FINANCING TECHNOLOGY-BASED SMEs IN MALAYSIA: PRACTICES AND PROBLEMS Ismail Ab. Wahab Malaysian Entrepreneurship Development Centre (MEDEC) Faculty of Business Management Universiti Teknologi Mara, 40450 Shah Alam, Selangor, Malaysia [email protected] uitm. edu. my Siti Zahrah Buyong Entrepreneurial Research and Support Centre (ESRC) Faculty of Business Management Universiti Teknologi Mara 40450 Shah Alam, Selangor, Malaysia [email protected] uitm. edu. my ABSTRACT
This paper reports the empirical study that examined the current financing practices and problems of technology-based small and medium enterprises (TBSMEs) in Malaysia. The study shows that, in addition to entrepreneurs’ personal savings and profits retained in the firms, most Malaysian TBSMEs have approached external sources to finance business development. Firms that use external finance rely heavily on debt finance. This empirical evidence confirms the “pecking order theory” as most of the firms follow some preferences in financing.
The heavy reliance on debt finance provides an evidence of the existence of an ‘external equity gap’ among TBSMEs. Whilst most firms which applied for financial assistance managed to obtain some amount of funding, there is evidence of some deficiencies in the funding market serving TBSMEs. The amount obtained is insufficient to finance research and development and business expansion, and some financiers require an unreasonable amount of collateral. Keywords: Financing, small and medium enterprise, small business, technology-based SME, Malaysia
INTRODUCTION Technology-based small and medium enterprises (TBSMEs) are an important source of both product and process innovation. These enterprises have an important role to play in the emergence of new technology-based sectors of industry and in preserving and enhancing the economic competitiveness of the established industries. It has been acknowledged that having a strong domestic technology sector is essential to the long-term health of an economy (Standeven, 1993).
Over the past decades, many developments have occurred in public and private sector markets serving SMEs in Malaysia. The Malaysian government has established a number of specialised financial institutions and funding schemes aimed at ensuring that SMEs have access to credit at reasonable cost, quickly and with a minimum of paperwork. Despite the wide range of finance options, it is commonly reported that some SMEs have been facing difficulties in obtaining external finance (e. g. Mahmud, 1981; Chee, 1986 & 1992; Salleh et al. , 2004).
This paper reports the empirical study that examined the current financing practices and problems of Malaysian TBSMEs in terms of the patterns and sources of external finance and the existence of difficulties in raising external finance. SME FINANCING IN MALAYSIA Baseline Census of Establishments and Enterprises 2005 reported that SMEs accounted for 99 percent of total business establishments, and contributed to 38 percent of total output of these establishments. In terms of employment, SMEs accounted for 55 percent of total workforce of business establishments in the agriculture, manufacturing and services sectors.
Since 1996, both Seventh Malaysia Plan (1996-2000) and Eighth Malaysia Plan (2001-2005) have introduced key support measures, notably fiscal incentives, and offered additional programmes to facilitate the expansion and modernisation of SMEs. During Eighth Malaysia Plan, more than 4 billion ringgit had been approved for the development of SMEs. A total of RM577 million was allocated from this amount for financing SMEs. The launching of Ninth Malaysia Plan (2006 – 2010) is the latest attempt by the Government to plan comprehensively for the development and promotion of SMEs.
Over the five-year period, the Government will promote SMEs with high innovation capabilities to become part of the global supply chain. The National SME Development Blueprint has been launched in 2006. A number of programmes have been implemented in order to accelerate the development of SMEs. These programmes are aimed at strengthening the enabling infrastructure to support SME development; building capacity and capability of SMEs and enhancing further SMEs’ access to financing. FINANCING TECHNOLOGY-BASED SMEs
The availability of finance is a key factor in the development of technology-based firms (Roberts, 1991). It has been acknowledged that the financing needs of these firms can be particularly great as a result of the high costs associated with technological product and process development and the long lead time required to transfer the technology to the market (Van Auken, 2001). The amount of finance required to develop and launch a technology-based product is between ten to twenty times higher than the initial research and development and this amount is likely to increase further in the future (Standeven, 1993).
Thus, the availability of financing will become a more crucial issue for the growth of TBSMEs. During the start-up stage, TBSME access to established sources of external finance is limited; hence, most entrepreneurs rely on their own resources, supplemented by funds from relatives and friends (Bollingtoft et al. , 2003). External funds providers usually cannot provide finance to support the development in the absence of any tangible support from the entrepreneurs. The financing needs of the business will normally change once the entrepreneurs are able to demonstrate that there is a profitable opportunity.
