Financing enterprises in transformation

The transition of micro and small enterprises to bigger entities, playing in the formal sector is good for the economy.It is actually the dream of those concerned with the development of that sector. However, in the euphoria of this growth and transition, we often overlook the challenges that confront transiting enterprises. The challenges of growth and transition, and indeed the requirements of sustained production, are often greater than those these enterprises had faced before their good fortune of growth. Inability to cope with the many changes, which occur in almost every aspect of the growing small business, may become the stumbling block to growth and effective transition of microenterprises, if not carefully managed. This ought not to be so. If that were to be the case, we may have a situation where growth and expansion become a source of pain rather than joy for transiting micro and small enterprises. That would not be a positive commentary on our MSME development activity.

In reality, this scenario actually plays out as MSMEs grow – when the challenges that come with success of an enterprise are allowed to become a burden to it and ultimately penalize such success. All over the world, small businesses are supported by credit programmes that are tailored to their needs. These programmes provide them with friendly credit facilities – loans and advances, capacity building support and asset protection insurance services, among other services. Many international organizations, including some non-profit institutions based in Europe and the United States, and even Latin America, have advanced the development of the small enterprise sector through a variety of such supportive financing models.

Before we discuss those financing models, it is important to note that as small and medium enterprises develop and expand, their needs also change and expand. New and bigger challenges show up in their faces. Often, the first thing that happens is that the composition of their personnel will change from a largely family labour force to a mix of family and hired labour, and responsibilities begin to get defined.This implies the introduction of substantial internal reforms in such areas as record-keeping and general administration with enhanced division of labour. At this point, it is good for the leader to begin to give up some of the many things that ate up his valuable time. He needs to begin to accept that the leader cannot do everything and do them alone.

One critical functional change at this stage is in the area of cash management. It should no longer be the case at this point that the leader sees the business as himself and its funds as his funds. A distinction between the two has become very important. The key evidence that this is happening is a change in the cash management process. The enlarged operating expenses, raw materials and staff costs, higher investment expenditure and so on that arise imply that time has come for business and family finance to be distinguished.

The next important change often occurs in the markets and marketing of the products of the enterprise. The local or neighbourhood markets may no longer be adequate as production increases. Effort must be made to expand the market and customer base beyond the immediate environment. Growing enterprises must therefore seek and find new markets and customer bases to absorb their expanding output, if their success is not to be short-lived.

The expansion into new markets raises yet another challenge – the challenge of technology. The larger output that targets the new markets is not likely to be produced under the existing technological capacity of the firm. The key man must at this time agree that the time has also come for upgrading of the machines, systems and entire technology, to meet the needs of the growing customer base. At this time, the need to ensure that supply lines are secure equally becomes critical. With expanding markets and effective technology to deliver the output, the enterprise must not allow its own suppliers to become the stumbling block on its way.

Finally, among the key challenges of growth is credit. Micro and small enterprises usually begin as integrated firms. They produce their own inputs in the form of raw materials. They buy unprocessed goods in bulk and resale. While the reliance on outside suppliers and larger output calls for increased capitalisation, especially of the working capital category, the need for increased technology and equipment calls for increased fixed asset investment capital.

There arevarious methodologies for addressing MSME finance. Each of them has in its DNA something that links it to particular types of small enterprises in need of growth and development. Ideally, as enterprises pass through various stages of development, they are supposed to be embraced and served by different institutional finance types that are properly attuned to their needs. Unfortunately, this is not always the case and operators make do with what they find.

The Village Banking methodology of microenterprise finance focuses on the poorest clients, especially those run by women and engaged in the simplest enterprise activities. This methodology of enterprise finance was pioneered by the Foundation for International Community Assistance (FINCA), a United States-based non-profit organisation that specializes in rural credit, FINCAhas been operating in several Latin American countries where it has been promoting the technology of village banking, including Mexico, Thailand, Costa Rica and even Guatemala.

Peer group lending has been extensively promoted in the search for ways to eliminate the challenge of collaterals in microenterprise financing. The Solidarity Grouplending methodology, which has been fairly successful in this regard also has its own best category of clients, for whom it is best suited. This form of financing targets the slightly more established entities. Under this system, three to ten microentrepreneurs come together to access credit and other services, including training and other organizational growth-promoting services. Moreover, as members collectively guarantee their loans and access to future loans is made to depend on repayment history, members need to have some substance and similarities among them.The requirement of bonding in groups presupposes some level of organizational foundation of participants.

Similarly, another lending methodology, Transformation Lending, also has its own focus group of entrepreneurs. It is concerned with entrepreneurs that have grown beyond the rudiments and have expanded their operations substantially beyond where they were and what they used to need financially. That is the focus of the series we begin to day – Transformation Lending. As the name suggests, it is the lending that targets institutions in transition from one stage of development to the next higher one.If we agree that that the needs of organizations vary according to their stages of development, then it becomes clear, and not a discovery, that different stages of the development of micro, small and medium enterprises demand different financing methodologies.This is one fact we must keep in mind if we are to better promote the sector and have good success in our enterprise development efforts.

Emeka Osuji