Understanding the SME finance

India has a vibrant SME sector that plays an important role in sustaining economic growth, increasing trade, generating employment and creating new entrepreneurship in India .Funding small and medium-sized enterprises is a major function of the general business finance market.

The importance of SME sector is well-recognized world over owing to its significant contribution in achieving various socio-economic objectives, such as employment generation, contribution to national output and exports, fostering new entrepreneurship and to provide depth to the industrial base of the economy. India has a vibrant SME sector that plays an important role in sustaining economic growth, increasing trade, generating employment and creating new entrepreneurship in India. Funding small and medium-sized enterprises is a major function of the general business finance market.

Funding/Business Finance
Business finance refers to the funds and monetary support required by an entrepreneur for carrying out the various activities relating to his/ her business organisation. It is needed at every stage of a business life cycle. For instance, in starting a business, it is essential for acquiring fixed assets, such as land, building, plant and machinery, etc as well as for meeting the day-to-day expenses (working capital) in the form of payment of wages and salaries, purchasing raw materials, etc. In order to successfully operate and expand the business, funds are necessary for promoting and marketing the product; distributing it to the prospective consumers; as well as for managing the firm’s human resource base. Further, in the changing business environment marked by increasing competition, additional funds are desirable for continuous modernisation and upgradation of the business unit. The major constituents of the Indian financial system are banks, financial institutions, non-banking financial companies and venture capital companies. Banks are the most important source of institutional credit in India and consist of nationalised banks, regional rural banks, co-operative banks, private sector banks including foreign banks.

A wide variety of financial institutions have been set up both at the national and the state level, which cater to the diverse financial requirements of the industry. They include all-India development banks, specialised financial institutions, investment institutions, state financial corporations as well as state industrial development corporations. Besides, the non-banking financial companies are a group of institutions which perform financial intermediation in various forms, like accepting deposits, making loans and advances, leasing, hire purchase, etc. On the other hand, venture capital is an important source of funding for the formation of small and medium enterprises in their early stages of development.
Given this financial set up, the Central and the State Governments have been making all efforts for meeting the financial requirements of the entrepreneurs. These are in the form of several financial schemes and funding options offered by the ministries, public and private banks, small industries development organisation, national small industries corporation limited, state financial corporations, etc. Thus, India has a sound financial structure which is capable of providing a strong base for setting up of business units in the country.

Venture Capital
‘Venture Capital’ is an important source of finance for those small and medium-sized firms, which have very few avenues for raising funds. Although such a business firm may possess a huge potential for earning large profits in the future and establish itself into a larger enterprise. But the common investors are generally unwilling to invest their funds in them due to risk involved in these types of investments. In order to provide financial support to such entrepreneurial talent and business skills, the concept of venture capital emerged. In a way, venture capital is a commitment of capital, or shareholdings, for the formation and setting up of small scale enterprises at the early stages of their life cycle.Venture capitalists comprise of professionals of various fields. They provide funds (known as Venture Capital Fund) to these firms after carefully scrutinizing the projects. Their main aim is to earn huge returns on their investments, but their concepts are totally different from the traditional moneylenders. They know very well that if they may suffer losses in some project, the others will compensate the same due to high returns. They take active participation in the management of the company as well as provide the expertise and qualities of a good banker, technologist, planner and managers. Thus, the venture capitalist and the entrepreneur literally act as partners.

The venture capital recognises different stages of financing, namely:-
Early Stage Financing -
This is the first stage financing when the firm is undertaking production and need additional funds for selling its products. It involves seed/ initial finance for supporting a concept or idea of an entrepreneur. The capital is provided for product development, R&D and initial marketing.

Expansion Financing:
This is the second stage financing for working capital and expansion of a business. It involves development financing so as to facilitate the public issue.

Acquisition/ Buyout Financing
This later stage involves:-
Acquisition financing in order to acquire another firm for further growth Management buyout financing so as to enable the operating groups/ investors for acquiring an existing product line or business and

Turnaround financing in order to revitalise and revive thesick enterprises.
Capital Market:
Capital market is one of the most important segments of the Indian financial system. It is the market available to the companies for meeting their requirements of the long-term funds. It refers to all the facilities and the institutional arrangements for borrowing and lending funds. In other words, it is concerned with the raising of money capital for purposes of making long-term investments. The market consists of a number of individuals and institutions (including the Government) that canalise the supply and demand for long -term capital and claims on it.

The demand for long term capital comes predominantly from private sector manufacturing industries, agriculture sector, trade and the Government agencies. While, the supply of funds for the capital market comes largely from individual and corporate savings, banks, insurance companies, specialised financing agencies and the surplus of Governments. The Indian capital market is broadly divided into the gilt-edged market and the industrial securities market. The gilt-edged market refers to the market for Government and semi-government securities, backed by the Reserve Bank of India (RBI). The term gilt-edged means ‘of the best quality’. This is because the Government securities do not suffer from risk of default and are highly liquid (as they can be easily sold in the market at their current price). The open market operations of the RBI are also conducted in such securities.

