Small regulatory, legal and financial frameworks conducive to entrepreneurship

Small businesses help stimulate economic growth by providing employment opportunities to people who may not be employable by larger corporations. Small businesses tend to attract talent who invent new products or implement new solutions for existing ideas. Many small businesses also possess the ability to respond and adapt quickly to changing economic climates. Many reasons for failure of SME’s are; weak control systems, insufficient capital, lower guaranteed pay, limited resources, limited fundraising capability, difficulties in exploiting technology, constrained managerial capabilities, low productivity, regulatory burdens, access to foreign markets. These become more acute in a globalized, technology-driven environment.

To succeed, sustainable SME development will require concerted efforts among the various parties concerned including commercial banks, leasing companies, consulting and training firms, internet providers, as well as local business associations. Analysis of SME sector in Azerbaijan, discussions with focus groups have shown developing business environment in Azerbaijan. However, there are some general problems in administrative procedures. Scale and frequency of auditing and checking, high requirements for permission and licenses, compulsory certificating creates difficulties for development of local entrepreneurship.

These administrative obstacles, financing edges, immature infrastructure negatively influence SME improvement. Government need to improve SME’s access to financing, information infrastructures and international markets. Providing regulatory, legal and financial frameworks conducive to entrepreneurship and small firm start-up growth is a priority. Reducing the regulatory burden on smaller firms can be one of the greatest spurs to entrepreneurship. SMEs identify high compliance costs, extensive and complicated paperwork, and economic regulations that prohibit certain activities as the most onerous burdens they face.

Access to information about regulations should be made available to SMEs at minimum cost. Policy makers must ensure that the compliance procedures associated with, e.g. R&D and new technologies, are not unnecessarily costly, complex or lengthy. Transparency is of particular importance to SMEs, and information technology has great potential to narrow the information gap. It would be of great help to set up a “one-stop-shop system”, where all the necessary information which affects firm strategies and decisions is made available in one place, as exists already in some countries. Electronic data interchange (EDI) would be particularly helpful to smaller enterprises, it is precisely these firms that are the least likely to have access to expertise in this area. Governments need to intensify their efforts to disseminate information, eliminate unnecessary red tape, and make programs more responsive to the changing needs of SMEs.

Fostering an adequate flow of financing for small firms is a crucial step in enhancing entrepreneurship and creating a vibrant economy. Small firms are disproportionately handicapped by a lack of finance, but they receive a stronger boost in growth than large firms if financing is provided. SME growth increases government income from taxation.

Revenues and profits of SMEs contribute to governments’ corporate tax income. Moreover, they stimulate increased indirect taxes (such as value-added taxes) These can be a number of initiatives undertaken by banks to better serve the SME sector. Ø Reducing information asymmetry of SMEs and high perceived risks by using credit scoring systems; using external information providers; risk self-assessment for the SME entrepreneurs; pricing to the level of risk; sharing risk with third parties; using covenants as an alternative to loan guarantees; and setting up special support units for high risk customers such as start-ups; Ø reducing costs of lending by applying latest information technologies; streamlining the organization and simplifying the lending process; Ø Developing products better adapted to SME’s needs; Ø Improving financial services for SMEs through training of bank staff and the segmentation of SME customers; Ø Cooperating with SME organizations and other business development providers in order to reduce risks and costs and combine financial with non-financial services. The challenge that banks face in managing SME risks is to make an accurate risk assessment of a large number of SME loan applications without generating high costs per application. Therefore, banks that work with large numbers of SMEs need to use automated processes in making their lending decisions in order to drive down the costs of each lending decision. This requires rather costly investment into IT systems and training of staff involved in small business lending.

These investments will, however, typically pay off through efficiency gains and improved risk assessment provided that the bank holds a sufficiently large SME portfolio. Examples of Covenants; • Request for the SME to report its financial status to the bank more often and in greater detail; • Obligation for the SME to ask the bank’s permission before making large investments which could endanger its solvency. • Obligation for the bank to charge lower interest rates and fees if the financial position of the customer stays above agreed limits, with the possibility for the bank to increase interest rate margins and fees if the SME breaches these limits. ( SMEs generally tend to be confronted with higher interest rates, as well as credit rationing due to shortage of collateral.) Special support units for high-risk customers such as start-ups: Banks can also develop a number of initiatives for reducing risks of SMEs in the start-up and early development stages. SMEs in these stages are especially high-risk clients for banks due to the lack of business skills, experience, strategies and resources.SME units or agencies are charged with promoting small business development by providing capital, reforming fiscal practices, reducing administrative burdens, providing management and skills training, improving information dissemination and increasing access to markets.

