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Module: FIN 631 Entrepreneurial Finance
Course leader: Prof AA Ndedi
Assistants: Dr Yota Kuete Baudelaire
Dr Florence Nisabwe
Dr Marcelus Ajonina
Course Number: FIN 631
At the Master or PhD levels, this course examines the framework for return on
investment calculation and criteria in new ventures, cash management
techniques and controls for small businesses; equity and debt sources and their
criteria for investment in new businesses; additional sources of capital and
entry strategies for new businesses. This course covers the financial skills
needed at each level and phase of a new venture‟s development. Students review
the equity and debt markets for startup firms and alternative entry strategies
such as franchising and acquisition. At the end of this course, an online
assessment will be conducted!
Learning Outcomes:
Examine the elements of entrepreneurial finance, focusing on technology-
based start-up ventures, and the early stages of company development.
Understand how much money can and should be raised; when should it
be raised and from whom; what is a reasonable valuation of the company;
and how funding, employment contracts and exit decisions should be
structured.
Conduct in-depth analysis of the structure of the private equity industry.
Analyze the equity and debt markets for startup firms and alternative
entry strategies such as franchising and acquisition.
DEFINITION
Entrepreneurial finance is the study of value and resource allocation, applied to
new ventures. This could be done in several ways, and each way includes several
points to be taken into account. Entrepreneurial financing entails the
understanding of the importance along with the distribution of resources and
its application to startups (Maleki, 2015; Kerr, Lerner & Schoar, 2014;
Cumming, 2007). The domain of entrepreneurial finance has helped in resolving
significant questions that confront all entrepreneurs in respect of how much
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finance to raise; when should it be sourced and where, as well as how much will
be considered appropriate for the new venture; and how should the financing be
structured? (Maleki, 2015; Salamzadeh, 2015a, b)
INTRODUCTION
Entrepreneurship is the process of designing, launching, and running a new
business, i.e. a startup company offering a product, process or service. (Ndedi,
2004) It has been defined as the "...capacity and willingness to develop,
organize, and manage a business venture along with any of its risks in order to
make a profit." In this definition, there is an implicit notion of entrepreneurial
finance. In fact, entrepreneurial finance is the study of value and resource al-
location, applied to new ventures (Cumming, 2007; Kerr et al., 2014). It ad-
dresses key questions which challenge all entrepreneurs: how much money can
and should be raised; when should it be raised and from whom; what is a
reasonable valuation of the startup; and how should funding contracts and exit
decisions structured (Smith & Smith, 2000; Denis, 2004; Winton & Yerramilli,
2008; Salamzadeh, 2015 a,b).
Many entrepreneurs discover they need to attract money to fully commercialize
their concepts. Thus they must find investors – such as their own employer, a
bank, an angel investor, a venture capital fund, a public stock offering or some
other source of financing (Chen, 2010; Jafari Moghadam et al., 2014). When
dealing with most classic sources of founding, entrepreneurs face numerous
challenges: skepticism towards the business and financial plans, requests for
large equity stakes, tight control and managerial influence and limited
understanding of the characteristic growth process that start-ups experience
(Mason, 2006; Salamzadeh & Kawamorita Kesim, 2015).
On the other hand, entrepreneurs must understand the four basic problems that
can limit investors‟ willingness to invest capital:
(i) Uncertainty about the future: in terms of start-ups development
possibilities, market and industry trends. The greater the
uncertainty of a venture or project, the greater the distribution
of possible outcomes will be,
(ii) Information gaps: differences in what various players know about a
company‟s investment decision,
(iii) Soft assets are unique and rarely have markets that allow for the
measure of their value. Thus, lenders are less willing to provide
credit against such an asset, and
(iv) Volatility of current market conditions: financial and product
markets can change overnight, affecting a venture‟s current
value and its potential profitability (Chatterji & Seamans,
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2012). In this paper, a critical review of the lit-erature on
entrepreneurial finance is conducted and different types and
techniques are discussed. Finally, the paper concludes with
some regards in order to improve this domain.
ENTREPRENEURIAL FINANCE
There are strong indications that entrepreneurial finance is a rapidly growing
research field (Denis, 2004). For instance, Venture capital as the business of
investing in new or young companies with innovative ideas emerged as a
prominent branch of Entrepreneurial finance in the beginning of the 20th
century. Wealthy families such as the Vanderbilt family, the Rockefeller family
and the Bessemer family began private investing in private companies. One of
the first venture capital firms, J.H. Whitney & Company, was founded in 1946
and is still in business today. The formation of the American Research and
Development Foundation (ARDC) by General Georges F. Doriot
institutionalized venture capital after the Second World War. In 1958, the Small
Business Investment Companies (SBIC) license enabled finance companies to
leverage federal US funds to lend to growing companies. Further regulatory
changes in the USA- namely the reduction of capital gains tax and the ERISA
pension reforms- boosted venture capital in the 1970s. During the 1980s and
1990s, the venture capital industry grew in importance and experienced high
volatility in returns. De-spite this cyclicality and crisis such as Dot Com;
venture capital has consistently performed better than most other financial
investments and continues to attract new investors (Leach & Melicher, 2011;
Mitra, 2012).
SOURCES OF ENTREPRENEURIAL FINANCING
(i) Financial Bootstrapping
Financial Bootstrapping is a term used to cover different methods for avoiding
using the financial resources of external investors. It involves risks for the
founders but allows for more freedom to develop the venture. Different types of
financial bootstrapping include Owner financing, Sweat equity, Minimization
of accounts payable, joint utilization, minimization of inventory, delaying
payment, subsidy finance and personal debt (Lam, 2010).
(ii) External Financing
Businesses often need more capital than owners are able to provide. Hence, they
source financing from external investors: angel investment, venture capital, as
well as with less prevalence crowd funding, hedge funds and alternative asset
management. While owning equity in a private company may be generally
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grouped under the term private equity, this term is of-ten used to describe
growth, buyout or turnaround investments in traditional sectors and industries
(La Porta et al., 1997).
(iii)Business Angels
A business angel is a private investor that invests part of his or her own wealth
and time in early stage innovative companies. Apart from getting a good return,
business angels expect to have fun. It is estimated that angel investment
amounts to three times venture capital. Its beginnings can be traced to
Frederick Terman, widely credited to be the “Father of Silicon Valley” (together
with William Shockley), who invested $500 to help start-ing up the venture of
Bill Hewlett and Fred Packard (Aernoudt, 1999; Parhankangas & Ehrlich, 2014).
(iv) Venture Capital
Venture capital is a way of corporate financing by which a financial investor
takes participation in the capital of a new or young private company in
exchange for cash and strategic advice. Venture capital investors look for fast-
growing companies with low leverage capacity and high-performing
management teams. Their main objective is to make a profit by selling the stake
in the company in the medium term. They expect profitability higher than the
market to compensate for the increased risk of investing in young ventures. Key
differences between business angels and venture capital: (i) Own money (BA)
vs. other people‟s money (VC), (ii) Fun + profit vs. profit, (iii) Lower vs. higher
expected IRR, (iv) Very early stage vs. start-up or growth stage, and (v) Longer
investment period vs. shorter investment horizon (Grilli & Murtinu, 2014;
Hellmann & Thiele, 2015).
