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8th International Scientific Conference on Economic and Social
Development and 4th Eastern European ESD
Conference: Building Resilient Economy, Zagreb, Croatia
283
INFLUENCE OF FINANCING SOURCE ON THE SMALL
BUSINESS
PERFORMANCE
Mihaela Mikic
University of Zagreb, Faculty of Economics and Business,
Croatia
[email protected]
Tomislav Novoselec
[email protected]
Dinko Primorac
University North, Croatia
[email protected]
ABSTRACT](https://image.slidesharecdn.com/entrepreneurialdevelopmentsinthemenaregionexamp-221030115630-730e533c/75/Entrepreneurial-Developments-in-the-MENA-RegionExamp-docx-24-2048.jpg)
![growing companies,
administrative barriers, under-developed financial market (too
dependent on traditional
instruments) and lack of education focused on honing
entrepreneurship knowledge and skills
are main traits of small businesses in Croatia.
Financial resources are needed for realization of every idea and
inovation. Financial requests
have a tight bond with business strategy, which in interaction
with financial strategy enables
creating added value and raising the level of competitiveness.
Without financial resources it is
impossible to realize new good business ideas. When a business
is started, financial resources
are ensured from owners own sources. With growth and
development of a company,
mailto:[email protected]
8th International Scientific Conference on Economic and Social
Development and 4th Eastern European ESD
Conference: Building Resilient Economy, Zagreb, Croatia
284](https://image.slidesharecdn.com/entrepreneurialdevelopmentsinthemenaregionexamp-221030115630-730e533c/75/Entrepreneurial-Developments-in-the-MENA-RegionExamp-docx-27-2048.jpg)
![the 12th Five-Year
Plan encourages the opening up of the capital markets for
technology-based firms to
improve the capability of the economy to innovate. The
interviewees expressed their
views that the introduction of the 12th Five-Year Plan has
changed banks’ credit
direction from lending to heavy industries to new industries like
information
technology, renewable energy, biotechnology and other high-
tech sectors.
According to the interviews with banks in China, one of the
banks stated that: “[…]
the 12th Five-Year Plan can be seen as the government’s
command that we have
to follow by setting up SME special unit to provide SME
financing. Although the policy
is not mandatory, in practice we must comply with these
directives. Otherwise,
the future of our business relations with the government will be
not easy […]”. Most of
the interviewees stated that as the 12th Five-Year Plan denotes
the policy signals that
policy makers attempt to favor SMEs, the banks have to comply
with the policy.
Nonetheless, by complying with the 12th Five-Year Plan, the
banks expressed concerns
305
SMEs
innovation and
entrepreneurial
financing](https://image.slidesharecdn.com/entrepreneurialdevelopmentsinthemenaregionexamp-221030115630-730e533c/75/Entrepreneurial-Developments-in-the-MENA-RegionExamp-docx-126-2048.jpg)
![World Bank (2010), Innovation Policy: A Guide for Developing
Countries, The World Bank,
Washington, DC.
World Bank (2012), China 2030 – Building a Modern,
Harmonious, and Creative High-Income
Society, The World Bank, Washington, DC.
Yin, R.K. (2003), Case Study Research, 3rd ed., Sage
Publications, London.
Corresponding author
Dr Jarunee Wonglimpiyarat can be contacted at:
[email protected]
For instructions on how to order reprints of this article, please
visit our website:
www.emeraldgrouppublishing.com/licensing/reprints.htm
Or contact us for further details: [email protected]
311
SMEs
innovation and
entrepreneurial
financing
mailto:[email protected]
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![INTERNATIONAL JOURNAL OF BUSINESS, 14(4), 2009
346
International Comparison of Entrepreneurial
Sub-Cultures within Cultures: Effect of Territory
on Entrepreneurial Strategies for Fundraising
Katariina Rantanen
a
and Michel Bernasconi
b
a
Ph.D. Student, Swedish School of Economics and Business
Administration,
Helsinki, Finland
[email protected]
b
Professor, CERAM Business School, Sophia Antipolis, France
[email protected]
ABSTRACT
Two technological hotspots: Silicon Valley (USA), and Sophia
Antipolis (France) have
been assessed for differences in entrepreneurs’ fund raising
strategies. The study
analyzed different stages in the venture capitalist’s (VC)
investment decision process
from the entrepreneur’s perspective, not from the frequently
examined VC’s viewpoint.
The qualitative study of nine cases compares the two different
cultural contexts, where](https://image.slidesharecdn.com/entrepreneurialdevelopmentsinthemenaregionexamp-221030115630-730e533c/75/Entrepreneurial-Developments-in-the-MENA-RegionExamp-docx-143-2048.jpg)
![the parties negotiate the investment agreements. The results
underline, that the different
subcultures require markedly different entrepreneurial strategies
for successful VC
fundraising. The investment decision process leads to a faster
investment in US
companies than in the French examples. Entrepreneurs in both
regions advised strongly
against signing exclusivity agreements. An unfavorable
bargaining position was seen
by entrepreneurs to arise from an urgency of receiving funding,
where a prolonged
investment decision process would make the venture apt to
accepting worsened
financing terms offered by the VC, and would increase the risk
of VC opportunism.
JEL Classification: M13
Keywords: Entrepreneurship; Investment decision process;
Venture capitalism;
Opportunism; Fundraising; Culture; Territory
mailto:[email protected]
mailto:[email protected]
310 Rantanen and Bernasconi
I. INTRODUCTION
Environment seems to play a key role in entrepreneurship, as
certain cultures seem to
foster entrepreneurship astonishingly efficiently, and some
domains within
entrepreneurially oriented countries seem to flourish](https://image.slidesharecdn.com/entrepreneurialdevelopmentsinthemenaregionexamp-221030115630-730e533c/75/Entrepreneurial-Developments-in-the-MENA-RegionExamp-docx-144-2048.jpg)
![significant proportion of start-up funding and can help the
founder(s) to acquire
financing from sources outside the new venture:
RQ5. Are personal funds a significant proportion of start-up
capitalisation, and
are they associated with external funding by other actors?
Methodology
A case-based approach to data collection and analysis is
suitable for examining a
particular issue or phenomenon (Chetty, 1996). Detailed
analysis of specific cases via
direct interaction with new venture founders will be particularly
important for
understanding the “opaque” capitalisation structures of new
ventures (Cassar, 2004), as
well as the evolving and often improvised structures of business
start-up funding
(Atherton, 2009). The data presented are financial in nature,
given the specific research
propositions and questions that are the focus of this paper.
Although not consonant
with current approaches in the small business literature, which
tend to view case-based
data analysis as qualitative (Chetty, 1996; Perren and Ram,
2004; Romano, 1989),
Eisenhardt (1989) noted that case approaches relate to the ways
in which the data are
extracted, rather than to a particular types of data:
[. . .] evidence may be qualitative (e.g. words), quantitative
(e.g. numbers), or both (Eisenhardt,
1989, pp. 534-535).
Many case-based approaches in the small business and](https://image.slidesharecdn.com/entrepreneurialdevelopmentsinthemenaregionexamp-221030115630-730e533c/75/Entrepreneurial-Developments-in-the-MENA-RegionExamp-docx-182-2048.jpg)
![Yin, R. (1989), Case Study Research, Sage, Beverley Hills, CA.
About the author
Andrew Atherton is Professor of Enterprise and
Entrepreneurship and Senior Deputy Vice
Chancellor at the University of Lincoln. At Lincoln, he
established the Enterprise Research and
Development Unit (ERDU), which has undertaken more than 30
commissioned policy studies
since 2003. Before joining Lincoln, he was Director of the
Foundation for SME Development at
the University of Durham, the successor department to the
Small Business Centre, a leading
international centre for enterprise and SME development. While
at Durham, he established the
Policy Research Unit, which undertook commissioned research
and policy analysis on enterprise
development and entrepreneurship. He has degrees in Chinese
and Economics from the School of
Oriental and African Studies, University of London, and Yale
University. His current research is
concerned with enterprise policy, entrepreneurship in China,
and new venture creation. Andrew
Atherton can be contacted at: [email protected]
Cases of start-up
financing
47
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[email protected]
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![mission. As SVPs become more ambitious and activities more
sophisticated,
more capital is required in forms that are appropriate to the
organizational
structure and life cycle stage of the enterprise.
Traditional forms of financing for social entrepreneurship are
no longer
adequate to the task. They are often short-term, categorical, and
transactional
in nature (Wei-Skillern et al. 2007), when what is needed are
financial resources
that free the social entrepreneur to focus on mission
achievement (not fundrais-
ing) at a scale that yields transformation. This has led to
experimentation that
has pushed the boundaries of traditional financing, such as
Crowdfunding and
program-related investments. However, even this has not proved
to be enough.
