Entrepreneurs as Business Leaders - Essay Example

Entrepreneurs as Business Leaders Executive Summary Entrepreneurs are those who are business leaders and start their business at their own risk implementing new ideas and innovations. These businesses employ huge number of people that upgrades the economic and social condition of the society. These small and medium scales enterprises are one of the ways that helps in poverty elevation. But these enterprises suffer a lot in getting funding for their business. The study conducts an in-depth analysis of the factors that influences capital structure of the SME, the various sources of finance for the SMEs and the issues faced and the policies that are there in UK to support the SMEs. On this regards recommendation are made on how the initiatives taken by the national, regional and local entities can be made better. 1. Introduction Small and Medium sized enterprises (SME) are considered to be potentially most dynamic in an emerging economy. SMEs are regarded to play an important role in the development process of not only developing but also developed countries. Various advantages can be generated from the rise in SME (Parker, 2004). They are assumed to use more labour intensive technology that may give rise to the employment opportunity. They are established quickly and rapidly that leads to immediate initiation of operation, which in turn generates quick returns. The development of SME may promote the process of intra and inter-regional decentralization that may act as a force in equilibrating the economic power of bigger enterprises. In simple terms the growth of SMEs are regarded to do major contribution towards the accomplishment of socio-economic and wider economic objectives such as poverty alleviation (Cook and Nixson, 2000). Most likely they have chances to move into the region of high value addition and comparative advantage though they face lots of obstacle in legal, financial, economic and institutional terms. The obstacles include “limited access to working capital and long-term credit, legal and regulatory restrictions, inadequate infrastructure, high transaction costs, and limited managerial and technical expertise” (Pissarides, 1999, p. 520). However lack of finance is the main obstacle in the growth of SMEs. This study highlights on the issues faced by the Entrepreneurs or the SME for financing their business in United Kingdom (UK). 2. Methodology The study conducts an in-depth analysis of the factors that influences capital structure of the SME, the various sources of finance for the SMEs and the issues faced and the policies that are there in UK to support the SMEs. After analysing the whole scenario the recommendations will be made. In this context the data of this study has been collected from secondary sources which include various journals, books, newspaper and other electronic sources (Sapsford and Jupp, 2006). The data collected are then analysed qualitatively to reach to the final conclusion. In a qualitative research the study id done by interpreting any phenomenon in terms of what meaning people gives to them (Klenke, 2008). 3. Discussion 3.1 Financing pattern While determining the capital structure of the SMEs theoretical frame work of the factors may be considered. The theoretical framework generally emphasizes on how the size of the firm can affect the capital structure. Many researchers have found the influence of size on the SMEs (Garcı´a-Teruel and Martı´nez-Solano, 2007; Hernandez-Canovas and Koetter-Kant, 2008; Sogorb-Mira, 2005; Michaellas, Chittenden and Poutziouris, 1999; Kotey, 1999). On analysing the literature it is found that size affects the capital determination of the firm. The most influential factors are asymmetric information, use of debt tax shield and agency cost. 3.1.1 Asymmetric Information The pecking order theory developed by Myers and Majluf (1984) and Myers (1984) is applied to the financing pattern under this approach. It has been emphasized by various researchers that pecking order theory is the most appropriate approach while deciding on financing of the SMEs (Ang, 1992; Cosh and Hughes, 1994; Holmes and Kent, 1991). The small firm bears more high information cost and are opaque. Though in case of internal funds the information cost is considered to be nil but in case of issuing new capital it is quite high. On the other hand debt lies in just the intermediate position (Jobst, 2006). Hence it is expected from the smaller firms that they would rely heavily on the internal funds, avoid using external equity for financing and lower the level of debt involved in the business. It is an important issue for the owner managers to manage the enterprise without any external interference. If the internal funds are insufficient, in such a case the SME will prefer debt than to equity since debt reduces the risk of losing decision making power or control and also lowers the level of intrusion as compared to finance through equity. 3.1.2 Debt Tax shield Pettit and Singer (1985) claimed that in case of SMEs especially the micro and small firms there is very little importance of tax considerations since these firms generally do not generate high profit so are less likely to get any advantage by using debt for tax shield. A similar claim has been made by Michaellas, Chittenden and Poutziouris (1999), who stated that the level of debt in SMEs has to do nothing with the tax. Hence it can be concluded that tax consideration has very little implication on the capital structure of the SMEs. 3.1.3 Agency cost Agency cost arises from the conflict of interest between the bondholders and the shareholders The agency model suggests that the conflict creates encouragement for the shareholders to take actions that would derive benefits for them on the expense of the bondholders but does not maximises the firm values. In case of SME the agency cost signifies the cost that prevents the managers who are materialising their own interest at the expense of the shareholders who are the principles but not influential from the perspective of equity. Therefore it is definite that the SMEs are managed by the owners and either have lower or almost no access to the equity market. However agency cost becomes severe when the SME goes for finance from the bank, mainly because of its opaqueness (Ang, 1992; Van der Wijst, 1989). 