MASTERS IN BUSINESS ADMINISTRATION (MBA)

BUAD 832: ENTREPRENEURSHIP AND SMALL BUSINESS

DEVELOPMENT

INDIVIDUAL ASSIGNMENT

ON

QUESTION: 1. Discuss formal and informal sources of finance

2. What are the inherent problems faced by entrepreneurs?  How can
they overcome such problems?

E-TUTOR: DR MUSBAU HASSAN

DENIS MAKERI CLEMENT

P18DLBA81637

1.0 Introduction
Finance has long been considered by Small and Medium Enterprises SMEs) operators as well as
start-ups and entrepreneurs as an important issue. Obtaining financial resource assistance
required and when they are needed, can be more difficult for small scale entrepreneurial ventures
than for established organisations. The critical issue is to ensure that sufficient cash is available
for current operations and growth of the business. It is also pertinent for the owners to ensure that
money is available to settle current liabilities when due.

The sources of this fund can be internal or external, formal or informal. Any source chosen by
the entrepreneur must be based on many factors such as availability, accessibility, lower interest
rate, less cumbersome processes, favourable terms and conditions, less collateral requirements,
etc.

Certainly, financing is one of the major inherent problems or challenges faced by entrepreneurs,
amidst many other problems that have continued to threaten the continued existence of
entrepreneurial ventures. However, there are various ways that these challenges can be
surmounted.

This assignment is structured to start with the introduction, which is followed by the discussion
on the formal and informal sources of finance; the inherent challenges facing entrepreneurs and
how to overcome it will be x-rayed before a conclusion will be drawn.

2.0 Formal and Informal Sources of Finance:

In simple terms, formal finance is financing capital that has been sourced from banks and other
formal financial intermediaries, whereas informal finance is the capital which has been sourced
from friends, family, relatives or private moneylenders (Elston et al. 2016). Formal finance
lending is processed based on hard information and arm-length principles while the informal
lending decision is made using soft (private) information and relationship-based principles.

Given this difference between the two, entrepreneurs face trade- offs in deciding on the
appropriate source of financing for their businesses. Wu et al (2016) suggest that informal funding
and formal funding differ in the provisions of the financing contracts. Specifically, informal debt
can be attractive to entrepreneurs because of its relative speed, lower initial transaction fees and
freedom from collateral requirements. While the lower interest rates of formal bank lending might
make it the preferred route, however, a longer loan processing time might not tally with the
required timeframe.

There are also different views about the relationship between the two sources. One view holds
that informal finance is the last resort for those entrepreneurs who are quantity-rationed in the
more desirable formal sector. This rationing may arise because formal lenders have limited
information and thus rely on collaterals to overcome the moral hazard and adverse selection that
are intrinsic in credit transactions. Firms that fail to provide sufficient collaterals are automatically
screened out and are forced to find informal lenders, who can substitute their informational
advantages of information-intensive screening and monitoring for collaterals (Bailetti, 2012). The
informational advantages of the informal sector (private moneylenders in particular) can
substantially reduce transaction costs, and this may push the effective cost of informal loans
below the effective cost of formal loans. However, the price (i.e., the interest rate) offered to
borrowers in the informal sector (private moneylenders in this case) is typically much higher than
the prices seen in the formal sector. This phenomenon could be explained by the regional
monopolism of the informal sector or because informal lenders are likely to engage in strategic
cooperation, thus limiting competition (Okeke and Eme, 2014).

In contrast to the ‘last resort’ view of informal finance, some scholars posit that the informal
sector may actually be preferred to the formal sector. Researchers typically cite funding from
family, friends and relatives as their research subjects’ finance choices (Lee and Persson 2016). In
the initial stage of the venturing process or in urgent situations, these informal funding
arrangements may act as seeding capital or quick capital that satisfies entrepreneurs’ capital needs
at low cost and with flexible repayment schedules. Private money- lenders are also of benefit to
entrepreneurs in the sense that they have greater access to private information, enabling them to
write contracts that are more state- contingent than formal contracts and are thus less risky for
borrowers (Okeke and Eme, 2014). As such, entrepreneurs that are reluctant to assume the risk of
a formal contract and are risk-rationed in the formal sector may also seek informal finance.