The newest idea in good currency in the social entrepreneurship
financing
arena is social impact investment, which combines financial
investment and
social and/or environmental impact. Social impact investors
seek both financial
*Corresponding author: Jill Kickul, Stern School of Business,
New York University, New York,
NY, USA, E-mail: [email protected]
Thomas S. Lyons, Baruch College, City University of New
York, 55 Lexington Avenue B9240,
New York, NY, USA, E-mail: [email protected]
Entrep. Res. J. 2015; 5(2): 83–85](https://image.slidesharecdn.com/entrepreneurialdevelopmentsinthemenaregionexamp-221030115630-730e533c/75/Entrepreneurial-Developments-in-the-MENA-RegionExamp-docx-282-2048.jpg)
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- 1. Entrepreneurial Developments in the MENARegion Example of an Information Rich PowerPoint Project Prof. R. Simeon Overview ▫ Intro to the MENA Region ▫ Historical Developments ▫ Regional Characteristics ▫ Main Countries Affected by Entrepreneurship Developed ▫ Significant Developments ▫ Highlights of Companies/Organizations ▫ Future Issues in the MENA Region Introduction to the MENA Region
- 2. Algeria Bahrain Djibouti Egypt Iran Iraq Israel Jordan Kuwait Lebanon Libya Malta Morocco Oman Qatar Saudi Arabia Syria Tunisia UAE West Bank Gaza Yemen MENAis an acronym referring to the Middle East and North Africa. The MENA region stretches from Morocco to Iran. It carries a population of 381 million people (6% of the world population). The vast majority of this population live in middle-income countries. The MENA region carries 60% of the
- 3. world’s oil reservesand 45% of the world’s natural gas reserves. 8 of the 12 OPEC nations are within the MENA region. It is relatively synonymous with the term the Greater Middle East. Historical Developments Throughout history there has been civil instability in the area that have been extremely publicized in the media, attracting attention worldwide. Iran-Saudi Arabia proxy conflict: Traced back to the Iranian revolution, both countries have long supported different militaries since the Cold War and, more recently, the Lebanese Civil War. Israeli-Palestinian conflict: Key issues revolve around borders, control of Jerusalem, Israeli settlements, and more importantly, cultural and religious interests. Rise in terrorism: After the terrorist attacks of 9/11, the Bush Administration declared its War on Terror, invading Afghanistan to take down the
- 4. Taliban Regime, in2001. U.S. Invasion of Iraq in 2003: Carried over from the War in Afghanistan, the invasion-Operation Enduring Freedom- had the mission to “disarm Iraq of weapons of mass destruction, to end Saddam Hussein’s support for terrorism, and to free the Iraqi people.” - President George W. Bush Rise of ISIS: Originated from Jama'at al-Tawhid wal-Jihad in 1999 (ISIS since 2014) pledged allegiance to al-Qaeda. It identifies its leader, Abu Bakr al-Baghdadi, as a caliphate, claiming religious, political and military authority over all Muslims worldwide. Historical Developments Iraq Civil War Ongoing conflict, as ISIS conquered major areas in northern Iraq. The Arab Spring A revolutionary wave of violent and nonviolent protests, riots, coups, and civil wars throughout the MENA region. Syrian Civil War
- 5. A multi-sided armedconflict resulting from protests calling for the removal of President Bashar al-Assad during the Arab Spring. Violent government response lead to many armed groups fighting and displacing over 6M people. Libyan Civil War Ongoing conflict, stemming from the Arab Spring. After death of Muammar Gaddafi, government control is unclear. The economy is shook as oil industry collapsed with most of its facilities blocked or damaged by rival groups. Yemeni Civil War Ongoing conflict as two groups want control of the government. Many organizations and countries have called for ceasefires as over 3M people have been displaced. “The people want to bring down the regime.” - Protesters U.S., Australia, France, and the UK send essentials via airdrops and soldiers to help the Iraqi people.The world, realizing it underestimated ISIS as they use social media to generate fear. Multiple ceasefires
- 6. have since occurred withmonths of negotiations, but an agreement has yet to be reached. S.W.O.T. “The Middle East and North Africa (MENA) region is in turmoil.” - The World Bank Syria, Iraq, Libya and Yemen are all in civil war. This has led to extreme loss of lives and physical infrastructure. There is a refugee crisis, as 15 Million have fled to already economically-strained surrounding countries. All Middle Eastern countries have experienced high youth unemployment. Gaza carries the highest total unemployment rate in the world, with GDP at 40% of its potential. Oil prices dropped below $28 per barrel, January 2016. This was a more than 60% decrease since June 2014.
- 7. “...the scale ofthe oil price collapse is such that many economies are facing significant deficits which have to be financed by drawing on reserves or debt issuance.” - Giyas Gökkent Senior Economist Institute of International Finance S.W.O.T. Within the Arab countries populations, 60% of the population is under 25 years old. The median age is 22, compared to a global median age of 28. The Middle East has also sustained remarkably high education enrollment rates. Education is nearly universal at the primary level, following an estimated 70% enrollment at the secondary level. Political developments seen in Jordan, Tunisia and Morocco have shown that engagement in policymaking has increased. Jordan First (below), for example, The (above) figure shows supporters of Nidaa Tounes celebrating after the first results following the second round of the country’s first free presidential election on Dec. 21, 2014 in Tunis.
- 8. promotes the concept ofa modern democratic state. Regional Characteristics Natural Resources International Relations Corruption “After decades of corrupt and repressive rule, citizens in these states are facing brutal and ineffective security forces, habitually divisive and confrontational politics, and a lack of productive avenues through which to lodge their grievances and assert their rights.” Vanessa Tucker Director of Freedom House Trade LinksHomogenous Culture Main Countries Affected by Entrepreneurship
- 9. Development Kingdom of Saudi Arabia ●Population of 28 million ● GDP Composition: Agriculture: 2.3% Industry: 46% Services: 51.8% ● Labor Force of 11.67 million (about 80% non-national) Saudi Arabia’s Capital City of Riyadh Pro Huge increase in entrepreneurship and startups, many startup communities to foster new entrepreneurs. Gender inequality in labor force is disappearing. Con
- 10. Poor economic growthdue to heavy reliance on oil prices, reduced government spending and subsidy cuts. Morocco ● Population of 34 million ● GDP Composition: Agriculture: 14.5% Industry: 29.2% Services: 56.3% ● Labor Force: 12.04 million Morocco’s Capital City of Rabat Pro Universities are creating business and entrepreneurship majors, the government modernizing the administrative procedures and aspects for entrepreneurs, events and conferences are being organized and sponsored. Con Lack of support, experts and mentors that could support entrepreneurs
- 11. Iran ● Population of83 million ● GDP Composition Agriculture: 9.2% Industry: 38.8% Services: 51.9% ● Labor Force of 29.07 million Iran’s Capital City of Tehran Pro $400 billion economy, second largest in the Middle East next to Saudi Arabia. Highly educated population with strength in the tech field. Con Lack of foreign investors, driven away by the fear of past obstacles, such as a lack of transparency and outdated legal and auditing practices. Shortage of skilled labor. Jordan ● Population of 8 million ● GDP Composition:
- 12. Agriculture: 4.2% Industry: 29.6% Services: 66.2% ● Labor Forceof 2.055 million Jordan’s Capital City of Amman Pro Jordan reduced its minimum capital requirement for starting a business by more than 96% in 2008. Con Establishing a business requires ten procedures, lack of venture capital, financial institutions are somewhat risk-averse. Lebanon ● Population of 6 million ● GDP Composition: Agriculture: 5.6% Industry: 24.9%
- 13. Services: 69.5% ● LaborForce of 1.6 million Lebanon’s Capital City of Beirut Pro Extremely startup friendly, Central Bank of Lebanon launched an initiative to encourage commercial banks to invest in startups directly. Many entrepreneur forums such as Lebanon for Entrepreneurs and ArabNet Con High number of entrepreneurs Egypt ● Population of 94 million ● GDP Composition: Agriculture: 11.2% Industry: 36.3% Services: 52.5% ● Labor Force of 31.14 million Pro Young Tech-savvy population with increasing interest in starting their
- 14. own business. Educationsystem introducing entrepreneurship to the people. Con Slow and complicated business registration system, poor contract enforcement, and high taxation. Egypt’s capital city of Cairo ● Population of 9 million (only 15% are nationals) ● GDP Composition: Agriculture: 0.8% Industry: 46.9% Services: 52.3% ● Labor Force: 5.087 million (85% are expatriates) United Arab Emirates UAE’s Capital City of Abu Dhabi Pro
- 15. Dubai’s ruler andVice President recently set up a $544 million fund to help entrepreneurs. Laws are supportive of entrepreneurship. Multicultural society with countless firms. Con Extremely competitive environment for entrepreneurs. Significant Developments ● Professionals believe the MENA job market is picking up 63% ● Top Industries perceived to be employing most talent by employees are: ○ Oil and Gas 30% ○ IT and Telecom 24% ○ Hospitality 8% ○ Education 8% ○ Healthcare 7% ● Misalignment of education and employment ● Top 6 departments with highest shortage of skills: HR, IT, Engineering, Marketing, Sales and Finance Organization Highlights
- 16. Souq.com was foundedin 2005 by Ronaldo Mouchawar alongside Jabbar Internet Group’s Samih Toukan and Hussam Khoury. Billed as being the ‘Amazon of the Middle East’, Souq.com operates both as a retail site and as a marketplace for third party sellers. It features more than 600,000 products and attracts over 24 million visits per month. The company now has over 2,000 employees across operations, customer service and logistics. Souq.com also emerged as the second most searched for brand in 2014 in the United Arab Emirates, according to Google. Ronaldo Mouchawar, Founder of Souq.com Organization Highlights In a society with both tradition and laws restricting women from the workplace, Khalid Al Khudair, through his company Glowork, has
- 17. sought to connectthem with jobs. The site now boasts a database of over 1.2 million Saudi women and has connected thousands with jobs. Organization Highlights Ralph R. Debbas founded W Motors, the Arab world’s first manufacturer of high performance luxury sport cars in Lebanon in 2012, before moving the company to Dubai a year later. W Motor’s first vehicle, the $3.4 million Lykan HyperSport was the most expensive car to feature in the Fast and Furious franchise, with its appearance in the latest film. Future of the MENA Region - More Political Accountability: political competition including broad based political parties, adequate transparency, regulation of party financing, disclosure of parliamentary votes, etc. - Checks and Balances: ensuring separation of powers like an independent and effective judiciary, legislative oversight via parliaments with
- 18. independent oversight institutions likeSupreme Audit Institutions and Anti-Corruption Agencies - Robust Civil Society and Media: Freedom of expression and open media with civil society organizations monitoring public and private agencies and citizens’ feedback via report cards and surveys - Effective Public Sector Management: strong and results- oriented public administration, ethical leadership and safeguards concerning assets, conflict of interest rules, effective financial management, procurement, and regulatory agencies - Social Sector Service Delivery: improve better service quality and delivery - Public Investment Management: must be strengthened to increase execution rate of investment budgets - Strengthen Social Accountability: Engage in both supply and demand to ensure that enhancing public engagements lead to long-lasting results References ▫ http://www.youthpolicy.org/mappings/regionalyouthscenes/men a/facts/ ▫ http://knowledge.wharton.upenn.edu/article/how-low-oil-
- 19. prices-are-battering- the-mena-region/ ▫ http://documents.worldbank.org/curated/en/56754146827594217 8/pdf/90142 0BRI0Box30coll0KNOWLEDGE0NOTES.pdf ▫ http://al-bab.com/albab-orig/albab/arab/econ/suleiman.htm ▫ https://www.entrepreneur.com/article/284540 ▫https://www.bayt.com/en/research-report-17482/ ▫ https://www.entrepreneur.com/article/245762 ▫ http://www.international.gc.ca/name-anmo/peace_process- processus_paix/canadian_policy- politique_canadienne.aspx?lang=eng ▫ http://www.nytimes.com/2009/11/29/world/asia/29torabora.html ?_r=1 ▫ http://www.independent.co.uk/news/world/middle-east/prince- mohammed- bin-salman-naive-arrogant-saudi-prince-is-playing-with-fire- a6804481.html ▫ http://www.huffingtonpost.com/dr-yousaf-butt-/saudi- wahhabism-islam- terrorism_b_6501916.html ▫ https://georgewbush- whitehouse.archives.gov/news/releases/2003/03/20030322.html ▫ https://fas.org/sgp/crs/natsec/RS21405.pdf ▫ http://www.bbc.com/news/world-middle-east-29052144 ▫ http://www.nybooks.com/articles/2016/06/23/how-to- understand-isis/ ▫ http://www.huffingtonpost.com/uriel-abulof/what-is-the-arab-
