Financial resources have been identified as one of the most important challenges that SMMEs face. Access to finance is a key factor that governs the capability of SMMEs to expand, grow and to employ the latest technologies (Abor and Quartey 2010; Krasniqi 2007). SMMEs have always faced challenges in access- ing loans and capital. Limited access to finance is a major constraint to SMME growth, regardless of its location, size, industry and the economic environment of the market (Hussain et al. 2006).
Similarly, other studies found the financing gap to be one of the greatest chal- lenges that prevent SMME growth and expansion (Beck and Demirguc-Kunt 2006; Demirg¨u¸c-Kunt et al. 2005; Hutchinson and Xavier 2006; Mahadea and Pillay 2008;Robson and Bennett 2000). All businesses require financial resources in order to start trading and to fund growth and so the financing gap can be an important constraint impacting SMME growth (Cassar 2004).
This financing gap exists in SMME financing because of mismatches between supply and demand. This lack also has been attributed to several reasons, in- cluding the attitudes of financial institutions towards SMMEs, attitudes which may be negative or to information asymmetry (Binks and Ennew 1996). In- formation asymmetry occurs when firms and lenders do not have access to the same information and as result there will be a gap in the demand and supply of finance.
Therefore, information asymmetry has been used to explain why lending SMMEs sometimes can be accepted despite very high interest rates or collateral require- ments (Tucker and Lean 2003). Financial institutions use the availability of collateral as a criterion when assessing applications for fund and loans. The collateral-based lending method limits the access of finance to SMMEs. It dis- criminates against those SMMEs that have the potential to be successful.
The discussion on accessing to finance for SMMEs is often directed to financial resources that have impact on the operational activities of a business (Tseng, Tansuhaj and Rose 2004). Some SMMEs use personal savings and loans from family and friends as the main source of funds for investment. While others rely on different sources such as banks and financial institutions for funding support. Several SMMEs depend on venture capital or on retained earnings, which are usually insufficient.
There is a wide classification of financing sources used by firms for investment. Whereas all types of firms mostly rely on retained earnings, SMMEs are more dependent on these funds than large firms. However, Westhead and Birley (1995) found that SMMEs that avoided the use of personal savings and funding from family and friends achieved higher growth rates than those that used such sources. Furthermore, they argued that those who used personal savings and funds from family and friends had lower growth rates because they were more cautious and risk averse than those that used funds from other sources.
It has been argued that collateral-based lending and the interest rate forces SMMEs to depend on internal sources of finance such as personal saving and retain earning or to borrow for short-term small amounts resulting in limited possibilities for SMMEs to achieve their growth objectives (Casson 2003). Fur- thermore, Casson (2003) highlighted that as firms grow, their needs for funds exceed the lending capabilities of personal savings and retained earnings, and external funds become more attractive.
Compared with larger enterprises, SMMEs are restricted in their access to banks and government funds. As a result of their disadvantaged status, SMMEs, seek recourse for finance in informal markets (Udell 2004). SMMEs are often unable to fulfil their financing needs.
The limited amounts of fund during the development stages may have negative effects on firm growth in later stages, which include reducing resources available to the firm for a variety of activities, in particularly, marketing activities and the acquisition of suitable assets (Fielden, Davidson and Makin 2000). The fact that SMMEs receive less finance or face worse conditions in secure their financial needs than larger firms puts them at a situation of competitive disadvantage. Without adequate long-term finance, SMMEs are unable to expand their busi- nesses and achieve their growth objectives.
Some studies have found the lack of access to finance to be one of the great- est challenges that prevent SMMEs growth and expansion (Hussain et al. 2006; Smallbone and Wyer 2000;Terpstra and Olson 1993). According to Lizano and Mesalles (1995), the limited access to formal sources of finance in developing countries compared to developed countries is largely due to the lack of liquidity, the underdeveloped nature of the financial system and inexperience in small- scale lending According to Fatoki (2011), the financing gap is a major problem for the SMMEs in South Africa, as a lack of access to finance is the second
3. Financial structure and sources of finance for SMMEs 101
most cited contributor to slowdown amongst new SMME creation process and increases failure, together with low levels of education and training. (FinMark Trust 2008) found out that only 2% of SMMEs in South Africa are able to access bank loans.
Turton and Herrington (2012) found that 75% of applications for bank credit by SMMEs in South Africa are rejected. This suggests that SMMEs without finance may not be able to survive and grow. Demirg¨u¸c-Kunt et al. (2005) sug- gest that bridging the finance gap is important for exciting entrepreneurship. In most countries, microenterprises are even less likely than small and medium-size firms to have access to finance from formal channels.
Informal sources of finance can overcome the finance gap that exists in SMME sector in South Africa. Nevertheless, bank financing is set to remain an im- portant factor for start-up of SMMEs. Importantly, the extent of and reliance on, informal networks of finance tend to be underdeveloped for SMMEs sector (Siyongwana 2004).
A finance gap therefore exists for firms starting up or wishing to grow. Notwith- standing, many firms within SMMEs sector are growing beyond the size of that informal sources of finance can support and institutional credit is the only fea- sible option for financing growth (Migiro 2005).