One key to a successful business start-up and growth is your ability to obtain and secure appropriate financing. Raising capital is the most basic of all business activities. But, as many new entrepreneurs quickly discover, raising capital may not be easy; in fact, it can be a complex and frustrating process. However, if you are informed and have planned effectively, raising money for your business will not be a painful experience.
In Tanzania, one cannot obtain a loan from financial institutions if you don’t have a running business for at least six months. So before starting a business it is advised that you source enough fund to keep you running at least for a year.
This information summary focuses on ways a small business can raise money. We will give you some alternatives, strategies, and things to think about in your search for financial help. You will learn how to locate, negotiate for, and maintain sources of money to help you start and expand your business.
In this, one continuously saves some amount of money in order to have a required sum of capital for establishing the required business. Among the basic ways used by people opting for this approach, is through saving their money in accounts such as fixed deposits. Almost all existing commercial banks and some financial institutions offers fixed account services.
About Fixed Account
Fixed Deposits are accounts opened for fixed contracted periods, currently ranging from 1 month to 2 years. They earn interest at attractive rates, thus providing customers with long term savings growth opportunities.
Another best option to raise fund to finance your business is through forming a business partnership. Here one looks for people and businesses that can finance the envisaged commerce and include them as potential partners. However for this to be effective, there should be a well-set contract or partnership agreement that will indicate on how each and every person involved in the business will benefit from such partnership.
Types of partnership click here
3. Family and Friends
Using family and friends can also be a better option of raising business capital. Here, a person interested in establishing business can seek for monetary assistance from both family members and friends who can be able to support such endeavors.
4. Guarantee Fund
MSMEs can access loans to fund their business using guarantee funds.
In Tanzania, the government designed Small and Medium Enterprises credit guarantee scheme to provide a guarantee to financing institutions aiming to enhance the creditworthiness of exporters so that they would be able to secure better and larger facilities from the financing institutions.
With the scheme, financing institution are assured that, in the event of default, the scheme would cover part of the loss.
So locally owned MSMEs dealing with exports may take advantage of this scheme to obtain fund for expanding their businesses.
o Formally registered entity and owned by Tanzanian citizens.
o Having viable commercial projects, which are the basis of requesting the credit facility.
o Ready to offer any enforceable collateral including their personal guarantee, with the condition of allowing assignment of such collaterals to the Scheme
o Having applied for a credit facility from a financial institution relating to eligible projects on which the financial institution has sought a guarantee cover from the scheme
Source of Gurantee Funds[link]
Another option that can be used in securing finance for business is through accessing loans from banks and micro-finance institutions (Get the list of Banking Institutions and List of Micro-Finance institutions that offer support to MSMEs in Tanzania). Majority of these institutions usually have a special package for MSMEs especially in the amount set and the overall requirements for securing such loans.
More information about Micro-Finance institutions can be obtained from this website http://www.tamfi.co.tz/
In order to be able to access finance from micro-finance institutions and banks there are general requirements that one needs to fulfill. These requirements include: –
Must be a Tanzanian of 18 years and above
Must have a business license (Original and its Copy)
Must have the business financial statement
Business Tax clearance certificate (Original and its copy)
Loan application letter addressed to the manager of branch concerned
Residential introduction letter from the local government and guarantor’s letter
Photocopy of personal identification and guarantor’s identification
Personal passport size and guarantor’s (5 each), with blue background
Collateral as specified by that particular financial institution. Commonly used are immovable assets like a house, farm, and other things like a car and valuable assets as it may be specified by the source.
Informal sources of Business Finance
Where and how you get fund to finance your business operation is very crucial in determining success or failure of your business
In previous articles, we saw that it is critical to have fund enough to sustain your business operations for at least first six months or one year . After those six months you must have evaluated the performance of your business and be able to forecast its future performance.
If your business is promising, the next key thing now is to think of expanding it. Getting an ideal source of fund is key at this stage.
In this article we will discuss informal sources of fund and how to effectively utilize them for your business prosperity.