(v) Buyouts
Buyouts are forms of corporate finance used to change the ownership or the
type of ownership of a company through a variety of means. Once the company
is private and freed from some of the regulatory and other burdens of being a
public company, the central goal of buyout is to discover means to build this
value. This may include refocusing the mission of the company, selling off non-
core assets, freshening product lines, streamlining processes and replacing
existing management. Companies with steady, large cash flows, established
brands and moderated growth are typical targets of buyouts (Wright et al.,
2013).
(vi) Funds Provided by Founder and Relatives
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This source of financing consists of the owner‟s „personal savings, including
money collected from relatives known as “love money”. At this embryonic stage,
the equity capital made available by the founder is the major source of funding
(Mitter, & Kraus, 2011). These kinds of funds facilitate the earliest working
capacity of entreprise. It also serves as an indicator of commitment and a display
of seriousness on the part of the owner of the new venture.
(vii) Business Alliances
Entrepreneurs at the startup level may resort to forming cooperative agreements
with other firms to procure funding, improve its cash flow and minimise costs
(Gulati, 1998; Chesbrough, 2007; Dyer, & Singh). Many benefits used in
justifying the formation of business alliances are: easy access to existing or
emerging markets and regions, effective utilization of sales personnel and
distribution channels, access to customer lists, product endorsement by bigger
firms, lack of capital to do it independently, customer orders, expedited product
development, economies of scale, cooperation instead of competition, increased
business expertise, joint venture arrangements on projects, and others. Business
alliance members are creative and commit to extensively looking out for most
compatible and complementary members on the basis of industry experience,
professional associations, industry networks and contacts, lawyers, trade fairs,
accountants, bankers, friends, investments fora, and others.
Functional business alliances are very useful to a new venture that is limited by
resources to do it alone.
There are several variations of buyouts: (i) Leveraged buyout (LBO):
combination of debt and equity financing. The intention is to unlock hidden
value through the addition of substantial amounts of debt to the balance sheet
of the company, (ii) Management buyout (MBO), Management buy in (MBI)
and Buy in management buyout (BIMBO): private equity becomes the sponsor
of a management team that has identified a business opportunity with a price
well above the team‟s wealth. The difference is in the position of the purchaser:
the management is already working for the company (MBO), the management is
new (MBI) or a combination (BIMBO), (iii) Buy and built (B&B): the
acquisition of several small companies with the objective of creating a leader
(highly fragmented sectors such as supermarkets, gyms, schools, private
hospitals)., (iv) Recaps: re-leveraging of a company that has repaid much of its
LBO debt, (v) Secondary Buyout (SBO): sale of LBO-company to another private
equity firm, and (vi) Public-to-private (P2P, PTOP): takeover of public
company that has been „punished‟ by the market, i.e. its price does not reflect
the true value (Tripathi, 2012; Le, 2012; Yeboah et al., 2014).
LINKAGES BETWEEN EF AND GROWTH
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Entrepreneurs have differing growth objectives and may be at different stages in
their own lifecycle and the lifecycle of their ventures. In fact, growth in any
organization can be financial, structural, organizational and strategic. Many
entrepreneurs, for example, are motivated by lifestyle factors and may have little
need for external finances. Others, whilst having future growth plans, may not
yet be ready to grow.
There are also other complexities. Entrepreneurial cognition influences the
decision to seek external finance by affecting perceptions of growth
opportunities and/or the desire/perceived ability to exploit these opportunities.
Start-up entrepreneurs may be reluctant to let go of control but also established
family firms with underlying growth prospects may be reluctant to take on
external funding that either dilutes family ownership or involves taking on debt
that would put family ownership at risk in the event of difficulties in servicing
the debt.
Previous research has looked at different parts of the relationship between
entrepreneurial finance and growth: capital structure and sources of finance;
market failure in the supply of entrepreneurial finance; internal/personal finance
constraints on growth; and the special role of venture capital in building high
growth firms. We, therefore, start by locating these different parts of the
entrepreneurial finance literature into paths leading from the initial funding
decisions through to growth mindful that, in view of the gaps in understanding
identified in the introduction, we may think we are measuring financial
constraints on growth when in fact we are measuring cognitive (and
motivational) constraints.
The pace of growth matters also. Growth orientated/ready businesses will be
more likely to seek external finance to meet their higher capital demands (Cosh
et al., 2009). Hence, more dynamic growth orientated firms tend to follow the
upper path and seek external finance while less dynamic lifestyle businesses
tend to follow the lower path and rely more on internal finance. For some firms
with growth potential, a change in ownership structure associated with
additional forms of debt and equity finance may be appropriate, such as in
growth oriented management buyouts and listings on stock markets. In other
words, business size, age and ownership form interact with growth potential to
affect financing decisions.
Aside from factors such as growth potential and entrepreneurs‟ growth
objectives, entrepreneurs‟ perceptions matter as well. Perceptions that the
supply of finance is poor may result in discouragement and reliance on internal
finance („discouraged borrowers‟: Kon and Storey, 2003; or discouraged finance
seekers: Xiang et al, 2014). In short the „pecking order‟ of sources of finance may
be skewed towards internal finance not just because it is actually harder to
obtain external finance (due to market failure) but also because it is perceived
to be harder (Fraser, 2014). This is in addition to any preferences for using
internal finance due to control-loss aversion and the general sufficiency of
internal finance for lifestyle businesses. Perceptions may be shifted if growing
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firms recognise and seek advice about what they can do to make themselves
ready for different types of investors over different growth phases.
The complexity of issues related to financing of entrepreneurial firms is now
palpable. It goes well beyond the much discussed issues of market failure and
information cost driven preferences for certain types of financing over others.
Growth potential as well as growth objectives of entrepreneurs matter, as do
entrepreneurial perceptions. Ownership structures can preclude certain types
of financing and growth potential can interact with some of these other factors
to ensure that financing needs and the nature of financing gaps vary over a firm's
life cycle.
VENTURE CAPITAL AND FIRM GROWTH: MORE THAN FINANCE
The emphasis so far has been on issues affecting the supply and demand of
finance and the impact on growth. However, finance providers often do more
than simply supply businesses with finance. Whilst both banks and VCs
monitor the businesses they are engaged with to reduce agency risk, VCs
(unlike banks) are not confined to the monitoring dimension of governance;
VCs are also active in providing added value services which may be especially
important to facilitate growth. We therefore conclude our overview of the
relationship between entrepreneurial finance and growth by looking at the
relationship between VC and firm growth with a view to understanding the
role of VC added value services. In relation to earlier and later stages in the
financial growth cycle, we also look at the impact of business angel finance and
private equity buy-outs on growth. Evidence from several countries generally
shows a positive relationship between VC backing and firm performance
(Manigart and Wright, 2013). Evidence from matching VC and non-VC backed
firms by size has shown that VC backed firms grow revenues faster.
