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CHAPTER ONE

INTRODUCTION

1.1   BACKGROUND TO STUDY

Small and medium-sized enterprises (SMEs) play a pivotal role in the national economies of countries around the world. This is especially true of emerging markets. They are considered to be an engine for growth in both developed and developing countries; the benefits of a vibrant SME sector include: the creation of employment opportunities; the strengthening of industrial linkages; the promotion of flexibility and innovation; and the generation of export revenues (Lerner, 2002; Rangamohan et al, 2007). In SA, for instance, eight out of 10 jobs that are created occur in the SME sector (Karungu et al, 2000). In the US, Japan and Germany, small business contributes more than half of the gross domestic product (GDP) in each of those economies. Though SMEs have been the engine for growth in various developed and developing economies, they have always faced problems in accessing finance. Without proper finance, SMEs can neither expand to compete globally nor can they acquire technology or meet their fixed and working capital requirements (Wanjohi and Mugure, 2008). SMEs face significant challenges, which include access to finance (Iwisi et al, 2003) and financial management skills and support (Gem Report, 2003). This contributes to slow development and high mortality rates of small businesses in Nigeria.

Access to finance is particularly relevant for previously disadvantaged entrepreneurs who do not have access to collateral and the networks of wealthy individuals who could provide angel financing. Financing is necessary to help SMEs set up and expand their operations, develop new products, and invest in new staff or production facilities. Many small businesses start out as an idea from one or two people, who invest their own money and probably turn to family and friends for financial help in return for a share in the business. But if they are successful, there comes a time when they need further funds to expand or innovate further. Some SMEs often run into problems, because they find it much harder to obtain financing from banks, capital markets or other suppliers of credit (Afua, 2011).

Almost every company we know of began as an SME. Vodafone as we know it today was once a little spin-off from Racal; Hewlett-Packard started in a little wood shack; Google was begun by a couple of young kids who thought they had a good idea; even Volkswagen at one point was just a little car maker in Germany (as opposed to being a giant small car maker globally) (Lukacs, 2005). Microsoft may be a software giant today, but it started off in typical SME fashion, as a dream developed by a young student with the help of family and friends. Only when Bill Gates and his colleagues had a saleable product was they able to take it to the marketplace and look for investment from more traditional sources Amissah 2009). The growth of SMEs has been hampered by the lack of adequate knowledge and a well structured financial market for the mobilization of capital. The role of finance has been viewed as a critical element for the development of SMEs Cook and Nixson, (2000). However, venture capital has had a significant impact on Small and Medium Enterprises (SME) in the developed countries; small businesses have been and are the stepping stone of industrialization in these countries.

1.2   STATEMENT OF THE PROBLEM

Arguably, SMEs have an important role in the development of an economy, as they contribute to the economic development of developing and developed countries. SMEs also contribute in the creation of employment and breeding ground for entrepreneurs, as well as a centre to investment generation and technological development. SMEs are also the sources of domestic and international trade. A weak business environment, lack of managerial or technical capacity and Lack of finance could be regarded as major problems contributing to slow development and high mortality rates of small businesses in Nigeria. Finally, several researches has been carried out on the impact of venture capital financing on SMEs but not even a single research has been carried out on an assessment into the effect of venture capital financing on the profitability of SMEs in Nigeria.

1.3   AIMS AND OBJECTIVES OF STUDY

The main aim of the study is to assess the effect of venture capital financing on the profitability of SMEs in Nigeria. Other specific objectives of the study include:

1. to determine the extent to which venture capital financing affects profitability of SMEs in Nigeria.

2. to determine the factors affecting venture capital financing of small and medium scale enterprises in Nigeria.

3. to examine the awareness of the SMEs towards venture capital as a significant source of financing.

4. to proffer possible solutions to the problems.

1.4   RESEARCH QUESTIONS

1. What is the extent to which venture capital financing affects profitability of SMEs in Nigeria?

2. What are the factors affecting venture capital financing of small and medium scale enterprises in Nigeria?

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3. What is the awareness of the SMEs towards venture capital as a significant source of financing?

4. What are the possible solutions to the problems?

1.5   STATEMENT OF RESEARCH HYPOTHESIS

H0:   Venture capital financing has no significant effect on the profitability of an SME in Nigeria.

H1: Venture capital financing has a significant effect on the profitability of an SME in Nigeria.

1.6   SIGNIFICANCE OF STUDY

The study on an assessment into the effect of venture capital financing on the profitability of SMEs will be of immense benefit to the entire SMEs in Nigeria in the sense that it will enable the government to gain an understanding of the role played by both formal and informal venture capital markets so as to provide a suitable environment for their operations especially to formulate policies that will support the entrepreneurs. The study will also enable the venture capitalists to review the need to provide seed financing which will lead to establishment of many such businesses. These financers can also review their stringent requirements to accommodate more users of their fund. Finally, the study will contribute to the body of existing literature and knowledge to this field of studies and basis for further research.

1.7   SCOPE OF STUDY

The study on the assessment into the effect of venture capital financing on the profitability of an SME is limited to Nigeria.

1.8   LIMITATION OF STUDY

Financial constraint- Insufficient fund tends to impede the efficiency of the researcher in sourcing for the relevant materials, literature or information and in the process of data collection (internet, questionnaire and interview). Time constraint- The researcher will simultaneously engage in this study with other academic work. This consequently will cut down on the time devoted for the research work.