Despite the dissimilar viewpoints concerning the relationship between the two sectors, there
seems to be a consensus that the formal and informal financing sectors serve distinct groups of
borrowers. In addition, they apply different sets of behavioural rules and incentive structures to
deal with monitoring and enforcement problems. As such, Jain (1999) considers the coexistence
of the two sectors as an equilibrium phenomenon in which entrepreneurs may want to borrow
from both sectors even in those markets that are unhampered by failures and distortions.

Although, the informal sources that include: Esusu, Adashe, Credit and Thrift Saving Scheme,
Cooperative Society etc has its own advantages and so does the formal sector too.

Advantages of formal sources of finance:

a) It Provides proper guidelines and documentation of loan.
b) There is business advisory support from the banks that is lending.
c) Helps the entrepreneur to stay focused on the business because of interest rates.

Disadvantages of informal sources of finance:

a) Accessing loan from the formal sources has a cumbersome procedure that must be
fulfilled.
b) The entrepreneur may not have the required collateral by the formal sources of finance
 c) There is also a detailed documentation requirement which usually takes time to fulfil
and as such, there will be delay in accessing the fund.
d) There are also charges to be incurred before accessing the funds in the formal sector.

Advantages of informal sources of finance:

a) It helps entrepreneurs to have easy access to funding.
b) Less documentationis involved in loan process.
c) Entrepreneurs do not stand the risk of loss of assets or business to the institution.
d) It does not require collateral from the entrepreneur
e) Its process is not cumbersome.

Disadvantages of informal sources of finance:

a) It is more expensive in terms of interest rate that the formal sources
b) There is no any form of business advisory support from the sector to the lending
c) The entrepreneur may not be serious in terms of repayment since the money may
be from family and friends.

3.0 Inherent Problems faced by Entrepreneurs

In developing economies of which Nigeria is one, it is not out of place to say that Nigeria also has
a valid traceability and share of the inherent challenges that have continued to act as a problem
towards its entrepreneurial development as Anderson (1982), Onugu (2005), Ács and Virgill
(2009), Ogundele and Abiola (2012) and Adejumo & Olaoye (2012) among other notable scholars
contend that the following, though not limited to these, are inhabited in the Nigerian economy as
deterrent against the enhancement and growth of its entrepreneurial development and has
continued to operate as problems hampering entrepreneurial progress. They include:

a) Poor managerial skills: From interaction with most entrepreneurs, the common problem is poor
leadership. One main reason for this is lack of training and poor capacity building. Most people
go into businesses without adequate knowledge or entrepreneurial skills on how to run
businesses. That is why the recent government initiatives on capacity building through the
various platforms such as BIG/GEM of the Federal Ministry of Trade and Investment and
YouWin connect of the Federal Ministry of Finance must be commendable. These trainings are
very key for government to achieve the objectives of the various grants that will be disbursed
under the schemes.

b)Poor or inadequate infrastructure: The poor state of infrastructure in the country has been a
major obstacle to the growth of entrepreneurs. Only few entrepreneurs can survive without
power. The epileptic or irregular power supply has contributed significantly to the high cost of
doing businesses in the country. Apart from power, lack of good access roads and other social
amenities have also hindered the growth of SMEs.
 c) Lack of access to finance: Most entrepreneurs find it difficult to access funds or capital. Most
Nigerian banks do not support start-ups and even existing businesses do not have the required
collateral. In addition, the high interest rate is always a burden for entrepreneurs that go to non-
conventional banks (informal source of finance). This Lack of easy access to funding/credits
and absence of long-term finance to fund capital assets is regarded as another major problem
bedevilling the process of entrepreneurs in the country. Without sufficient funds, business
operations will be difficult if not completely impossible. The problem of finance could be as a
result of high cost of initial capital, inability to obtain the required funds and weakness in
financial planning and management.