There are a number of informal sources of finance that an entrepreneur can use to access financing. Informal sources of finance are normally characterized by lack of contract documents. However the borrower in most cases is well known by the lender. In Tanzania the mostly used informal sources of finance includes; relative and friends, money lenders and rotating savings and credit associations. Below is a detailed elaboration on each of the commonly used informal sources in Tanzania.
Relatives and friends.
This is by far the most commonly used informal method of sourcing finance. With this source of financing MSMEs borrow from relatives and friends to finance their businesses. Some of the reasons why MSMEs opt for family and friends financing includes:
- Easy to approach: Entrepreneurs can easily source funds from family members or a friend through a simple agreement struck between them. In most cases, the borrower and lender have a personal relationship and do not need any formal introduction. This makes it easy for the entrepreneurs to approach the relative/friend and seek for funds.
- Few requirements: In comparisons to banks and other formal sources relatives/friends normally have fewer requirements. Many entrepreneurs do not have proper books of accounting, business plans, business licenses, perfected collateral or guarantors which are required by the banks and Microfinance Institutions (MFI). The financing is usually based on a gentleman’s agreement between the parties.
Despite lesser requirements, there are some disadvantages associated with sourcing funds in such fashion including:
- Small loan size: Many of the entrepreneur’s friends and relatives have limited funds and may not be in a position to provide finance to the level that the business require. This leaves the entrepreneur sourcing for funds from other sources and could potentially lead to multiple loans that normally are difficult to service.
- Not reliable: One disadvantage associated with relying on relatives and friends for financing is that at times they do not hold their end of the bargain. This leaves the MSME in a precarious position more-so if the expected funds had been factored to the working capital budget for expenses such as stock purchases, rent payment and salaries. In the situation where relative or friend does not provide the financing as agreed, the MSME has little recourse and there is not much s/he can do.
- Interference: Many times when relatives and friends have financed an MSME, they want to be involved in making decisions for the business. Some of these decisions are detrimental to the business. It is important for the MSME to limit the involvement of relatives/friends to providing finance only.
Another commonly used informal source of financing for MSMEs is through money lenders.
In Tanzania we have currently seen people of the same interest forming saving groups which allow them to collect agreed amount of money from each member every month. These groups are commonly known as Vikoba. After saving for a certain period they start lending to people including businessmen and women.
Money lenders usually demands for collateral that is many times more valuable than the loan borrowed to be deposited in their custody. In the event when the MSME fail to service the loan, the lender sell the collateral and recoups their money. Benefits of sourcing finance from money lenders includes;
Quick processing: In the event that the MSME requires money on short notice then s/he may go to a money lender. Upon satisfying the set requirements almost all the money lenders disburse cash on the spot without any delays.
It is worth pointing out that there are serious challenges of using money lenders as sources of business funds such as:
- High cost of funds: Majority of money lenders charge very high interest rates that are compounded frequently on the borrowed funds. When the borrower fails to service the loan then the outstanding balance balloons to huge amount that are many times equivalent to the initial borrowed funds. Many MSME have difficulties in servicing loans from money lenders and end up losing the collateral that is many times more valuable than the loan borrowed. MSMEs are advised to avoid borrowing money from money lenders unless it is very necessary and they are very sure that they can service the loan in the agreed duration.
- Miscommunication of interest rates, fees and penalties: Many money lenders communicate the interest rates charged on loans very attractively but do not disclose that they compound the interest to the principal. This causes a situation where MSMEs are always behind on their loan repayments leading to further penalties that further raise the outstanding loans. MSMEs should be very careful and make sure that s/he understands all the costs related to the loan and how they are calculated.
Rotating Savings and Credit Associations (ROSCAS):
Many MSMEs are members of Rotating Savings and Credit Associations (ROSCAS) in which they save and extend credit to each other. The members contribute a prescribed amount of money regularly and then the total/part of the money raised is given to one of the members during each meeting until all the members have been covered. Some of the advantages for a MSMEs to raise funds through ROSCAS are:
- Affordable: MSMEs make savings in the ROSCAS by making small contributions. In each meeting -which is done in most cases once every month, a member who is in need of money is given a loan. ROSCAS charges very little interest to members making the funds cheap.