- 20. third- es_b_832628.html References ▫ http://www.middleeasteye.net/news/yemen-s-arab-winter- 1470341500 ▫ http://www.cbsnews.com/news/syria-crackdown-has-killed- 5000-people-un- says/ ▫http://www.nytimes.com/2015/10/13/world/middleeast/syria- russia- airstrikes.html?_r=1 ▫ http://www.bbc.co.uk/news/resources/idt-841ebc3a-1be9- 493b-8800- 2c04890e8fc9 ▫ https://www.washingtonpost.com/news/worldviews/wp/2014/08/ 08/when- obama-talks-about-iraq-his-use-of-the-word-genocide-is-vital/ ▫ http://www.bbc.com/news/world-middle-east-29003321 ▫ http://www.nytimes.com/2014/06/16/world/middleeast/iraq.html ?_r=0 ▫ https://www.eia.gov/beta/international/analysis_includes/countr ies_long/Libya /libya.pdf
- 21. ▫ https://web.archive.org/web/20150320232806/http://www.confli ct- news.com/libyas-second-civil-war-how-did-it-come-to-this/ ▫ http://in.reuters.com/article/yemen-security-china- idINKBN0MY0LV20150407 ▫ https://www.icrc.org/en/document/yemen-humanitarian-pause ▫https://www.theguardian.com/australia- news/2015/apr/12/australia-calls-for- yemen-ceasefire-on-eve-of-julie-bishops-visit-to-iran ▫ http://en.abna24.com/service/middle-east-west- asia/archive/2015/06/19/696106/story.html ▫ http://www.cfr.org/yemen/yemen-crisis/p36488 ▫ https://www.foreignaffairs.com/articles/middle-east/2015-03- 25/houthi-who ▫ https://refugeesmigrants.un.org/more-3-million-displaced- yemen- %E2%80%93-joint-un-agency-report Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. Equity Financing and Capital Market Funding Policies to Support ... Wonglimpiyarat, Jarunee The Journal of Private Equity; Fall 2012; 15, 4; ABI/INFORM Collection pg. 10
- 22. Reproduced with permissionof the copyright owner. Further reproduction prohibited without permission. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
- 23. Reproduced with permissionof the copyright owner. Further reproduction prohibited without permission. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
- 24. Reproduced with permissionof the copyright owner. Further reproduction prohibited without permission. 8th International Scientific Conference on Economic and Social Development and 4th Eastern European ESD Conference: Building Resilient Economy, Zagreb, Croatia 283 INFLUENCE OF FINANCING SOURCE ON THE SMALL BUSINESS PERFORMANCE Mihaela Mikic University of Zagreb, Faculty of Economics and Business, Croatia [email protected] Tomislav Novoselec [email protected] Dinko Primorac University North, Croatia [email protected] ABSTRACT
- 25. Finding funds forfinancing entrepreneurial venture often presents most difficult obstacle in realization of entrepreneurial idea. During this process choosing the source of financing represent the special challenge. Although in first it may look there is a wide selection of source of financing as: private equity, business angels, public finance, etc., in practice entrepreneurs usually depend on their own assets, informal investors and debt financing. This paper gives detail overview of possible source of financing for new and already existing entrepreneurs. Based on conducted research and multiple linear regression analysis is defined influence of individual source of financing and small business performance. As profit represents the core motive for entrepreneurship, these research findings should be entrepreneurs’ guidelines in choosing the source of financing their venture. Keywords: business angels, business performance, private equity, small business, source of financing
- 26. 1. INTRODUCTION Like everywherein the world, small entrepreneurship in Croatia is the most important generator of development, it openes new workplaces, encourag sole proprietorships and inovation, increase production and export, and thus create added value. Role of this companies is not only in ecenomical spheres of society, but also in social, cultural and historic spheres. Due to their contribution to employment, creating GDP and export, sole proprietorships represent a huge part of Croatian economy. Small and middle sized companies (SMEs) encompass 99.6% of total number of registered businesses in 2012. Out of that, 98.3% are small sized and 1.34% are middle sized businesses. Share of small businesses in employment in 2012 recorded a growth compared to 2011 and now stands at 67.04% (49% are small sized and 18.04% are middle sized businesses). At the same time, SMEs constitute 43.06% of total Croatian export, 21% are small busineses, 22.6% are middle sized businesses (HGK 2014). Small activity in new ventures, small share of
- 27. growing companies, administrative barriers,under-developed financial market (too dependent on traditional instruments) and lack of education focused on honing entrepreneurship knowledge and skills are main traits of small businesses in Croatia. Financial resources are needed for realization of every idea and inovation. Financial requests have a tight bond with business strategy, which in interaction with financial strategy enables creating added value and raising the level of competitiveness. Without financial resources it is impossible to realize new good business ideas. When a business is started, financial resources are ensured from owners own sources. With growth and development of a company, mailto:[email protected] 8th International Scientific Conference on Economic and Social Development and 4th Eastern European ESD Conference: Building Resilient Economy, Zagreb, Croatia 284
- 28. requirements grow withthem, and so possibility to finance come from many different sources. Each stage of a company's life cycle has different sources of financing. In earlier phases personal assets, loans from family/friends and micro loans present key financing resoruces, while in later phases they can be expended with equity funds, business angels (as informal investors) and public financing. Small businesses face many barriers in they life cycle and financing is one of most common to appear and hardest to overcome. 2. POTENTIAL SOURCES OF FINANCING 2.1. Self-financing When launching a business, every entrepreneur must first turn to his own personal property. Although entrepreneurs prefer to invest only someone else's capital to reduce their risk, banks and other investors require capital investment by entrepreneurs as a sign of faith in the venture. The largest part of their funds is personal savings they've acquired over the years. The funds presented as savings can be found at the current bank
- 29. accounts, saving bank accountsor in the form of effective money. There's a positive correlation between savings and probabilities, it is a cause - effect relationship characterized by great likelihood that a person will start a business venture if it has a larger amount of savings, on the one hand, and that he/she will generate greater amounts of savings if he/she engages in running a business, on the other (Hurst and Lusardi, 2006). Likewise, savings (wealth) is concentrated by entrepreneurially active people and entrepreneurship is a powerful factor which affects the level of aggregate savings (wealth), and thus the aggregate consumption (Gentry and Glenn, 2004). Surveys show that the majority of entrepreneurs in Croatia opted for entrepreneurship out of necessity (GEM, 2013), so an important source of self- financing is redundancies that can reach very high amounts. The next type of self-financing is personal debt that can be result of overdraft on current account or credit card. Among these, personal loans are suitable for setteling short-term liabilities and are sometimes used in
- 30. order to achievetax benefits on such loans (Grgić, Bilas and Franc, 2011). When they exhaust their own sources of financing entrepreneurs turn to informal investors, friends and family. Unlike other investors family members and friends are often more patient and don't interfere in the way entrepreneurs conduct their business. Also they usually do not sign formal contracts and the contractor doesn't pay any interest (if they exist they are insignificant) for the borrowed funds. Information on the return and the potential benefits are also informal (Skrtic and Mikic, 2011). Repayment period of the borrowed funds is often flexible and it adapts to the undertakings' capabilities, and the borrowing decision depends on the personal trust in the entrepreneur as a person. Because of the mutual relations of family members or friends and business drivers, they will prefer to invest in entrepreneur’s investment than decide to hold cash or invest in other investments (Scarborough and Zimmerer, 2009). In this case there may be conflicts between entrepreneurs and family or
- 31. friends, and themain causes of disagreement are usually unrealistic expectations or misunderstood risk by those who have invested in venture project. In order to avoid distortion of relations, the entrepreneur must honestly and realistically present strengths, weaknesses, opportunities and threats of the project and the nature of the investing risks. If we talk about financing of the existing company, then we need to mention another form of self – financing, which in this case is the most important, financing from business retained earnings. There are two options that a company can use if it makes profit. One is to reinvest the acquired funds in the business to help them achieve new value added, and the other option is to distribute its profits to owners in the form of dividends. 8th International Scientific Conference on Economic and Social Development and 4th Eastern European ESD Conference: Building Resilient Economy, Zagreb, Croatia
- 32. 285 2.2. Debt financing Themost common form of debt financing is a bank loans. Such financing can be shorterm or longterm and is marked by giving collateral as insurance of payment by entrepreneurs. It is for this reason that this type of financing is difficult to apply to businesses that are at the very beginning of their life cycle. Bank wants proof of successfully conduction of business and real evidence of stable sales and the ability of products or services to generate adequate cash flows to ensure the repayment of the loan, and therefore they insist on collateral when financing entrepreneurial projects in early stage of development. In assessing the requirements for lending resources, banks focus on the ability of the company to generate cash flows since it will continue to serve for servicing the loan. Other forms of debt financing include: trade credits, factoring and leasing. Trade credit is given by the supplier (also called loan of
- 33. manufacturer to thecustomer), and is implemented through the granting of loans under a contract for the delivery of goods with deferred payment, usually 30 to 90 days. Suppliers often use this type of financing to attract new customers, and customers or contractors use it as a way of acquiring the additional working capital. Since these loans are often not linked to interest payments, entrepreneurs often use it in their daily business. Factoring, as a form of debt financing, represents a form of shortterm financing on the basis of sales of short, in general, unsecured assets of enterprises (primarily trade receivables without collateral payments) to specialized financial organization, which is called a factor. These financial institutions may also provide other services, such as claims management and underwriting payment from the debtor. Factoring regularly represents a shortterm rating with a large circle of regular customers and large annual turnover and is often not an option for small businesses. Leasing is a form of financing that is based on the idea that it is better to use the object of
- 34. leasing than tobuy it. It allows the user to obtain any equipment or property for use during needed time, rather than to buy it. By leasing, SMEs can obtain manufacturing and other goods without spending their own funds and without taking expensive loans in the financial market, and allows compensation for the use of subjects on the principle of "pay out of what you earn." There are two types of leasing: financial and operational. Financial leasing is a basic contract period of the lease, in which one of the contracting parties can't cancel, it is designed as a "contract of full amortization," which means that the user, during the duration of the contract paid the full value of the service (where the costs of maintenance and obsolescence of subjects bears the recipient). On the other hand, operating leasing represents a shortterm contract for the lease that can be terminated at any time (under the terms of the agreement), it lasts less than the economic life of the subject, the fee is smaller than the value of the object, so the service is depreciated only by a portion of their expenses and assumes the
