CHAPTER THREE: FINANCING MEDIUM-SIZED BUSINESSES
THE CONCEPT OF MEDIUM-SIZED BUSINESSES
FINANCING MEDIUM-SIZED BUSINESSES:
Refers to the process of providing capital or funds to help medium enterprises start, operate, or expand their activities.
MEDIUM-SIZED BUSINESSES:
Are companies that are larger than small enterprises but smaller than large corporations, typically employing between 50 and 250 people.
FEATURES OF MEDIUM-SIZED BUSINESSES
Number of employees:
Medium-sized businesses employ 50 to 99 people who are engaged in various business activities like production and marketing of products.
Capital invested:
Medium-sized businesses invest capital which range from Tshs 200 million to Tshs 800 million.
Operations:
Medium-sized businesses employees are divided into different sections of operations like production, marketing, finance, information technology, procurement and human resources.
Proprietorship:
Medium-sized businesses may be owned by an individual, family members as well as the public who have a common interest to ensure pre-determined goals are achieved.
IMPORTANCE OF MEDIUM-SIZED BUSINESSES
The following are the importance of the medium-sized businesses.
Create employment
Medium-sized business employ a relatively large number of people to carry out various business activities.
Foster decision making
Medium sized business decisions can be made by a single person or group of persons unlike large enterprises.
Easy sharing of information
Medium sized businesses communication process is easier compared to large businesses since management and employees are closer due to its smaller size.
Enhances growth of the economy
Medium sized businesses contribute to the country economic growth through payment of different taxes which are used in the provision of public services.
Cost effectiveness
Medium sized businesses are likely to have lower operational costs compared to large business due to their scale of operations.
Easy access to resources
Medium sized businesses have better access to resources including finance compared to small businesses. Such access facilitates medium sized businesses to grow and pursue more business opportunities to foster optimum business performance.
Closer relationship with customers
Medium sized businesses can provide satisfactory customer services than large sized businesses due to their smaller customer base.
SOURCES OF FINANCING FOR MEDIUM SIZED BUSINESSES:
These are money that enterprises need conducting different activities including buying raw materials, paying labours, or other production costs.
Types of sources of finance for medium sized business.
There are two main categories which are
- Internal sources
- External sources
A) INTERNAL SOURCES OF FINANCE:
Is a source that acquired within the business without any support from outside. The following are examples of internal sources of finance.
(i) RETAINED EARNINGS:
Refers to the amounts of profit left over by the business after the distribution of profit. These are profits obtained in the business that are not distributed to owners as returns on their investment.
The owners decide to re-invest it to business rather than distributing it to help the growth of the business.
ADVANTAGES OF RETAINED EARNINGS:
No Interest or Repayment Required:
Unlike loans, retained earnings don’t incur interest and don’t have to be repaid, reducing financial pressure.
Maintains Ownership and Control:
It avoids diluting ownership, as there’s no need to issue new shares or bring in outside investors.
Boosts Financial Stability:
Using internal funds shows good financial health and can improve the company’s creditworthiness.
Flexible Use:
Management can use retained earnings as needed, without restrictions from lenders or shareholders.
Encourages Long-Term Planning:
Promotes a culture of saving and reinvesting profits to support growth and sustainability.
DISADVANTAGES OF RETAINED EARNINGS:
Opportunity Cost to Shareholders:
Shareholders might miss out on dividends, which could lead to dissatisfaction or reduced investor confidence.
Limited Availability:
Not all businesses generate enough profit to rely on retained earnings, especially startups or those in financial difficulty.
May Encourage Inefficient Use:
Easy access to internal funds can lead to wasteful spending or poor investment decisions if not carefully managed.
Slower Growth Compared to External Funding:
Retained earnings may not be enough to fund large-scale projects, limiting rapid expansion.
Negative Market Perception:
Investors might interpret low dividend payouts as a lack of profitable opportunities, which could affect stock prices.
