Several sources of financing are available to firms in order to finance their expansion plans. A majority of funds come from external sources, with commercial banks making up more than half of this. Other sources include suppliers, leasing, and equity investment. Less than two percent of funds come from informal sources. As a result, the source of finance for a given firm’s expansion plan can play a significant role. Listed companies are the most likely to attract outside capital, while privately held firms are less likely to attract it.
However, despite these advantages, a major problem is that small firms do not receive significantly more funding from government or development banks. Often, government and development banks are more interested in giving larger firms more money. The financial and legal systems of smaller firms cannot compensate for this, and other forms of financing do not fill this gap. The lack of trade credit in underdeveloped countries is one of the main reasons why the government tends to fund larger firms.
Despite this, a significant proportion of small firms are not adequately financed by government and development banks. The problem is that smaller firms have less access to formal financing and do not have the resources to offset the lack of a robust legal and financial system. The solution is to develop alternative sources of finance for small firms. This is the only way to overcome this problem. But if we do this, we will be able to reduce the disparity between the size of a firm and its access to capital.
The main source of funding for small firms is the private sector. Government programs that target small-firm financing are often politically popular and do not have a tangible impact. The majority of small- and medium-sized businesses don’t get government funding, while development banks tend to fund larger firms. In contrast, the existence of alternative sources of finance is minimal. Further, the emergence of alternative sources of finance like trade credit is rarer in developing countries.
In developing countries, many small firms do not receive significant financing from government sources, and the development banks do not finance their growth through public financing. These institutions and governments focus on larger firms. By providing a large proportion of finance for smaller companies, however, government programs do not help small firms. Most of their money goes to larger firms. This gap is filled by alternative sources of finance. For instance, governments tend to offer higher government loans to large firms, which is a good thing in the long run.
Governments and development banks are less likely to fund small firms than they do larger firms. Nonetheless, they do provide an important source of finance for these firms, and these loans are usually issued at a lower interest rate than the cost of capital. By providing debt to smaller firms, government funding is not enough. Instead, small-firm financing may even be a better alternative, but this requires that the firm invests more than it is able to.