Similarly, VC backed firms also have higher asset and employment growth than
non-VC backed firms. The benefits of VC-backing may contribute to higher
productivity growth both leading up to an exit, notably through an IPO, as well
as afterwards. In contrast, some other studies of the growth of VC and non-VC
backed firms that went to IPO have found no effect of VC backing on post-IPO
growth. In a Canadian study VCs, along with business angels and bank
financing have been shown to contribute significantly to sales growth in
biotechnology firms while there is apparently no impact of funding from
government, alliance partners and IPOs (Ahmed and Cozzarin, 2009). However,
portfolio firms backed by experienced government-related VC firms have higher
survival rates compared to those backed by independent VC firms, mainly
because government VC firms often have a regional economic development goal
and hence prefer to keep the “living dead” alive (Manigart et al., 2002). Portfolio
firms backed by inexperienced government-related VCs had higher failure rates.
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Companies backed by VC investors have a higher tendency to internationalize
than those funded only by internal owners who tend to be more risk averse
(George et al., 2005).
Similarly, higher equity-holdings of VC firms are associated with the
development of the knowledge-based resources needed for internationalization.
The monitoring expertise of VCs appears to be most effective in promoting
export behavior for late-stage ventures, while VCs‟ value-added skills are more
important in promoting export behavior in early-stage venture (Lockett et al.,
2008). Venture capital firms may also be closely involved in relocating portfolio
companies from developing to developed markets to better enable access to
resources, trading partners and stock markets as an exit route. They thereby
positively contribute to a portfolio firm‟s internationalization. The nature of the
financing provided by VCs influences the extent of internationalization. Staged
financing and financing through a syndicate have positive effects on
internationalization when used separately but not when used in combination.
Several important issues contribute to explaining these different findings. Some
growth studies have been cross-sectional in nature and have often failed to
address the issue of survivor bias and endogeneity in VC backing.
Differentiating between selection and treatment effects is especially important
in the VC context as VCs select ventures with specific characteristics, which
differ from ventures not seeking venture capital (Bertoni et al., 2011).
Disentangling the effect of value adding of VC firms from the mere effect of
receiving more financial funds is also important. One meta-analysis concluded
that VC portfolio companies have higher growth rates compared to non-VC
backed companies, but a large fraction of the difference is explained by VCs
selecting high growth industries (Rosenbusch et al., 2013).There is evidence
that VCs select firms with higher total factor productivity (TFP), sales and
salaries, which then growth faster after receiving VC.
Different VC investors contribute differently to portfolio firm growth because
they are driven by differences in goals, knowledge and processes employed. For
example, independent VCs may have limited time horizons because of their
closed end funds but have greater expertise in adding value to portfolio
companies than public sector or captive VCs (Manigart and Wright, 2013).
The type of VC matters in other ways. Traditional financial VCs rather than
corporate VCs appear to strongly spur employment and sales revenue growth in
their portfolio companies. Companies, backed by independent VC firms, grow
more strongly in sales in the first years after VC backing compared to
companies backed by corporate VC firms, but not in employees. Differences
disappear in the long term, however. The apparent disappearance of long term
differences may reflect the earlier exit of high growth ventures from
independent VC firms‟ portfolios. Importantly the selection effect by
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independent VCs appears to be small with growth mainly coming from the
treatment effect shortly after the first VC investment (Bertoni et al., 2011;
Bertoni et al., 2013).
VCs differ in their reputations, skills and expertise. Low-reputation VCs rely on
selecting more efficient firms to begin with (screening), but high-reputation
VCs are able to improve the efficiency of the firms they invest in to a greater
extent, through greater increases in sales with lower increases in production
costs. An examination of the influence of human capital and VC backing on the
growth of VC backed new technology based firms (NTBFs) in Italy found, after
controlling for survivor bias and the endogeneity of VC funding, that once a
NTBF receives VC backing the role of founders‟ skills becomes less important
and the coaching skills of VCs become more important in contributing to firm
growth.
Portfolio companies receiving funding from domestic VC investors grow more
strongly in the short run, but those backed by cross border VC investors grow
more strongly in the long run. Portfolio companies backed by a syndicate
comprising both domestic and cross border VC investors outperform all other
combinations. While domestic investors have expertise about local conditions,
cross border investors have the expertise to enable growth in international
markets which may take longer to come to fruition (Devigne et al., 2013; Mäkelä
and Maula, 2006).
There is a general debate about whether growth adequately reflects
performance with some arguing that it is important to consider profitability as
well (Davidsson et al., 2009). Growth studies have tended to focus on product
market performance without considering the role of VCs and the financial
market. VCs tend to focus on stimulating growth rather than improving
profitability, with there being no difference in profitability between VC backed
firms and matched non-VC backed firms at the time of exit by the VC backed
firms. This apparent contradictory finding may be consistent with VCs seeking
to build value in revenue and technology markets, which take time to feed
through into profitability, in order to obtain higher valuations in sales to
strategic buyers or through IPOs where the focus is on future earnings growth
(Clarysse et al., 2011).
More firms receive business angel financing than is the case for venture capital
(Cosh et al., 2009). Business angel investment tends to be complementary to
venture capital especially for smaller investments. Compared to early stage
venture capital investments, business angels tend to avoid bad investments but
find fewer where they earn significant returns (Parhankangas, 2012). Business
angels‟ involvement in their investments tends to be different from formal
venture capital firms notably being more flexible regarding monitoring
requirements but making less contribution in times of distress (Ehrlich et al.,
1994). There is some debate about whether business angels predominantly
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invest locally because of their personal networks and because this facilitates
hands-on involvement. However, a significant minority of angel investments are
long distance beyond immediately adjacent counties to the angels‟ home
location (Harrison et al., 2012).
Some problems in assessing the impact of business angels on growth concern
the availability of data, with many studies using convenience samples which
may be biased. There is also a lack of comparative analysis of the impact of
business angels on firm growth compared with other sources of finance.
Besides the classic venture capital reviewed above, private equity (PE) finance
also provides support for established firms undergoing restructuring through a
change in ownership (management buyouts and buy-ins) (CMBOR, 2013).
Close monitoring by PE investors can add value in firms that have been
constrained in realizing their growth opportunities under their previous
ownership regime (Wood and Wright, 2010; Bacon et al., 2010). Further, PE
investors can structure deals with debt instruments that allow for servicing
costs to be aligned with investment needs.
Evidence from systematic studies worldwide shows positive effects on growth
(Gilligan and Wright, 2012). These studies identified growth along a variety of
measures, although the effects seem less strong than in the first wave. PE
involvement generally leads to growth in labour productivity, although the
effects on employment are less clear cut. In France, recent evidence from
generally smaller buyouts shows growth in operating performance, productivity
and employment (Boucly et al., 2011). In the UK, PE ownership adds
significantly to growth in operating profitability of PE backed buyouts over the
first three years post-buyout, compared to peers. Growth was greater in
buyouts funded by more experienced PE firms with closer involvement in their
portfolio companies (Meuleman et al., 2009). U.K. evidence also shows that
while employment appears to fall initially, this is generally followed by
subsequent growth, especially for management buyouts but less so for
management buy-ins (Amess et al., 2008).
