com will be employed extensively for up-to-date materials on the topic.
3.3 Population
SMEs are scattered across the length and breadth of the country with most of them located in Ashanti, Western, Central and Greater Accra regions of the country. These regions have been identified to have a high concentration of SMEs. In adopting a case study method in research, the selection of the research site is very important. With this in mind, the Ashanti region will be selected for the following reasons.
Firstly, most of the SMEs are located in this area, so are the banks and non-bank financial institutions which provide financing sources to these SMEs. With this objective in mind, selecting this region allowed the researcher to contact SME operators who have made numerous contacts with different banks and non-banks for financial support and therefore have a lot of experience to share.
Secondly, it will be easier for the researchers to approach these SMEs operators since the researchers have had many experiences in that region and are well known to most of these SMEs that are located in the region. Choosing any other region would mean traveling a long distance just to make contact with the SMEs operators, which will be very difficult considering the time frame of the research.
The sampling frame, however, for this study, chose a few SMEs in the Ashanti region, specifically those in the Kumasi metropolis and its environs because of the easy access to these SMEs.
3.4 Sample Size
Questionnaires will be issued to a total of 400 SME businesses in the Ashanti region of Ghana. The study will be based on 400 SME because the researcher believes that considering the total number of SME businesses in the Ashanti region. This sample size will provide enough statistical findings to the data that will be collected.
3.5 Sampling Technique
The method of convenience sampling was employed in arriving at the 396 SMEs, which the researchers believe possesses the experience relevant for this study and who have sufficient time and were willing to participate. This technique, convenience sampling, involves obtaining responses within the sample frame from willing respondents and also their availability for the study.
The advantage here is that respondents will participate in their own choice and not selected against their will. This technique was chosen to boost response rate because respondents in this sector are reluctant to give out information since they believed in one way or the other, information about their business might leak through to competitors and also exposed them to tax authorities.
3.6 Data Collection Instruments
The study will use questionnaires and interviews as data collection techniques. Questionnaires will comprise of both structured and unstructured questions to assist the researcher in gathering the needed information to successfully ensure the validity of data
3.7 Data Analysis
Descriptive statistics were found to be an ideal analysis technique and will subsequently be used in ascertaining how to enhance financial channels for SMEs and entrepreneurial businesses. Aided by the tabulation of data extracted from close-ended questions surveyed, it will be easier to understand the issues identified by the respondents.
3.8 Validity and Reliability of Data
Information will be obtained from NBSSI and questionnaires will also be issued out for respondents to provide information that will be relevant for the research. There was the assurance given by the NBSSI that information that will be obtained from them will be accurate. Questionnaires will also be pilot tested on some selected SMEs to obtain information that will be reliable and relevant for the research. According to Merriam (1998), reliability describes the extent to which the findings and conclusion can be replicated. Further, it refers to the consistency between the data collected and the results found that make a study reliable. To make certain the reliability of the study, evidence that will be obtained in the course of the research will be checked with the respondent. Irrespective that errors can be obtained, the respondent will provide information that will be relevant for the research.
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