d)Unfair competition: Most entrepreneurs in Nigeria cannot compete with items or products from
other countries especially China and other Asian countries. The activities of smugglers have
also not helped in this area because Nigeria has been turned into a ground dumping for fake
and sub-standard goods. When this is combined with the high cost of production in the
country, locally made goods can hardly compete in pricing.

e) Government Bureaucracy: Another challenge faced by entrepreneurs is administrative

bottlenecks of various government agencies like Corporate Affairs Commission (CAC),
National Agency for Food and Drug Administration and Control (NAFDAC), Standards
Organization of Nigeria (SON) and Nigeria Customs Service (NCS) etc. For instance, getting
NAFDAC approval for food item or drug take an unpredictable duration. Even with the recent
government initiatives on ease of doing business, a lot still needs to be done to address this
issue.

f)Multiple Taxes and Levies: entrepreneurs are subject to so many taxes and levies from the local
government to the federal government. Moreover, many agents are involved in the collection
of taxes and levies thereby giving room for unauthorized levies and taxes. The impact of this
on the operational costs of SMEs cannot be overemphasized Government needs to streamline
these taxes if entrepreneurial ventures must remain.

g) Inconsistent Economic Policy and weak implementation: Political instability in less

developed countries like Nigeria is a major impediment to the growth of entrepreneurial
ventures. Good policies are abandoned midway and where they are not, the implementation
is poor because of lack of buy-in.

h) Low Financial Inclusion or Exclusion: Financial exclusion has manifested prominently in

Nigeria with the bulk of the money in the economy staying outside the banking system. The
issue of financial exclusion has therefore been a major economic challenge that has received
the attention of the various governments over the past four decades yet the impact is little.
This has remained another major problem to
 i) Corruption of Government Authorities: Widespread corruption and harassment of start-
ups by government officials with illegal levies and charges, taxes and unholy restrictions; in
addition to the multiplicity of government regulatory agencies thereby exorbitantly
increasing the operation costs for entrepreneurs.

j) Inadequate and Incompetent Manpower: In developing countries, entrepreneurs usually

do not only have shortage of manpower, the ones they have are not adequately trained for
the job. The indigenous entrepreneurs are yet to accept the fact that qualified workers, are
the greatest assets for any business and any investment on employees’ skills improvement,
is invaluable in the growth of the business.

k) Sociological and Latitudinal Influences: The unconventional ways in which many businesses
are being carried out, coupled with the general unethical practices of businessmen, these can
hinder entrepreneurship. For example, product are poorly designed with poor quality,
consequently, there are preference over products made in other countries not minding their
prices and quality. Social vices such as constant union strike, students’ unrest, tribal clashes,
fuel scarcity, constant traffic jam, ethnic clashes, religious differences, human right
infringement etc, also adversely affect the development of entrepreneurship.

.
l) Poor Manpower Training and Development: the consequences of managerial
inefficiency results to poor manpower training and development. A typical entrepreneur in
an underdeveloped economy does not see any need to spend money on manpower training
and development. They consider it a waste of resources recruiting well trained and
experienced personnel for the management of their enterprises, rather, they prefer to employ
their close relations on whom they will not spend much in maintaining. Also, high labour
turnover is very rampant in the indigenous enterprises due to lack of good relationship
between entrepreneurs and their workforce. This often has adverse effect on the operations
of the indigenous enterprises.

m) Entrepreneurs’ Personal Problems: Most indigenous entrepreneurs engage in sole trade

businesses, that may have started from their parents’ occupation, which do not go beyond
farming, trading, craftsmanship, local manufacturing and so on. These businesses do not
grow or expand beyond their traditional scopes. Other personal problems include marrying
many wives and having many children and catering for members of the extended families.
Inferiority and superiority complexes, often affect the progress of entrepreneurs as well, just
as emotional instability, resulting from immaturity and lack of experience on the part of the
entrepreneur can negatively affect his business.