Programs to increase the technology base of SMEs include R tax credits, loans or grants for innovative activities, and technology diffusion schemes. There is need to continue to liberalize telecommunications markets and ensure competitive ICT infrastructure, prices and services. Also, the difficulty of building a reputation and establishing consumer trust and confidence in their activities make SMEs more vulnerable than larger firms to problems linked to authentication and certification; data security and confidentiality; and the resolution of commercial disputes. The needs of SMEs should be specifically addressed in creating an effective business environment for e-commerce. • Creating a technology-neutral e-commerce and e-finance friendly regulatory environment and developing secure methods of electronic transmission of commercial messages, e-signatures and e-contracts, which should be considered as legally binding by contracting parties; • Adopting flexible regulations and creating a supportive institutional environment to encourage the introduction of e-payments, Internet banking, online trade finance and credit information and other e-finance relevant to SMEs in developing and transition economies and ensure public–private cooperation in that respect Access to global markets for small businesses can offer a host of business opportunities, such as larger and new niche markets; possibilities to exploit scale and technological advantages; upgrading of technological capability; ways of spreading risk; lowering and sharing costs, including R costs; and in many cases, improving access to finance. Gaining access to global markets can help prospective high-growth firms realize their potential and often an essential strategic move for SMEs with large investments in intellectual property.

Venture capital and leasing could be significant sources of long term funds which at present are underdeveloped. To this end, governments are now fostering the development of secondary stock markets to allow easy entry and exit for venture investors; easing taxes on capital gains and other dividends; and allowing greater use of stock options as compensation in small firms. Historically, there were few external equity providers in developing countries, whether private equity or venture capital. The venture capital and private equity industry is still relatively new, and most players have not expanded beyond the developed world. Furthermore, equity financing is hampered by similar reasons as debt financing (e.g.

asymmetric information, lack of reliable financial information). In addition, entrepreneurs in developing countries have little familiarity and affinity with the equity model. Experience from developed countries suggests that the informal venture-capital sector can be stimulated through: • improved networking services to enhance the flow of information between investors and investees; • use of the taxation system to encourage wealthy individuals to invest in private business.

Venture capital has the potential of offering a valuable source of finance complementing the more traditional credit finance provided by commercial banks. Some of the fundamental reasons hindering SMEs from obtaining credit from commercial banks and other credit institutions are less important in attracting venture capital. The advantages of venture capital are: • Potentially large gains from the sale of shares in the company.

• Venture capitalists do not require collateral from borrowers. • Operating costs are lower due to the absence of high interest rate payments. • Venture capital – by nature – is long-term or at least medium-term capital, in contrast to short-term loans from banks. • The managerial know-how provided by venture capitalists can in some cases be more valuable to the start-ups or SMEs than the actual financing received. Rather different approaches to stimulate SME’s: ü Ecosystems Cooperation between small and big businesses can take the form of a business ecosystem. Ecosystems are increasingly common in business sectors such as information technology where companies collaborate to offer customers a solution that incorporates products and services from different partner companies. A large network operator, for example, would work with smaller software companies, application developers and consultancies to develop a complete network solution. Clustering can be of particular benefit to smaller firms who, because of their size, often cannot provide specialized training or maintain in-house services such as R&D or marketing.

ü Businesses should practice “just in time” inventory management, with inventory on hand only as needed. Additional methods • Stimulating additional research on the impact of capital provision to SMEs on economic indicators at the micro- and macro-level. • Analyzing the comparative cost-effectiveness of interventions that strengthen financial structures, such as those focused on strengthening property rights and contract law (e.g. collateral recovery procedures), and those that aim to reduce information asymmetries (e.g.

credit bureaus and harmonized accounting systems) in relationship to direct financial support to SMEs. • Work toward a differentiated understanding of the impact of SME financing on different sectors (e.g.

agriculture, services) and lending channels In conclusion, to prosper, SMEs need a conductive business environment and regulations, adequate basic infrastructure services, access to short and long-term funding at reasonable rates, capital, advisory assistance, and knowledge about market opportunities. SMEs are fundamental part of the economy and they play a crucial role in furthering growth, innovation and prosperity.