- 35. risk of obsolescenceand maintenance costs of leased items. Also after the expiry of the lease entrepreneur can (if the contract was concluded) redeem the subject of leasing. In operations of European companies leasing is mostly used for the acquisition of transport equipment and machinery, and technology (European Commission, 2013). Leasing purchase of equipment allows small businesses to keep up with technological change and to preserve their technological competitive advantage. 2.3. Equity capital Venture capital funds are a form of equity financing, and represent funds for medium and longterm investment in companies that typically are not listed and have high growth potential (Cvijanovic, Marovic and Sruk, 2008). These funds are known under the name of private equity funds and by the Investment Funds Act of Republic of Croatia defined as mutal venture capital funds with a private offering (150/05). Venture capital funds usually invest in companies that are engaged in hightech service sectors such as
- 36. Internet, communications, 8th InternationalScientific Conference on Economic and Social Development and 4th Eastern European ESD Conference: Building Resilient Economy, Zagreb, Croatia 286 information technology, biotechnology, etc.. To attract capital, company must primarily have potential for rapid growth. The process of obtaining capital is rigorous and requires entrepreneur to professionally prepare project documentation with longterm business plan. When a venture capital fund accepts an entrepreneurial project follows an agreement on all relevant business issues with special emphasis on the management team. Venture capital funds do not buy more than twenty to forty percent ownership of the company, since the purchase of a large stake would reduce the enthusiasm of entrepreneurs to manage the company. The dynamics of investing funds in an entrepreneurial project is not always a one
- 37. time investment; instead,if it comes to large amounts, it can be realized in several phases. Acceptance of this form of financing requires a waiver of part of ownership by the entrepreneur, and sometimes loss of control over operations. Business angels are individuals or groups that provide capital for financing new business projects. Most often these are wealthy individuals who are looking for entrepreneurial ventures (projects) in which they would invest their own resources in exchange for the acquisition of shares of those companies (Garaca and Marjanovic, 2010). This is an informal form of investment whose holders are highly educated business people who invest their funds in start up projects with high potential of growth. This implies that angels expect a high annual return on investment and a multiple increase of the initial investment after a few years when they decide to retire from the business (Figar, 2010). The reason why they are willing to accept such a degree of risk is that one investment is only a tiny fraction of the total portfolio of personal investments that angels
- 38. make (Vasilescu, 2009).On capital market business angels fills the gap between the founders, family and friends on one side and the venture capital funds on the other, and therefore have a key role in the financing of SMEs, particularly innovative businesses and businesses with high growth potential. In some cases, firms choose to raise capital through the public sale of shares in the capital market, so called going public. By analysing the strengths and weaknesses of public offering, we can conclude that going public primarily allows the entrepreneur to collect large amounts of capital, but not without consequences. For some businesses, the consequences are too big. Most entrepreneurs enter entrepreneurship with the goal of independence and creating something of their own, so the loss of independence in decision making and conducting business, shared ownership and a sense of "accountability" are simply too big sacrifice that most entrepreneurs are not ready to make. For those entrepreneurs who enjoy the fact that their company outgrew themselves and who want to try some other
- 39. challenges, public offeringis a good way to achieve that dream. Once an entrepreneur, a small business owner, weighs all the pros and cons and decides for public offering he will meet with the formal problems. Today in the world there are only a few specialized stock exchanges for SMEs, of which the most important for Croatian entrepreneurs is AIM (Alternative Investments Market) in London. AIM London is the largest and most liquid world market for growing SMEs, and its biggest advantage over other stock exchanges is that it belongs to the London Stock Exchange which brings listed companies many advantages and great number of competitors as well. 3. CHOOSING THE SOURCE OF FUNDING Raising funds for launching an entrepreneurial project is a big challenge for every entrepreneur. Constant changes on the market only make the mentioned challenge more difficult. When selecting sources of financing entrepreneurs need to consider the following factors (Stokes and Wilson, 2010):
- 40. business 8th International ScientificConference on Economic and Social Development and 4th Eastern European ESD Conference: Building Resilient Economy, Zagreb, Croatia 287 Companies with more complex legal forms of conducting business, such as public limited companies, will have an increasing number of opportunities related to funding the company, while those with simpler legal forms (sole traders) will be much more limited in terms of the diversity of funding sources. Thus, for example, sole traders can't get access to equity capital because there is no possibility of selling shares of the company. At different company life cycle stages (start up, growth, differentiation, consolidation, liquidation) company will require increasing amounts of resources for growth and prosperity
- 41. of business. Theneeds for financial resources of a recently founded company and one that has a long tradition of conducting business are not the same. It is essential that strategy and structure of the company are changing along with the changes in the life cycle and therefore business conditions, and indirectly the needs for financial resources will also change. Funding problems are encountered mostly by entrepreneurs who are at the very beginning of their entrepreneurial adventures, so at the very beginning, funds come from entrepreneurs, friends, relatives, business angels. Banks are reluctant to finance new business ideas for entrepreneurs usually can't provide adequate collateral. On the other hand, the venture capital funds are usually not interested in these investments because for them the amounts of profit are very low. In the next stage, the resources are needed for the development of the business idea and its expansion, so for the entrepreneur, through well developed business plan the possibility of using others financing resurses is opening up. When a company occupies a certain market
- 42. position through qualitybusiness it will have a full range of possible sources of funding available. In the case of fixed resources, financing is mostly carried out through owner’s equity, and funding source is most often seen in the proportion of entrepreneur’s ownership (in the form of shares) in the company or personal loans of entrepreneurs or their partners. This serves to cover the initial operating expenses or new product development in the stage of development and expansion. Unlike fixed assets, current assets are covered by shortterm financing and are used to cover operating costs and often the procurement of rolling stock. Financing assets carried out through medium and long term financing (3 – 10 years) is used for the acquisition of plants, machinery, equipment, while making sure that credit conditions correspond to life expectancy (or shorter) of the underlying assets. In financing sources entrepreneur should pay attention to the potential problems that are presented by exchange rate fluctuations,
- 43. requirements and safetycharges. 5. SMALL BUSINESS FINANCING IN CROATIA 5.1. Methodology Population of this research is all Croatian small businesses. Small business has maximum of 50 employees and size data are available in the register of business entities at Croatian Chamber of Economy. Research sample consists of 350 small businesses from various business activities: manufacturing, construction, wholesale and retail sale, repairs of motor vehicle and motorcycles, and objects for personal consumptions and households, transportation, storage and communications. Research was conducted via electronic mail, and rate of return is 11.71%. Regardless relatively small percentage of return, given sample is sufficient for relevant analysis and impact assessment of choosing financing source on small business performance. Questionnaire was answered by owners of small business, ie small entrepreneurs.
- 44. Determining financing sourceswas done by using five-level Likert item scale. Financing sources include: self-financing by entrepreneur, informal investor (3F), venture capital funds and business angels. This research was based on acquisition of self-selected, subjective answers about the financial and non-financial performance of the firm from the entrepreneurs 8th International Scientific Conference on Economic and Social Development and 4th Eastern European ESD Conference: Building Resilient Economy, Zagreb, Croatia 288 of the retained sample companies with an effort to reflect its multi-dimensionality. Business performance was operationalized accordingly by Gupta and Govindarajan (1984) where the respondents were asked to rate the extent to which stated financial and non-financial indicators are important for their business, and subsequently, to assess the extent of satisfaction with the achieved performance of these indicators. For this purpose three financial
- 45. and three non-financialindicators were used; each of the indicators was measured with three questions using a five point Likert scale. Financial performance represents the key of business effectivity and it is considered important, but not self-sufficient for defining business performance (Murphy et al., 1996). We used these indicators of finance performance: Business performance represents market oriented components and includes indicators of total revenues and market share. This definition was subject in numerous researches (Koufopoulos et al., 2010; Postma, Zwart, 2001) Multiple linear regression method is used for the prediction of the dependent variable on the basis of the insights that can be obtained from a number of independent variables and for determining the nature and relationship between these variables and the variables used to measure the quantitative scale. Standard methods of multiple
- 46. linear regression isused and all independent variables entered into the regression equation simultaneously in order to explore the relationship between the entire set of independent variables and the dependent variable. For the evaluation of the strength of relations among variables the regression coefficients and t-test is used. 5.2. Sample characteristics We gathered responses from 41 small business. The biggest part of questioned business is from construction 37% and wholesale and retail sale 29% (Figure 1). The majority was founded in period of 1990 to 2000, average year of foundation is 1996, and the modal year is 1991. Figure 1: Distribution of the business according the business activity 37% 29%
- 47. 17% 17% Construction Wholesale and retailsale Transportation, storage and communications Manufacturing 8th International Scientific Conference on Economic and Social Development and 4th Eastern European ESD Conference: Building Resilient Economy, Zagreb, Croatia 289 As main reason for using self-financing entrepreneurs stated completely ownership over the resources 24%, no interest rates and monthly payments As main reason for using self- financing entrepreneurs stated completely ownership over the resources 24%, no interest rates and monthly payments 23% and independence in disposing resources 22% (Figure 2).
- 48. Figure 2: Reasonsfor using self-financing Most common source of self-financing is savings through the years 34%, and from other sources inheritance and selling of the personal property (Figure 3) Personal debt financing and current account overdraw are least represented, which can be interpreted as willingness of entrepreneurs to stay independent in disposing resources without attachments to interest rates and terms as in the case of bank loans. Figure 3: Source of personal property As for the entrepreneus who used the loans to family/friends to finance busienss equity, 65% of them stated these reasons for using this form of financing: no detachment deadlines and high interest rates and the fact that family members/friends will not interfere with their way of doing business. Interesting is that the 35% of the sample did not use any borrowings from family/friends to finance equity (Figure 4).