In order to grow, the business needs additional funds to finance plant, equipment and working capital. Inadequate availability of external finance has been identified as one of the factors that impedes SME growth (Hay & Kamshad, 1994). In the early stage, when there is high uncertainty, the primary source of funds is from internal source, i. e. from retained earnings. However, retained earnings in this stage of business development are relatively small, and as a result, there is a danger of under-investment and poor project selection (Berkovitch & Greenbaum, 1991).
During start-up and early stages, since most firms have neither established reputations in the market nor developed clear business models, they face difficulties in accessing bank loans (Boocock & Ab. Wahab, 1997). Furthermore, most SMEs find difficulties in providing collateral when seeking financing from banking institutions (Bank Negara Malaysia, 2006). The difficulties faced by SMEs in obtaining external finance have been the subject of government-sponsored and academic research for more than seventy years.
In an important early study in the United Kingdom, the Committee of Inquiry on Finance and Industry identified a lack of ‘long-dated capital’ (known as ‘Equity Gap’) to finance the growth of SMEs (MacMillan, 1931). Since that initial Report, the adequacy of external finance for SMEs has continued to be an issue for debate across the globe (e. g. University of Cambridge, 1992; Boocock & Ab. Wahab, 2001; Behr & Guttler, 2007; Tambunan, 2007). The funding sources available to TBSMEs are now explored.
The main sources of finance are commonly categorised into three categories: government-backed financing schemes, debt finance, and equity finance. Government-backed Financing Schemes The Malaysian Government has established a number of funds, through the Central Bank or Bank Negara Malaysia (BNM), administered by various ministries and agencies. Such funds offer reasonable cost finance to rehabilitate ailing business and promote investment in priority sectors. Under its National SME Development Blueprint 2007, the Government provides greater access to financing for SMEs.
As of December 2007, a total of RM128 billion of financing was approved by the banking and development financial institutions to more than 625,000 SME accounts (Bank Negara Malaysia, 2007). Several government grants have been set up for TBSMEs that require financing particularly at the early stage. The available government grants include Technology Acquisition Fund, Commercialisation of Research and Development Fund, Technology Acquisition Fund, MSC Research and Development Grant Scheme, and Industry Research and Development Grant Scheme.
Debt Finance Debt finance can be obtained from formal and informal sources. Cosh & Hughes (1994) follow Myers & Majluf (1984) in suggesting that the financial structure of the vast majority of SMEs is consistent with a ‘pecking order theory’ – internal debt and equity is preferred to external debt, with external equity considered as a last resort. The pecking order theory also suggests that entrepreneurs are reluctant to organise their finances in order to have an optimal capital structure in terms of debt to equity ratio.
Most entrepreneurs are more inclined to use financing options that can ensure their control on their businesses; thus, they prefer to choose debt rather than external equity (Ismail & Abdul Razak, 2003). Formal sources of external debt for SMEs in Malaysia have historically been dominated by the commercial banks (Chee, 1986; Fong, 1990; Boocock & Ab. Wahab, 1997). It has also been found that informal sources of external finance such as trade credit, leasing and factoring are providing an increasing proportion of the needs of SMEs (Bank Negara Malaysia, 2006; Boocock & Ab.
Wahab, 1997). Besides the commercial banks and other informal sources, a variety of government-sponsored institutions extend credit facilities to SMEs. They include the development financial institutions such as SME Bank, Malaysian Industrial Development Finance, Export-Import Bank of Malaysia, Agro Bank Malaysia, and Bank Pembangunan Malaysia. Equity Finance Equity finance, or equity capital, is also important in financing TBSMEs. Previous studies found that the most important source of equity for Malaysian SMEs is the owners’ personal savings (Md.
Salleh, 1990; Levy, 1993), internally generated profit (Roberts, 1991, Austin et al. , 1993), and other internally generated funds and funds sourced from friends and family members (Bank Negara Malaysia, 2006). Venture capital, another source of equity finance, represents an important source of externally generated equity for SMEs in developed countries seeking to expand (Boocock, 1989; Hall, 1989). Indeed, venture capital has proved to be a superior form of finance in innovative industries (Audretsch & Lehmann, 2004).