- Few requirements: There are few requirements in sourcing funds from ROSCAS. All that is required is for the MSME to join a ROSCAS and make the required contributions. This makes ROSCAS attractive to MSMEs as they do not have to meet the normally stringent requirements of formal sources or charged punitive interest rates by money lenders.
There are some shortcomings associated with ROSCAS that the SME should be aware of. They include:
- Loss of monies: The ROSCAS are informal groups and normally are not registered. There are cases where some members of a ROSCAS receive money and then fail to make further contributions to the ROSCAS. In such cases those members that had not received contributions from the ROSCAS end up losing their money.
- Small loan amounts: The funds that are advanced to ROSCAS members are limited to the contributions they collected in their meetings and ultimately only amount an individual member’s savings. This is because ROSCAS do not charge fees or high interest hence they do not have any other source of funds. In most cases these funds cannot meet the financing need of the entrepreneur.
Formal sources of Business Finance
Last week we discussed about informal sources of fund and how to effectively utilize them for your business prosperity. We saw that while getting fund from informal sources can be quicker and easier, careful consideration should be taken whenever an entrepreneurs chose to borrow from such sources. Today we are discussing about formal sources of obtaining fund for your business.
Micro, Small and Medium Enterprises (MSMEs) can obtain money to finance their businesses from formal sources such as commercial banks. However it is critical to understand that for most commercial banks, before seeking for a loan from them, it is required to have a bank account with them and be a regular customer of some of the products offered. Some of the products offered includes opening savings account and regularly depositing part of the profit from the business as savings until such a time when you have accumulated sufficient funds to finance the intended business need. This is known as saving up. However saving up is not easy as many of the MSME needs are immediate and cannot wait until when they have enough saving to finance their business plans.
For instance if an MSME is manually producing Mango Juice and requires to mechanize their operations to meet increased demand, the MSME may find it difficult to wait until such a time that it has raised sufficient funds to mechanize.
Some of the benefits of sourcing finance from banks include:
- Security: In comparison to other modes of saving, funds deposited in banks as savings are secure. Funds deposited in the bank are safe from loss, theft, fire, misappropriation and other risks associated with holding cash in hand.
- Big loans: In comparison with informal sources of financing, banks can provide a bigger loan that can meet the intended business needs. Banks are well placed to advance bigger loans to MSMEs.
- Advisory services: The banks’ credit officers provide guidance and advice on technical areas such as business planning, record keeping, separation of duties and many other areas of the business.
- Flexible and Longer loan repayment periods: Banks’ offer MSMEs with flexible and relatively longer loan repayment periods to service their loans. This enables the entrepreneur to schedule their loan repayments according to the installments that they can comfortably service. (It’s worth pointing out that longer repayment duration increasingly result into increased amount to return.)
- Wide product range: Banks offer MSMEs with a wide variety of products over and above the saving account. These products are tailor-made to meet the MSME business needs which include:
- i) Loans for business Assets. example, Mango Juice producing machines or processing Unit, vehicles and others.
- ii) Emergency loans. This is provided especially when the MSME has an immediate need that requires cash.
iii) Top-up loans which mean an additional loan to top up an already existing loan.
- Prompt loan disbursement: Upon fulfillment of the prescribed requirements and submission of a duly completed loan application form banks are very prompt in making loan disbursement. This is an attractive factors to MSMEs as some of the business opportunities require immediate interventions.
While borrowing from banks is attractive for most MSMEs, the process and loan qualification requirement is stringent. Most commercial banks require a loan applicant to provide guarantors who are regular customers with the bank, or collateral such as logbooks and title deeds. A good number of MSMEs may not meet such requirements for they do not have properties which can be used as collateral hence failing to access funds from banks.
- Microfinance Institutions.
There are many microfinance institutions (MFI) operating in East Africa. They mostly provide financial services to low income clients that normally cannot access financial services from commercial banks. They are characterized by few requirements when joining and provision of un- secured loans or loans that are not backed by physical collateral since they use other forms of collateral such as group guarantee.
