Sources of Finance for

Small-Medium Sized
Enterprises
Chapter 8&9

Definition of SMEs
Sales turnover and number of full-time employees are two criteria
used in determining the definition with the “OR” basis of follows:

• For the manufacturing sector, SMEs are defined as firms with sales
turnover not exceeding RM50 million OR number of full-time
employees not exceeding 200.

• For the services and other sectors, SMEs are defined as firms with
sales turnover not exceeding RM20 million OR number of full-time
employees not exceeding 75.

Source: SME Corp. Malaysia (2021)

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 i. Are family owned and operated.
ii. Operated in rented small premise or backyard
of the house.
iii. Have moderate to aggressive expansion or
growth.
iv. Have insufficient capital because capital comes
from the owners. The limited capital and
Characteristics resources restrict the expansion.
of SMEs v. Are labor intensive but employ only a few
skilled workers as employees learn their skills
from their senior.
vi. Use simple technologies and have low research
& development (R&D) capabilities resulting
difficulties in upgrading the technology and
diversify into new product lines and processes.

vii. Involve little specialised management. Many

managers and entrepreneurs who operate SMEs
have limited skills and managerial capabilities.
They have little exposure to scientific techniques
and management technology such as ‘Just In
Time’ system. Hence, they do not have the
technology and know how to automate and
modernise their operation. They also practice a
Characteristics personalised and informal style in managing
their employees.
of SMEs viii. Produce for the domestic market and have little
knowledge and experience in the exporting
market. They focus on the local market as they
are unable to meet the demands and
competition of international export market.
ix. Have insufficient collateral such as property
charged to the bank to raise bank loans.

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The Nature of Financing Problem of SMEs
• SMEs in Malaysia are facing stiff (hard and tough) competition
and challenges.
• If the SMEs continue to ignore the global trends and lack of
technology and knowledge, eventually, they will lose out.

Lack of Funding and Inadequate

information maturity gap security

• Most of the management teams of the SMEs

are family members.
• They often use traditional ways of managing
their business.
• They may lack professionalism in the running
of the business.
(A) Lack of • Staff training and development is not an
Information emphasis.
• Due to these challenges, the management
team of SMEs are often facing the problem of
lack of information.
• They do not have sufficient information
concerning the new technology, market, new
process and overseas market.

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 • Most of the funding of SMEs are from
the owners themselves and their friends
or relatives.
(B) Funding • This limits the sources of fund.
and maturity • The owners are often not wealthy
gap enough to provide additional finance
when the business needs it.

• Due to the limitation of resources, SMEs

often find it difficult to provide security
(C) or collateral to the banks for the loans
and other financing facilities.
Inadequate
• They seldom have land, property, fixed
Security deposit or other types of tangible
assets that can be used as a security for
a loan.

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  The capital markets are not accessible to SMEs, but
only to large companies.
 The owners are often not wealthy enough to
provide additional finance when the business
Other needs it.
 Banks are cautious about lending to SME although
Financial they are the main source of new debt finance.
Problems in  SMEs can obtain some trade credit, but suppliers
might be reluctant to give credit beyond a certain
SMEs amount, because of the potential credit risk or bad
debts.
 SME might obtain capital equipment on a lease,
but leasing and hire purchase finance are limited
to the acquisition of certain types of fixed assets
only.

The Response of Government Agencies and

Financial Institutions to SME Financing Problems
• The government established SME Corporation (previously known
as SMIDEC - Small and Medium Industries Development
Corporation) to promote the overall development and
competitiveness of SMEs in the country through financial
assistance, technical supports, advisory services, human resources,
etc.

• SMEs are further supported by Bank Negara Malaysia (BNM), which

has allocated special funds and loan schemes for them. BNM has
set up a Credit Guarantee Corporation Bhd (CGC) to become a
corporate guarantor to the SMEs. In addition, SME Bank has also
been set up to provide loan and financing facilities to the SMEs as
well.

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The Response of Government Agencies and
Financial Institutions to SME Financing Problems
• Government aid for SMEs
• Advice & Support (subsidised training for their employees to
increase their productivity)
• Tax incentives (reduce tax payment)
• Loans (with lower interest rate)
• Finance (often available from central or regional government to
businesses that are willing to invest in a particular area or industry)
• Tax concessions (tax relief or granted for various purposes like R&D)

The Response of Government Agencies and

Financial Institutions to SME Financing Problems
• Commercial banks are also encouraged to offer practical and reasonable
loan package to SMEs. Banks can help finance SMEs through the
following ways:
• Develop innovative loans package to cater to the needs of SMEs.
• Package SME loans together with other financial schemes such as those schemes
offered by Credit Guarantee Corporation (CGC) to make the loan package more
competitive.
• Have more awareness seminars and road shows together with SMIDEC to promote
financing package to SMEs.

