FEDERAL UNIVERSITY DUTSE

CENTRE OF ENTREPRENEURIAL DEVELOPMENT

GST 311 LECTURE NOTES

Sources of Funds
(1) Venture Capital Investment
Venture capital originated in the late 18th century but it only became popular in the industry in
the late 1970s and early 1980s when a number of venture capital firms were founded as
entrepreneurs found wealthy individuals to back their projects on an ad hoc basis. Venture
capital fund is the pool of capital constituted for investing in relatively high-risk opportunities.
Therefore, venture capital investors are very selective in deciding where to invest in. They used
to provide long-term, committed share capital, to help unquoted companies grow and succeed.
The venture capitalist makes money by owning equity in the companies they invest in. Obtaining
venture capital is substantially different from raising debt or a loan from a lender. Lenders have a
legal right to claim interest on a loan and repayment of the principal irrespective of the success
or failure of the business. Venture capital investors immediately become part of the owners as
investment take place. As a shareholder, the venture capital return depends on the growth and
profitability of the business. The return of venture capital is often earns when he sells his
shareholding to another owner.

(2) Personal Savings

Personal savings is the most common source of financing for small business enterprises. It has to
do with the personal money which the entrepreneur has been able to set aside for an intended
business venture. This includes cash and any personal assets convertible into cash or to business
use. This may also be from past savings, trust accounts or some other form of personal equity of
the business owner. This is the least expensive method of financing and also the easiest as the
decision to lend is made by the same person wishing to borrow the fund.

(3) Borrowing from Friends and Relatives

Funds can be raised for entrepreneurial ventures through borrowing from friends and relatives.
The amount to be raised through this source however, depends on the financial capabilities of the
friends and relatives and the relationship that exists between the business owner and his friends
or relatives. The repayment period and the interest payable are a function of the terms of
borrowing which are usually determined by the lender.

(4) Trade Credit

Trade credit as a source of fund occurs when a buyer makes an arrangement with the seller to
buy goods on credit and pay later. However, this arrangement depends on the customer’s credit
reputation and it often requires a pre-arrangement between the buyer and the seller. Trade credit
is one of the most widely used short term sources of funds and the term normally falls within the
range of thirty to ninety days which can still be extended after the expiration period, depending
on the relationship between the parties involved.

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(5) Accrual Accounts
Accrual accounts can also be called account payable. It represents the continually occurring
current liability of a particular business. These include wages, interest, taxes and other expenses
that are payable in arrears. They are due but yet to be paid. Their repayment period is usually
within a period of one year.

(6) Retained Earnings

Funds can also be obtained through undistributed profits. A business owner may decide to
reinvest part of his or her profit back to business for efficient operations of the business. This is
also called plough-back profit and it shows the value of ownership rights that result from the
business retention of its past income. In business, retained earnings are usually considered as an
additional funds for financing the future growth of the business. Retained earnings are helpful as
a last resort in business finance. Usually, the inability of the business owners in meeting up with
the stringent conditions of the financial institutions usually makes the business owner come to
fall back to their business reserves for funds raising.

(7) Equity Financing

Equity finance is a form of business finance in which funds borrowed to operate a business
venture are not taken as loan but converted to equity (stake in ownership) which now makes the
lender a part of the owners of the business venture, risk and profit are shared together. The
amount of equity finance in a particular business may be substantial subject to factors such as the
nature of the business, the total amount of capital required and the interest of the investor. The
advantage of equity financing is that its infusion of capital does not have to be repaid like a loan.

(8) Bank Loan

A small business entrepreneur can approach bank for a loan. This is a common practice among
established small business enterprises with good reputation doing business with a particular
bank. Banks usually charge their borrowers a prime rate and an additional charge usually called
handling charge. The actual interest rate charged depends on the creditworthiness of the
customers. Banks usually charge a higher interest rate to borrowers whom they perceive as
having a higher risk of default. The bank interest rate also depends on the type of loan involved
whether is fixed or variable. If the loan is fixed rate loan, the interest rate will be the same for the
amount of money over the number of years involved. But if the loan is variable rate loan, the
interest payable will vary periodically over the terms of the loan subject to the fluctuation of the
market interest rates. Bank loan can be given either on short term or long term basis. Short term
bank loan usually covers between one month and less than one year, while long term bank loan
covers a period that is more than one year.