4.0 Ways for Entrepreneurs to Overcome their Numerous Inherent Problems

a) For Poor Managerial Skills, entrepreneurs can overcome this by ensuring that they
attending seminars, webinars, workshops, training, conferences, etc. on practical
management. They should Do well to acquire more education as well as read about other
entrepreneurs in order to improve on their managerial skills on job. Also, entrepreneurs
should take very seriously the recent government initiatives on capacity building through
the various platforms such as BIG/GEM of the Federal Ministry of Trade and Investment
and YouWin connect of the Federal Ministry of Finance. These trainings are very key for
government to achieve the objectives of the various grants that will be disbursed under the
schemes.

b) Also, Entrepreneurs should take advantage of the various programmes and institutions
established by the federal government to provide the needed capital for the financing of
their businesses. Some of those programmes and institutions include the National
Directorate of Employment (NDE), the National Poverty Eradication Programme
(NAPEP), and most recently, the establishment of Micro-finance Banks to provide capital
majorly for entrepreneurs and the CBN programme with Nisal Microfinance bank Limited
for entrepreneurs and start-ups businesses.

c) Entrepreneurs need to understand the importance of manpower development.

Consequently, they should ensure that the manpower needed for the success of their
entrepreneurial business is properly trained and developed. The employees should be
allowed to attend workshops and take courses that would enhance their productivity,
innovative skills and creativity.

d) Entrepreneurs are expected to be focussed and more than ever, be devoted to their ideas
and ensure that their personal problems do not, in any way, interfere with their businesses.
This way, they will grow and be able to sustain their businesses.

e) Entrepreneurs should engage in proper planning and rigorous and effective marketing.
This will bring about increase demand on their products. It will also be able to make them
forecast the market and expand with the market trend. Proper planning will guide the
entrepreneur on what to do and how to it in order to thrive in the market.
f) Entrepreneurs should also show creativity in their product packaging and production
processes. They should avoid using outdated technology and must continually improve on
their product design.

g) Entrepreneurial forums: Formation of well-structured and organized forums to

coordinate and represent the interests of entrepreneurs both at the national and local levels,
 liaising with the government on the issues of policy formulation and reformation will
serve as a good starting point to provide a conducive environment for businesses to thrive.

h) Finance: Certain policies and structures aimed towards making loans and financing
opportunities available to entrepreneurs are already in place in Nigeria, examples include
SMEDAN a National body established to promote and facilitate growth of
entrepreneurship in Nigeria. Banks in Nigeria as a matter of policy also set apart a
certain percentage of their profit on a yearly basis to serve as source of capital for
entrepreneurs. However, corruption within these bodies make it difficult for beneficiaries
that do not have personal affiliations with the bodies to have access to the available
revenues. It is therefore important that the government establish internal monitoring and
control within these bodies to ensure that they are functioning to achieve the purpose for
which they were established.

i) Capacity building: Introducing entrepreneurship opportunities, education and training in

higher institutions of learning further supported through establishment of career centres to
provide counsel to growing entrepreneurs is one sure way in Nigeria to improve potential
entrepreneurs’ success as this would ensure that young Nigerians develop a mindset of
independence, creativity and innovation. Backing this idea up with government legislation
will ensure that it is incorporated in all institutions of learning as part of their programs
and courses. Extending education and training to the illiterate population which represents
a large pool within the entrepreneurial community in Nigeria, as well as Regular training,
seminars, research and development both for management of both their business and
personnel will ensure that all involved are well prepared for maximum productivity.

j) Regulations /Internal Control: Ensuring that SMEDAN, HAS, ETDP, SBA etc., are
efficiently and effectively carrying out the services which they were established to
undertake with drive and determination. And that would require setting up regulatory
bodies as well as internal control and auditing system as is the case in developed countries
to ensure that corruption is curbed to the minimal to zero level, where people are held
accountable for their actions, so that services are provided as required even in the absence
of the higher authorities.