The industrial securities market refers to the market which deals in equities and debentures of the corporates. It is further divided into primary market and secondary market. Primary market (new issue market):- deals with ‘new securities’, that is, securities which were not previously available and are offered to the investing public for the first time. It is the market for raising fresh capital in the form of shares and debentures. It provides the issuing company with additional funds for starting a new enterprise or for either expansion or diversification of an existing one, and thus its contribution to company financing is direct. The new offerings by the companies are made either as an initial public offering (IPO) or rights issue.

Secondary market/ stock market (old issues market or stock exchange):- is the market for buying and selling securities of the existing companies. Under this, securities are traded after being initially offered to the public in the primary market and/or listed on the stock exchange. The stock exchanges are the exclusive centres for trading of securities. It is a sensitive barometer and reflects the trends in the economy through fluctuations in the prices of various securities. It been defined as, “a body of individuals, whether incorporated or not, constituted for the purpose of assisting, regulating and controlling the business of buying, selling and dealing in securities”.

Listing on stock exchanges enables the shareholders to monitor the movement of the share prices in an effective manner. This assist them to take prudent decisions on whether to retain their holdings or sell off or even accumulate further. However, to list the securities on a stock exchange, the issuing company has to go through set norms and procedures. The capital market plays a vital role in fostering economic growth of the country, as it augments the quantities of real savings; increases the net capital inflow from abroad; raises the productivity of investments by improving allocation of investible funds; and reduces the cost of capital in the economy.

Government Funding and Schemes
An entrepreneur requires a continuous flow of funds not only for setting up of his/ her business, but also for successful operation as well as regular upgradation/ modernisation of the industrial unit. To meet this requirement, the Government (both at the Central and State level) has been undertaking several steps like setting up of banks and financial institutions; formulating various policies and schemes, etc. All such measures are specifically focussed towards the promotion and development of small and medium enterprises.

The public sector banks are the major source of financial assistance to the industrial sector. They extend credit support to the firms in the form of loans, advances, discounting bills, project financing, term loans, export finance, etc. Small scale industries need credit support on a continuous basis for running the enterprise as well as for its diversification and modernisation. Recognising the need for a focused financial assistance to such industries, the Government of India, together with the State Governments, has formulated several policy packages including schemes and funds for their growth and development.

Financial Institutions
Financial sector plays an indispensable role in the overall development of a country. The most important constituent of this sector is the financial institutions, which act as a conduit for the transfer of resources from net savers to net borrowers, that is, from those who spend less than their earnings to those who spend more than their earnings. The financial institutions have traditionally been the major source of long-term funds for the economy. These institutions provide a variety of financial products and services to fulfil the varied needs of the commercial sector.

Besides, they provide assistance to new enterprises, small and medium firms as well as to the industries established in backward areas. Thus, they have helped in reducing regional disparities by inducing widespread industrial development. The Government of India, in order to provide adequate supply of credit to various sectors of the economy, has evolved a well developed structure of financial institutions in the country. These financial institutions can be broadly categorised into All India institutions and State level institutions, depending upon the geographical coverage of their operations. At the national level, they provide long and medium term loans at reasonable rates of interest. They subscribe to the debenture issues of companies, underwrite public issue of shares, guarantee loans and deferred payments, etc. Though, the State level institutions are mainly concerned with the development of medium and small scale enterprises, but they provide the same type of financial assistance as the national level institutions.

Regulation:
An entrepreneur has to take into account the basic regulatory requirements of the country in order to ensure sustainability of the profits and productivity of his/her business. The most important regulation relates to the environment. The environmental regulatory requirements envisage a wide legislative framework covering every aspect of environment protection. Broadly, it includes the emission standards for air, noise, water, etc. Separate set of laws for emission of hazardous wastes have also been enacted. Every industry has to abide by these guidelines and parameters for environmental protection.

An organization, for its smooth and effective functioning, must ensure health and safety of its employees. The major legislations relating to Occupational Health and Safety in India are:- the Factories Act, 1948; the Mines Act, 1952 and the Dock Workers (Safety, Health & Welfare) Act, 1986. The Directorate General of Mines Safety (DGMS) and the Directorate General of Factory Advice Service and Labour Institutes (DGFASLI) are the two field organisations of the Ministry of Labour and Employment in the area of occupational safety and health in mines, factories and ports. For regulation of the export and import of goods and services an entrepreneur has to abide by the Foreign Trade (Development and Regulation) Act, 1992 and the EXIM policy announced by the Government from time to time.

The Ministry of Commerce and Industry is the most important organ concerned with the promotion and regulation of the foreign trade in India. The Ministry has an elaborate organizational set up to look after the various aspects of trade. Within the Ministry, the Department of Commerce is responsible for formulating and implementing the foreign trade policy. The Local Bodies are empowered to levy tax on properties (buildings, etc.), Octroi (tax on entry of goods for use/consumption within areas of the Local Bodies), Tax on Markets and Tax/User Charges for utilities like water supply, drainage, etc. In the wake of economic reforms, the tax system in India has under gone a radical change, in line with the liberal policy.

Some of the changes include:- rationalization of tax structure; progressive reduction in peak rates of customs duty; reduction in corporate tax rate; customs duties to be aligned with ASEAN levels; introduction of value added tax; widening of the tax base; tax laws have been simplified to ensure better compliance. Tax policy in India provides tax holidays in the form of concessions for various types of investments. These include incentives to priority sectors and to industries located in special area/ regions. Tax incentives are available also for those engaged in development of infrastructure.