EMERGING FORMS: SUPPLY CHAIN FINANCING, CROWDFUNDING,
PEER TO PEER LENDING, ACCELERATORS
Recent developments including supply chain finance (referred to earlier), peer
to peer lending and crowd-funding may further help to fill gaps in the supply of
bank funding (Breedon, 2012). These sources of finance are currently used by
only a very small minority of small businesses. This is due to both a lack of
availability and behavioural barriers crowdfunding) (SME Finance Monitor,
2013), a lack of financial expertise and a lack of confidence in being able to
obtain these sources of funding.
However, from a low base crowdfunding is growing rapidly. The different
approaches to crowdfunding comprise gifting, reward, loan and equity models.
Individuals with small amounts to invest have been attracted to loan forms of
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crowdfunding because of the apparent greater returns available than from bank
deposit savings (Schwienbacher, Belleflamme and Lambert, 2013). Equity
crowdfunding has experienced slower growth than other models but recent
regulatory developments may facilitate growth (FCA, 2014).
Nevertheless, there is debate about the likely effectiveness of crowdfunding in
helping SMEs to grow (Harrison, 2013; Mollick, 2014). Although the ability to
obtain follow-on funding is emerging, entrepreneurs lack the support that other
types of investors may provide.
Investors face some difficulties in conducting due diligence on investments,
creating a „lemons‟ problem, although this may be alleviated to some extent by
the development of reputation systems, friendship networks, and discussion
boards (Tomboc, 2013). However, entrepreneurs may be able to provide
potentially misleading signals about the quality of an investment by getting
their personal networks to invest early on in the online investment process
(Franzoni et al., 2014).
One of the issues associated with alternative modes of financing such as
crowdfunding or peer-to-peer lending is that these investors may not be in a
position to undertake the roles played by investors and financial
intermediaries aside from providing funding or capital. Traditional investors,
whether equity or bond holders, can facilitate governance issues in firms in
which they invest, by way of market discipline.
Financial intermediaries, banks in particular, can, on the other hand, monitor
debtor firms on behalf of the dispersed group of depositors whose savings are
used to provide credit, thereby resolving incentive problems between lenders
and borrowers (Diamond, 1984). While the platforms used for crowdfunding
and peer-to-peer lending may facilitate the flow of information in a way that
results in better monitoring and governance (Moenninghoff and Wieandt,
2013), the exact role of the providers of these alternative forms of financing in
the context of monitoring and governance remains somewhat unclear.
Accelerators involve programmes enabling entrepreneurs to access initial
amounts of funding together with mentoring support from experienced
entrepreneurs and business angels (Miller and Bound, 2011). Three broad
strategic foci of accelerators have been identified: ecosystem developers,
investors and matchmakers (Clarysse, Wright and Van Hove, 2014). Ecosystem
builders aim to create business ecosystems as well as to try to reduce the rate of
failure of young ventures. They are typically publicly funded and tend to select
entrepreneurial teams in the idea stage onwards. Investors and matchmakers prefer
ventures with a working prototype and more mature teams. As expected,
investors have a business model of a high-risk investment fund and are sponsored
by private investors and/or corporates. In contrast matchmakers have a focus on
customers and implement structured methods to drive this. Some accelerators
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are generic, while others focus on providing focused support for early stage
ventures in particular sectors. Accelerators may help entrepreneurs better
attract funding from venture capital firms and business angels, but the
challenges in bridging to this next stage of achieving growth are little
understood. Researchers need more data about non-standard sources of finance
to better understand the factors that might influence take-up of these sources
and their success rates.
ENTREPRENEURIAL FINANCIAL PLANNING
In fact, financial planning allows entrepreneurs to estimate the quantity and the
timing of money needed to start their venture and keep it running. The key
questions for an Entrepreneur are: Is it worthy to invest time and money in this
business? What is the cash burn rate? How to minimize dilution by external
investors? A start-up‟s Chief Financial Officer (CFO) assumes the key role of
entrepreneurial financial planning. In contrast to established companies, the
start-up CFO takes a more strategic role and focuses on milestones with given
cash re-sources, changes in valuation depending on their fulfillment, risks of not
meeting milestones and potential outcomes, as well as alternative strategies
(Finkle et al., 2013).
The first step in raising capital is to understand how much capital you need to
raise. Successful businesses anticipate their future cash needs, make plans and
execute capital acquisition strategies well before they find them-selves in a cash
crunch. Three axioms guide start-up fund raising:
(i) As businesses grow, they often go through several rounds or stages
of financing. These rounds are targeted to specific phases of the
company‟s growth and require different strategies and types of
investors,
(ii) Raising capital is an on-going issue for every venture,
(iii) Capital acquisition takes time and needs to be planned accordingly.
Moreover, four critical determinants of the financial need of a
venture are generally distinguished, i.e. Determination of
projected sales, their growth and the profitability level,
Calculation of start-up costs (one-time costs), Estimation of
recurring costs, and Projection of working capital (inventory,
credit and payment policies. This determines the cash needed to
maintain the day-to-day business). Typically, venture capitalists
are part of a fund. Their average size in Europe includes five
investment professionals and two supports. They generate
income through management fees (on average 2.5% annual
commission) and carried interest (“Carry”, on average 20-30% of
the profits of the fund) (Bygrave & Zacharakis, 2009; Archuleta,
2013).
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VALUATION IN ENTREPRENEURIAL FINANCE
Financial planning also helps to determine the value of a venture and serves as
an important marketing tool towards prospective investors. Traditional
valuation techniques based on accounting, discounting cash flows (Discounted
cash flow, DCF) or multiples do not reflect the specific characteristics of a start-
up. Instead, the venture capital method, the First Chicago or the fundamental
methods are usually applied. To determine the future value of a start-up, a
venture capital investor is guided by the question: What percentage of the
portfolio company should I have at exit to guarantee that I get the IRR
committed with my investors? (Smith et al. 2011).
The valuation of the future company can be broken down into four steps:
(i) Determination of company‟s value at exit,
(ii) Requested fraction (percentage) of the VC at exit?,
(iii) Number of shares to be bought in the current round of financing to get the
desired percentage of the company, and
(iv) Estimation of maximum price per share willing to pay in current round of
financing. Usually there is more than one round of financing. Venture capital
investors generally prefer staged investments to reduce the money invested at
the higher risk and control entrepreneurs via milestones. Entrepreneurs benefit
from dilution in future rounds by reducing the price of the shares to be
exchanged for financing (Brösel et al., 2012).
COURSES ON ENTREPRENEURIAL FINANCE
Today, entrepreneurial finance courses are offered in different universities, for
example at Babson College, the Stern School of Business, the Kellogg School of
Management and ESADE. Special centers to promote entrepreneurship within
universities also cover finance topics, for example the Center for International
Development at Harvard University, which works to generate shared and
sustainable prosperity in developing economies. Such trainings examine the
elements of entrepreneurial finance, focusing on technology-based start-up
ventures and the early stages of company development. This fact shows the
importance of the topic.