(9) Project Financing

Project financing is the funding of a particular project by a financial institution. This can be a
source of funds only when the proceeds from the project are sufficient to repay the capital sum
usually known as the principal which is the amount of money borrowed for the execution of the
project with interest accrued. The project will be used as the security for such loan and the
advance is self–liquidating. In this case, the borrower‘s financial standing or position is less

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important because the institution must ascertain the value of the project and ensure that the value
is high enough to settle the amount of money borrowed by the contractor.

(10) Debt Financing

These are funds that the business owner borrows and must repay with interest. Borrowed capital
maintains ownership of the business (unlike equity financing, which dilutes ownership) but is
carried as a liability on balance sheet. In general, small businesses are required to pay more
interest than large businesses because of perceived higher risks, that is, few percent above prime
rate. Entrepreneurs seeking debt capital can have access to a range of credit options varying in
complexity, availability and flexibility, both from commercial and government sponsored
lenders.

(11) Bills Discounting

Bills discounting is a source of finance where the supplier of goods (creditor) writes a bill of
exchange for the customer for acceptance. Immediate cash may be obtained by the supplier for
his goods after the goods have been dispatched to the customer by discounting the bill with the
bank or discount house after the bill has been accepted by the debtor (customer). Other aspects of
bill discounting involve government securities such as treasury bills and certificates which can
be surrendered before their maturity dates to banks or discount houses for purchase. The amount
paid to the bill owner is less than face value.

(12) Borrowing from Cooperative Societies

A cooperative society is an association established by group of individuals who pooled their
resources together to engage in a business transaction for profit making but mainly for the
benefit of members. Depending on the financial capability of the cooperative society, it can
provide funds for its members to start business or finance their business transactions. The
amount that can be raised from cooperative society is subject to the financial commitment of the
members. The repayment period is not usually beyond one year since the fund is provided on
short-term sources of finance. The interest charged is also considerably low compared with
commercial bank interest rates.

(13) Leasing: A lease is an agreement between two parties: the lessor and the lessee. The lessor
owns the asset but allows the lessee to use it. The lessee makes payments under the terms of the
lease to the lessor, for a specified period of time. Leasing is, therefore, a form of rental. Leased
assets include plant and machinery, cars and commercial vehicles, but may also be computers
and office, industrial or business equipment. When the tenure of the lease ends, the lessee can
decide to purchase the equipment for a sum which must represent at 10% of the cost of the
equipment. There are two basic forms of lease: "operating leases" and "finance leases".
Operating leases are rental agreements between the lessor and the lessee while finance leases are
lease agreements between the user of the leased asset (the lessee) and a provider of finance (the
lessor) for most, or all, of the asset's expected useful life.

(14) Bank Overdraft: Bank overdraft is when the bank allows its customers to withdraw more
money than they have in their accounts. It’s a short-term financial facility which is renegotiated
every year depending on the performance of the business. It is always at the bank’s discretion to

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decide whether or not to let your account be overdrawn. Bank overdraft has a higher interest rate
than a normal loan.

(15) Inventory Financing: Inventory financing is the use of inventory or stocks as collateral
security for borrowing of fund by small to medium-sized retail or wholesale businesses. When a
company borrows money from a lender such as a bank and secures it with its inventory, it is
called inventory financing. Note that, not all stocks are qualified for such transaction. The
marketability, durability and the price stability of the stocks must be considered before such
stocks will be used for inventory financing.