(ii) SELLING OF AN ASSET
It involves selling a property or a non-current asset of an individual so as to raise finance for the business.
Selling non-current assets (like land, building, property, machinery, vehicles, or equipment) can be a way for a business to raise capital.
ADVANTAGES OF SELLING A NON-CURRENT ASSET AS A SOURCE OF FUNDS:
Immediate Cash Inflow:
It provides a quick source of cash, which can be used to finance operations or pay off debts.
Reduces Maintenance Costs:
Assets that are no longer in use or outdated can cost money to maintain. Selling them reduces these ongoing expenses.
Improves Efficiency:
Encourages the business to streamline operations and focus on core assets.
No Repayment or Interest:
Unlike loans, the money raised does not need to be repaid or accrue interest.
Avoids Dilution:
Unlike issuing new shares, selling assets does not dilute ownership.
DISADVANTAGES OF SELLING OF A NON-CURRENT ASSET AS A SOURCE OF FUNDS:
One-Time Source of Funds:
It’s not a sustainable or repeatable source of capital.
Potential Loss of Productive Capacity:
Selling key operational assets can hurt future production or service capabilities.
May Undervalue Assets:
Assets might have to be sold at a lower price, especially in distress situations.
Reduces Collateral Base:
Fewer assets mean less collateral available for securing future loans.
Signal of Financial Trouble:
May be seen by investors or stakeholders as a sign the company is in financial difficulty.
(iii) LEASING OF NON-CURRENT ASSETS:
Refers to an agreement in which one party allows another party to use the non-current assets and return them after the specified period of time.
The assets owner is known as “lessor” the person that uses the leased assets is called “lessee”
ADVANTAGES OF LEASING NON-CURRENT ASSETS:
Lower Initial Costs
Leasing avoids large upfront payments compared to buying the asset outright.
Improves Cash Flow
Fixed lease payments help with budgeting and preserve working capital.
Access to Latest Equipment
Leases often allow upgrades, keeping equipment up to date with minimal hassle.
Flexibility
Shorter lease terms provide the option to switch or stop using the asset if business needs change.
No Ownership Risk
Maintenance and obsolescence risks may be borne by the lessor, not the lessee.
Tax Benefits
Lease payments are often tax-deductible as business expenses.
DISADVANTAGES OF LEASING NON-CURRENT ASSETS:
Higher Long-Term Cost
Total lease payments may exceed the cost of purchasing the asset.
No Ownership Rights
The lessee doesn’t build equity or gain ownership, even after long-term use.
Contractual Obligations
Breaking a lease early may incur penalties or fees.
Usage Restrictions
Leased assets may come with usage limits or maintenance requirements set by the lessor.
Dependence on Lessor
Issues with the lessor (e.g., delayed service or upgrades) can disrupt operations.
(iv) SALE AND LEASEBACK OF NON-CURRENT ASSETS
Refer to the process whereby asset owner sells some of their assets in another party then the assets are promptly leased back from the buyer. (such as property, machinery, or equipment):
ADVANTAGES SALE AND LEASEBACK OF NON-CURRENT ASSETS:
Immediate cash inflow
Frees up capital tied in assets, which can be used for investment, debt reduction, or working capital.
Improved liquidity
Strengthens the company’s balance sheet by increasing available cash.
Continued use of the asset
The business can continue using the asset without disruption.
Off-balance sheet financing
Lease obligations may not always appear as liabilities, improving financial ratios (depending on accounting standards).
Tax benefits
Lease payments may be tax-deductible as business expenses.
DISADVANTAGES SALE AND LEASEBACK OF NON-CURRENT ASSETS:
Loss of ownership
The company no longer owns the asset and loses potential future appreciation in value.
Long-term cost
Lease payments over time may exceed the asset’s sale value, making it more expensive in the long run.
Lease obligations
The company is committed to ongoing lease payments, which can strain future cash flows.
Reduced borrowing capacity
Having fewer owned assets may limit the company’s ability to secure future loans.