• Initiatives from Government & Private Sectors for SMEs In Malaysia (Covid-19 Outbreak)
• https://www.favebiz.com/blog/initiatives-from-government-private-sectors-for-smes-in-
malaysia-to-battle-covid-19

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Sources of Finance for SMEs

Overdraft & Trade

Owner Financing Equity Finance
Credit (refer to Chapter 6)

Business Angel Venture Capital Hire Purchase (refer to

Chapter 7a)

Leasing (refer to Chapter Factoring (refer to Second-Tier Listing

7a) Chapter 6)

Owner Financing
• Finance from the owners’ personal resources or those of
family connections is generally the initial source of finance.
• At this stage, owners may not have sufficient physical assets to
be pledged as collateral, thus external funding may be difficult
to obtain.

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Equity Finance
• Equity financing is the method of raising capital by selling
company stock to investors.
• Businesses with few tangible assets will probably have
difficulty obtaining equity finance when they are formed.
• However, once small firms have become established, they do
not necessarily need to seek a market listing to obtain equity
financing as shares can be placed privately.
• Small companies may find it difficult to obtain large sums by
this means.

Business Angel Financing

• Business angels are private investors who invest in unquoted
(not listed on a stock exchange) small and medium sized
businesses.
• They provide not only finance but experience and business
skills.
• Business angels invest in the early stage of business
development and filling the equity gap.

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Venture Capital
• A businessman starting up a new business will invest venture
capital of his own, but he will probably need additional
funding from a source other than his own pocket.
• The term “venture capital” is associated with putting money
into the business in the return of equity stake.

Venture Capital: Example

• Assuming that you have RM500,000 cash. Your friend wants to start up a new
business. He is short of capital and invites you to joint venture into his new
business.
• You have no experience in running this new business but you want to participate in
this new business because you believe that the return of the business is higher than
fixed deposit in the bank.
• Finally, you have decided to invest the RM500,000 cash into your friend’s business
in the return of 500,000 ordinary shares @ RM1 each.
• You are not interested in how the company is running but you are interested in the
potential return.
• Once you have obtained the return, you will exit or sell back the shares to the
company.
• In such a scenario, you are said to be a venture capitalist.

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Main Features of Venture Capital
• The risk is normally higher, it may take a long time before any profits and
returns materialised. But there is also a prospect of high risk, high return.

• A venture capitalist will require a high expected rate of return on

investments to compensate for the high risk.

• A venture capital organisation (e.g. OSK Venture Capital Sdn Bhd) will
normally invest in a company for a temporary period of time only. Once
they have achieved the rate of return, they will pull out from the business
and realise the profits.

• Venture capitalist will acquire a percentage of equity (holding shares) in

the business entity.

The Common Types of Venture Capital

Business When the business has just been set up and the owners are
short of capital, then venture capitalist would be able to help
start-ups by providing funds.

Research and The venture capitalist will provide development capital for a
company to develop its business such as invest in a new
development innovative product, new market, etc.

Management
A management buyout is the purchase of all or part of a
buyouts business from its owners by its managers.

Business A private company might want to invest more capital in an

expansion programme, but unable to raise the funds internally
expansion or from a bank loan. It might therefore seek venture capital.

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Areas of Concern to a Venture Capitalist
• There must be a well produced and convincing business plan. This should set out
the future plans for the company, including how it proposes to use its new
investment capital and the profits it will expect to make.

• The quality and commitment of the management team. It is important to have

reassurance that the key management will be committed to the company (e.g.
offering key managers an equity interest in the company.)

• The venture capitalist will want to know what its likely exit route will be, e.g an
idea whether it will seek a stock market listing (going public).

• Having certain financial control in place. E.g to have some system for monitoring
and safeguarding the investment.

Advantages of Venture Capital

• It makes funding and expertise available to the company.
• Large sum of equity finance can be provided.
• The business does not stand the obligation to repay the
money.
• In addition to capital, it provides valuable information,
resources, technical assistance to make a business successful.

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Disadvantages of Venture Capital
• As the investors become part owners, the autonomy and
control of the founder is lost.
• It is a lengthy and complex process.
• It is an uncertain form of financing.
• Benefits from such financing can be realised only in the long
run.

Second Tier Listing

• Second tier listing is referring to listing the company stock in the LEAP market to
source funds from the public.
• The requirements for second tier listing are lesser than main board which is
suitable for SMEs to source fund.
• One of the examples is the Alternative Investment Market (AIM) listing in the U.K.,
it is primarily designed as a separate market for the shares of smaller, growing
companies that are not yet ready for a full listing on the main market.
• The advantages of second tier listing is that the company is able to obtain
cheaper source of fund from the capital market and listing in second tier can
serve as a spring board to transfer the listing status to main board.
• The limitations are the costs involved. Listing involves high cost and there are
many regulations needed to be complied.

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LEAP Market
• The Leading Entrepreneur Accelerator Platform (LEAP) Market was
officially launched on 25 July 2017.
• It is a new listed market in Bursa Malaysia positioned to provide SMEs
greater access to the capital market.
• LEAP Market is intended to broaden the funding options available to
companies that are too small to list on the Main Market or ACE Market.
• The market is positioned to fill the gap between capital market and start-
ups. It is also a platform for companies to showcase their companies.

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