However, venture capital financing in Malaysia is still in its infancy. Bank Negara Malaysia encouraged the banks and merchant banks to get directly involved in this industry as far back as the early 1980s, but official attempts to promote growth in the supply of venture funds have not been a success (Boocock, 1995). On the demand side, impediments to growth include: a reluctance to dilute ownership; the relative ease of obtaining bank credit; and a general lack of awareness of the role of venture capitalists (Lin, 1994; Bank Negara Malaysia, 1994 & 1995).
METHODOLOGY Sample and Data Collection The sample for this study consisted of technology-based SMEs. To date, there has been no universally accepted definition of technology-based enterprises. The term ‘technology-based’ used in this study adapts the definition used by Brierly (2001). He defined technology-based enterprises either as enterprises whose products or services depend largely on the application of scientific or technological knowledge, or as enterprises whose activities embrace a significant technology component as a major source of competitive advantage.
In this study, a small and medium enterprise is defined as an enterprise with full-time employees not exceeding 150 or with annual sales not exceeding RM25 million (manufacturing) and an enterprise with full-time employees not exceeding 50 or with annual sales not exceeding RM5 million (services and ICT). Based on these definitions, 462 TBSMEs were identified from the listing obtained from the Small and Medium Industries Development Corporation (SMIDEC). Out of the total number of 462 respondents selected, 94 questionnaires were completed and usable for analysis, representing a response rate of 20 percent.
In preparing the questionnaire, some of the questions utilised in the previous studies have been adapted (such as Mahmud, 1981; Austin et al. , 1993). The rationale for basing the questionnaire on these studies is that some items used in the studies have been demonstrated to be reliable and valid for measuring certain variables that the researchers are directly concerned with in this study. In the process of preparing the questionnaire, the principles and procedures suggested by Sudman & Bardburn (1982) and Oppenheim (1992) have been used.
As suggested by Sudman & Bradburn (1982), a booklet format questionnaire was used in order to achieve a good response. In order to determine the potential effectiveness of the research instrument, and to ensure that it met the objectives of the study, a pre-test and pilot study of the questionnaire was conducted. A number of changes were incorporated to enhance return rates. Measures There are four main variables of primary interest to this study: the need for external finance, the patterns of external finance, the use of sources of external finance, and the difficulties in obtaining external finance.
These variables are known as dependent variables as they relate to the financing practices and problems of TBSMEs. The ‘need for external finance’ is a categorical variable and was measured by asking the respondents to indicate whether they had approached external sources of finance. The ‘pattern of external finance’ is a continuous variable and was measured in terms of number of sources of external finance used and current level of debt to equity ratio of the respondent firms. The ‘use of sources of external finance’ is a categorical variable and was measured by asking the respondents to indicate the sources they had used.
The use of each source of external finance was coded as ‘no” and “yes’. The existence of ‘difficulty in obtaining finance’ is a categorical variable and was measured by asking the respondents to indicate whether they faced ‘no difficulty’ or ‘some difficulties’ in the process of applying and obtaining the external finance. Two key independent variables are used in an attempt to explain the financing practices and problems of TBSMEs: firm’s characteristics and entrepreneur’s characteristics.
The firm’s characteristics are measured in terms of two elements relating to the firm itself. First, the elements which refer explicitly to the characteristics of the firm, i. e. age of firm (AGEFM), size of firm (SIZEFM), and stage of business development (STAGE). Second, the elements which reflect decisions made by the entrepreneur at the start or during the course of his/her business, i. e. size of start-up capital (STRTUP), legal form (INCOR), and existence of business plan (BPLAN).
Age of firm is measured by the number of years since the firm was established up to the year of the study. This ordinal variable is grouped as ‘5 years and below’, ‘6 to 10 years’, ‘11 to 15 years’, ‘16 to 20 years’, and ‘21 years and above’. Size of firm is measured in terms of employment size, i. e. number of full-time and part-time employees working in the firm. This ordinal variable is grouped as ‘1 to 25 employees’, ‘26 to 50 employees’, ‘51 to 75 employees’, ‘76 to 100 employees’, and ‘101 employees and above’.
Stage of business development is categorized into three categories: ‘start-up stage’ (less than five years old), ‘early stage’ (between five to ten years old) and ‘later stage’ (more than ten years old). Legal form is categorized into two categories: ‘unincorporated firm’ (registered as a sole-proprietorship or a partnership) and ‘incorporated firm’ (registered as a private limited company). Business plan is defined as a written document which contains an analysis of the firm’s current position, where it would like to be in the future, and how it plans to get there.