- 49. 22% 24% 23% 18% Independence in disposing resources Completelyownership over the resources No interest rates and monthly payments Signaling to investors faith in investment 34% 14% 11% 10% 15% Savings throug the years Personal loan Current account overdraw
- 50. Redundancy Funds from selling property 8thInternational Scientific Conference on Economic and Social Development and 4th Eastern European ESD Conference: Building Resilient Economy, Zagreb, Croatia 290 Figure 4: Reasons for using funds form family/friends The other interesting finding is that 44% questiond entrepreneust said that the concept of venture capital is completely unknown to them. Only 41% of respondents answered that they have heard of venture funds, but are not familiar with possibility of using their finance resources (Figure 5). Figure 5: Familiarity of venture capital funds Even worse indicators relate to knowledge of the term of business angels and their advantages
- 51. and disadvantages. Only15% of respondents is fully aware of business angels (Figure 6). At the same time, to 59% of entrepreneurs business angels are completely unknown concept. The above shows an extremely negative trends of Croatian SMEs, and states the area within is necessary to conduct additional training of entrepreneurs in order to improve these negative trends. 18% 17% 15% 15% 35% Detachment to return deadlines and high interest rates Family members/friends do not interfere with their way of doing business Not obligatory to report business performance details Do not have enought own
- 52. funds Did not usedthis financing source 44% 41% 15% Do not know Heard, but do not know the details Fully understand 8th International Scientific Conference on Economic and Social Development and 4th Eastern European ESD Conference: Building Resilient Economy, Zagreb, Croatia 291 Figure 6: Familiarity of business angels As conclusion it can be stated that the Croatian small businesses or entrepreneurs show a more traditional approach to finance business equity. Majority of
- 53. financing is basedon their personal property and only a small part on the borrowed funds from family/friends or informal investors. 5.3. Results of multiple linear regression Regression equation is: Y = α + β1X1 + β2X2 + β3X3 + ei Y = business performance X1 = entrepreneur's savings X2 = funds form family/friends X3 = bank loans In the above regression equation venture capital funds and business angels are exempt as previously mentioned results show that questioned entrepreneurs did not use their funds for financing their business venture. The business performance(Y) is the dependent variable and is measured as a weighted average which is obtained through multiplying the importance and satisfaction for each individual
- 54. criterion. Criteria usedare: (1), Financial performance: company total profit, profitability of total assets (ROA) and return on equity (ROE); (2) Business performance: total revenue and market share. The independent variables in this model represent the types of financing that take three modalities: personal property of entrepreneur, fund from family/friends and bank loans. The outcome of a multiple linear regression using method of least squares (Table 1) show estimated equation model of the impact of financing source on small business performance as follows: Ŷ= 0,14 + 0,67X1 – 0,37X2 + 0,49X3 58% 27% 15% Do not know Heard, but do not know the details Fully understand
- 55. 8th International ScientificConference on Economic and Social Development and 4th Eastern European ESD Conference: Building Resilient Economy, Zagreb, Croatia 292 Table 1: The outcomes of the multiple linear regression (financing source/small business performance) N=41 Coefficient Standard deviation t(41) p-level α 0.136546624 0.769284092 0.177498 0.860085165 X1 0.66667436 0.120485453 5.533235 0.0000026921391 X2 -0.369496985 0.251370055 -1.46993 0.150032975 X3 0.489712921 0.128733438 3.804085 0.000516709 Statistics Value Multiple R 0.698670101 Multiple R 2
- 56. 0.48813991 Adjusted R 2 0.44663774 F(3,37) 11.76179259 p0.0000147744 Contribution of financing sources to explanation of business performance is satisfactory because it explains 48.81% of variance, on the whole population is 44.66%. This data is significant as a source of financing is one of the most influential factors of business success - but not the only one. There are many other factors that affect business performance - both on the internal as well as external level, which in this analysis was not included. Regardless of the high coefficient of multiple linear determination, the impact of the financing source on small business performance is highly significant (p <0.01.). Personal assets of entrepreneur has a positive impact on business performance (β1 = 0.67, p
- 57. <0.01 - significantat 1%). The above result was expected because when investing their own funds entrepreneurs are acting and making decisions more prudently. As an entrepreneur invests his savings accumulated for years, thereby risking the financial stability of your family, it is logical that he will be managing it more responsibly while avoiding investment in high-risk activities. In this case, we can say that the entrepreneur takes reasonable assumption of risk when making business decisions. And financing through bank loans has a positive impact on business performance (β3 = 0.49, p <0.05 - significant at 5%). The reason for this can be found in the complex procedure of loan approval which credit institutions protect against bad loans. When applying for funds, entrepreneurs are responsible for providing high quality and systematically developed a business plan which covers all areas of the business in order to reduce potential operational risks to a minimum. By doing so, companies are obliged to comply with the plan. At the same time, the bank will only approve funding for promising projects
- 58. that have acertain economic potential. In this way the bank invests only in ventures that promise a return, so it is logical that between bank loans - as a form of business financing - and the business performance we have a positive link. Interesting results showed that analysis of the impact of funds from family/friends on small business performance. Results of the analysis indicate a negative relationship (β2 = -0.37, p = 15 - significant at 15%). This is explained with very informal relationship that exists between entrepreneurs and investors mentioned. As the landing of the funds is usually based on acquaintance and relationship with the entrepreneur, or trust, all the information about the entrepreneurial venture and the potential returns are usually verbal. The lack of formal developed business plan that will provide an objective picture of the business venture potential may lead to worse malpractice risk management operations, thereby to achieving
- 59. 8th International ScientificConference on Economic and Social Development and 4th Eastern European ESD Conference: Building Resilient Economy, Zagreb, Croatia 293 poorer financial results. Also, entrepreneurs are often turning to family and friends when they exhausted all their own available funds or personal property and at the time when they can no longer get any bank loans. The most common reason is high-risk from non-viability of a business project or already high indebtedness of entrepreneur. The research results bring answers to many questions related to the Croatian small businesses and ways to finance it, but also many questions remain open for further research. Additional limitation is the scarcity of data on business performance in the Republic of Croatia so the quality of doing business is still incomplete. A small sample represents a kind of restriction regarding the use of inferential statistics and advanced statistical models for more detailed and better analyses.
- 60. 5. CONCLUSION Finding andselecting sources of financing is a significant problem in implementation of Croatian entrepreneurs' ideas. Although they have available many sources of financing, as shown in this paper, they usually use only three types: personal property of entrepreneur (self- financing), informal investors (family and friends) and bank loan. The reason for this lies in the lack of knowledge of other forms of financing that are at their disposal, such as venture capital funds and business angels. Also, stated unwillingness of investors to finance entrepreneurial ventures in the initial phase of the life cycle or to finance such "small" amount does not help. The limiting factor in finding funding represents a legal form of business, which entrepreneur is not usually aware of when starting a business. The empirical research has shown that there is a positive relationship between self-financing of the entrepreneurial venture or investment of his personal property, and small business
- 61. performance, and aboveis explained by the fact that such firms conduct much more sensibly risk management. Entrepreneurs are investing savings gathered through the years and inherited assets, the reason is completely ownership over the resources, no interest rates and monthly payments and independence in disposing resources The reverse situation is present when borrowings from family/friends. Results of multiple linear regression show a negative correlation between this form of financing and business performance. The main reason for borrowing from family/friends is detachment to high interest rates. The fact that family members/friends do not interfere in doing business, is the second most common reason for using this type of financing. Financing through bank loans positively affects the achievement of successful business results, and one of the reasons is systematically and holistically developed a business plan that is needed for obtaining bank funds. Croatian small businesses show a more traditional approach to funding equity, the majority of funding is based on the
- 62. personal assets ofthe entrepreneur (in 2012 the average proportion of self-financing was 80.14%), and only a small part is based on the borrowed funds from family/friends and bank loans. Precisely for this reason, the Croatian entrepreneurs should through education for entrepreneurship, improvement of technical and technological knowledge and skills, and international entrepreneurial practices adopt the best European (global) trends in entrepreneurship so their work and business efforts could result with a long term national and international competitiveness. LITERATURE 1. Amoros, J. E., Bosma, N. (2013). GEM 2013 Global Report, Retrieved: 22.04.2014. from http://www.gemconsortium.org/docs/3106/gem-2013-global- report 2. Centar za politiku razvoja malih i srednjih poduzeća i poduzetništva (2014). Izvješće o malim i srednjim poduzećima u Hrvatskoj – 2013, Retrieved: 22.9.2014. from 8th International Scientific Conference on Economic and Social
- 63. Development and 4thEastern European ESD Conference: Building Resilient Economy, Zagreb, Croatia 294 http://cepor.hr/Izvjesce%20o%20malim%20i%20srednjim%20po duzecima%202013_CEP OR.pdf 3. Cvijanović, V., Marović, M., Sruk, B. (2008). Financiranje malih i srednjih poduzeća, HVCA, Zagreb 4. European Commission (2013). SMEs Access to Finance, Retrieved: 23.04.2014. from http://ec.europa.eu/enterprise/policies/finance/data/index_en.ht m 5. Figar, N. (2010). Uloga „poslovnih anđela“ u finansiranju malih i srednjih preduzeća, Ekonomske teme, 48 (2), Niš 6. Garača, N., Marjanović, I. (2010). Uloga poslovnih anđela u poduzetništvu, Praktični menadžment, 1, p. 75-80 7. Gentry, W.M., Hubbard, R.G. (2004). Entrepreneurship And Household Saving, Advances in Economic Analysis & Policy, 4 (1), article 8 8. Grgić, M., Bilas, V., Franc, S. (2010). Poduzetništvo u međunarodnoj ekonomiji, Sinergija, Zagreb
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- 65. 15. Scarborough, N.M.,Zimmerer, T.W. (2009). Effective Small Business Management, Pearson 16. Stokes, D., Wilson, N. (2010). Small Business Management & Entrepreneurship, Cengage Lmg Business Press 17. Škrtić, M.; Mikić, M. (2011). Poduzetništvo, Sinergija, Zagreb 18. Vasilescu, L.G.: Business Angels (2009). Potential Financial Engines for Start – UPS, Ekonomska istraživanja, 22 (3) 19. Venkataraman, N., Ramanujam, V. (1986). Measurement of Business Performance in Strategy Research, Academy of Management Review, 11, p. 801.-814. 20. Zakon o investicijskom fondovima, (2014.). Narodne novine: klasa: 402-09/05-01/03 ******* http://hrcak.srce.hr/practicalmanagement Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
