Summary Introduction to Entrepreneurship & Corporate Governance Final
Note: Cases are not included so you must read them yourself.
Chapter 9 Finances: raising capital for new ventures.
There are broadly three ways of raising finance for your business: (1) founders, friends, and
family (bootstrapping), (2) debt (borrowing), or (3) equity (raising investment by selling
shares). Debt can be obtained by overdrafts, loans, leasing, and invoice discounting. You will
pay interest on debt. Raising equity from investors will require selling shares of your business
to investors. This can lead to you losing control over your company. But it can help reduce
costs and bring in outside expertise. Through these easier ways of raising capital on average
it costs $17000 to start a venture. Venture capitalist are people who only invest in new
companies to get a better return of their investment.
1.Founders, family, and friends
Founders who fund their business mostly with their own money are more attractive to
potential investors because they show commitment to their firm. This funding comes typically
from savings and borrowing. Credit cards are important and often an unrecognized source of
capital because they are flexible and have easy access. But balancing multiple credit card
debts can be challenging. Bootstrapping means going to friends and family for personal
sources of funding. After a start-up becomes a small business suppliers will look more
favorably on providing a trade or credit account.
2.Borrowing
Banks provide most of the borrowed capital by business. They charge interest, which is
variable (base rate plus a fixed amount of, say 2%) or fixed. Banks will normally charge a fee
for arranging financing and annually for agreeing overdrafts.
The most used form of unsecured borrowing is credit card debt. Credit cards are
appealing to small businesses because they are easy to use, can streamline payments, are
easier to get than bank borrowing, widely accepted and an anonymous source of funding.
But credit cards are more expensive, on average 15%. An overdraft linked to a current bank
remains the most popular method. This means borrowing at a variable rate with an agreed
limit. It is used for day-to-day expenses rather than purchasing expensive items.
Some governments provide loan guarantee schemes for small businesses. Governments
do this to support creating new ventures because it delivers job creation and increase
productivity.
Banks make money because they calculate how much they can ask so they make a net
return greater than other forms of investment. Obtaining a loan secured against assets tends
to be cheaper and easier to obtain than equity finance and you retain control of your
business. Secured borrowing is most of the time referred to be secured against property.
Hire purchase (HP), means you own the asset the end of the agreement. Leasing means
where you might have the option to purchase the product at the end of the agreement.
3.Equity
Establishing your business as a limited company allows for the sale of equity(shares) to
external investors. This could be used to bring in a new director or private equity investment
firm. There are a number of bodies who can provide this form of investment, such as seed
funds, business angels and venture capitalists.
,There are 5 sources of finance: Banks, Business Angels, Venture capitalists, Crowdfunding
and Peer-to-peer lending.
Banks
Banks are a vital source of formal finance for small businesses and new ventures. Choosing
the right bank for you can be difficult because their services can seem very similar. It is worth
investing some time meeting with different banks and asking for experiences.
Business angels
When bank lending and other informal sources are insufficient you may decide to sell shares
to private equity investors. Business angels are wealthy individuals who want to invest their
own money in high-growth businesses. They also bring experience, skills, and contacts they
will look for opportunities in industries where they have relevant experiences. It can be very
risky for a business angel to invest in start-up firms because they can lose everything.
Venture capitalists
Venture capitalists are also a source of private equity, but they usually manage larger funds
than syndicates of business angels. They manage usually deals between $250.000 to $2
million. They are also more likely to look for an exit through an initial public listing (IPO) or
trade sale to a larger company. It is important to consider the extent of venture capital
funding and the high degree of variation between countries. Usually, it takes between three
and eight months to raise funds from VCs. Entrepreneurs can expect to give at least 20% but
sometimes considerably more and the exit is expected within three to seven years.
When entrepreneurs take professional money, they have fundamentally lost their complete
freedom of action. Because the shareholders always have a veto over all important
decisions.
Crowdfunding
Crowdfunding is a relatively new form of business financing that allows businesses,
organizations, and individuals to raise funds and contributions, typically through the use of an
electronic platform. Crowdfunding has different forms: donation-based, reward-based, debt-
based or equity crowdfunding. Equity crowdfunding (ECF) is recognized to confer significant
benefits to firms that amount to ‘more than money’. These include improving the valuation to
their firms getting validation of their products and services, building their networks and
sending positive signals to their investors such as business angels and venture capitalists.
Crowdfunding is making finance more accessible to new and early-stage ventures.
Peer-to-peer lending
Peer-to-peer lending is a form of finance which allows for loans to be negotiated, often
anonymously, between a business and an investor through a web-based platform. The
anonymously character of this kind of finance overcomes gender biases.
Once you have launched your new venture it is possible to arrange access to the funds tied
up with trade customers, a technique called ‘factoring’ or ‘invoice discounting’.
Factoring
Factoring can provide valuable finance to growing companies who trade with other
, businesses and offer credit accounts. Such companies will raise an invoice for goods or
services and give the customer 30 days to pay it. It is not unusual that this period is extended
to 60 days, which helps with cash flows. Two most common methods are:
1. Factoring, the bank agrees to pay a percentage, for example 80% of approved debts
as soon as they receive a copy of the invoice. The balance, in this example 20% is
paid when the customer settles the full invoice. A small percentage or fixed fee is
deducted from this payment.
2. Invoice discounting, similar to factoring but is likely to be offered to younger or
smaller businesses. One important difference: the bank provides the debt collection
service and your customer is aware that a third party is involved.
Both methods can be a valuable source of working capital. It can also prove cost effective
with modest charges and interest only being charged on the funds used rather than the total
available.
Many high-growth companies, particularly in a sector with a history of acquistions, will
receive the necessary finance from trade investors. People who have expert industry
knowledge or with to gain it. The initial investment may be followed by an attempt to acquire
the company.
Flotation
Some high-growth companies work through several types of financing until they reach the
point where a flotation becomes both desirable and profitable. One mechanism is public
offering (IPO), where a company offers shares for sale on a public platform, such as the
NASDAQ stock market (Google example).
What see investors as a good business idea?
1. A strong proposition, there are plenty of bright ideas but is is much easier to have
one than to execute it. We need to make sure that the innovative idea also provides a
service or product that is needed in the market. It has to be a special idea with insight
into a particular market need.
2. Access to experienced people, when someone has a good idea it is really attractive
that he brings in somebody with commercial experience.
3. An interesting business plan, the plan has got to be sufficiently interesting for us to
take it to the next stage. Only a few plans are chosen and then get a meeting for 1
hour to present the idea. The goal is to persuade the potential investor that your
venture is attractive, and that your entrepreneurial team is capable of achieving your
operational and financial goals.
The nature of the return to investors
For lenders the return will simply be interest, for investors this will be dividends and shares.
But where lenders will have capital repaid, investors want capital growth on equity
investment. But not all returns are financial, for example increasing quality of live, social or
environmental returns. Meredith’s law of innovation: ‘The invention is 10% of the product
and the product is 10% of the business’.