The respondent was asked to indicate whether his/her firm ‘did not have a written business plan’ or ‘had a written business plan’. The entrepreneur’s characteristics include age of entrepreneur (AGEEN), gender (SEXEN), marital status (MAREN), education level (QUAEN), training (TRNEN), and work experience (WRKEN). Age of entrepreneur is grouped as ‘21 to 30 years’, ‘31 to 40 years’, ‘41 to 50 years’ and ’51 years and above’. Gender is a categorical variable indicating the respondent’s female or male status.
Marital status, a categorical variable, is categorized as ‘single/divorcee/widow(er)’ and ‘married’. Education level is a four-level variable capturing the highest level of education completed: ‘lower secondary’, ‘secondary’, ‘high school, certificate and diploma’, and ‘degree or equivalent’. Training is related to the entrepreneur’s level of training in the field of business management, and this variable is categorized as ‘no training’ and ‘some training’. Work experience variable is categorized as ‘no work experience’ and ‘had some work experience’.
Descriptive statistics are presented concerning the characteristics of entrepreneurs and their firms, need for external finance, patterns and sources of external finance, and existence and types of difficulties in applying for external finance. A simple bivariate Pearson correlation analysis was used to determine the association between dependent and independent variables. The phi correlation coefficient was used to determine the association between two categorical or nominal variables. THE SURVEY: RESULTS AND ANALYSIS TBSMEs and Their Entrepreneurs Table 1 shows that the majority of the sample firms (91. percent) are private limited companies employing fewer than 25 employees (60. 5 percent). More than half of them (55. 3 percent) had been in business for less than 10 years. Firms involved in automotive and engineering, ICT and telecommunication, and biotechnology and life science sectors account for more than 51 percent of the sample firms. The majority of TBSMEs prepare written business plans (63. 8 percent). Nearly one-half of the sample firms started operations with less than RM100,000, while almost one-third of them started with more than RM500,000.
About one-half (49 percent) of the sample firm are in the later stage of business development, with start-up stage and early stage accounted for 25. 5 percent each. Two-thirds of the sample entrepreneurs are more than 40 years old (Table 2). The vast majority of the sample entrepreneurs are married (93. 6 percent) and most of them are male (83. 0 percent). While most entrepreneurs have not undergone any training programmes in business and management (56. 5 percent), a significant majority of them (63. 9 percent) are university educated.
In terms of work experience, the majority of the respondents (75. 0 percent) had some form of experience in related fields. Need for External finance Most TBSMEs (80. 9 percent) had applied for external finance (Table 3). A significant number of them (19. 1 percent) did not use external finance; the financing was made either through the entrepreneurs’ savings or through profits retained in the business. The study provides evidence that, in addition to profits retained in the business, the majority of TBSMEs in this country have approached external sources to finance business development.
Table 4 illustrates the need for external finance at three different stages of business development. Table 7 demonstrates that the age of firm (AGEFM), employment size (SIZEFM), start-up capital size (STRTUP), and stages of business development (STAGE) of TBSMEs are significantly and positively associated with the external financing need of the firms; the mature and larger firms are more likely than the younger and smaller ones to approach external sources of finance.