(16) Factoring: Factoring is a financial transaction between a business owner and a third party
that provides instant cash to the former in exchange for the account receivables of the business.
In other words, a cash-strapped business, unable to get desperately needed funds, sells off its
invoices, that are called account receivables, to a third party and in exchange, gets the much
needed cash. Factoring is not a loan, but a sale of invoices of the business. In return, the factor
issues receipt on behalf an organization upon collection of the payments. One of the advantages
of factoring is that the business owner will receive the majority of the cash from debtors within
24 hours rather than a longer time.
o Factoring - where firms sell their invoices to a factor such as a bank. They do this to get cash
right immediate, rather than waiting 28 days to be paid the full amount.
(17) Microfinance Banks -- The Central Bank of Nigeria in 2005 introduced a "Micro finance
policy" for entrepreneurs and how low income household can get access to financial services to
expand their Micro, Small and Medium Enterprises (MSMEs) operations in order to contribute to
rapid economic growth. Micro finance refers to loans, deposits, insurance, fund transfers and
other ancillary non-financial products for low income clients. Three main features distinguish
microfinance from other formal financial products: 1). Small amount of loans, saving and other
financial services 2). Absence or reduced emphasis on asset-based collateral 3).Simplicity of
operations. The establishment of microfinance banks is expected to expand the financial
infrastructure of the country so as to meet the financial requirements of the MSMEs.

(18) Hire Purchase: Hire purchase is a form of installment credit. It allows buyers to purchase
expensive goods on credit, such as plant, equipment, machinery and vehicles, except they do not
own the goods until the last installment has been paid. Usually the customer pays a deposit and
pay-off the value of the car in monthly installments over a period (between 1 to 3 years),
depending on the asset, with the loan secured against the assets. The asset legally belongs to the
owner of the asset and if the buyer defaults, the owner of the assets automatically repossesses his
or her asset. Upon the payment of the initial deposit, the customer enjoys immediate use of the
asset. Hire purchase is similar to leasing, with the exception that ownership of the goods passes
to the hire purchase customer on payment of the final credit installment, whereas a lessee never
becomes the owner of the goods.

(19) Public Offerings

Public offering is a financing option that is only available to companies that are well-established.
Businesses with sustainable growth potentials in the course of expanding their businesses might
decide to use public offerings by ‘going public’ to raise required funds for their business

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operations. However, before a company decides to use public offerings as financing means,
certain factors need to be considered. These factors include; the cost of the security, other
financial obligation of the business, the prospect of the money market, issues concerning the
ownership and control of the business. Public offering usually starts with selling of equity
holding to the public and this is called initial public offering (IPO) in which stock is registered
with the Securities and Exchange Commission (SEC). This is usually offered to the public
through a registered brokerage firm or an investment banker and this gives the organization the
opportunity to trade its shares in the floor of the stock exchange market. To get firms’ shares
quoted in the stock exchange market, the firm needs to make provision for the associated
expenses, filling requirements and other equity considerations. Many small and medium scale
enterprises consider these requirements as stringent conditions and this affects their readiness to
undertake IPO as a financing option.
Public offerings usually result in long term sources of funds which include the following:
(i) Ordinary shares
(ii) Preference shares
(iii) Debentures
(i) Ordinary Shares: Ordinary shares represent the ownership position in an organization.
Ordinary shares holders are also called shareholders and the risk bearers of the firm. Their rate of
dividend is not fixed rather it depends on the discretion of the management. Ordinary shares can
be issued at par, discount or premium. The rights of ordinary shareholders include:
(i) Right to participate in the annual general meeting and vote.
(ii) Right to appoint a proxy.
(iii) Right to have access to the organization’s books.
(iv) Right to contribute to the appointment of members of the board of directors.
(ii) Preference Shares: Preference shares as a long term source of funds are certificates of
ownership in organizations that usually have a fixed rate of dividends which must be paid before
ordinary share dividends. It is considered as a hybrid security because it has many features of
both ordinary shares and debentures. The types of preference shares include: cumulative and
non-cumulative preference shares, redeemable and non-redeemable preference shares,
participating and non-participating preference shares.
(iii) Debentures: Debentures are certificates of debts and they are long term sources of funds
that give the holders the opportunity to collect the principal amount at a fixed future date.
Debentures have definite interest rate which is payable at annual basis until the capital sum of the
amount borrowed is fully paid. They are issued in units of hundred and the interest rates depend
on the prevailing interest rate in the money market and financial condition of the firm.