REFERENCES
Aernoudt, R. (1999). Business angels: should they fly on their own wings?.
Venture Capital: An International Journal of Entrepreneurial Finance, 1(2), 187-
195.
Archuleta, K. L. (2013). Editorial-Volume 4, Issue 1. Journal of Financial
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14
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Course Entrepreneurial Finance

  • 1. 1 Module: FIN 631 Entrepreneurial Finance Course leader: Prof AA Ndedi Assistants: Dr Yota Kuete Baudelaire Dr Florence Nisabwe Dr Marcelus Ajonina Course Number: FIN 631 At the Master or PhD levels, this course examines the framework for return on investment calculation and criteria in new ventures, cash management techniques and controls for small businesses; equity and debt sources and their criteria for investment in new businesses; additional sources of capital and entry strategies for new businesses. This course covers the financial skills needed at each level and phase of a new venture‟s development. Students review the equity and debt markets for startup firms and alternative entry strategies such as franchising and acquisition. At the end of this course, an online assessment will be conducted! Learning Outcomes: Examine the elements of entrepreneurial finance, focusing on technology- based start-up ventures, and the early stages of company development. Understand how much money can and should be raised; when should it be raised and from whom; what is a reasonable valuation of the company; and how funding, employment contracts and exit decisions should be structured. Conduct in-depth analysis of the structure of the private equity industry. Analyze the equity and debt markets for startup firms and alternative entry strategies such as franchising and acquisition. DEFINITION Entrepreneurial finance is the study of value and resource allocation, applied to new ventures. This could be done in several ways, and each way includes several points to be taken into account. Entrepreneurial financing entails the understanding of the importance along with the distribution of resources and its application to startups (Maleki, 2015; Kerr, Lerner & Schoar, 2014; Cumming, 2007). The domain of entrepreneurial finance has helped in resolving significant questions that confront all entrepreneurs in respect of how much
  • 2. 2 finance to raise; when should it be sourced and where, as well as how much will be considered appropriate for the new venture; and how should the financing be structured? (Maleki, 2015; Salamzadeh, 2015a, b) INTRODUCTION Entrepreneurship is the process of designing, launching, and running a new business, i.e. a startup company offering a product, process or service. (Ndedi, 2004) It has been defined as the "...capacity and willingness to develop, organize, and manage a business venture along with any of its risks in order to make a profit." In this definition, there is an implicit notion of entrepreneurial finance. In fact, entrepreneurial finance is the study of value and resource al- location, applied to new ventures (Cumming, 2007; Kerr et al., 2014). It ad- dresses key questions which challenge all entrepreneurs: how much money can and should be raised; when should it be raised and from whom; what is a reasonable valuation of the startup; and how should funding contracts and exit decisions structured (Smith & Smith, 2000; Denis, 2004; Winton & Yerramilli, 2008; Salamzadeh, 2015 a,b). Many entrepreneurs discover they need to attract money to fully commercialize their concepts. Thus they must find investors – such as their own employer, a bank, an angel investor, a venture capital fund, a public stock offering or some other source of financing (Chen, 2010; Jafari Moghadam et al., 2014). When dealing with most classic sources of founding, entrepreneurs face numerous challenges: skepticism towards the business and financial plans, requests for large equity stakes, tight control and managerial influence and limited understanding of the characteristic growth process that start-ups experience (Mason, 2006; Salamzadeh & Kawamorita Kesim, 2015). On the other hand, entrepreneurs must understand the four basic problems that can limit investors‟ willingness to invest capital: (i) Uncertainty about the future: in terms of start-ups development possibilities, market and industry trends. The greater the uncertainty of a venture or project, the greater the distribution of possible outcomes will be, (ii) Information gaps: differences in what various players know about a company‟s investment decision, (iii) Soft assets are unique and rarely have markets that allow for the measure of their value. Thus, lenders are less willing to provide credit against such an asset, and (iv) Volatility of current market conditions: financial and product markets can change overnight, affecting a venture‟s current value and its potential profitability (Chatterji & Seamans,
  • 3. 3 2012). In this paper, a critical review of the lit-erature on entrepreneurial finance is conducted and different types and techniques are discussed. Finally, the paper concludes with some regards in order to improve this domain. ENTREPRENEURIAL FINANCE There are strong indications that entrepreneurial finance is a rapidly growing research field (Denis, 2004). For instance, Venture capital as the business of investing in new or young companies with innovative ideas emerged as a prominent branch of Entrepreneurial finance in the beginning of the 20th century. Wealthy families such as the Vanderbilt family, the Rockefeller family and the Bessemer family began private investing in private companies. One of the first venture capital firms, J.H. Whitney & Company, was founded in 1946 and is still in business today. The formation of the American Research and Development Foundation (ARDC) by General Georges F. Doriot institutionalized venture capital after the Second World War. In 1958, the Small Business Investment Companies (SBIC) license enabled finance companies to leverage federal US funds to lend to growing companies. Further regulatory changes in the USA- namely the reduction of capital gains tax and the ERISA pension reforms- boosted venture capital in the 1970s. During the 1980s and 1990s, the venture capital industry grew in importance and experienced high volatility in returns. De-spite this cyclicality and crisis such as Dot Com; venture capital has consistently performed better than most other financial investments and continues to attract new investors (Leach & Melicher, 2011; Mitra, 2012). SOURCES OF ENTREPRENEURIAL FINANCING (i) Financial Bootstrapping Financial Bootstrapping is a term used to cover different methods for avoiding using the financial resources of external investors. It involves risks for the founders but allows for more freedom to develop the venture. Different types of financial bootstrapping include Owner financing, Sweat equity, Minimization of accounts payable, joint utilization, minimization of inventory, delaying payment, subsidy finance and personal debt (Lam, 2010). (ii) External Financing Businesses often need more capital than owners are able to provide. Hence, they source financing from external investors: angel investment, venture capital, as well as with less prevalence crowd funding, hedge funds and alternative asset management. While owning equity in a private company may be generally
  • 4. 4 grouped under the term private equity, this term is of-ten used to describe growth, buyout or turnaround investments in traditional sectors and industries (La Porta et al., 1997). (iii)Business Angels A business angel is a private investor that invests part of his or her own wealth and time in early stage innovative companies. Apart from getting a good return, business angels expect to have fun. It is estimated that angel investment amounts to three times venture capital. Its beginnings can be traced to Frederick Terman, widely credited to be the “Father of Silicon Valley” (together with William Shockley), who invested $500 to help start-ing up the venture of Bill Hewlett and Fred Packard (Aernoudt, 1999; Parhankangas & Ehrlich, 2014). (iv) Venture Capital Venture capital is a way of corporate financing by which a financial investor takes participation in the capital of a new or young private company in exchange for cash and strategic advice. Venture capital investors look for fast- growing companies with low leverage capacity and high-performing management teams. Their main objective is to make a profit by selling the stake in the company in the medium term. They expect profitability higher than the market to compensate for the increased risk of investing in young ventures. Key differences between business angels and venture capital: (i) Own money (BA) vs. other people‟s money (VC), (ii) Fun + profit vs. profit, (iii) Lower vs. higher expected IRR, (iv) Very early stage vs. start-up or growth stage, and (v) Longer investment period vs. shorter investment horizon (Grilli & Murtinu, 2014; Hellmann & Thiele, 2015). (v) Buyouts Buyouts are forms of corporate finance used to change the ownership or the type of ownership of a company through a variety of means. Once the company is private and freed from some of the regulatory and other burdens of being a public company, the central goal of buyout is to discover means to build this value. This may include refocusing the mission of the company, selling off non- core assets, freshening product lines, streamlining processes and replacing existing management. Companies with steady, large cash flows, established brands and moderated growth are typical targets of buyouts (Wright et al., 2013). (vi) Funds Provided by Founder and Relatives