The result provides evidence to support the previous findings which showed that the youngest and smallest TBSMEs were more dependent upon internal sources than the mature and larger ones (e. g. Oakey, 1984). A significant positive relationship was revealed between training (TRNEN) and applications for external finance (Table 8), suggesting that entrepreneurs who had undergone training in business and management are more likely to approach external sources of finance. This result supports the previous research findings (e. g. Boocock & Ab. Wahab, 1997). Table 1: Sample Firms’ Characteristics Characteristics |Frequency |Valid |Cumulative | | | |Percent |Percent | |Employment Size | | | | | 1 – 25 employees | 52 |60. 5 |60. 5 | | 26 – 50 employees | 22 |25. |86. 0 | | 51 – 75 employees | 8 | 9. 3 |95. 3 | | 76 – 100 employees | 2 | 2. 3 |97. 7 | | 101 employees and above | 2 | 2. 3 |100. 0 | |Missing |8 |100. | | | | 94 | | | |Legal Form | | | | | Unincorporated (sole-proprietorship & partnership) | 8 |8. 5 |8. 5 | | Incorporated (private limited company) | 86 | 91. |100. 0 | | |94 |100. 0 | | |Age of Firm | | | | | 5 years & below | 24 |25. 5 |25. 5 | | 6 -10 years | 24 |25. |51. 1 | | 11 – 15 years | 28 |29. 8 |80. 9 | | 16 – 20 years | 8 |8. 5 |89. 4 | | 21 years & above | 10 | 10. 6 |100. 0 | | |94 |100. | | |Main Sector of Industry | | | | | Automotive & engineering | 20 |22. 2 |22. 2 | | ICT & telecommunication | 16 |17. 8 |40. 0 | | Biotechnology & life science | 10 |11. |51. 1 | | Health care | 10 |11. 1 |62. 2 | | Electrical & electronic equipment | 8 |8. 9 |71. 1 | | Rubber & plastic product | 6 |6. 7 |77. 8 | | Other technology-based industry | 20 | 22. |100. 0 | | Missing | 4 |100. 0 | | | |94 | | | |Business Plan | | | | | Did not have a written business plan | 34 |36. 2 |36. | | Had a written business plan | 60 | 63. 8 |100. 0 | | |94 |100. 0 | | |Size of Start-up Cost | | | | | RM100,000 & less | 38 |47. 4 |47. | | RM100,001 – RM200,000 | 8 |10. 0 |57. 5 | | RM200,001 – RM300,000 | 4 |5. 0 |62. 5 | | RM300,001 – RM400,000 | 4 |5. 0 |67. 5 | | RM400,001 – RM500,000 | 2 |2. 5 |70. | | RM500,001 & more | 24 | 30. 0 |100. 0 | |Missing |14 |100. 0 | | | |94 | | | |Stages of Business Development | | | | | Start-up stage | 24 |25. |25. 5 | | Early stage | 24 |25. 5 |51. 0 | | Later stage | 46 | 49. 0 |100. 0 | | | 94 |100. 0 | | | | | | | Table 2: Entrepreneurs’ Characteristics | |Characteristics |Frequency |Valid |Cumulative | | | |Percent |Percent | |Age Group | | | | | 21 – 30 years |6 |6. |6. 4 | | 31 – 40 years |26 |27. 7 |34. 0 | | 41 – 50 years |42 |44. 7 |78. 7 | | 51 years & above |20 | 21. 3 |100. | | |94 |100. 0 | | |Gender | | | | | Female |78 |17. 0 |17. 0 | | Male |16 | 83. |100. 0 | | |94 |100. 0 | | |Marital Status | | | | | Single/divorcee/widow(er) |6 |6. 4 |6. 4 | | Married |88 | 93. 6 |97. | | |94 |100. 0 | | |Training in Business Management | | | | | No training |52 |56. 5 |56. 5 | | Some training |40 | 43. |100. 0 | |Missing |2 |100. 0 | | | |94 | | | |Level of Education | | | | | Lower secondary |2 |2. |2. 1 | | Secondary |10 |10. 6 |12. 7 | | High school, certificate & diploma |22 |23. 4 |36. 1 | | Degree or equivalent |60 | 63. 9 | 100. | | |94 |100. 0 | | |Work Experience | | | | | No work experience |22 |25. 0 |25. 0 | | Had some work experience |66 | 75. |100. 0 | |Missing |6 |100. 0 | | | |94 | | | | | | | | Table 3: Need for External Finance | |Need for External Finance |Frequency |Percent | |Did not apply for external finance | 18 | 19. | |Applied for external finance | 76 | 80. 9 | | | 94 | 100. | | | | | |Table 4: Need for External Finance and Stages of Business Development | |Need for External Finance |Stages of business development | | |Start-up |Early |Later | | |Percent (N=24) |Percent (N=24) |Percent (N=46) | |Did not apply for external finance | 41. 7 | 25. | 4. 3 | |Applied for external finance | 58. 3 | 75. 0 | 95. 7 | | | 100. 0 | 100. 0 | 100. 0 | | | | | | Patterns of External Finance Tables 5 and 6 show information regarding the patterns of external finance used by the respondents. Most respondents (23. 4 percent) used four or more sources of external finance.
The respondents were also asked to indicate the approximate level of debt to equity ratio of their firms. Most respondents (36. 2 percent) had debt to equity ratio of 30%:70% (or 2:3). A significant number of respondents (21. 3 percent) had 100 percent equity (without debt). There are statistically significant positive associations between patterns of external finance and the firms’ age (AGEFM), employment size (SIZEFM), size of start-up cost (STRTUP), and stage of business development (STAGE). The results suggest that mature and larger TBSMEs are more likely to depend on a higher number of sources for financing business development (Table 7).