Dependence on the lessor
The company may face restrictions or risks if the leasing terms change or the lessor’s financial position weakens.
B) EXTERNAL SOURCES OF FINANCE
Refer to finance provided by individuals or group of people outside the business venture. The following are examples of external source of finance.
(i) SHARE CAPITAL
Is the money a company raises by issuing shares to investors or the public. Shareholders become part-owners of the company and may receive dividends and voting rights, depending on the type of shares (e.g., ordinary or preference shares).
ADVANTAGES OF SHARE CAPITAL:
No repayment
Unlike loans, share capital does not need to be repaid.
No interest
There are no interest payments, reducing pressure on cash flow.
Large funding potential
Can raise substantial capital for expansion or investment.
Improves creditworthiness
A strong capital base can make it easier to obtain loans.
Spreads risk
Risk is shared among many shareholders.
DISADVANTAGES OF SHARE CAPITAL:
Loss of ownership
Issuing shares means giving up part of the company to new shareholders.
Dividend expectations
Shareholders may expect dividends, reducing retained profits.
Dilution of control
More shareholders can mean reduced control for original owners.
Cost and regulation
Issuing shares involves legal, administrative, and regulatory costs.
Public scrutiny (for public companies)
Companies may face pressure to meet shareholder expectations and disclose financial information.
(ii) VENTURE CAPITAL (VC)
Is a type of financing where investors provide money to startups or small businesses with high growth potential in exchange for equity (ownership).
VC is commonly used by companies that are too risky for traditional bank loans but have strong potential for success.
ADVANTAGES OF VENTURE CAPITAL:
Large capital access
Can provide significant funding for scaling and growth.
Expert support
VC firms often offer strategic guidance, mentorship, and industry connections.
No repayment
Unlike loans, there’s no obligation to repay if the business fails.
Credibility boost
Attracts other investors and partners due to the trust VC firms bring.
Fuels innovation
Ideal for businesses with innovative ideas that need capital to develop.
DISADVANTAGES OF VENTURE CAPITAL:
Loss of control
Investors get equity and may influence key decisions or gain board seats.
Equity dilution
Founders give up a portion of ownership, reducing their share of profits.
High expectations
VCs expect rapid growth and significant returns on their investment.
Complex process
Securing VC involves extensive pitching, due diligence, and negotiations.
Exit pressure
VCs typically want a profitable exit (like an IPO or sale) within a few years, which may not align with the founder’s long-term vision.
(iii) OVERDRAFT
These occurs when the bank allows the account owner to withdraw more money than what they actually have in their bank balance.
ADVANTAGES OF OVERDRAFTS:
Flexible borrowing
You only borrow what you need, when you need it.
Quick access to funds
Ideal for short-term cash flow issues.
No repayment schedule
You can repay as you go, unlike structured loans.
Interest on used amount only
You only pay interest on the overdrawn amount, not the entire limit.
Emergency cover
Helps in covering unexpected expenses or delays in income.
DISADVANTAGES OF OVERDRAFTS:
High interest rates
Often more expensive than loans or credit cards.
Fees and charges
Banks may charge daily, monthly, or unauthorized overdraft fees.
Temporary solution
Not suitable for long-term borrowing.
Risk of dependency
Can lead to a cycle of debt if frequently used.
Possible reduction or cancellation
The bank can reduce or cancel your overdraft at any time.
(iv) SECURED LOAN:
Is a loan backed by an asset (collateral), such as a house, car, or property. If the borrower fails to repay, the lender has the right to seize the asset to recover the debt.
ADVANTAGES OF SECURED LOANS:
Lower interest rates
Less risk for lenders means lower rates for borrowers.
Higher borrowing limits
You can borrow larger amounts compared to unsecured loans.
Longer repayment periods
Easier to manage with smaller monthly payments.
Easier approval
More accessible for people with limited or poor credit history.
Helps build credit
Regular, on-time payments can improve your credit score.
