A substantial portion of the SME sector may not have the security required for conventional collateral based bank lending, nor high enough returns to attract formal venture capitalists and other risk investors. It stands in between the two extreme zone of risk averse investment and risk prone investment. In addition, markets may be characterized by deficient information (limiting the effectiveness of financial statement-based lending and credit scoring). This has led to claims of an "SME finance gap" – particularly in emerging economies.
There have been at least two distinctive approaches to try to overcome the so-called SME finance gap.
The first has been to broaden the collateral based approach by encouraging bank lenders to finance SMEs with insufficient collateral. This might be done through an external party providing the collateral or guarantees required. Still ,it is seen that, to convince both the external party and the Bank , SME would require good business plan .
The major obstacles a SME faces are mainly in the form of:
- lack of satisfactory business plans, accounting and other information;
- inadequate assets for use as security; and
- insufficiently high levels of profitability, gearing, liquidity, stability, and other business-financial performance criteria on the part of funding applicants.
The second approach has been to broaden the viability based approach. Since the viability based approach is concerned with the business itself, the aim has been to provide better general business development assistance to reduce risk and increase returns. This often entails a detailed review and assistance with the funding agency.
A common aim or feature of the viability based approach is the provision of appropriate finance that is tailored to the cash flows of the SME.
Although the returns generated by this approach in less developed countries may never be attractive to Western venture capitalists, they can be significantly better than conventional collateral based lending – whilst at the same time being less risky than the typical venture capitalist project. Some investors have promoted this approach as a means of achieving wider social benefits, while others have been interested in developing it largely in order to generate better financial-economic returns for shareholders, other investors, employees, and clients.
In the past, a significant obstacle to applying this approach in less developed countries has been getting the information required to assess viability plus the costs of transferring and providing business development assistance. However, in the last several years improved information and communications technology have made the process easier and cheaper. As technology and information sharing etc. continue to improve, the approach could become significantly more cost-effective and attractive to established financiers with viability based approaches and to consultants providing business plan development assistance to SMEs in other, more mainstream areas.
With higher profitability than traditional SME finance and lower risk than traditional venture capital, this might even be dubbed the new "Growth finance sector".