(20) Small Business Investment Organizations -- These can be government owned or private
owned with debts being government guaranteed. Small business investment organizations can be
regular or specialized, for example, giving loans only to agro-business or manufacturing firms,
business research, product research and development, business start-ups and minority/vulnerable
groups. Unlike traditional venture capital companies, they use private funds or government funds
to provide both for debt and equity financing to small businesses. Examples of institutions under
this category are - Small and Medium Industries Equity Investment Scheme (SMIEIS), Central
Bank of Nigeria (CBN), Bank of Industry (BOI) and Small Scale Industries Credit Scheme
(SSICS).

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Internal and External Sources of Funds
Internal financing is capital which is generated from within a company usually referred to as
"retained profits" or ‘Ploughing back of profits’as a source of capital for investment, rather than
distributing them to firm's owners or other investors and obtaining capital elsewhere. Internal
sources of finance are ploughing back of profits, selling of surplus inventories and fixed assets,
accelerating debt collection of receivables etc. External financing consists of capital obtain from
outside the firm brought in for investment or the business will be indebted to external institutions
or people. There are two types of external sources of finance, i.e. long term source of finance and
short term sources of finance. External sources of finance are bank loan or overdraft, equity
capital, leasing, hire purchase, selling company share, debentures, government grants etc.
External financing is generally considered to be more expensive than internal financing, because
the firm often has to pay a transaction cost to obtain it. Internal financing is generally considered
to be less expensive for the firm than external financing because the firm does not have to incur
transaction costs to obtain it, nor does it have to pay the taxes associated with paying dividends.

Advantages of Internal financing

Advantages of internal sources of finance include the following:
i. capital is immediately available; ii there is no interest payable on such fund; iii. There is no
control procedures regarding the credit worthiness of the owners; and iv.there is no third party’s
influence.
Disadvantages of Internally sourced funds
i. It is somehow expensive ii. It does not easily increase capital. iii. It is not as flexible as
external financing. iv. It is not tax-deductible. v. It is limited in volume because it is subject to
the capability of the owner(s) to raise fund internally.

Advantages of External Financing:

(i) It helps in accelerating growth when demand is high and the business needs immediate capital
to expand operations and hire more workers.
(ii) It helps in getting capital without losing ownership or control of the company. Maintaining
autonomy is a main advantage for any business owner or group of owners

Disadvantages of External Financing

(i) High interest rate payment demands and increased liability. Many lenders require collateral,
and if you default on your payments, the business may lose critical equipment to the lender.
(ii) Borrowing too much can be risky. The corporation loses some ownership rights and may also
mean reducing the control of decision-making held by existing shareholders in the business.
Formal and Informal Sources of Funds
Formal sources of funds represent those institutions that are registered with appropriate
authorities to transact the business of finance with entrepreneurs. Examples of formal sources of
funds include loans from commercial banks, insurance company etc. Formal financial services
are usually provided by financial institutions that are controlled by the government and subject to
banking regulations and supervision. On the other hand, informal sources of funds are provided
outside the structure of government regulations and supervision. Examples of informal sources
of funds include those groups or individuals that are involved in loan disbursement with little or
no formal regulations e.g. Esusu, thrift savings scheme, cooperative society etc.

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Advantages of formal sources of finance
a) Provides proper guidelines and documentation for loans.
b) Business advisory support from the banks that is lending.
c) Helps the entrepreneur to stay focused on the business because of interest rates.

Advantages of informal sources of finance

a) It helps entrepreneurs to have easy access to funding.
b) Less documentation is involved in loan process.
Entrepreneurs do not stand the risk of loss of assets or business to the institution.

Government Initiatives in Funding Small & Medium Enterprises (SMEs) in Nigeria

In order to make the SMEs sector more dynamic, the Central Bank of Nigeria evolved new
initiatives, which are directed towards improving accessibility and availability of finance to
the SMEs through the following schemes:

