ISL453U-ENTREPRENEURSHIP
Chapter 6: Resourcing New Businesses
Entrepreneurial Resources
Types of Entrepreneurial Resources
Companies that have better and stronger resources can better survive during the start-up and early phases, and are more promising for growth. These resources can be grouped into two groups: tangible and intangible resources (see Table 6).
Fundraising Challenges of Entrepreneurs
New companies need to acquire external sources to sustain and develop their businesses, and three of these can be regarded as critical for the new start-ups: financial resources, team members, and an order from an important customer. Many entrepreneurs rank fundraising as the number one challenge during their start-up process. This fundraising challenge has many reasons that originate from the entrepreneurs.
It is obvious that investing in a start-up company brings uncertainty and high risk to the table for the investor, and these make the dealing process difficult for the both parties. Since entrepreneurs have more information about their business ideas, products or their capabilities when compared to investors, information asymmetry occurs naturally. So, in addition to uncertainty and high risk, information asymmetry also complicates and brings challenges to the investment process. Another important issue during the funding process is the issue ethics.
Business Growth Phases and Changing Funding Opportunities
Businesses go through different stages from foundation to maturity and their characteristics evolve between these phases (Adelman and Marks, 2013, p.53):
• Seed/Start-Up Phase: Nascent enterprise, business model is present, generally less than 18 months old • Early Phase: Product or service is commercialized, business is less than 36 months old • Growth Phase: No or low profit, hardly stable cash flow, business is older than 36 months • Maturity Phase: Positive profit and cash flow figures
Entrepreneurial companies which are at the beginning of their journey generally depend on internal finance sources such as personal finance, support from families and friends, and they apply financial bootstrapping methods. As the company grows, there is a shift from internal finance sources to external finance sources and investment from business angels and venture capitalists become more attractive.
Funding During the Seed and Start-Up Phase
Personal Finance
It is very common that entrepreneurs use their own savings to start their businesses. Relying on personal
finance during the seed/start-up phase is an inevitable situation since banks or investors are not eager to take high risk by lending money to a company with no cash flows.
Family and Friends
Borrowing money from friends, family members or even colleagues is a form of debt financing in an informal way. Raising money from these “informal investors” has both advantages and disadvantages (see Table 6.2). One of the most important drawbacks of borrowing money from your relatives or friends is its potential to damage relationships. In order to prevent this, an entrepreneur should be honest about where the money will be utilized and communicate the risks of losing the money.
Bootstrap Financing
Bootstrap financing is starting a business with very limited internal resources and no external funding. Different bootstrap financing methods include both business as usual actions such as discount for cash payments or buying used equipment, but also some questionable actions such as delaying tax payments or delaying payments to suppliers (see Table 6.3).
Funding During the Early Phase
Incubators and Accelerators
Incubators are defined as support environments for start- ups and a typical incubator offers the following services to entrepreneurs:
• Physical space for no or low cost (commonly shared offices with shared equipment and organizational services) • Advisory on technical, managerial, marketing, finance, business planning/ modeling, legal issues • Access to business networks • Access to funding opportunities
Not-for-profit incubators are generally supported by national or regional governments and mostly associated with universities and they mainly focus on supporting local entrepreneurship and innovation attempts. On the other side, there are for-profit incubators and they differ from not-for-profit incubators in some aspects:
• Generating profits is a priority. • Capital is brought by private and/or nonprivate parties. • They are more selective for tenants and there is a focus on industries and enterprises that have rapid growth potential.
Accelerators are defined as cohort-based programs with limited time frames (in average 3 months) in which entrepreneurs are provided with seed capital and efficient and intense networking, training and mentoring services and a demo-day (pitch to investors) at the end of the program. Since most accelerators provide a capital to the start-up in exchange for equity, they have a more
competitive selection process when compared to business incubators.
Crowdfunding
Crowdfunding is defined as a funding source for entrepreneurs where a large number of people invest small amounts of money in a company or a project via an online platform. Generally, crowdfunding is a source of capital for entrepreneurs in the early phase or growth phase of their business. It should be noted that the legal system regarding equity (crowdinvesting) and/or interest (crowdlending) issuing through crowdfunding differs in each country and some countries ban these types of crowdfunding or do not have a legal infrastructure to enable these actions.
Business Angels
Business angels are individuals that have excess money and look for profitable investments. They do not have a family or friend relationship with the entrepreneur and they are generally former or current entrepreneurs and focus on investments in sectors that they have expertise.
Presence of business angels is important for entrepreneurs: First, business angels consider investing in small amounts when compared with venture capital investments, thus filling a gap in the ecosystem. Second, they generally operate locally and enable local entrepreneurs to grow their businesses. In addition to these, business angels bring their experience and network to the table as well as their money and enable the entrepreneur to utilize these sources. Finally, policy makers intend to boost the number of business angels, thus resulting in wider options for entrepreneurs in the future.
Government Funding
Public institutions give grants or loans to entrepreneurs in order to spur entrepreneurship among the population. Grants are defined as money provided to businesses that they do not have to repay unless the business utilized the money in the way that the grant was approved. In addition to grants, many governmental organizations in the world also offer project financing, low or zero-interest governmental loans and investment financing to enterprises during their early phases and growth phases. KOSGEB (Small and Medium Enterprises Development Organization of Turkey) is the leading public organization in Turkey that is authorized to support SMEs and improve the entrepreneurial ecosystem with numerous services and supports.
Funding During the Growth Phase
Venture Capital
Venture capital funding is a form of equity finance and it is described as investment of institutional investors to companies with high growth potential in exchange for equity. Venture capital investors ask for large shares due to the large amount of capital brought to the company and they can restrict some risky actions of the entrepreneur to
protect their investment. Due to uncertainty issues, venture capitalists do not invest all of their money at once to a start-up. Instead, they prefer to invest in successive stages and each stage is called a “round”. The main reason for this round-based investment is that investors try to follow a wait-and-see approach and value the start-up in each round if it is still worth to invest.
Banks
Entrepreneurs have many contemporary options for funding their businesses these days, but banking services should still be considered as an alternative.
Public and private banks develop innovative solutions for the needs of entrepreneurs. Today, many commercial banks offer beneficial products and services to entrepreneurs including high-limit credit cards, reasonable interest rates, low or zero commission rates, mentoring and training or even incubation services. Some banks also target special groups such as young or women entrepreneurs. In addition to SME banking, entrepreneurial banking has emerged as a new segment for the commercial banks.
Selection of Resources and Post-Funding
Selecting the Right Resource
There are interesting differences between nations and regions for the primary sources of entrepreneurial funding:
• 81% of the Indian entrepreneurs receive funding from family members • In Columbia 25% of the entrepreneurs are supported by their employers • Peru, Finland and Ecuador are the countries where banks play an important role for funding new enterprises • Regarding governmental funding; Greece, Ireland and Estonia show considerable action where more than 40% of entrepreneurs are funded by governments • Ireland, United States, Macedonia and the Philippines are countries where venture capital system is developed. • Crowdfunding operations play a vital role in Greece, Guatemala and the United States.
Post Funding Issues
There are no general rules about where to spend the external funds because each start-up has its own needs for expenditures according to its circumstances. Some may utilize this money to hire staff and build a team, some may spend the money on the prototype or some may raise an advertising campaign. To sum up, receiving resources may be important but it should be noted that spending this money wisely on business operations is also a very critical issue.