Small and medium-sized enterprises play a critical role in most economies, particularly in developing countries such as Kenya, and are important contributors to job creation and global economic development. Despite their contribution to the economy, businesses still face a myriad of challenges, with the key one being access to sustainable financing.
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For a company or any other institution that is in need of money, they can raise capital either through debt financing or equity financing. Debt financing involves borrowing money with the obligation to pay it back at a later date with interest. On the other hand, Equity financing involves selling a portion of the ownership of the company to an investor with the obligation of giving the investor a portion of the profits made by the company.
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In Kenya, businesses go to banks or the capital markets to raise the needed funds. However, financing through banks has been historically dominant, with businesses relying on banks for 99.0% of their funding while a mere 1.0% of the funding comes from the capital markets. This is in contrast with developed countries, where businesses rely on banks for just 40.0% of their funding, with the larger percentage, 60.0%, coming from capital markets.
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One of the causes of overreliance on bank funding is a lack of understanding of the available capital market products that can help businesses raise capital. Capital markets are known for raising capital through Equity financing. However, there are other capital market products, such as commercial papers and corporate bonds, that can enable businesses to raise capital through debt financing.
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Debt financing in capital markets has a different approach from that of banks in terms of how the payment is made. With Banks, the borrower settles the debt by making monthly remissions to the bank, which constitute a portion of the principal plus the interest accrued. However, the payment plans for capital markets borrow the same structure as those for government securities, where the principal amount is paid upon maturity.
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Commercial paper usually settles the debt by paying the principal plus the accrued interest upon maturity. Corporate bonds, on the other hand, only pay the interest accrued during the tenure of the bond, and the payments are made twice a year. Upon maturity, the corporate bond issuer pays back the corporate bond plus the accrued interest for the last 6 months before the bond matures.
The structure of debt financing in capital markets is suitable for companies that are struggling with cash flow problems as the principal is settled upon maturities. This is significantly beneficial for companies that are expanding their business or starting new projects, as the extended payment cycles give them more time to build up their cash flow as the new projects and business start to pick up.
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Some of the companies in Kenya that have issued corporate bonds include East African Breweries Limited, Family Bank, Centum Investments, Kenya Mortgage Refinancing Company, Acorn Holdings Limited, and Real People Kenya.
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