- 66. Challenges of SMEsinnovation and entrepreneurial financing Jarunee Wonglimpiyarat College of Innovation, Thammasat University, Bangkok, Thailand Abstract Purpose – Today, the financing mechanisms to support small- and medium-sized enterprises (SMEs) development have been a subject of great interest and a challenge to policy makers as SMEs are regarded as an important sector contributing to economic growth and stability. This paper is concerned with the bank financing policies to support SME development in China. The purpose of this paper is to examine the governmental financing policies and the innovation financing system of China. The discussions are focused on the bank financing policies to support SME development in China. Design/methodology/approach – This study is a qualitative research with the use of case study methodology (Eisenhardt, 1989; Yin, 2003). The research is focused on the policy perspectives of bank financing to support SME development in the case of China, the world’s fastest-growing economy. To explore the role of financial institutions and banks in SME financing in China, the research also derives evidence from a collection of documentary investigation. The research fieldwork and interviews were undertaken in Beijing and Shanghai, major financial centers in China, with the use of semi-structured questionnaire. The analyses are undertaken to
- 67. answer the keyquestions of: What are the Chinese government’s strategies to support the development of SMEs? To what extent the government policies in bank financing can support SMEs and promote the development of an innovative economy? Findings – The empirical study has shown that despite the introduction of the 12th Five-Year National Economic and Social Development Plan to support SMEs development, China still needs to improve regulatory policies in support of innovative businesses which would help its transition to an innovation-driven economy. The study provides lessons and policy guidelines to improve the competitiveness of SMEs in China. The insights from this study can also be applied to other developing and emerging economies attempting to understand the role of financing mechanisms in building an innovative economy. Originality/value – The study has addressed the policy challenges to support SME development in China, a major Asian emerging country and one of the fastest- growing economies in the world (with averaged growth rate of 10 percent per annum). The empirical study of policy challenges was undertaken in Beijing and Shanghai, major financial centers in China. The study offers insights which can be applied to other developing and emerging economies attempting to understand the role of SME financing policies and mechanisms in building an innovative economy. Keywords Sustainable development, SMEs Paper type Research paper 1. Introduction China is one of the fastest-growing economies in the world
- 68. (with averaged growthrate of 10 percent per annum). In 2014, China was placed in 23rd position according to the International Institute for Management Development world competitiveness ranking and 28th position by the World Economic Forum. After joining World Trade Organization (WTO), China has adopted trade liberalization policies and various government policies to drive its economy. Small-and medium-sized enterprises (SMEs) play a significant role in the economy of China as they are the thrust sector that account for 60 percent of total World Journal of Entrepreneurship, Management and Sustainable Development Vol. 11 No. 4, 2015 pp. 295-311 © Emerald Group Publishing Limited 2042-5961 DOI 10.1108/WJEMSD-04-2015-0019 Received 23 April 2015 Revised 9 June 2015 Accepted 16 June 2015 The current issue and full text archive of this journal is available on Emerald Insight at: www.emeraldinsight.com/2042-5961.htm The author is thankful to Dr Pravit Khaemasunun, Yanathip
- 69. Techawiset, Professor ShufenDai, Kesrin Ariyaponges and China Thai Chamber of Commerce for all research advice and support. 295 SMEs innovation and entrepreneurial financing industrial outputs and 80 percent of jobs created in China. The Chinese government thus realizes the importance of building an innovative economy through enhancing SMEs’ capabilities. In building an innovative economy, the Chinese government has introduced the 12th Five-Year National Economic and Social Development Plan to support SMEs development. This paper attempts to understand the challenge of financing innovative economy through SME development in China. The paper is organized as follows. Section 2 reviews the theoretical framework on the banks, financial institutions and their role in innovation. It also reviews the literature on venture capital (VC) financing to support SME development. Section 3 describes the research design and methods. Section 4 discusses the analyses of findings with a focus on the bank financing policies to support SME development in China.
- 70. Section 5 concludesthe paper by drawing lessons and insights that can be used as policy guidelines to improve the competitiveness of SMEs. 2. Theoretical framework SMEs are the economic sector making a significant contribution to economic growth and job creation. However, they often face significant difficulties in accessing the kinds of financing they need for growth (Pissarides, 1999; Hyytinen and Toivanen, 2005). Although the studies on traditional sources of finance for start- up are already voluminous (e.g. Moore, 1993; Gompers and Lerner, 1998, 1999, 2001; Mani, 2004), there is a gap of research linking the study of entrepreneurial financing to the aspect of public policies in developing countries. Therefore, this study attempts to fill a gap in existing research by exploring the bank financing and VC financing to support entrepreneurial activities. Table I lists the types of financing and sources of capital to support SMEs. In filling the research gap, this study will make a contribution to the body of knowledge in SMEs innovation and entrepreneurial financing. Thus, the structure of the theoretical framework section will be divided into two parts: (1) Banks, financial institutions and their role in innovation. (2) VC financing to support SME development. 2.1 Banks, financial institutions and their role in innovation
- 71. Banks and financialinstitutions play an important role in terms of providing credits to support the economic growth. Bank financing is critical to the functioning of the economy since it is an important source of funding to support SMEs development. Nevertheless, banks and financial institutions are reluctant to provide credit lending to Investor Goals Family Success, payback Friends Payback, friendship Credit cards Payment Suppliers Payment relationship Business angels (private investors) Payback, returns, control Venture capital Fast growth, multiple returns, ownership Banks Payback, collateral Source: The author’s design Table I. Types of financing and sources of capital to support SMEs 296 WJEMSD 11,4 SME sector due to the riskiness of early stage ventures in terms of insufficient assets, having no proven track record and low capitalization (Berger
- 72. and Udell, 1998,2006; Black and Gilson, 1998; Wonglimpiyarat, 2007; Menkhoff et al., 2012; Fredriksson and Moro, 2014). As a result, they do not see this sector as a profitable business. In other words, they do not see worthwhile returns on SME investments or whether such investments would provide a potential pay-off. Figure 1 portrays the valley of death (or the funding gap), the difficulties encountered by all SMEs in accessing the needed capital to grow their businesses. The valley of death refers to the period before a company can generate revenues, making it difficult to get the finance it needs to grow a business in the start-up period (Ehlers, 1998). Table II shows the target returns by investment stages (Bygrave et al., 1999). It can be seen that the high level of risks in early stage investment requires the highest return (internal rate of return over 50 percent) to compensate the risks that are higher than those in other stages. Looking from an economic development perspective, Schumpeter (1939, 1967) argues that finance and financial institutions are the mainstream of innovation system as well as crucial determinants of the entrepreneurial ability to develop the new economy. The entrepreneurial firms are seen as playing a crucial role to the economy in terms of creating jobs contributing to economic growth and stability. Realizing the high risk nature of SMEs, many governments have
- 73. tried to bridge thevalley of death and improve SME capability. They see the valley of death as a challenging task in terms of introducing policies to manage the financial risks that Basic Research; Invention The Valley of Death Political picture of the “gap” “Valley of Death” Applied Research; Innovation Source: Ehlers (1998) Figure 1. The valley of death faced by SMEs Investee development phase Expected return represented by internal rate of return (IRR) % per annum Early stage (Seed/Start-up) IRRW50 Expansion and growth 40WIRRW35 Maturity stage (Bridge, Management buyout) IRRW30
- 74. Source: Bygrave etal. (1999) Table II. Target returns by investment stages 297 SMEs innovation and entrepreneurial financing SMEs face with the aim to help SMEs cross the valley of death (bridge the financing gap). The establishment of specialized development banks/SME banks with special type of loan offerings for SMEs can be seen as part of the government policies to help alleviate SMEs’ financial constraints (Mani, 2004; Hyytinen and Toivanen, 2005; de la Torre et al., 2010). In recent years, the issue of SME financing has received an increased attention as a way towards building an innovative economy. Many economists argue that despite the heavy concentration of research and development (R&D) expenditure in large firms, it is the small firms that account for most of the important inventions and innovations (Freeman and Soete, 1997). Taking into account the conventional
- 75. models of innovativeeconomies, Schumpeter’s (1939) Mark 1 theory postulates that small firms predominate in the process of innovation. Arguably, the Mark 1 model stresses the ability of the entrepreneurial small firms to innovate (whereas the Mark 2 model is concerned with the technological innovation developments by large firms). It is argued that small firms play an important role in innovation and industrial development (Freeman and Soete, 1997; World Bank, 2010; Krishnaswamy et al., 2014). Realizing the trend of knowledge-based economy (whereby the basis of competition is increasingly built upon research knowledge and innovation), many governments have developed strategies/policies to support SME financing with the aim in building an innovative economy (Lerner, 1999, 2002; Jeng and Wells, 2000; Mani, 2004). 2.2 VC financing to support SME development Figure 2 shows the funding requirement along the life cycle of SME development. Given the high uncertainties and risks in an early stage of development, the source of finance for new ventures is rather limited. The source of capital to support early stage venture is mainly from seed funds, business angels, VC financing whereas commercial banks and stock markets play a significant role in providing finance in the growth and mature stages (commercial banks providing finance in the form of
- 76. Seed Start-up GrowthMaturity High Low Low Time Source of funds: seed funds, business angels, venture capital financing Source of funds: commercial banks, stock markets R a te o f g ro w th Risk profile Source of funding Source: Wonglimpiyarat (2007) Figure 2. Funding requirement along the life cycle
- 77. of SME development 298 WJEMSD 11,4 loancapital or debt and stock markets providing finance in the form of equity capital) (Black and Gilson, 1998; Mani, 2004; Hyytinen and Toivanen, 2005; Giot and Schwienbacher, 2007; Wonglimpiyarat, 2007). Taking into account start-up financing, VC provides an important source of business finance to support SME development. By definition, VC is a high risk, potentially high-return investment to support business creation and growth. It is a source of funds that typically finances new and rapidly growing companies through equity participation (Bygrave and Timmons, 1992; Gompers and Lerner, 1999, 2001). VC has characteristics that set it apart from debt financing alternatives and traditional capital markets (Gompers and Lerner, 1999, 2001). It is a high- risk financing investment whereby venture capitalists generally expect high returns in the form of capital gains and dividends (Dixon, 1990; Pandey and Jang, 1996; European Private Equity and Venture Capital Association, 2005). The concept of modern VC is defined by Megginson (2004) as a professionally managed pool of money raised for the