DISADVANTAGES OF SECURED LOANS:
Risk of asset loss
You could lose your property or asset if you default.
Long-term debt
Extended terms can mean paying more interest overall.
Slow approval process
Valuation and legal checks on the asset can delay loan approval.
Limited flexibility
Loan terms may be strict, especially regarding early repayment or asset use.
Increased financial pressure
The risk of losing a valuable asset can create stress and pressure.
(v) CROWD FUNDING
Is a method of raising money from a large number of people, typically via online platforms, to fund a project, business, or cause.
Contributors may donate money, invest for equity, or pre-purchase a product or service.
There are different ways for an enterprise to be engaged in crowd funding:
i. Debt crowd funding
Involves raising funds from investors who should be repaid the invested money with interest.
ii. Equity crowd funding
Involves collecting money from people and originations in exchange for shares or certain levels of ownership in a business enterprise.
iii. Reward crowd funding
Involves raising funds from people and organization in exchange for non-financial benefits such as free gifts.
iv. Donations crowd funding
Involves raising funds from people and organizations in exchange for social or charitable activities.
ADVANTAGES OF CROWDFUNDING:
Access to capital
Raises funds without needing traditional loans or investors.
Market validation
Shows public interest or demand before full-scale launch.
Publicity and marketing
Campaigns often generate buzz and increase visibility.
Loyal customer base
Early supporters often become loyal customers or advocates.
No repayment (for donation or reward models)
You don’t have to repay the money or give up equity unless it’s equity crowdfunding.
DISADVANTAGES OF CROWDFUNDING
Not guaranteed
Many campaigns fail to meet funding goals.
Time-consuming
Requires effort in planning, promoting, and managing the campaign.
Fees
Platforms often charge a percentage of the funds raised.
Public exposure
Ideas are shared publicly, which may lead to imitation.
Obligations to backers
If rewards or products are promised, they must be delivered, which can be costly or complex.
(vi) DEBENTURES:
Are a type of long-term debt instrument used by companies to borrow money from investors.
They are typically unsecured, meaning they are not backed by physical assets but rather the company’s creditworthiness and reputation.
In return, the company pays fixed interest to debenture holders and repays the principal at maturity.
ADVANTAGES OF DEBENTURES:
Fixed interest rate
Predictable cost of borrowing for the company.
No loss of ownership
Debenture holders don’t get voting rights or ownership in the company.
Long-term funding
Provides stable financing for long-term projects or expansion.
Tax benefits
Interest paid on debentures is often tax-deductible.
Investor confidence
Attracts conservative investors seeking fixed income.
DISADVANTAGES OF DEBENTURES:
Repayment obligation
Interest must be paid regularly, regardless of company profits.
Default risk
Failure to meet payments can damage credit and lead to legal action.
Credit rating impact
Heavy reliance on debentures can affect a company’s credit standing.
Not suitable for weak firms
Companies with poor credit may struggle to issue debentures.
Interest burden
Fixed interest payments can strain finances, especially in low-profit periods.
(vii) GRANTS:
Is financial support from either the government or private organization that is given to enhance business activities.
Grants can be offered both local and international organisation to support specific projects or initiatives.
ADVANTAGES OF GRANTS
Non-repayable
Grants do not need to be paid back, unlike loans.
Encourages growth
Helps fund new projects, research, or expansion without adding debt.
Supports innovation
Often available for innovative or socially beneficial initiatives.
Improves credibility
Receiving a grant can enhance your organization’s reputation and attract other funding.
No equity loss
You don’t give up ownership or control of your business or project.
DISADVANTAGES OF GRANTS:
Highly competitive
Many applicants compete for limited funds, making it hard to secure a grant.
Time-consuming application process
Requires detailed proposals, plans, and documentation.
Strict conditions
Grants often come with rules on how funds must be used and require regular reporting.
Delays in funding
Approval and disbursement can take time, delaying project start.
Short-term funding
Grants usually support specific projects for a limited time, not long-term operations.
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