A barista prepares coffee.SMEs rely on bank loans as a source of capital. PHOTO BY RACHEL MABALA In East Africa, the question is: What does it take to encourage investors, grow our economies and create jobs? Small and Medium Enterprises (SMEs) form a vital sector of our economy. But they suffer high costs of financing. SMEs need capital to start up or run their businesses but borrowing or using investors’ funds is not free. The cost of capital is the return required as compensation for contributing capital
Primary capital markets are markets in which companies and governments raise capital. Companies raise funds by borrowing money or issuing equity; governments by borrowing. These securities can later be traded in the secondary market.
In a liquid market, transaction costs are low, shareholders and lenders can easily value their securities and sell when they need to, so they are more willing to fund potential investments.
A market is considered deep when large trades can be made without causing large price movements and the costs of trading large amounts is relatively small.
The capital markets need to channel savings to the most productive use. Economies grow when resources are used productively, and remain poor when they are not. The regulators – the Capital Market Authorities, ensure there is a system that protects investors from fraud. They vet companies seeking funding and regulate the companies who receive the funding. The market encourages investments by offering attractive returns for savings and gives an alternative to borrowing as a source of capital.
In East Africa, the question is: What does it take to encourage investors, grow our economies and create jobs? Small and Medium Enterprises (SMEs) form a vital sector of our economy. But they suffer high costs of financing. SMEs need capital to start up or run their businesses but borrowing or using investors’ funds is not free. The cost of capital is the return required as compensation for contributing capital.
To justify contributing capital, returns need to be equal or higher than returns of other investment opportunities with similar risk. The riskier the investment, the greater the cost of capital. SMEs that generate returns greater than the cost of capital are able to keep going, add value to the economy, create jobs, and attract investors.
Alternative sources
The capital markets provide an option for a source of capital for SMEs. The Exchanges in East Africa are the Uganda Securities […]