- 78. purpose of making equityinvestments in growing private companies with a well defined exit strategy (Giot and Schwienbacher, 2007). SMEs assume a major influence in the economic development, employment and creation of new innovations (Birch, 1979; Gallagher and Steward, 1986; Sahlman, 1990; Massa and Testa, 2008). However, SMEs generally face difficulties in getting access to finance since investors do not prefer making investments in SMEs due to their risky nature of business operation. Since very small proportion of monies seems to be allocated to early stage ventures, therefore, the provision of risk capital by VC firms may be the most suitable form of external finance. This form of investing brightens SMEs’ prospects by relieving the capital constraints (Bygrave and Timmons, 1992; Gompers and Lerner, 1999, 2001; Wonglimpiyarat, 2007). Currently, a number of developing countries have introduced VC as an economic development tool whereby the government of these countries takes an operational role in the development of VC industry (Lasserre and Schutte, 1995; Naqi and Hettihewa, 2007; Tsai et al., 2009). The main focus of VC in these countries is similar, i.e., to provide seed capital and financing for technology and innovation development. Nevertheless, the structure of VC financing differs among countries due to different set of interacting institutions and structures of the national
- 79. innovation system (Lundvall, 1992,1993, 1998, 1999, 2003). 3. Research methodology This study attempts to fill a gap of existing research of SME financing by linking the aspect of public policies in developing countries to entrepreneurial financing. In particular, the research explores the challenges of SMEs innovation and entrepreneurial financing in the country case of China, the world’s fastest-growing economy. The research study uses the case study approach, a qualitative research (Eisenhardt, 1989; Yin, 2003), to analyze the impacts of the 12th Five-Year National Economic and Social Development Plan on the bank financing and VC financing for supporting entrepreneurial activities. In exploring the role of financial institutions and banks in SME financing in China, the research also derives evidence from a collection of documentary investigation. The research fieldwork and interviews were undertaken in Beijing and Shanghai, major financial centers in China, with the use of semi-structured questionnaire. The conduct of fieldwork interviews in the financial sector of China was coordinated by the Bank of Thailand, the Securities and Exchange Commission and the Thai Chamber of 299 SMEs
- 80. innovation and entrepreneurial financing Commerce inChina. The interviews were conducted with banks, financial institutions and government agencies as shown in Table III. In carrying out fieldwork research, the study aims to elicit views on the government policies and strategies to support SMEs and innovative businesses, the backbone of the Chinese economy that can lead to improved national innovative capacity. The key questions guiding the research are: RQ1. What are the Chinese government’s strategies to support the development of SMEs? RQ2. To what extent the government policies in bank financing can support SMEs and promote the development of an innovative economy? In order to provide a cross-check on internal validity, interview data are supported by an examination of secondary data. The conduct and analysis of the case study have enabled the development of conclusions and recommendations for the research. The analyses provide lessons and insights which would be useful for other emerging economies to use the policy guidelines in supporting SME
- 81. development. 4. Analyses offindings 4.1 The economy of China and government strategies to support SME development China is the fastest-growing major economy in the world with an average gross domestic product (GDP) growth rate of 10 percent. The overview of economic and innovation performance of China is shown in Table IV. Currently, the Chinese government mainly uses the open door policy in attempts to remodel itself from an agriculture-based economy towards an innovation-driven economy. Taking into account the policies to support SME development, the Chinese government has launched various innovation policies to catch up with leading- edge countries after it joined the WTO in 2001. Specifically, the 12th Five-Year National Economic and Social Development Plan is a major government policy that places a specific emphasis on Name of institutions Characteristics of institutions 1. Bank of Beijing Bank owned by the local government 2. Huaxia Bank Bank owned by the central government 3. China Citic Bank Bank owned by the central government 4. United Overseas Bank or UOB Foreign bank 5. Bank of China Bank owned by the central government and one of the Big Five 6. Bank of Shanghai Bank owned by the local government 7. Bangkok Bank China Co., Ltd. Foreign bank 8. Siam Commercial Bank Public
- 82. Company Limited The bankis currently planning to open a representative office in China 9. Thai Chamber of Commerce in China An agency promoting economic relationships between Thailand and China 10. Bank of Thailand Bank of Thailand – the Department dealing with investment and trade relations with China 11. The Securities and Exchange Commission The Securities and Exchange Commission in Thailand with specific research department providing advice on China’s financial and monetary policy Source: The author’s design Table III. List of institutions providing research interviews 300 WJEMSD 11,4 supporting SMEs in terms of creating an environment conducive
- 83. to entrepreneurship and innovationfor SMEs. In China, SMEs are defined as follows according to the 12th Five-Year National Economic and Social Development Plan 2011-2015 by the Ministry of Industry and Information Technology: (1) Small-sized enterprises: companies that employ fewer than 300 people and earn less than 20 million RMB Yuan in annual sales revenue. (2) Medium-sized enterprises: companies that employ 300-1,000 people and have annual sales revenue of 20-400 million RMB Yuan. In 2010, the number of registered SMEs in China is approximately 11 million, contributing to employment creation of more than 44 million people. Therefore, SMEs are important in driving China’s economic growth that the government cannot afford to overlook. Table V gives an overview of indicators to support entrepreneurship in SMEs according to the Global Entrepreneurship Monitor Report 2013, a global report which provides an annual survey of entrepreneurial activities worldwide. The first column lists the indicators that influence entrepreneurial activities in various dimensions. The highlighted box shows the performance of China compared to the average performance of Asia Pacific and South Asian countries which include China. It can be seen that the performance of China in supporting entrepreneurship in SMEs is likely the same as the
- 84. average performance in NorthAmerica and the Asia Pacific and South Asia (except that China is relatively weak in entrepreneurship education with the score of 1.6 but performs better than other countries in terms of physical infrastructure with the score of 4.0). These scores reflect the government attempts to support entrepreneurial development in China. They also reflect the importance of entrepreneurship in building China’s innovative economy. Realizing the importance of SMEs in economic development as they constitute more than 90 percent of all firms in China, the Chinese government has placed importance on SME development to drive the national economy. Figure 3 depicts major institutions and players providing support to SMEs as well as high-growth innovative SMEs in China. Indicators Year Important figures Population (million) 2014 1,393 Gross domestic product (GDP) (USD billion) 2014 1,253 GDP growth (%) 2014 7.4 IMD world competitiveness ranking 2014 23 WEF competitiveness ranking 2014 28 Knowledge Economy Index (KEI) Ranking 2012 84 KEI Index 2012 4.37 % of R&D expenditure to GDP (approximate) 2014 1.95 No. of patent applications Residents 2012 535,313 Non-residents 2012 117,464 Amount of venture capital (VC) investments (USD billion) 2013
- 85. 3.5 Sources: The author’sdesign, based on the World Competitiveness Scoreboard (various years) by International Institute for Management Development (IMD), World Economic Forum (WEF) Global Competitiveness Report, World Bank, United Nations Conference on Trade and Development (UNCTAD), OECD Main Science and Technology Indicators and Dow Jones Venture Source 2013 Table IV. Overview of economic and innovation performance of China 301 SMEs innovation and entrepreneurial financing The government plays an important role in developing policies and strategies to support the transition to an innovation-driven economy. For example, the Decision on Developing High-Tech and Realizing Industrialization (CCCP) sets forth the tenth plan (2001-2005) to promote innovation commercialization. The Guideline for
- 86. Developing National University ScienceParks provides a plan to promote the development of university science parks. The government policy in encouraging R&D can be seen a result of adopting Deng Xiaoping’s open door policy to encourage foreign investments and attract new technologies. The major policy of the Ministry of Science and Technology includes the guidelines on national medium-and long-term program for science and technology development during the period of 2006-2020. China’s Ministry of Science and Technology plays a significant role in the design and implementation of national innovation policies. The special economic zones and science parks were established to foster new technology development. In particular, the Torch program was developed to support the creation of industrial clusters. The national Science and Technology Industrial Parks (STIPs) were established to support high-technology enterprises. Up to now, there are 54 national STIPs established by the Torch program to promote the development of innovation clusters and advance upgrades in high technologies. Currently, the government policy has placed a greater emphasis on strengthening clusters of special economics and high-technology zones as the government realizes their important role in offering infrastructure for implementing the innovation strategies. The government has also reduced the
- 87. corporate income tax rateand value-added tax to promote high-technology enterprises. Recently, the Rating scores based on a five-point Likert scale Indicators of entrepreneurship North America (Average) Europe (EU) (Average) Asia Pacific and South Asia including China (Average) China Entrepreneurial finance 2.4 2.6 3.0 2.5 Government policy to support entrepreneurship 2.7 2.6 2.8 2.7 Government policy to support new SMEs 2.0 2.4 2.6 2.6 Government programs to support entrepreneurship 2.6 2.8 2.7 2.6 Entrepreneurship education at basic school 2.0 2.1 2.2 1.6 Entrepreneurship education at post-secondary levels 2.9 2.8 2.9 2.7 R&D transfer 2.3 2.5 2.6 2.5 Commercial and legal Infrastructure to support SMEs 3.1 3.2 3.1 2.6 Regulations related to market dynamics 3.1 3.1 3.6 3.9 Regulations related to market
- 88. openness 2.6 2.62.7 2.6 Physical infrastructure 3.8 4.0 3.8 4.0 Cultural and social norms that encourage business activities 3.2 2.6 3.2 3.0 Source: The author’s design, based on the Global Entrepreneurship Monitor (GEM) Report 2013 Table V. Entrepreneurship overview of China in various indicators 302 WJEMSD 11,4 C h in a S e cu ri tie s R e
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- 121. SMEs innovation and entrepreneurial financing Ministry ofScience and Technology has proposed State Council of 2009 to strengthen the science, technology and innovation system. Interestingly, innovation is one of the policy aspects (the Chinese dream) that President Xi Jinping emphasizes: patriotism (aiguo); innovation (chuangxin); inclusiveness (baorong) and; morality (houde). The financial policies under the political leadership of President Xi Jinping can be seen as a continuation of using an open door policy to improve financing mechanisms and provide financial funds to support SMEs. The Chinese government provides grants, loans and other incentives (such as tax incentives for R&D, low income tax rates for high- technology enterprises) to drive innovation and growth. The SME financing policies can be seen as a result of government intervention in the financial market to fill SME financing gap. 4.2 Challenge of the government policies in bank financing to support SMEs Financing constraints of SMEs are one of the major difficulties faced by entrepreneurs in China. The central government attempts to improve SME
- 122. access to financeby introducing the 12th Five-Year National Economic and Social Development Plan. In China, the Big Five banks providing a major source of credit for SMEs in China are Industrial and Commercial Bank of China, Agricultural Bank of China, China Construction Bank, Bank of China and Bank of Communications. Table VI shows the performance of the Big Five accounting for 47.3 percent of total market share. As a result of the 12th Five-Year National Economic and Social Development Plan, the Beijing Municipal Government supports Chinese financial institutions in setting up SME credit departments. The policies of Beijing municipal government put greater emphasis in upgrading small scale financial institutions into commercial banks so as to facilitate SME access to finance. Table VII shows the granted credits in China. As a 2008 2009 2010 2011 Credits granted to USD % USD % USD % USD % Small enterprises 0.71 21 0.93 22 1.20 24 1.74 24.7 Medium enterprises 1.12 32 1.40 33 1.66 33 1.79 25.3 Large enterprises 1.61 47 1.90 45 2.16 43 3.53 50 Total 3.44 100 4.23 100 5.02 100 7.06 100 Source: China Monetary Policy Report Table VII. Credits granted in China (units in USD billion)