Benefits of accessing funds from MFI include;
- Easy terms of joining: The MSME will find that MFI have easy terms of joining and becoming a client. In most of the MFI, all that is required is a client photo, identification documents, business license and registration fee.
- Weekly or Monthly repayments: Many MFIs offer their clients weekly repayments that are easy to make. Majority of the MSMEs would be comfortable in making weekly loan repayments that are small and manageable while some may opt for monthly loan repayments.
Despite MFI popularity in Tanzania, this source of financing also have challenges including;
- Small loan size and slow graduation: In comparison with banks MFI advance small loans that at times is not sufficient to meet the SME needs. Additionally MFI normally do provide loan to clients on strict graduation. For instance some MFIs only advance a maximum TZS.500,000/- for the first loan.
- Short loan repayment period: The loan repayment period by the MFI to clients is generally short. For instance many MFI only offer maximum repayments period of 12 months. The loan repayment installment amounts for bigger loans are big and the loan applicants find it difficult to put together the huge repayments installments.
- Limited number of products: Many MFIs only offer a limited product range. Some MFIs only offer business loans which do not meet other needs of business such as those related to asset acquisition and investment.
Micro, Small and Medium enterprises in East Africa has been steadily growing despite of poor access to financing. Most of the enterprises are at infancy stages hence limiting them to acquire financing from formal sources. There is also a challenge associated with inadequate availability of financial facilities offering tailored or sector specific services to enterprises.
To overcome challenges of poor access to financial services, MSMEs should position themselves and prove to formal sources of finance that they are profitable, properly managed and have a market for their product.
Why do MSMEs take business loans?
It is no secret that the economy is tough especially for small business owners in Tanzania having to cope with rising costs, lack of manpower and the shortage of working capital.
Money lenders demand high interest rates for MSMEs to obtain capital. This makes the riddle of starting and managing a small business to be more difficult.
However, despite all these stumbling blocks MSMEs need to borrow money to run their businesses.
MSMEs borrow money from financial institutions to do the following:
- To start a business
- To obtain working capital to meet business needs – specifically to increase the businesses work force or increase inventory
- To expand into new markets – the entrepreneur may want to borrow in order to enter new energy markets.
- To improve cash flow of the enterprise
- To build a credit history or relationship with a financial Institution- an entrepreneur may not have borrowed before so taking out a loan can help in developing a good repayment history and can help the entrepreneur obtain financing in the future.
Considerations for borrowing
An entrepreneur should plan carefully before deciding to borrow money for either starting up a business or for business expansion. Entrepreneurs are required to make informed borrowing choices, which should be based on the business performance. Prior to borrowing entrepreneurs should carefully consider the following:
- A thorough knowledge of the business – this includes analysis of the business, seasonality of the business (identification of peak seasons, slow seasons, and business cycles among others). Knowing the business very well helps the entrepreneur to plan the loan repayments around some of the factors mentioned.
- A well laid out business plan will allow entrepreneurs to forecast on their cash requirements, enabling them to determine business needs as well as identifying the correct timing for finances. This will give them extra time to explore all possible borrowing sources and negotiate the most favorable terms.
- Knowledge of business competitors: This information is important because it helps the entrepreneur access whether the timing of borrowing will be affected by activities conducted by the competition. An entrepreneur may borrow without studying the competition only to find that he/she cannot make more sales as a result of activities conducted by the competition.
- Strengths, Weaknesses, Opportunities and Threats (SWOT) analysis of the entrepreneur as well as the enterprise. An entrepreneur needs to conduct a SWOT analysis to be able to maximize both personal and business strengths, minimize weaknesses, take advantage of opportunities as well as have contingency plans to take care of threats. Borrowing should not be done when the business weaknesses and threats outweigh business opportunities.
- Business Profile – A business profile defines the business in detail. For start- ups, the business profile provides a justification why the entrepreneur wants to start the particular business as well as sources of startup capital. For expanding businesses the profile highlights when the business was started, how it has grown over time and helps to forecast where it is heading. This is very critical in helping the entrepreneur to make borrowing decisions.
