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The economic and social importance of the Small And Medium Enterprise (SME) sector is well recognized in academic literature.1 It is also recognised that these actors in the economy are underserved, largely in terms of finance.2 This has led to significant debate on methods to serve this sector. Although there have been numerous schemes and programmes in markedly different economic environments, SME Finance can be summarised by two main approaches.Adapted from: 3 These are: # Collateral based lending is offered by traditional banks and finance companies, made up of a combination of the following: ## Asset-based Finance ## Contribution based finance ## Factoring based finance, using reliable debtors or contracts # Information based lending ## Financial statement lending ## Credit Scoring ## Relationship lending ## Viability based finance is offered by Venture Capital SME FINANCE GAP A substantial portion of the SME sector does not have sufficient collateral required for collateral based lending, and does not have high enough returns to justify the risks taken by venture capitalists. In addition, many markets have little or unreliable information, limiting the effectiveness of financial statement lending and credit scoring. This has led to the SME finance gap. The finance gap is particularly pronounced in emerging economies. There have been two approaches to overcome the SME finance gap. The first is to broaden the collateral based approach by encouraging collateral based lenders to finance SMEs with insuffcient collateral. This is largely done through an external party providing the collateral or guarantee. Unfortunately, this method has seldom been based on Free Market principles and has largely been unsustainable. The second has been to broaden the viability based approach. Since the viability based approach is concerned with the business itself, the approach is to provide business development assistance 4 to reduce risk and increase returns. This is driven through the detailed review and assistance with the Business Plan . A supplemental feature to the viability based approach is to provide appropriate finance that is tailored to the cash flows of the SME. Although the returns generated by this approach will never be attractive to the venture capitalist, they can be significantly better than collateral based lending, whilst at the same time providing a lower risk profile than the venture capitalist. Some stakeholders are emphasising this approach because it provides a sustainable approach to social benefits,5 while other stakeholders are developing their capacity in this area in order to generate sustainable returns for shareholders, investors, employees and clients. In the past, a significant barrier to this approach has been the information gap required to understand the viability, and the transference cost required to provide business development assistance. This has largely been overcome in the last several years due to improved communications technology, allowing for easier and cheaper access to information resources. As technology and information sharing continues to improve, this second approach will become increasingly cost effective and attractive to a financiers with a viability based approach, or consultants adept at providing business development assistance to SMEs. This gap, with higher profitability than traditional SME finance, and lower risk than traditional venture capital, has been increasingly called the Growth finance sector. REFERENCES EXTERNAL LINKS |
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