Addressing the funding challenges of SMEs in Nigeria

Nigeria is said to have a population of about 211 million people as at 2021, with an estimated annual population growth rate of c.2.6% according to data (the Data) made available by United Nations Population Fund (UNFPA). The Data also reveals that c.95% of the population are below 65 years of age, making a case for a predominantly youthful population. While the population growth rate solidifies Nigeria’s position of being the largest country in Africa, it however presents a real challenge in terms of youth employment and engagement in meaningful work.

The challenge of providing meaningful work for the teeming youth population has led to the proliferation of small and medium enterprises (SMEs) in Nigeria. According to a comprehensive SME survey carried out by SMEDAN, it was noted that SMEs account for 96% of businesses, 84% of employment, and contributes c.50% to Nigeria’s gross domestic product (GDP). Noteworthily, this places SMEs at a pivotal position for driving the growth and development of Nigeria’s economy.

In the first quarter of 2021, data published by Nigeria Bureau of Statistics (NBS) as precisely captured by Bloomberg, reported that Nigeria’s unemployment rate was now 33.3%. The implication is that one-third of Nigeria’s labour force have no work to do. Since SMEs account for 84% of Nigeria’s employment, it therefore suggests that unemployment in Nigeria is largely occasioned by frictions and dislocations experienced by SMEs. Hence, tackling the challenges faced by SMEs is pertinent to solving the issue of rising unemployment in Nigeria.

According to a report (the Report) published by World Bank, it was observed that while SMEs create 7 out of 10 jobs in emerging markets, access to finance has remained a key constraint to SME growth. The Report noted that access to finance is one of the most cited obstacles facing SMEs to grow their businesses in emerging markets and developing countries. This was further corroborated by a research project published by Helsinki Metropolia University of Applied Sciences.

Another key challenge that besets SMEs in Nigeria is the scaling ability of the ventures. A report made available by the Central Bank of Nigeria (CBN) lists low investment commitment to bring pilot plans to commercial scale as a key challenge facing SMEs in Nigeria. It is important to stress that the inability to scale is a direct consequence of the financing issues faced by SMEs. Financing breeds stability which in turn gives rise to scalability as no unstable business can be scaled. Hence, addressing the financing issue faced by SMEs would also serve to indirectly address their scalability issue.

For the purpose of clarity, SMEs have been defined by a CBN publication as businesses with a turnover of less than NGN100 million and / or less than 300 employees. Further definitions have been made in line with their capital requirements, scope and cost of projects, annual turnover, financial strength, and number of employees as explained by Mondaq.

Recent trends in SME funding

The Federal Government (FG) through its various agencies such as Development Bank of Nigeria (DBN), Bank of Agriculture (BOA), Bank of Industry (BOI), Federal Ministry of Trade and Investment (FMTI), the CBN, and others, have continued to make concerted efforts to provide funding to SMEs in Nigeria primarily via loans and grants.  One of the recent initiatives launched by the FG to support SMEs was the NGN50 billion targeted credit launched by CBN in March 2020. As explained by ICLG, the objective of the scheme was to provide support to SMEs and households who were adversely affected by COVID19, and to stimulate credit to SMEs to enable them to expand their productive capacity through equipment upgrade, and research and development. Unfortunately, as outlined by Carnegie Endowment for International Peace, these programmes run by the government have been characterised by controversies around corruption and financial malfeasance which has undermined the potency of the programmes in addressing the funding challenges faced by SMEs.

In a related move, the CBN has continued to mandate deposit money banks (DMBs) to meet a 65% loan to deposit ratio (LDR) in order to expand credit to SMEs and other sectors. It is expected that SMEs would benefit from increased access to loans provided by DMBs since it is intended to encourage SMEs, retail, mortgage and consumer lending who have been assigned a weight of 150% in computing the LDR as stated in the LDR circular. Although the LDR is a laudable initiative, it however did nothing to address the major issues faced by SMEs in accessing bank loans which lies in the onerous requirements and collaterals demanded of SMEs as studied in this research project. Hence, the funding problem remains unaddressed by this initiative.

Aside government funding, we have witnessed a surge in the number of SMEs taking advantage of crowdfunding to raise short-term finances for their various ventures, promising very high interest returns to investors. The sectors notable for this have been particularly agriculture and short-let real estate companies whose product life cycle have been structured to have a coinciding period with the due date for the payment of the interest and principal to the investors. Some of the available platforms for such investments is documented here. While this can be described as a survive or die mentality on the part of the SMEs, it is important to note that these activities are typically done outside the purview of the regulatory authorities which exposes investors to significant investment risk.

In addition, the number of venture capitalists and private equity firms providing funding to some high growth sector SMEs in Nigeria has skyrocketed in recent times. As TechPoint reported, Nigerian start-ups raised USD377 million in 2019 which was more than twice the value of what was raised in 2018. Furthermore, it was reported that out of USD120.6 million raised by Nigerian start-ups in 2020, c.71.8% were provided by foreign funders. While this is good information which demonstrates the potential of Nigerian businesses to scale and to thrive globally, the foreign funds which may be provided at a cost of ownership or transfer of certain rights may see some high growth companies in the coming years being dominated by foreign ownerships.

Solutions to the SME funding challenges in Nigeria

1. Revamp the government SME funding initiatives for maximum impact: There is need to revamp the system of selection, disbursement, management, monitoring, evaluation, and repayment of the loans made available to SMEs in Nigeria by the government. Emphasis should be placed on achieving transparency and inclusion in the selection of SMEs to benefit from the funding initiatives. One of the easiest ways to achieve this is to involve institutions notable for integrity and high social values such as professional services firms, to manage the entire process of SME funding from selection of SMEs to fund repayment (where required) including carrying out monitoring and evaluation. The scope of work can be expanded to capture all key activities across the entire funding value chain.

2. Provide SMEs with access to capital market funds: Several articles suggest that providing loans / debt financing to SMEs may be inappropriate since they are relatively young businesses which may be exploring new business models with a slim chance of profitability in the short to medium term. This in turn increases their default risk. Equity financing are said to be more appropriate for SMEs as it provides stable funds without the pressure of trying to make immediate profits to meet debt covenants. Hence, it is recommended that the government through the relevant capital market regulator such as SEC, may explore the possibility of setting up a stock exchange specifically for SMEs similar to NASDAQ in the US which provides lower listing fees and lower listing requirements. This would provide SMEs with the opportunity to obtain equity financing from the public.

3. Set up an SME fund to take equity positions in SMEs operating in high growth sectors: The government may set up a fund specifically for the purpose of taking up equity stakes in SMEs operating in some high growth key sectors such as defence and security, technology, or finance. The intent would be to ensure that the enabling technologies or intellectual property driving such businesses are not transferred to foreign counterparts through ownership sale, while also providing these businesses with stable funds to innovate and grow. 

4. Harness public private partnerships (PPP) to establish SME innovation centres across the country: The government may liaise with private institutions and educational organisations such as business schools, to establish SME innovation centres across the country. These centres would provide relevant trainings and growth opportunities for SMEs across Nigeria, while also being used as a medium through which SMEs would be able to access loans / grants from the government. 

The above solutions are by no means exhaustive as other solutions to drive financing for SMEs may exist. However, it is important to note that where these solutions are implemented, the key issues of access to finance facing SMEs in Nigeria may be significantly addressed, to in turn reposition SMEs for greater impact in and outside Nigeria. Also, the article demonstrates sufficient enough reasons for the government to pay critical attention to solving the funding challenges faced by SMEs in Nigeria.