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The limited availability of financial resources is one of the major constraints
faced by start-ups and SMEs. What are the major sources of finance for startups and SMEs and why are such firms at a disadvantage in accessing external
sources of finance?

Financial resources are one of the biggest financial constraints that are faced by Small
and Medium Enterprises (SMEs) in todays world. According to Spadavecchia (2014), SMEs
are at a disadvantage in securing market finances due to their liability of being new and
small. However, there are some major sources of finance that SMEs could divulge into and
approach for financial support. This essay will discuss these sources of finance, outlining
their details and providing the positive and negative aspects of them. The essay will also
discuss the main problem that SMEs have when attempting to approach these types of
sources of finance.
For a SME to successfully start-up, they need the find the correct perspective in
regards to attaining capital. Companies starting up can approach many different types of
sources of finance. However, they all have their advantages and disadvantages for companies
who are starting up. According to Spadavecchia (2014), there are two types of finances:
internal finances, such as equity, personal savings, current and fixed assets and external
finances, such as business angels, bank loans, venture capitalists, and government finance.
According to Lee (2014), internal sources of finance are a more viable option for a
business due to various reasons. He backs up his argument with that fact that external
sources lenders and investors are often sceptical of small businesses. Small businesses
are constantly under scrutiny for the fact that they are unreliable in terms of finances and
therefore lenders and investors tend not to divulge in those areas of the market. That is why
internal sources of finance are the better option for SMEs. One of the biggest sources of
finance, according to Spadavecchia (2014), is personal savings. Personal savings are
considered the backbone of any SME and they are the most viable option outside of external
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sources. However, when these savings are not financially available, one must look towards to
the other sources of internal finance. A major source is the current assets of the company. If
ever a company reaches crisis, these assets can be converted into cash quickly and due to its
high liquidity factor. This would allow the company to generate an influx of cash back into
the company and allow it to come back once again.
However, these internal sources of finance also have a few negative aspects as well.
The first major problem that SMEs might face is the fact that they are newly started or have
yet to start. This way, the company would not be able to use any of their retained profits or
be able to sell any assets because they are not readily available to them at this point. Another
major problem would be foreseeing the sale of the assets. Assets are generally not easy to sell
and may take a long time, which may be problematic for a company that is in dire need of a
cash influx. Also, by selling their assets, the value of the company would heavily decrease and
therefore would make it very difficult to obtain bank loans and mortgages in the future,
should they ever need to do so. As Jennings (2014) states, Some assets, such as retirement
accounts, are safe from creditors and bankruptcy courts; placing such assets at risk may
not be good for you, especially if you're approaching retirement age and are running out of
time to rebuild depleted accounts.
On the other hand, external sources of finance can provide an additional supporting
hand in SMEs. According to Spadavecchia (2014), 13.2% of SMEs financial sources come
directly from external sources. The largest of these sources is the bank loans which consist of
93.5%. Government grants and other loans consist of the 6.5%, which include those from
venture capitalists and business angels. Companies can also attain finance from other
sectors, such as trade credits, hire purchasing, and issuing shares of their own. However,
these sources would not apply to start-up businesses and SMEs since they are not listed on
the stock market and are not large enough to obtain such sourcing.
For SMEs and start-up businesses, the biggest form of external financial source is the
use of a bank loan. These loans are generally a long-term source of finance and generally are
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used to buy equipment or property for the company. The advantage to borrowing the
money is that it enables you to keep your cash on hand to use as operating capital or for
personal survival during a down period in your business (Jennings, 2014). This financial
support is good for companies that cannot afford to sell any assets or use personal funding in
order to stay afloat. Bank loans do come with a burden however. For a certain period, banks
add an interest rate to the amount that is being loaned out. This means that at the time the
loan has to be repaid it will include a certain percentage increase on it. Since start-up
companies and SMEs are considered high risk financially, banks usually have a high interest
rate on their loans. This reason causes many companies to look at other sources of finance
that will not be a high burden on them over a long period of time.
Venture capitalists and business angels are another major external source of finance
for SMEs and start-up companies. Both these sources have their own reasons and
responsibilities. However, venture capitalists are generally attracted to companies that have