  • 5. 5 This source of financing consists of the owner‟s „personal savings, including money collected from relatives known as “love money”. At this embryonic stage, the equity capital made available by the founder is the major source of funding (Mitter, & Kraus, 2011). These kinds of funds facilitate the earliest working capacity of entreprise. It also serves as an indicator of commitment and a display of seriousness on the part of the owner of the new venture. (vii) Business Alliances Entrepreneurs at the startup level may resort to forming cooperative agreements with other firms to procure funding, improve its cash flow and minimise costs (Gulati, 1998; Chesbrough, 2007; Dyer, & Singh). Many benefits used in justifying the formation of business alliances are: easy access to existing or emerging markets and regions, effective utilization of sales personnel and distribution channels, access to customer lists, product endorsement by bigger firms, lack of capital to do it independently, customer orders, expedited product development, economies of scale, cooperation instead of competition, increased business expertise, joint venture arrangements on projects, and others. Business alliance members are creative and commit to extensively looking out for most compatible and complementary members on the basis of industry experience, professional associations, industry networks and contacts, lawyers, trade fairs, accountants, bankers, friends, investments fora, and others. Functional business alliances are very useful to a new venture that is limited by resources to do it alone. There are several variations of buyouts: (i) Leveraged buyout (LBO): combination of debt and equity financing. The intention is to unlock hidden value through the addition of substantial amounts of debt to the balance sheet of the company, (ii) Management buyout (MBO), Management buy in (MBI) and Buy in management buyout (BIMBO): private equity becomes the sponsor of a management team that has identified a business opportunity with a price well above the team‟s wealth. The difference is in the position of the purchaser: the management is already working for the company (MBO), the management is new (MBI) or a combination (BIMBO), (iii) Buy and built (B&B): the acquisition of several small companies with the objective of creating a leader (highly fragmented sectors such as supermarkets, gyms, schools, private hospitals)., (iv) Recaps: re-leveraging of a company that has repaid much of its LBO debt, (v) Secondary Buyout (SBO): sale of LBO-company to another private equity firm, and (vi) Public-to-private (P2P, PTOP): takeover of public company that has been „punished‟ by the market, i.e. its price does not reflect the true value (Tripathi, 2012; Le, 2012; Yeboah et al., 2014). LINKAGES BETWEEN EF AND GROWTH
  • 6. 6 Entrepreneurs have differing growth objectives and may be at different stages in their own lifecycle and the lifecycle of their ventures. In fact, growth in any organization can be financial, structural, organizational and strategic. Many entrepreneurs, for example, are motivated by lifestyle factors and may have little need for external finances. Others, whilst having future growth plans, may not yet be ready to grow. There are also other complexities. Entrepreneurial cognition influences the decision to seek external finance by affecting perceptions of growth opportunities and/or the desire/perceived ability to exploit these opportunities. Start-up entrepreneurs may be reluctant to let go of control but also established family firms with underlying growth prospects may be reluctant to take on external funding that either dilutes family ownership or involves taking on debt that would put family ownership at risk in the event of difficulties in servicing the debt. Previous research has looked at different parts of the relationship between entrepreneurial finance and growth: capital structure and sources of finance; market failure in the supply of entrepreneurial finance; internal/personal finance constraints on growth; and the special role of venture capital in building high growth firms. We, therefore, start by locating these different parts of the entrepreneurial finance literature into paths leading from the initial funding decisions through to growth mindful that, in view of the gaps in understanding identified in the introduction, we may think we are measuring financial constraints on growth when in fact we are measuring cognitive (and motivational) constraints. The pace of growth matters also. Growth orientated/ready businesses will be more likely to seek external finance to meet their higher capital demands (Cosh et al., 2009). Hence, more dynamic growth orientated firms tend to follow the upper path and seek external finance while less dynamic lifestyle businesses tend to follow the lower path and rely more on internal finance. For some firms with growth potential, a change in ownership structure associated with additional forms of debt and equity finance may be appropriate, such as in growth oriented management buyouts and listings on stock markets. In other words, business size, age and ownership form interact with growth potential to affect financing decisions. Aside from factors such as growth potential and entrepreneurs‟ growth objectives, entrepreneurs‟ perceptions matter as well. Perceptions that the supply of finance is poor may result in discouragement and reliance on internal finance („discouraged borrowers‟: Kon and Storey, 2003; or discouraged finance seekers: Xiang et al, 2014). In short the „pecking order‟ of sources of finance may be skewed towards internal finance not just because it is actually harder to obtain external finance (due to market failure) but also because it is perceived to be harder (Fraser, 2014). This is in addition to any preferences for using internal finance due to control-loss aversion and the general sufficiency of internal finance for lifestyle businesses. Perceptions may be shifted if growing
  • 7. 7 firms recognise and seek advice about what they can do to make themselves ready for different types of investors over different growth phases. The complexity of issues related to financing of entrepreneurial firms is now palpable. It goes well beyond the much discussed issues of market failure and information cost driven preferences for certain types of financing over others. Growth potential as well as growth objectives of entrepreneurs matter, as do entrepreneurial perceptions. Ownership structures can preclude certain types of financing and growth potential can interact with some of these other factors to ensure that financing needs and the nature of financing gaps vary over a firm's life cycle. VENTURE CAPITAL AND FIRM GROWTH: MORE THAN FINANCE The emphasis so far has been on issues affecting the supply and demand of finance and the impact on growth. However, finance providers often do more than simply supply businesses with finance. Whilst both banks and VCs monitor the businesses they are engaged with to reduce agency risk, VCs (unlike banks) are not confined to the monitoring dimension of governance; VCs are also active in providing added value services which may be especially important to facilitate growth. We therefore conclude our overview of the relationship between entrepreneurial finance and growth by looking at the relationship between VC and firm growth with a view to understanding the role of VC added value services. In relation to earlier and later stages in the financial growth cycle, we also look at the impact of business angel finance and private equity buy-outs on growth. Evidence from several countries generally shows a positive relationship between VC backing and firm performance (Manigart and Wright, 2013). Evidence from matching VC and non-VC backed firms by size has shown that VC backed firms grow revenues faster. Similarly, VC backed firms also have higher asset and employment growth than non-VC backed firms. The benefits of VC-backing may contribute to higher productivity growth both leading up to an exit, notably through an IPO, as well as afterwards. In contrast, some other studies of the growth of VC and non-VC backed firms that went to IPO have found no effect of VC backing on post-IPO growth. In a Canadian study VCs, along with business angels and bank financing have been shown to contribute significantly to sales growth in biotechnology firms while there is apparently no impact of funding from government, alliance partners and IPOs (Ahmed and Cozzarin, 2009). However, portfolio firms backed by experienced government-related VC firms have higher survival rates compared to those backed by independent VC firms, mainly because government VC firms often have a regional economic development goal and hence prefer to keep the “living dead” alive (Manigart et al., 2002). Portfolio firms backed by inexperienced government-related VCs had higher failure rates.