- Purpose of the loan – When an entrepreneur is planning to borrow money they should provide a well written statement showing the purpose of the loan, what it will be used for, how the loan will contribute to increased sales and profitability.
- Accurate financial records – these are proof of how an enterprise is performing. This information is used to evaluate whether the enterprise has capacity to repay the loan. Capacity of the enterprise can only be accessed if proper records are maintained describing how much money the business is generating against business expenditure.
- Cash flow projection – a cash flow shows money into the business and out of the business on a day-to-day basis.
- Collateral – this refers to the security an entrepreneur is willing to give a financial institution to secure a loan. Collateral can include business and personal property such as inventory, equipment, and accounts receivable or real estate, stocks, bonds, etc.
- A repayment plan that shows how and when an entrepreneur will pay back the loan. As a contingency, an entrepreneur might outline a plan of action on how they will pay off the loan if profits alone aren’t enough.
- Supporting documentation – these consist of documents that verify the information for a loan request – for instance, a lease, certificate of incorporation, partnership documents and letters of reference, contracts, invoices or vendor quotes.
Costs related to borrowing
MSMEs who are willing to borrow need to understand all the costs related to borrowing. Some financial institutions do not disclose borrowing costs unless asked to do so by the entrepreneur. It is important for entrepreneurs to understand costs in order to compare what financial institutions are offering the best borrowing rates for them to make informed choices.
The following section presents a number of costs that an entrepreneur needs to consider before deciding to take a loan.
- a) Interest rates. Interest rate is the charge for using the borrowed money and is expressed as an annual percentage of the principle. This fee is added to the amount of the loan.
An entrepreneur should seek the following information with regard to interest rates:
- The amount of interest charged. The entrepreneur should do a research to several institutions.
- How do different financial institutions calculate the interest rate?
- What is the default rate of interest and is it competitive?
- Is the interest rate coupled with all fees, competitive with other available loans?
- Is the interest rate fixed or variable? Fixed interest rate means that the interest will remain at a per- determined rate for the entire term of the loan while variable interest rate means that the interest rate will move up or down based on the changes of the interest rate index (base lending rate).
- b) Payment Terms. Payment terms refer to the duration an MSME is given by a financial institution to pay the loan. What happens if an entrepreneur pays before the stipulated end date? What penalties are charged if the loan is not paid timely? Some financial institutions charge entrepreneurs for late and delayed payments therefore it is important that an entrepreneur understands how much the lender will charge for late payments.
An entrepreneur should seek the following information from a financial institution:
- What are the monthly or other periodic payment obligations?
- When is the final principal payment due?
- Is there a right to extend the due date of the loan?
- c) Fees and charges. Fees are different from interest rates because they are charges incurred in loan processing and differ from one financial institution to another. Some common types of fees includes: loan underwriting fees, loan application fees, loan disbursements fees, loan insurance fees, legal costs, collateral valuation costs, due diligence costs, expenses of arranging the loan among others. Find out the following:
- Are there any loan fees, commitment fees, placement fees?
- Are they payable upfront?
- Are there any on-going fees or charges during the life of the loan?
Let us end here for today, next week we will discuss about tactics of negotiating for a loan.
Prepared by Veneranda Sumila
Tanzania Private Sector Foundation (TPSF)
For more detailed information on sources of business finance please visit the below web address http://entrepreneurs.or.tz/access-to-finance/
Questions and enquiry contact firstname.lastname@example.org
6. Be prepared to show how you'll use the money
You may want to include projected financial statements for the next 3-5 years. In your projections give a clear description of how you’ll use the proceeds and how you intend to pay the money back.
Be specific. Show how you’ll use the money to open up new markets, introduce new products, or other definite business use that will positively impact your bottom line.
If you’re looking for debt financing, you’ll want to emphasize your ability to repay the loan. On the other hand, equity investors will want to see the potential for strong rate of return.