It is also observed that size of firm, size of start-up capital, and stage of business development are significantly and positively associated with the level of debt to equity ratio; implying that the ratio of debt to equity increases as the firms’ size and stage of business development increase. However, most of the entrepreneurs’ characteristics, such as gender (SEXEN), marital status (MAREN), education level (QUAEN), training (TRNEN), and work experience (WRKEN) are not significantly associated with the need for and patterns of external finance (Table 8); only age of entrepreneurs (AGEEN) is significantly associated with the level of debt to equity ratio. The results imply that older entrepreneurs were more likely to have high debt to equity ratio. Table 5: Patterns of External Finance | |Financing Patterns |Frequency |Percent |Cumulative | | | | |Percent | |None |18 | 19. 1 | 19. 1 | |One source |18 | 13. 8 | 32. 9 | |Two sources |19 | 22. | 55. 3 | |Three sources |17 | 19. 1 | 74. 4 | |Four or more sources |22 | 25. 6 | 100. 0 | | |94 | 100. 0 | | | | | | | |Table 6: Debt to Equity Ratio | |Debt to equity ratio |Frequency |Percent |Cumulative | | | | |Percent | |0% : 100% | 20 | 21. 3 | 21. 3 | |10% : 90% | 4 | 4. 3 | 25. 6 | |20% : 80% | 8 | 8. 5 | 34. 1 | |30% : 70% | 34 | 36. 2 | 70. 3 | |40% : 60% | 8 | 8. 5 | 78. | |50% : 50% |10 |10. 6 |89. 4 | |60% : 40% |2 |2. 1 |91. 5 | |70% : 30% |2 |2. 1 |93. 6 | |80% : 20% |6 |6. 4 |100. 0 | | | 94 | 100. 0 | | Table 7: Correlation Between Need for and Patterns of External Finance | |and Firms’ Characteristics | | |AGEFM |SIZEFM |STRTUP |INCOR |BPLAN |STAGE | |Need for external finance |. 293** | . 315** | . 450** | . 068 | -. 029 |. 398** | |Patterns of external finance |. 358** | . 266** | . 457** | . 002 | . 049 |. 415** | |Debt to equity ratio |. 159 |. 272* | .381** | . 102 | . 006 |. 273** | |** Correlation is significant at the 0. 01 level (2-tailed) | |* Correlation is significant at the 0. 05 level (2-tailed) | Table 8: Correlation Between Need for and Patterns of External Finance | |and Entrepreneurs’ Characteristics | | |AGEEN |SEXEN |MAREN |QUAEN |TRNEN |WRKEN | |Need for external finance | . 146 | -. 067 | -. 041 | . 031 | . 211* | . 098 | |Patterns of external finance | . 060 | -. 191 | -. 084 | . 130 | . 021 | -. 093 | |Debt to equity ratio | . 250* | -. 151 | . 038 | -. 144 | . 043 | . 142 | |* Correlation is significant at the 0. 5 level (2-tailed) | Sources of External Finance Most TBSMEs had used bank term loans (71. 4 percent) and overdrafts (55. 3 percent). One-half of the sample firms (50. 0 percent) used hire-purchase (Table 9). A significant number of them used trade credit (38. 6 percent). Only a small number of TBSMEs had resorted to other sources such as government-backed schemes (22. 9 percent), leasing (14. 4 percent), grants (14. 3 percent) and venture capital (11. 4 percent). Only 5. 7 percent of the respondents used factoring. Table 10 demonstrates that an overwhelming majority of TBSMEs in start-up stage are dependent on banks and government financing schemes.
The results show that, among TBSMEs which have obtained external finance, banks are the most important sources of external finance, confirming that banks and other financial institutions are the main providers of funds for TBSMEs. This study also confirms previous studies in showing that short-term finance, particularly overdrafts, is one of the most important sources of external finance among SMEs (e. g. Austin et al. , 1993; Boocock & Ab. Wahab, 1997). The vast majority of TBSMEs do not rely on external equity to finance their business activities. Venture capital financing is rarely considered since there is a lack of awareness of the availability and benefits of this source of finance. Table 11 shows that the age (AGEFM) and size of firms (SIZEFM) are associated with some of the sources of external finance.