3.2 Issues faced in financing It has been seen that the SMEs face difficulties in accessing finance whether it is equity or loans of short or long term. The major reason for suffering from such difficulties is that the lenders fail to distinguish between the bad and good borrowers. This is due to the high cost involved in obtaining the entire information that the lender may feel appropriate amongst the thousands of individual SMEs. In such a situation the lender is more obvious to affirm typical price for risk of average degree across a certain class of business rather than on an individual basis. This will lead to the problem for those businesses whose private knowledge made them to believe that they are performing better than the average will get loan at an unattractive price while other who is believed to perform below average will not do so. The good lenders are seen to leave the market while the bad lenders remain. In such a situation it can be argued that the pricing for degree of badness or the risk through interest rate will not work. There will be a lot of alternatives present to share the available finance. This will lead to reliance where the businesses will find alternatives such as collateral backed funding. The businesses rich in assets will find funding much easier than the other businesses that lack such assets to guarantee. Hence the younger and smaller businesses who lack such assets backing will find it difficult to gather finance for their business. Furthermore the availability of information for assessing risk in case of younger businesses would be much lower than those of the established one, which in turn makes the process of obtaining funding further complicated. Another factors that acts as the barrier of getting finance for the new businesses is that the older and established businesses may have good relationship with the lenders that gives them better access to the finance. This makes it clear that the SMEs are at a disadvantageous position in these markets (Cosh, et al., 2007). The structure of banking system of United Kingdom (UK) has further exaggerated the situation by creating problems for debt finance, which has lead to the lack of competition in the supply of SMEs. The result of such a situation has been argued as the lack of competitive choices for the small firms and has created limitations for them to switch banks. Competitive Commission and some other committees like Cruickshank Review are conducting a number of investigations that addresses the issues and the actions taken or being undertaken by the clearing banks in relation to the operations of these markets. The well established principles in the argument have inferred that the practices that the banks have adapted over time has been highly criticised. In order to overcome these problems the banks have developed a mixture of collateral and interest rate combination and other ways of monitoring the financial base of the customers. In context to this problem the government of UK has adapted a huge number of initiatives like Small Firm’s Loan Guarantee that addresses these issues (Cosh, et al., 2007). Some different sets of issues are seen to arise in case of equity. A range of fixed costs along with a number of other invisible problems are playing a major role in creating barrier for the small businesses as compared to the large businesses by making the equity per unit of finance raising more costly. The small businesses that are at an early stage of developing innovative activities through any technological breakthrough or any new scientific innovation have a problem of accessing risk capital. This arises due to the relatively higher rate of failure in case of new businesses that deals in technology based activities and found it difficult in getting venture capital and high risk supplies. Earlier the failure of the lending market has been indicated and in order to address all these issues the government of UK has framed several policies. Tax incentives have been offered to encourage venture capital investments. Venture Capital Trusts Scheme and Enterprise Investment Scheme (EIS) are some of those initiatives and a range of policies has been designed in relation to taxation of capital gains. Apart from the above identified issues there are some government objectives too that needs to be met while promoting enterprises like women, those amongst ethnic minorities or those amongst the most deprived, a range of policies have been framed for them to be adopted and promoted to resolve the failure in the financial market (Cosh, et al., 2007). 