  • 8. 8 Companies backed by VC investors have a higher tendency to internationalize than those funded only by internal owners who tend to be more risk averse (George et al., 2005). Similarly, higher equity-holdings of VC firms are associated with the development of the knowledge-based resources needed for internationalization. The monitoring expertise of VCs appears to be most effective in promoting export behavior for late-stage ventures, while VCs‟ value-added skills are more important in promoting export behavior in early-stage venture (Lockett et al., 2008). Venture capital firms may also be closely involved in relocating portfolio companies from developing to developed markets to better enable access to resources, trading partners and stock markets as an exit route. They thereby positively contribute to a portfolio firm‟s internationalization. The nature of the financing provided by VCs influences the extent of internationalization. Staged financing and financing through a syndicate have positive effects on internationalization when used separately but not when used in combination. Several important issues contribute to explaining these different findings. Some growth studies have been cross-sectional in nature and have often failed to address the issue of survivor bias and endogeneity in VC backing. Differentiating between selection and treatment effects is especially important in the VC context as VCs select ventures with specific characteristics, which differ from ventures not seeking venture capital (Bertoni et al., 2011). Disentangling the effect of value adding of VC firms from the mere effect of receiving more financial funds is also important. One meta-analysis concluded that VC portfolio companies have higher growth rates compared to non-VC backed companies, but a large fraction of the difference is explained by VCs selecting high growth industries (Rosenbusch et al., 2013).There is evidence that VCs select firms with higher total factor productivity (TFP), sales and salaries, which then growth faster after receiving VC. Different VC investors contribute differently to portfolio firm growth because they are driven by differences in goals, knowledge and processes employed. For example, independent VCs may have limited time horizons because of their closed end funds but have greater expertise in adding value to portfolio companies than public sector or captive VCs (Manigart and Wright, 2013). The type of VC matters in other ways. Traditional financial VCs rather than corporate VCs appear to strongly spur employment and sales revenue growth in their portfolio companies. Companies, backed by independent VC firms, grow more strongly in sales in the first years after VC backing compared to companies backed by corporate VC firms, but not in employees. Differences disappear in the long term, however. The apparent disappearance of long term differences may reflect the earlier exit of high growth ventures from independent VC firms‟ portfolios. Importantly the selection effect by
  • 9. 9 independent VCs appears to be small with growth mainly coming from the treatment effect shortly after the first VC investment (Bertoni et al., 2011; Bertoni et al., 2013). VCs differ in their reputations, skills and expertise. Low-reputation VCs rely on selecting more efficient firms to begin with (screening), but high-reputation VCs are able to improve the efficiency of the firms they invest in to a greater extent, through greater increases in sales with lower increases in production costs. An examination of the influence of human capital and VC backing on the growth of VC backed new technology based firms (NTBFs) in Italy found, after controlling for survivor bias and the endogeneity of VC funding, that once a NTBF receives VC backing the role of founders‟ skills becomes less important and the coaching skills of VCs become more important in contributing to firm growth. Portfolio companies receiving funding from domestic VC investors grow more strongly in the short run, but those backed by cross border VC investors grow more strongly in the long run. Portfolio companies backed by a syndicate comprising both domestic and cross border VC investors outperform all other combinations. While domestic investors have expertise about local conditions, cross border investors have the expertise to enable growth in international markets which may take longer to come to fruition (Devigne et al., 2013; Mäkelä and Maula, 2006). There is a general debate about whether growth adequately reflects performance with some arguing that it is important to consider profitability as well (Davidsson et al., 2009). Growth studies have tended to focus on product market performance without considering the role of VCs and the financial market. VCs tend to focus on stimulating growth rather than improving profitability, with there being no difference in profitability between VC backed firms and matched non-VC backed firms at the time of exit by the VC backed firms. This apparent contradictory finding may be consistent with VCs seeking to build value in revenue and technology markets, which take time to feed through into profitability, in order to obtain higher valuations in sales to strategic buyers or through IPOs where the focus is on future earnings growth (Clarysse et al., 2011). More firms receive business angel financing than is the case for venture capital (Cosh et al., 2009). Business angel investment tends to be complementary to venture capital especially for smaller investments. Compared to early stage venture capital investments, business angels tend to avoid bad investments but find fewer where they earn significant returns (Parhankangas, 2012). Business angels‟ involvement in their investments tends to be different from formal venture capital firms notably being more flexible regarding monitoring requirements but making less contribution in times of distress (Ehrlich et al., 1994). There is some debate about whether business angels predominantly
  • 10. 10 invest locally because of their personal networks and because this facilitates hands-on involvement. However, a significant minority of angel investments are long distance beyond immediately adjacent counties to the angels‟ home location (Harrison et al., 2012). Some problems in assessing the impact of business angels on growth concern the availability of data, with many studies using convenience samples which may be biased. There is also a lack of comparative analysis of the impact of business angels on firm growth compared with other sources of finance. Besides the classic venture capital reviewed above, private equity (PE) finance also provides support for established firms undergoing restructuring through a change in ownership (management buyouts and buy-ins) (CMBOR, 2013). Close monitoring by PE investors can add value in firms that have been constrained in realizing their growth opportunities under their previous ownership regime (Wood and Wright, 2010; Bacon et al., 2010). Further, PE investors can structure deals with debt instruments that allow for servicing costs to be aligned with investment needs. Evidence from systematic studies worldwide shows positive effects on growth (Gilligan and Wright, 2012). These studies identified growth along a variety of measures, although the effects seem less strong than in the first wave. PE involvement generally leads to growth in labour productivity, although the effects on employment are less clear cut. In France, recent evidence from generally smaller buyouts shows growth in operating performance, productivity and employment (Boucly et al., 2011). In the UK, PE ownership adds significantly to growth in operating profitability of PE backed buyouts over the first three years post-buyout, compared to peers. Growth was greater in buyouts funded by more experienced PE firms with closer involvement in their portfolio companies (Meuleman et al., 2009). U.K. evidence also shows that while employment appears to fall initially, this is generally followed by subsequent growth, especially for management buyouts but less so for management buy-ins (Amess et al., 2008). EMERGING FORMS: SUPPLY CHAIN FINANCING, CROWDFUNDING, PEER TO PEER LENDING, ACCELERATORS Recent developments including supply chain finance (referred to earlier), peer to peer lending and crowd-funding may further help to fill gaps in the supply of bank funding (Breedon, 2012). These sources of finance are currently used by only a very small minority of small businesses. This is due to both a lack of availability and behavioural barriers crowdfunding) (SME Finance Monitor, 2013), a lack of financial expertise and a lack of confidence in being able to obtain these sources of funding. However, from a low base crowdfunding is growing rapidly. The different approaches to crowdfunding comprise gifting, reward, loan and equity models. Individuals with small amounts to invest have been attracted to loan forms of
