Managing Small and Medium Sized Businesses

Table of contents

1 Introduction
1.1 Subject Matter
1.2 Objective

2 Risk Management in SMEs
2.1 Design of Risk Management
2.2 Risk Management Process

3 Financing of Small and Medium Sized Businesses
3.1 Financing Instruments with Equity Capital Characteristics
3.1.1 Equity Financing
3.1.1.1 Flotation (Public Equity)
3.1.1.2 Private Equity
3.1.2 Venture Capital
3.2 Financing Instruments with Debt Capital Characteristics
3.2.1 House Bank Loan
3.2.2 Leasing
3.2.3 Factoring
3.2.4 Bonds
3.3 Mezzanine-Capital
3.4 Public Financial Aids
3.4.1 KfW-Starting Money
3.4.2 KfW-Entrepreneur´s Credit
3.4.3 KfW Entrepreneur´s Capital

4 Conclusion

Literature

1 Introduction

The present topic “managing small and medium sized businesses” is about the special parts of risk management and of financing small and medium sized enterprises. Therefore, an overview about risk management of SMEs will be demonstrated before the problems and objectives concerning financing matters. Thereafter, key terms and some sub areas of financing SME´s will be specified.

The first part comprises the objective and the problematic of this subject. Furthermore, we shall determine definitions of important terms as well as an illustration of important sections of this area. This paper will show how SME activities are enframed in the legal and economic perspective of the Federal Republic of Germany.

1.1 Subject Matter

Small and medium sized businesses are exposed to risks all the time. These risks can directly affect day to day operations, decrease revenue or increase expenses. Their impact may be serious enough for the business to fail. Every business is subject to possible losses from unmanaged risks.¹ So we will have an overview why an installation of risk management is necessary for SMEs.

This is one aspect why the other part about the financing situation of SMEs should at least be guaranteed so that possible risks reduced. Therefore firms need capital in order to run their respective businesses, do necessary investments and eventually, expand. These actions and decisions are combined with high costs where both internal and external financing might be appropriate.

The corporate finance of SMEs is primary characterized by bank loan financing. New developments in capital markets, such as the introduction of Basel II in 2007 or even the high write-downs in the nineties, led to a reconsideration of lending principles and then to a fundamental reorientation.² These changes in conditions led to a more restrictive lending by the banks, which ultimately led to the fact that alternative financing instruments became more important in the perspective of small and medium sized enterprises.

Due to the lack of experience of the managing board, alternative financing elements of small and medium sized businesses are not widely known. The problem in this case is, if the business does not have enough funds or is running out of money, there could be significant risks to the business and to the owner who might become personally liable for the debts of the business.

Investigations on the failure of small and medium sized businesses confirm that mistakes in the area of financing represent one of the most common causes for a commercial fiasco.³ The following chart gives an overview of the most common causes for a commercial fiasco:

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Table 1: foundation barriers

1.2 Objective

A business is successful if the risk management process and the financing situation is thoughtout and carefully planned.⁴ Therefore, the risk management process is shown and furthermore, alternative financing possibilities and public support facilities will be included and evaluated. So the focus of this project lies on financing instruments and public promotion programs which are used to illustrate alternative financing possibilities for SMEs.

Finally, the results of this work will be presented and a conclusion will be drawn also giving a perspective for the future.

2 Risk Management in SMEs

Small and medium businesses mainly do not deal with this risk subject or relate this in a short term way.⁵ According to today's perspective a risk management system for small and medium enterprises is inevitable to take care of the risks due to market uncertainties, especially in commodity markets and strong dependence on suppliers and customers. Therefore, risk management should also be implemented in these businesses, even though in a smaller extent. Concerning the risk management of small and medium sized businesses the management takes over the primary responsibility, which can be attributed to the low staff resources and the dominance of the owner. If this is not the case, the task will be adopted by the controlling or the commercial management.⁶

Risk management helps companies to take advantage of the identified opportunities and to manage risks so that targeted goals can be reached. In principle, risk management means the continuous assessment and evaluation of events that could prevent a company to achieve the objectives and to implement a successful strategy. Therefore, risk management must be geared to comply with the corporate goals and corporate strategy.