1. Know what you need.
If you’re not sure how much cash your company needs to operate or expand, meet with an adviser or an accountant before approaching any lenders. Be prepared to supply documentation to back up your request and to answer lenders’ questions about your finances, business model, and future plans. Also be ready to discuss exactly how the loan will be used. For instance, you might show how the cash will be used to purchase materials, to set up a new location, or to pay additional staff.
2. Consult an Expert
Whether you need help on finding the right loan for your business or a guiding hand that can help you through the application process, don’t feel that you have to go about it alone. Local Small Business Development Centers, Women’s Business Centers, and mentoring organizations for small businesses can help you through the process.
3. Get your business plan in shape
Any business must have a business plan. Before applying for a business loan make sure that your business plan tells the story of your company accurately. Ensure that it is clearly written to the extent that it can attract investors. Cross check the following issues
– How effectively have you demonstrated that you understand how to market your great product or service and turn a profit while doing so?
– How strong is your executive summary? Do your financials show when and how you will obtain long-term profitability?
-How honest have you been in your assessments of the market and your competition?
4. Put your paperwork in order
A standard loan application requires specific documents and numbers. You should take some time before going through the loan process to get this information in order. It’s always a good idea to schedule a meeting with a financial advisor to do this.
Among the documents you’ll need are:
-Organizational papers, such as articles of incorporation, , business licenses, etc.
-Lists of business and personal assets that could be used as collateral
– Names and contact information for at least three credit references
-Accountant-prepared business financial statements (P&L, balance sheet) for the past three fiscal years (If available)
-Business tax return documents for the past three years (If available)
6. Check your credit
Many banks now use “credit scoring” to determine whether you qualify for a loan or not. Commonly used for consumer loans, credit scoring uses factors such as credit history to determine whether or not you’re a good risk. Even if your bank doesn’t rely solely on this method, it will no doubt look at your past payment records to determine your future credit worthiness. There’s also a good chance that you will be asked to guarantee any loan personally, so your personal credit history is also important.
7. Make your applications impeccable
Your financials are probably the most important criteria for helping you get financing, but neatness counts too. Don’t forget about the little things that will help you impress money sources and reinforce your image of professionalism. Make forms neat and easy to read. Dress in appropriate, conservative business attire for meetings. Do everything possible to demonstrate trustworthiness and show that you’re highly capable.
8. Be patient
Finding financing, no matter what stage your business is at, is a time consuming and exhausting process. Many small business owners vastly underestimate the time it will take them to find the money they need, and it’s not uncommon for businesses to run out of cash during the process. Be sure you factor in time for all the tasks you’ll need execute — from refining your business plan to weeding through lists of banks, lending institutions, or outside investors.
Who are Qualified MSMEs to access guarantor funds
Formally registered entity and owned by Tanzanian citizens.
Having viable commercial projects, which are the basis of requesting the credit facility.
Ready to offer any enforceable collateral including their personal guarantee, with the condition of allowing assignment of such collaterals to the Scheme
Having applied for a credit facility from a financial institution relating to eligible projects on which the financial institution has sought a guarantee cover from the Scheme.
Procedures involved when seeking for guarantee fund
Any enforceable collateral of the SME borrower is acceptable, for example a house, car, farm etc.
Assets financed by the guaranteed credit facility
Assets under lease arrangements.
The financing institution would be required to undertake the same prudence in appraising the collaterals as it would in other credit facilities based on the prudential requirements.
The collaterals shall be assignable to the scheme. This condition shall be imposed in the agreement with the financing institutions.
2. Guarantee Fees
The guarantee fees shall be 1.5% of the total contingent liability of the scheme at the time of issue of the guarantee and it is subject to review from time to time by the Scheme.
These fees apply for credit facilities that do not exceed 360 days, in case of medium to long-term credit facilities; applicable guarantee fees shall be charged 0.75% per annum on the subsequent years and would continue for the duration of the guarantee.
All MSMEs on-going activities from different sectors are qualified to access this fund
Source of Guarantee Fund
Bank Of Tanzania
African Development Bank
Ministry of Finance