AN ASSESSMENT INTO THE EFFECT OF VENTURE CAPITAL FINANCING ON THE PROFITABILITY OF SME IN NIGERIA

CHAPTER ONE

1.0      INTRODUCTION

1.1   BACKGROUND OF STUDY

Small and medium-sized enterprises (SMEs) play a pivotal role in the national economies of countries around the world. This is especially true of emerging markets. They are considered to be an engine for growth in both developed and developing countries; the benefits of a vibrant SME sector include: the creation of employment opportunities; the strengthening of industrial linkages; the promotion of flexibility and innovation; and the generation of export revenues (Lerner, 2002; Rangamohan et al, 2007).

In SA, for instance, eight out of 10 jobs that are created occur in the SME sector (Karungu et al, 2000). In the US, Japan and Germany, small business contributes more than half of the gross domestic product (GDP) in each of those economies. Though SMEs have been the engine for growth in various developed and developing economies, they have always faced problems in accessing finance.

Without proper finance, SMEs can neither expand to compete globally nor can they acquire technology or meet their fixed and working capital requirements (Wanjohi and Mugure, 2008). SMEs face significant challenges, which include access to finance (Iwisi et al, 2003) and financial management skills and support (Gem Report, 2003). This contributes to slow development and high mortality rates of small businesses in Nigeria.

Access to finance is particularly relevant for previously disadvantaged entrepreneurs who do not have access to collateral and the networks of wealthy individuals who could provide angel financing. Financing is necessary to help SMEs set up and expand their operations, develop new products, and invest in new staff or production facilities. Many small businesses start out as an idea from one or two people, who invest their own money and probably turn to family and friends for financial help in return for a share in the business.

But if they are successful, there comes a time when they need further funds to expand or innovate further. Some SMEs often run into problems, because they find it much harder to obtain financing from banks, capital markets or other suppliers of credit (Afua, 2011).

Almost every company we know of began as an SME. Vodafone as we know it today was once a little spin-off from Racal; Hewlett-Packard started in a little wood shack; Google was begun by a couple of young kids who thought they had a good idea; even Volkswagen at one point was just a little car maker in Germany (as opposed to being a giant small car maker globally) (Lukacs, 2005). Microsoft may be a software giant today, but it started off in typical SME fashion, as a dream developed by a young student with the help of family and friends.

Only when Bill Gates and his colleagues had a saleable product was they able to take it to the marketplace and look for investment from more traditional sources Amissah 2009). The growth of SMEs has been hampered by the lack of adequate knowledge and a well structured financial market for the mobilization of capital. The role of finance has been viewed as a critical element for the development of SMEs Cook and Nixson, (2000).

However, venture capital has had a significant impact on Small and Medium Enterprises (SME) in the developed countries; small businesses have been and are the stepping stone of industrialization in these countries.