Significant negative associations are observed between government-backed financing schemes with the age, size, and stages of business development of the firms, suggesting that younger and smaller TBSMEs are more likely to use government-backed financing schemes. The results also reveal that mature and larger firms are more dependent upon bank overdraft, hire-purchase and factoring. Legal status of the firms (INCOR) has no influence upon the use of various sources of external finance. The study also fails to indicate the importance of business plan (BPLAN) in utilising various sources of external finance. These results confirm the earlier findings by Boocock & Ab. Wahab (1997). Table 9: Sources of External Finance Applied | |(Respondents who applied for external finance) | |Sources |No. of Responses |Percent | | | |(N = 76) | |Term loans from bank/financial institutions |54 |71. 4 | |Bank overdraft |42 |55. 3 | |Hire-purchase |38 |50. 0 | |Trade credit |29 |38. | |Government-backed schemes |17 |22. 9 | |Leasing |11 |14. 4 | |Grants |11 |14. 3 | |Venture capital |9 |11. 4 | |Factoring |4 |5. 7 | Table 10: Sources of External Finance and Stages of Business Development | | |Stages of business development | |Sources | | | |Start-up |Early |Later | | |Percent (N=12) |Percent (N=14) |Percent (N=44) | |Term loans from bank/financial institutions |83. 3 |71. 4 |68. 2 | |iinstituinstitutions | | | | |Bank overdraft |35. 7 |44. 4 |65. 9 | |Hire-purchase |0. 0 |57. 1 |61. | |Trade credit |25. 5 |57. 1 |36. 4 | |Government-backed schemes |66. 7 |14. 3 |13. 6 | |Leasing |0. 0 |28. 6 |15. 9 | |Grants |0. 0 |14. 3 |18. 2 | |Venture capital |16. 7 |21. 4 |6. | |Factoring |0. 0 |0. 0 |9. 1 | |Table 11: Correlation Between Sources of External Finance and Firms’ Characteristics | | | With regard to entrepreneur characteristics, there are significant negative associations between training (TRNEN) and work experience (WRKEN) of respondents and the use of bank overdrafts, suggesting that less educated and less experienced entrepreneurs are more likely to use bank overdrafts (Table 12).
While the use of bank and other financial institutions is significantly and negatively associated with marital status (MAREN) and training, the use of trade credit is significantly and positively associated with training (TRNEN). However, the associations between age (AGEEN), gender (SEXEN) and academic qualifications (QUAEN) of the entrepreneur and the choice of various sources of external finance are not significant. | |Table 12: Correlation Between Sources of External Finance | | |and Entrepreneurs’ Characteristics | | |
Difficulties in Raising External Finance This study reveals that, while most TBSMEs would generally be able to raise external finance, 84. 3 percent of firms seeking external funding had experienced difficulties in terms of shorter loan duration, insufficient financing, collateral requirements, and high interest rates (Table 13 and Table 14). The entrepreneurs, however, did not face problems in preparing business plans. |Table 13: Existence of Difficulties in Applying for External Finance | |Existence of Difficulties |No. f |Percent | | |Responses | | |No Difficulty | 11 | 15. 7 | |Some Difficulties | 59 | 84. 3 | | Total | 70 | 100. 0 | | | | | Table 14: Types of Difficulties in Applying for External Finance | |(N = 59) | |Types of Difficulties |Mean |Standard |Variance | | | |Deviation | | |Duration of loan offered was too short |3. 61 |1. 07 |1. 14 | |Insufficient amount of finance |3. 58 |1. 24 |1. 56 | |Difficulty in providing collateral |3. 46 |1. 30 |1. 0 | |High interest rate |3. 41 |1. 13 |1. 28 | |Difficulty in preparing business plan |2. 73 |1. 05 |1. 10 | |The mean scores for the variables rest on a five-point Likert-type scale, with “1” denoting strongly disagree and “5” strongly agree | |on the variables. | Table 15 shows that, among respondents who failed to obtain external finance, ‘lack of collateral/security’ was perceived by respondents as the only main reason for their failure in securing the finance. Table 15: Perceived Reasons for Failure in Obtaining External Finance | |(N = 6) | |Reasons |Mean |Standard |Variance | | | |Deviation | | |Lack of collateral/security |4. 00 |1. 55 |2. 40 | |Lack of personal capital contribution |2. 67 |0. 52 |0. 27 | |Unsuitable project |2. 33 |1. 03 |1. 07 | |Lack of viability of the project/too risky |2. 00 |0. 89 |0. 80 | |Lack of management competence |2. 00 |0. 89 |0. 0 | |Difficulty in preparing business plan |1. 67 |1. 03 |1. 07 | |Entrepreneur not ready to use the technology |1. 67 |1. 03 |1. 07 | |The mean scores for the variables rest on a five-point Likert-type scale, with “1” denoting strongly disagree and “5” strongly agree on| |the variables. | The unwillingness on the part of the financiers to provide financing on favourable terms to TBSMEs might be due to the cost and risk involved. Therefore, this causes greater reliance on short-term sources such as overdrafts.