 The Small and Medium Industries Equity Investment Scheme (SMIEIS) -- The Small
and Medium Industries Equity Investment Scheme (SMEIS) is a voluntary initiative of
Bankers Committee. The initiative was in response to the Federal Government policy on
Entrepreneurship development for the promotion and development of Small and Medium
Industries (SMI) in the country. The Scheme requires all banks in Nigeria to deposit 10%
percent of their Profit After Tax (PAT) annually for equity investment and promotion for
small and medium enterprises. The 10% Profit After Tax (PAT) is the banking industry’s
contribution to the Federal Government’s efforts towards stimulating economic growth,
developing local technology and generating employment. The activities targeted under the
scheme include agro-allied, information technology, telecommunications, manufacturing,
educational establishments, services, tourism and leisure, solid minerals and construction.
The Scheme also provides financial, advisory, technical and managerial services from the
banking industry.
 Bank of Agriculture (BOA) -- The Bank was incorporated as Nigerian Agricultural Bank
(NAB) in 1973 and in 1978, was renamed Nigerian Agricultural and Cooperative Bank
(NACB). In year 2000, it was merged with the People’s Bank of Nigeria (PBN) and took
over the assets of Family Economic Advancement Programme (FEAP) to become Nigerian
Agricultural Cooperative and Rural Development Bank Limited (NACRDB). The BOA is
100% wholly owned by the federal government of Nigeria. The bank provides credit
facilities for financing both agriculture and non-agricultural initiatives and activities
including traders, artisans etc.

 The Bank of Industry (BOI) - The Bank of Industry was established in 2002 with the aim to
provide financial assistance for the establishment of small and medium and large industries
in Nigeria as well as expansion, diversification and modernization of existing enterprises and
rehabilitation of ailing ( or not performing well) industries. It was formed by the merger of
three previously existing development financial institutions: The Nigerian Bank of
Commerce and Industry (NBCI), The Nigerian Industrial Development Bank (NIDB) and
The National Economic Reconstruction Fund (NERFUND).

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 Refinancing and Rediscounting Facility (RRF) -- This programme was introduced by the
Central Bank of Nigeria in January 2002 to provide medium and long term lending at
concessionary interest rate of 2% below the Minimum Rediscounting Rate (MRR). It is an
incentive meant to provide temporary relief to deposit money banks which may face liquidity
problems as a result of committing their resources to medium to long-term funding of real
sector activities. This facility aim to resolve two problems. It provides alternative sources of
funds for lending by banks and it offers additional potential for increased business activities
and profit earning. The medium and long term business operators, who are involved in
productive sectors of the economy, are reassured through the RRF. The RRF loan schemes
include the following sectors: agricultural production, manufacturing and semi
manufacturing, solid minerals and information technology. Under the facility, banks can
access up to 60% percent of qualifying loans. The loan portfolio for which the facility is
required must have been held for not less than one year, and must have an original tenor of
not less than five (5) years.

 World Bank Facility for Small and Medium Scale Enterprises (SMEX) Loan --In order
to further promote the growth of the SMEs, the Federal Government also negotiated further
financial assistance with the World Bank to complement other sources of funding for the
SMEs. The project will help facilitate increased access and availability of financing for
Micro, Medium and Small-Scale Enterprises (MSME) in agriculture, trade, light-
manufacturing, services, and other areas. This involves a loan of US$270 million of which
US$265.7 million is to be made available for on lending to SMEs through eligible
participating banks. The Development Finance Institution (DFI) will provide funding to
eligible financial institutions to finance long-term lending to MSMEs, as well as funding to
Micro-Finance Banks for on-lending and to expand their outreach. The SMEX is managed
directly by the SME Apex unit loan scheme in the Central Bank of Nigeria (CBN).

 Nigerian Export and Import Bank (NEXIM) -- NEXIM was established in January 1990
as an Export Credit Agency (ECA), with the directive to promote the diversification of the
Nigerian economy and expand the external sector particularly the non-oil sector. The Bank
provides short and medium term loans to Nigerian exporters. The establishment of NEXIM
was also intended to support farmers and other small scale exporters to have direct access to
international markets. The facilities offered by NEXIM include the export stimulation loan
(ESL), the foreign facility (FF) and the refinancing and rediscounting facility (RRF). The
Bank provides credit facilities in local and foreign currencies to its clients in support of
exports, risk-taking facilities through export credit guarantee and export credit insurance
facilities to its clients, business development and financial advisory services etc.

Prepared by: Usman Sabo

February, 2025