  • 11. 11 crowdfunding because of the apparent greater returns available than from bank deposit savings (Schwienbacher, Belleflamme and Lambert, 2013). Equity crowdfunding has experienced slower growth than other models but recent regulatory developments may facilitate growth (FCA, 2014). Nevertheless, there is debate about the likely effectiveness of crowdfunding in helping SMEs to grow (Harrison, 2013; Mollick, 2014). Although the ability to obtain follow-on funding is emerging, entrepreneurs lack the support that other types of investors may provide. Investors face some difficulties in conducting due diligence on investments, creating a „lemons‟ problem, although this may be alleviated to some extent by the development of reputation systems, friendship networks, and discussion boards (Tomboc, 2013). However, entrepreneurs may be able to provide potentially misleading signals about the quality of an investment by getting their personal networks to invest early on in the online investment process (Franzoni et al., 2014). One of the issues associated with alternative modes of financing such as crowdfunding or peer-to-peer lending is that these investors may not be in a position to undertake the roles played by investors and financial intermediaries aside from providing funding or capital. Traditional investors, whether equity or bond holders, can facilitate governance issues in firms in which they invest, by way of market discipline. Financial intermediaries, banks in particular, can, on the other hand, monitor debtor firms on behalf of the dispersed group of depositors whose savings are used to provide credit, thereby resolving incentive problems between lenders and borrowers (Diamond, 1984). While the platforms used for crowdfunding and peer-to-peer lending may facilitate the flow of information in a way that results in better monitoring and governance (Moenninghoff and Wieandt, 2013), the exact role of the providers of these alternative forms of financing in the context of monitoring and governance remains somewhat unclear. Accelerators involve programmes enabling entrepreneurs to access initial amounts of funding together with mentoring support from experienced entrepreneurs and business angels (Miller and Bound, 2011). Three broad strategic foci of accelerators have been identified: ecosystem developers, investors and matchmakers (Clarysse, Wright and Van Hove, 2014). Ecosystem builders aim to create business ecosystems as well as to try to reduce the rate of failure of young ventures. They are typically publicly funded and tend to select entrepreneurial teams in the idea stage onwards. Investors and matchmakers prefer ventures with a working prototype and more mature teams. As expected, investors have a business model of a high-risk investment fund and are sponsored by private investors and/or corporates. In contrast matchmakers have a focus on customers and implement structured methods to drive this. Some accelerators
  • 12. 12 are generic, while others focus on providing focused support for early stage ventures in particular sectors. Accelerators may help entrepreneurs better attract funding from venture capital firms and business angels, but the challenges in bridging to this next stage of achieving growth are little understood. Researchers need more data about non-standard sources of finance to better understand the factors that might influence take-up of these sources and their success rates. ENTREPRENEURIAL FINANCIAL PLANNING In fact, financial planning allows entrepreneurs to estimate the quantity and the timing of money needed to start their venture and keep it running. The key questions for an Entrepreneur are: Is it worthy to invest time and money in this business? What is the cash burn rate? How to minimize dilution by external investors? A start-up‟s Chief Financial Officer (CFO) assumes the key role of entrepreneurial financial planning. In contrast to established companies, the start-up CFO takes a more strategic role and focuses on milestones with given cash re-sources, changes in valuation depending on their fulfillment, risks of not meeting milestones and potential outcomes, as well as alternative strategies (Finkle et al., 2013). The first step in raising capital is to understand how much capital you need to raise. Successful businesses anticipate their future cash needs, make plans and execute capital acquisition strategies well before they find them-selves in a cash crunch. Three axioms guide start-up fund raising: (i) As businesses grow, they often go through several rounds or stages of financing. These rounds are targeted to specific phases of the company‟s growth and require different strategies and types of investors, (ii) Raising capital is an on-going issue for every venture, (iii) Capital acquisition takes time and needs to be planned accordingly. Moreover, four critical determinants of the financial need of a venture are generally distinguished, i.e. Determination of projected sales, their growth and the profitability level, Calculation of start-up costs (one-time costs), Estimation of recurring costs, and Projection of working capital (inventory, credit and payment policies. This determines the cash needed to maintain the day-to-day business). Typically, venture capitalists are part of a fund. Their average size in Europe includes five investment professionals and two supports. They generate income through management fees (on average 2.5% annual commission) and carried interest (“Carry”, on average 20-30% of the profits of the fund) (Bygrave & Zacharakis, 2009; Archuleta, 2013).
  • 13. 13 VALUATION IN ENTREPRENEURIAL FINANCE Financial planning also helps to determine the value of a venture and serves as an important marketing tool towards prospective investors. Traditional valuation techniques based on accounting, discounting cash flows (Discounted cash flow, DCF) or multiples do not reflect the specific characteristics of a start- up. Instead, the venture capital method, the First Chicago or the fundamental methods are usually applied. To determine the future value of a start-up, a venture capital investor is guided by the question: What percentage of the portfolio company should I have at exit to guarantee that I get the IRR committed with my investors? (Smith et al. 2011). The valuation of the future company can be broken down into four steps: (i) Determination of company‟s value at exit, (ii) Requested fraction (percentage) of the VC at exit?, (iii) Number of shares to be bought in the current round of financing to get the desired percentage of the company, and (iv) Estimation of maximum price per share willing to pay in current round of financing. Usually there is more than one round of financing. Venture capital investors generally prefer staged investments to reduce the money invested at the higher risk and control entrepreneurs via milestones. Entrepreneurs benefit from dilution in future rounds by reducing the price of the shares to be exchanged for financing (Brösel et al., 2012). COURSES ON ENTREPRENEURIAL FINANCE Today, entrepreneurial finance courses are offered in different universities, for example at Babson College, the Stern School of Business, the Kellogg School of Management and ESADE. Special centers to promote entrepreneurship within universities also cover finance topics, for example the Center for International Development at Harvard University, which works to generate shared and sustainable prosperity in developing economies. Such trainings examine the elements of entrepreneurial finance, focusing on technology-based start-up ventures and the early stages of company development. This fact shows the importance of the topic. REFERENCES Aernoudt, R. (1999). Business angels: should they fly on their own wings?. Venture Capital: An International Journal of Entrepreneurial Finance, 1(2), 187- 195. Archuleta, K. L. (2013). Editorial-Volume 4, Issue 1. Journal of Financial Therapy, 4(1), 9-11.
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