started and are looking to expand. Business angels look towards companies wanting to startup but do not have a funding to do so. According to Spadavecchia (2014) venture capitalists
are those that use others money to invest in ones company. Business angels are those that
invest their own money into those companies that are starting up. Generally, venture
capitalists look towards how the company has performed so far. They tend to look at all
perspectives before approaching the company. On the other hand, business angels look at the
future of the company. This relies heavily on the key people that are trying to start-up the
company. However, both these sources of finance are extremely challenging to impress and
difficult to attain their help. Therefore, the success rates of companies that approach these
sources of finance have very little to no luck.
External sources of finance are good sources for companies to use and many around
do tend to divulge with them. Therefore, the main question is why are these companies at a
disadvantage when attempting to access these external sources of finance? One explanation
is that banks are now more risk cautious than they were 20 years ago (SME Access to
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External Finance, 2012). They have increased the percentage of interest to the loans that they
offer exorbitantly and therefore many SMEs are becoming unattracted to this option as a
source. Also, in order to secure themselves, banks are asking companies to mortgage their
assets in order to receive the loans. By doing so, companies are unable to sell these assets as
it puts in a legal bind over them and the bank.
SME Access to External Finance (2012) explains that bank loans are not the only
reason. Venture capitalists have become heavily affected by the recent recession and it has
caused a downturn in the amount of companies they are willing to invest with. If a company
does receive venture capital funding, they will lose a lot of shares in the company since they
have received a new investor. Spadavecchia (2014) stated that some of the control is
relinquished to the outsiders and therefore is taking control from one hand and giving it to
another. Most SMEs do not want to lose control of their company and therefore face a major
decision on choosing this source of finance.
Finally, angel investors are the last main cause for concern for SMEs and start-up
businesses. The scrutiny that emerges from angel investors appraisal of the company is
daunting. They consider every aspect of the company, good and bad, before dropping a single
penny into the pot. Since they generally consist of entrepreneurs and businessmen, angel
investors have a strong viewpoint in everything that they have a share in. If a company were
divulge with an angel investor, his or her input would be constant and authoritative.
Difference in views and styles of thinking may cause problems within the management of the
company and therefore a difference in approach. This is also a major disadvantage when
using angel investors as an external financial source.
The decision of using external sources of finance is a major decision and the
management within the company must determine what their aims and focus in the short
terms and long terms are. Staying independent by using personal savings and the sale of
assets can keep the company afloat in the short term, but what would that mean for the long
term? On the other hand, they could approach the external sources of finance, such as banks,
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where the long term would be more secure although the added pressure of matching the
monthly payments can be daunting. Similarly, usage of venture capitalists and angel
investors is another external option but how much of the business is one ready to give up? A
different approach in the company may be a step towards the right direction, but the
variations in thinking and cultural/educational styles may cause major problems within the
company.
In both areas of finance, SMEs and start-up businesses have positive and negative
aspects for both the short and long term. The correct choice has to be made in order for the
company to be successful but sacrifices must be made as well. Many factors such as the risk,
financial constraint, duration, and availability must be considered when going for certain
financial options. Although there are more disadvantages and limitations to usage of external
sources than using internal sources, the financial gain that one would receive from the
external would be tremendous in comparison to the latter. Therefore, it is up to the one who
is ready to make the decision for their company and the outcome of their choice can only be
determined once they have made it so. This idea does not only work for SMEs and start-up
business, but it would be the same for any business within the industry.
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REFERENCES
Jennings, R. 2014. Sources of Finance and Their Advantages & Disadvantages. [online]
Available at: http://smallbusiness.chron.com/sources-finance-advantagesdisadvantages-14407.html [Accessed: 18 Mar 2014].
Lee, M. 2014. What Are Internal Sources of Finance?. [online] Available at:
http://smallbusiness.chron.com/internal-sources-finance-47552.html [Accessed: 21
Mar 2014].
Mottershead, A., Challoner, S. and Grant, A. 2008. OCR AS business studies. Deddington:
Philip Allan Updates.
SME Access to External Finance. 2012. [e-book] London: Department of Business,
Innovation and Skills. Available through: Gov.uk
https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/322
63/12-539-sme-access-external-finance.pdf [Accessed: 22 Mar 2014].

Spadavecchia A. (2014). Lecture 3: The sources of finance of SMEs. [Lecture to Managing

Small Enterprises, Whiteknights Campus, University of Reading]. 31 January