k) Government incentives: Creating a competitive environment where businesses thrive by

encouraging and supporting business ideas among students and young school leavers
through provision of finances and connection to already thriving business networks where
their ideas could be implemented would motivate young Nigerians to come up with bright
ideas. Other incentives include provision of affordable basic amenities and infrastructural
facilities to ginger marketing performance, modern technology machineries and
equipment required for effective and efficient production, favorable policies, free or
reduced custom and excise duties for local and foreign investors, favorable immigration
 and repatriation laws for foreign investors, strict adherence to taxes and levies, consistent
supply of electricity, encouraging buying local products.

l) System Changes: At the base of all the problems facing entrepreneurs listed in this
research is widespread corruption, therefore for sustainable solutions within the various
sectors which are responsible for supporting growth and development of entrepreneurship
to occur, the Nigerian government needs to fight corruption at all levels of the system.
Strategies should be devised by experts to fight factors such as inflation and political
instability so that entrepreneurs are not be affected by the negative impact of these
economic ills. Ensuring political stability will lead to peaceful co-existence in the nation
to encourage expansion in other regions of the country.

5.0 Conclusion
In conclusion, funding sources has remained a great challenge to entrepreneurs as well as one of
their major constraints. Scholars have argued that both the formal and informal sources are very
important sources to entrepreneurs one time or the other, depending on the timing and need of the
particular entrepreneur.

The problems and solutions to the problems encountered by entrepreneurs in Nigeria require a
collective effort by all the stakeholders’ concerned. A nations economic development depends on
the successful entrepreneurship combined with the forces of established corporation. Martin
Buchholtz (2018) wrote that “In the theory of Economic Development” Schumpeter stated the
responsibility of the entrepreneurs as prime cause of economic development. Entrepreneurs are
backbone part of every economy, developed or developing country and should be given proper
attention to their business for their economic growth. Nigeria government should therefore imitate
developed countries by providing support measures in encouraging entrepreneurs in the country
because of their importance in the society.

References
Akeredolu, A. E. (1977) The Solution of Private Indigenous Entrepreneurship in Nigeria.
Ibadan: Ibadan University press Ltd.
Bailetti T. (2012). Technology Entrepreneurship: Overview, Definition, and Distinctive
Aspects. Technology Innovation Management Review, 2(3), 5-12.
Baumol, W. J. (1990). Entrepreneurship: Productive, Unproductive and Destructive. Journal of
Political Economy, 98(5), 893–921.
Buchholtz, A. K. (2018). Entreprenurship and Business Ethics. (E. Heath, B. Kaldis, & A.
Marcoux, Eds.) New York: Routledge.

Carland, J.W., Hoy, F., Boulton, W.R. & Carland, J.C. (1984). Differentiating Entrepreneurs
from Small Business Owners: A Conceptualization. Academy of Management Review, 9
(2), 354 - 359.

CIBN. (2019). Small and Medium Enterprises: Management and Development. Lagos: CIBN
Press Ltd.

ICAN. (2014). Management, Governance and Ethics (1st ed.). United Kingdom: Emile Woolf
International.

Ebbena, J and Johnson, A. (2006). Bootstrapping in Small Firms: An Empirical Analysis of

Change Over Time. Journal of Business Venturing, 21(6), 851-865.

Emerson, J. and Twerksy, F. (Eds.) (1996). New Social Entrepreneurs: The Success, Challenge
and Lessons of Non-profit Enterprise Creation. San Francisco: The Roberts Foundation.

Gartner, W.B. (1989). “Who is an Entrepreneur?” is the Wrong Question. Entrepreneurship,

Theory and Practice, Summer: 47 - 68.

Okeke, M. I, and Eme, O. I. (2014). Challenges Facing Entrepreneurs in Nigeria. Singaporean

Journal of Business Economics and Management Studies, 3(5), 18-34.