3.3 Public Policies framed Because of these potential failures in the supply of fund for the SMEs the government has taken initiatives to introduce wide range of programmes that provides financial support to the new entrepreneur. The government has provided considerable amount of support to the SMEs. The estimation says that through Small Firm’s loan Guarantee Schemes since 1981 about 100.000 loans with valuation of £5 billion has been made. While on the other hand for investment purpose EIS has raised more than £6.1 billion in about 14000 high risk small companies and VCT has invested in more than 1500 companies an amount of £3.2 billion. These two schemes were later made to focus specifically on the “small and high-risk end of the small business market” (Cosh, et al., 2007). Shell Livewire is another initiative in UK that looks for developing quality programs that enhances the opportunities for realising the potential among the young people through foundation and expansion of business enterprises. It has been argues by Shell LiveWIRE that every year around 45,000 businesses starts up in UK but just over half of them only successfully survives for more than three years. This number can be significantly increased if a proper business arrangement and sound advice is provided. This program looks for offering information, free advice and support at a local level to the people with the age of 16 to 30. In terms of finance competitive cash awards will be given to those businesses who display excellent progress since starting up (European Commission, 2000). The prices Youth Business Trust of UK is engaged in helping the unemployed youth between the age of 18 to 30 years, especially those from the ethnic minorities to start a new business. A comprehensive package of microfinance is offered to them as support. The special feature of this trust is that it provides a mentor who acts as the volunteer from the local business community to provide all required support to the business. Because of this mentoring the survival rate of the business after 3 years on an average has been seen to increase by 60%. More than 35,000 people have started over 30,000 businesses since 1986 with the support of PYBT (European Commission, 2000). 4. Conclusion The overall study suggests that the SME are making huge contribution towards the development of the economic and socio-economic condition of the country. The government of various countries are paying huge attention towards promoting the SMEs. But apart from all these the SMEs are facing large number of obstacles from legal, operational and financial point of view. They suffer while getting finance from lenders or from banks. Raising funds from the equity market has its own disadvantages due to which most the SMEs are seen not to go for this option. Some banks and financial institutions often goes for securitised funding but this can be only availed by those who have huge backing of assets in the business. Thus most of the SMEs are seen to go mostly for financing through their own funds and very low debt funding. In this context government of UK has also taken certain measures to encourage and promote small business, which has made certain positive changes. 5. Recommendations The government should ensure that there is greater coordination between the actions taken to support the target group and all the programs running to support them. The entrepreneur should be made aware of the initiatives that are taken at national and local level, so that they can avail proper support in terms of planning and finance from these programs. The government while extending specialist and general support to the SMEs through various support programs must prioritise their works. The involvement of the organizations rendering support to the business organizations should be increased in order to promote the tailor made support services. The government should assist and encourage the organization for recruiting trainers, advisors and mentors so that more specialist people can help the SME with valuable business ideas. The SME organizations should be encouraged so that they work more closely with the business support organization. Initiatives must be taken so that women, individual from ethnic minority and other groups entering into SME business should be properly supported and represented by the support organizations. Promotional initiatives should be taken to support the campaign that fights to stop discrimination by the regulatory bodies and the financial institutions. The government should monitor that no discriminations are made by the regulatory bodies or the support organization while giving support to the SMEs. International exchange of good practices should be implemented by the government. They should intensify the exchange of experiences, good practices and ideas so that the support organization can come to know about the initiatives adapted by other organizations working in other countries. This will help them in designing better programs to extend support to the SME organization. An internet platform should be developed so that this facility can be potentially implemented. The entrepreneur can also take advantage from this platform by knowing more about the strategies and facilitates the entrepreneur of other countries are getting. Apart from this the banks should also take special effort while financing the SME business. They should strictly evaluate all the available information and then decide on the risk involved in the financing. They should clarify every information provided by the SME. The government can announce special incentives for the banks for promoting finance in the SME organization. This will increase the motivation of the banks towards SME finance. REFERENCES Ang, J., 1992. On the theory of finance for privately held firms. The Journal of Small Business Finance, 1, pp. 185-203. Cook, P. and Nixson, F., 2000. Finance and Small And Medium-Sized Enterprise Development. Working Paper no. 14, FINANCE AND DEVELOPMENT RESEARCH PROGRAMME. Manchester. Cosh, A., Hughes, A., Bullock, A. And Milner, I., 2008. 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