On the hand, the heavy reliance on short-term finance might indicate a lack of understanding on the part of the entrepreneurs of the danger of relying heavily on short-term loans, especially when used to finance long-term commitments. Furthermore, the relative importance of non-bank sources, particularly hire-purchase, might suggest that, for the acquisition of new assets, TBSMEs were more willing to use them despite the higher interest rates charged. It might also imply that the amount of finance available from banks and other financial institutions was insufficient so the firms were forced to use hire-purchase or other non-bank sources to make new investments.
Another observation from this study is the fact that the heavy reliance on debt finance by TBSMEs provides an evidence of the existence of an ‘external equity gap’; a gap which has existed since 1931 among SMEs in the United Kingdom. Tables 16 and 17 reveal that almost all firm and entrepreneur characteristics (except work experience) are not associated with the incidence of difficulties among TBSMEs in raising external finance. However, entrepreneurs’ work experience is significantly and negatively associated with financing difficulty; suggesting that entrepreneurs with some work experience face less difficulty in raising external finance. Overall, the results imply that the characteristics of TBSMEs and their entrepreneurs are not necessarily related to the ease, or otherwise, of obtaining external finance.
The results are unexpected since they do not support the established contention in the existing literature relating to the relationship between these variables. |Table 16: Correlation Between Financing Difficulties and Firms’ Characteristics | | | | | CONCLUSIONS AND IMPLICATIONS Our empirical research reveals that, in addition to personal savings of the entrepreneurs and the retained profits of the firms, the majority of TBSMEs in Malaysia use external sources to finance their businesses.
However, the results also reveal that while a significant number of TBSMEs have been successful in their applications for external finance, the majority of them have problems in obtaining external finance. Notwithstanding the complexities, they normally manage to obtain a certain amount of funding, which is still insufficient to support working capital and expansion requirements. Overall, most TBSMEs rely on debt finance. In many cases, they have turned to non-bank sources, particularly trade credit and hire purchase. Other non-bank sources, including leasing and factoring, are less favoured. However, a significant number of TBSMEs have resorted to government-backed financing facilities.
This study incorporates firms’ and entrepreneurs’ characteristics as a means to establish whether those characteristics could be used to explain the financing practices and problems of the firms. It has been shown that some variables such as age, size and stages of business development of the firms are found to be attributes contributing to the firms’ likelihood of obtaining external sources of finance such as factoring and government-backed financing schemes. These variables are also found to be associated with financing patterns and level of debt to equity ratio of the firms. Some variables, however, such as legal status and existence of business plan have been found to have no impact on the financing behaviour of the firms.
While most of the entrepreneurs’ characteristics are not associated with the incidence of financing difficulties, entrepreneurs with some work experience are more unlikely to face difficulties in obtaining external finance. Since TBSMEs continues to be important to the country’s economy, this sector remains an important market for most banks. Therefore, it is important for the banks to improve the availability of finance for these firms. In providing finance, the banks should differentiate between ‘growth-oriented’ TBSMEs and “non-growth’ TBSMEs. Banks should be more flexible towards growing firms and consider the dynamics of the firms by paying more attention to cash flow positions rather than relying solely on collateral and property-based security.
The empirical evidence which shows the heavy reliance of entrepreneurs own savings, retained profits, and external debts confirms the “pecking order theory”, as most of the firms follow some preferences in financing. For external source of finance, most TBSMEs prefer debt over external equity. However, the need for external equity is also vital, especially for TBSMEs wishing to expand. Despite the reported benefits of venture capital, this type of equity finance is rarely considered by TBSMEs in this country. The government together with the venture capital industry should consider ways of encouraging TBSMEs to accept venture capitalists as partners. In view of the rising number of TBSMEs (start-ups and early stages), the setting up of more venture capital funds is necessary.
In many developed economies, the existence of private investors, known as “business angels”, has played an important role in narrowing the equity gap among SMEs (e. g. Lund, 1999; Clarke, 2005). Business angels not only contribute capital but also bring value added to the firms in which they invest. However, there is evidence from this study that this type of equity finance has not been significant in this country. As such, the development of “business angels” needs to be promoted. REFERENCES Audretsh, D. B. , & Lehmann (2004). Financing High-Tech Growth: The Role of Banks and Venture Capitalists. Schmalenbach Business Review, October, p. 340-357.
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