In summary, risk management pursues four main objectives:

- Livelihood security of the company
- Securing the future success
- Increase in market value of the company
- Reduction of risk costs⁷

For SMEs, the risk management gains increasing importance, because of legal provisions (for example Basel 2)⁸, as a result the installation of a risk management in SMEs is essential. The risks that threaten a small or medium sized company are often difficult to overview. However, they must be fully identified and evaluated. That is why there are significant systematic risk categories. You can divide most of the risks in two categories. First of all there are financial risks, divided in market risks and credit risks and second operational risks, also divided in 5 Compare to Lim (2010), p.4 operational and strategic risks.⁹ These categories only serve the understanding and will not be used further in the essay.

2.1 Design of Risk Management

The design of risk management depends on the size and complexity of the company. For small businesses it is sufficient to identify 4-5 key risks and to establish warning indicators for the risks and to review the warning indicators every year. For medium and large sized companies it is important that all the risks are identified and reviewed periodically. Risk management starts by identifying possible threats and then implements processes to minimize or eliminate them. These risks can be differentiated in the following way:

- Risks posed by customers;
- Risks posed by suppliers;
- Risks posed by staff members;
- Risks posed by the business premises and its location;
- Risks posed by information technology;
- Risks posed by financial transactions;
- Risks posed by the market or the economy.¹⁰

2.2 Risk Management Process

A risk management process starts by the risk analysis, in which the risk identification and the risk assessment takes place, followed by risk navigation and risk control.¹¹

illustration not visible in this excerpt

Image 1: Risk management process¹²

Risk identification:

Risk identification seeks a complete coverage of all sources of harm and potentials for disruption.

It is the hardest and most critical phase of the risk management process and provides an important information base for the subsequent process stages because risks can only be assessed and controlled if they have previously been identified. To capture the risks you should use different methods, for example the Failure Modes and Effects Analysis (FMEA), expert interviews, Delphi technique, checklists, brainstorming, etc. Procedures that require special or external knowledge are not used in SMEs.¹³

Risk Assessment:

As part of the risk assessment you have to determine which threats are posed by the individual risks. For this purpose, the likelihood and the extent amount of loss or damage of the risks are determined. Risk assessment procedures are for example, a risk map or the value at risk.¹⁴ Risk Navigation:

Risk control includes a number of available methods. Regarding their effect you can differentiate between active navigation alternatives and passive navigation alternatives. Part of the active risk navigation is to influence the likelihood and the impact of a risk. However, by the passive navigation risk, the risk profile will not be changed. Therefore, the risk remains the same. Moreover, it is important to take measures to be able to face the consequences.¹⁵ Risk control:

Risk Control is responsible for verifying the effectiveness and efficiency of the actions that have been taken in the stages of risk analysis and risk navigation.¹⁶

3 Financing of Small and Medium Sized Enterprises

When we are talking about financing some important questions arise for instance, how do I finance my project? Therefore, financing represents the basis for all further steps, and thus, a financing concept proposes a perfect overview in answering the following questions: How much equity capital should be invested?

Which securities does one have at his disposal?

[...]

¹ Compare to Henschel (2008), p.10

² Compare to Henschel (2008), p.2f.

³ Compare to http://www.gruenderbrief.info

⁴ Compare to Henschel (2008), p.4

⁶ Compare to Henschel (2008), p.6ff.

⁷ Compare to Henschel (2008), p.7

⁸ Compare to Henschel (2008), p.28

⁹ Compare to Lim (2010), p.23ff.

¹⁰ Compare to Henschel (2008), p.8f.

¹¹ Compare to Weidner (2010), p.57ff.

¹² Source: own representation

¹³ Compare to Henschel (2008), p.51ff.

¹⁴ Compare to Lim (2010), p.11f.

¹⁵ Compare to Henschel (2008), p.54

¹⁶ Compare to Weidner (2010) , p.51f.