- 123. Total assets Operating income Totalloans Growth rate per annum Bank 2010 2011 2010 2011 2010 2011 2010 2011 Industrial and Commercial Bank of China 2,195,534 2,524,775 62,124 76,770 1,107,750 1,270,619 22.68 23.32 Agricultural Bank of China 1,686,363 1,904,988 47,676 61,950 781,078 880,728 22.23 20.26 China Construction Bank 2,003,562 1,763,510 52,771 64,778 901,472 1,031,842 22.45 22.36 Bank of China 1,706,340 1,929,864 45,158 53,534 903,387 1,011,931 18.68 18.10 Bank of Communications 644,632 752,231 17,004 20,711 364,915 417,904 20.08 20.49 Source: China Securities Regulatory Commission Table VI. Performance of the Big Five (USD million) 304 WJEMSD 11,4
- 124. result of theimplementation of this credit policy, it can be seen that the total loan amounts granted to SMEs account for approximately USD3.53 billion (from total credits granted of USD7.06 billion in 2011). It is argued that the 12th Five-Year National Economic and Social Development Plan reflects the efforts of the Chinese government to help SMEs cross the valley of death (according to the study by Ehlers, 1998). Clearly, the SME financing policies play an important role in helping alleviate SMEs’ financial constraints (in line with the studies by Mani, 2004; Hyytinen and Toivanen, 2005; de la Torre et al., 2010). In China, the majority of the banking sector is owned by the central government. The credit granting system of each bank therefore has to follow the prescription policy from the central government. In credit granting, most of the banks prefer to grant loans to large enterprises since granting credits to SME is more risky. Understanding the problems of SMEs, the Chinese government, through the People’s Bank of China and the China Banking Regulatory Commission (CBRC), has encouraged banks to increase access to credits and supports to SMEs. The government would assess the performance of policy implementation or the effectiveness of banks’ credit granting system from the non-performing loans (NPLs) rate. It is interesting to note that the proportion of NPLs to GDP in 2010 is 2 percent compared to 25 percent in 2000. The reduction in loan losses is a
- 125. result of thegovernment’ s policy in taking steps to control NPLs, an attempt to build solid economic footing in China’s banking system (World Bank, 2012). Table VIII summarizes reflections from the interviews with regard to the government policy on SME financing and the extent of bank financing to support SMEs. Most banks state a consistent view that the introduction of the 12th Five- Year National Economic and Social Development Plan does have influence on the banks’ lending policy in terms of increasing SME loans as the banks are under control by the government (via the CBRC). They view that the 12th Five-Year National Economic and Social Development Plan is an overarching strategic plan defined by the government. However, in practice the policy implementation differs across the banks depending on the policies of each bank and the extent of credit risks that each bank can bear (risk exposure). At present, most SMEs depend on informal loans outside the banking system which bear relatively high interest rates (charging the high interest rates of 18-20 percent) and thus constrain the SMEs’ ability to grow. Therefore, the Chinese government attempts to terminate this informal lending system so as to help SMEs. Interviewees stated that the introduction of the 12th Five-Year National Economic and Social Development Plan has not only increased SME lending but also placed emphasis on capital market financing to build an innovative economy since
- 126. the 12th Five-Year Planencourages the opening up of the capital markets for technology-based firms to improve the capability of the economy to innovate. The interviewees expressed their views that the introduction of the 12th Five-Year Plan has changed banks’ credit direction from lending to heavy industries to new industries like information technology, renewable energy, biotechnology and other high- tech sectors. According to the interviews with banks in China, one of the banks stated that: “[…] the 12th Five-Year Plan can be seen as the government’s command that we have to follow by setting up SME special unit to provide SME financing. Although the policy is not mandatory, in practice we must comply with these directives. Otherwise, the future of our business relations with the government will be not easy […]”. Most of the interviewees stated that as the 12th Five-Year Plan denotes the policy signals that policy makers attempt to favor SMEs, the banks have to comply with the policy. Nonetheless, by complying with the 12th Five-Year Plan, the banks expressed concerns 305 SMEs innovation and entrepreneurial financing
- 127. Policies/strategies of SME financing Enabling policies/ strategiesDescription 1. Government policies/ strategies to support SMEs x The policies from the central government not only influence the small banks having a high proportion of SME clients but also the Big Five commercial banks. The Big Five need to comply with the government policy by increasing SME lending portfolio despite their reluctance to lend to SMEs The government provides incentives for banks to increase SME financing. If the banks follow the government policy guidelines on SME lending, they would receive positive consideration and support in terms of getting approval on opening more branches Despite the government policies to support SMEs, they still face difficulties in accessing finance. Most SMEs turn to informal lending outside the banking system (most SMEs still rely on black market lending) 2. Bank credit policies x Even though most banks view that the intellectual property (IP) assets such as patents, copyright, trademarks, trade secrets should play an increasing role as lending criteria for innovative businesses, this is not the case in practice. Almost all banks argue that the
- 128. lending decisions stilldepend on the collateral value and the borrower’s credit worthiness Foreign banks in China are constrained by the limit that they can give out credit loans. Consequently, foreign banks operating in China tend to focus on providing financial services to serve their own customers doing businesses in China (rather than serving the Chinese businesses) Due to the difficulties in valuing IP assets, they are not the preferred collateral (loan security) for banks. The valuation of these types of assets requires IP valuation experts to assess their actual economic value 3. Bank financing programs to support SMEs x Banks assist SMEs to save on bank charges by waiving fees or charges related to SME transactions. Banks also help SME businesses in terms of lowering upfront fees, commitment fees to reduce SME financing costs Banks see that the policy from the central government has greatly influenced their decisions in setting up the SME Special Unit to provide SME financing, for example, HuaXia Bank’s Dragon Boat Program to provide small business financing Banks are still conservative in providing loans or credits to SMEs to maintain lower loan to deposit ratios (75% loan to deposit ratio limit for all commercial banks according to China’s Commercial Bank Law), for example, China Citic Bank, one of the banks established during China’ reform said that the bank could allow SME loan losses by only 2-5% (continued)
- 129. Table VIII. Summary of interviewresults on the government policies of bank financing to support SME development in China 306 WJEMSD 11,4 about the high credit risks of SME financing which would result in high incidents of NPLs. Many banks have emphasized the importance of credit risk management in terms of laying the procedures to limit loan losses to 2-5 percent of the SME lending portfolio. The banks stated that, they try to limit loan losses not to exceed 2 percent of the SME portfolio in the actual practice. Otherwise, they would be under scrutiny over their policies on SME lending/bank lending standards. The banks also stated that the introduction of the 12th Five-Year Plan seems problematic since the government expects that there should be no loan losses from SME lending. Taking into account of VC financing, another important mechanism to support innovative SMEs, the VC industry in China is not well developed and limited in scale
- 130. due to regulatoryrestrictions of fund-raising. The China Venture Capital Association was established in 2002 to promote government policies conducive to the development of VC industry. The Government-financed Venture Capital Funds was established in 1993 in Guangdong, Jiangsu, Zhejiang and Shanghai together with the formation of University-backed Venture Capital Funds to provide university incubating services and encourage the process of technology commercialization. At present, the VC industry is dominated by international VC funds. The international VCs have helped build the high-tech industries of internet, networking as can be seen from the successful enterprises like Lenovo and Huawei Technologies. Figure 4 presents comparative VC investments in China and other countries during 2006-2012. It has shown that China’s VC industry is not fully developed. The major obstacle to VC development in China is a lack of policies to induce VC investments, a lack of credibility and transparency in China’s capital markets and legal system. Moreover, the industry also suffers from a lack of skilled professionals Policies/strategies of SME financing Enabling policies/ strategies Description
- 131. 4. Policy aspectsto support innovation x Although most banks implement the 12th Five-Year Plan to support SMEs by setting up specific units to increase the supply of SME financing, most of them do not operate VC investment units to support high-tech SMEs. At present, China’s VC industry is not fully developed and still needs incentive programs to foster the VC industry Concerning credit lending, if the borrowers are technology-based firms in Beijing’s Zhongguanchun Science Park, they would get financial support from the government in the form of fee refund. China has the formal business angel market but its business angel community is still small The government has launched the national strategy to promote Shanghai Free Trade Zone by providing tax incentives to encourage investments and trade. In promoting an innovative economy, the government also gives tax breaks as an incentive to importers and exporters in this zone Note: x, category of policies/strategies as enabling policies/strategies Source: The author’s design (summarized from interview results) Table VIII. 307 SMEs innovation and entrepreneurial financing
- 132. with experiences inVC management. The government has increasingly recognized such difficulties and tried to improve regulatory policies so as to support the growth of VC investments in China. For example, at present, China’s Ministry of Commerce has issued regulations allowing foreign-invested VC firms to invest in China. The Ministry of Finance has also eased the regulations regarding the capital requirements of international VC firms – lowering the capital requirement by USD10 million as well as easing stringent regulations of foreign VC structure. Nevertheless, the venture capitalists still have difficulties in exiting their investments in the VC market. Currently, the development of VC industry in China is still at the initial development stage. In transitioning to an innovative economy, the country needs the policy supports in terms of VC financing, private equity funds, capital markets for technology-based firms. Most of the VC investments are in the sectors of internet, clean technology, electronics and optoelectronic equipment, telecom and value-added services. The centers of VC industry are Beijing, Shanghai, Chengdu and Shenzhen. In the growing VC industry, Zero2IPO Capital is the major VC corporation among others (such as Accel Partners- Beijing, Redpoint Ventures-China, Sequoia Capital-Beijing, GSR Ventures-Beijing-China, Eastern Bell Venture Capital, Walden International-Shanghai-
- 133. China, Warburg Pincus- Beijing-China,VantagePoint Venture Partners-Beijing-China, Vivo Ventures-Chengdu- China) targeting investments in high-potential an high-growth companies. 5. Conclusions This paper explores the challenges of SMEs innovation and entrepreneurial financing in China. The empirical research is focused on the impacts of the 12th Five-Year National Economic and Social Development Plan, the main policy function after China joined the WTO, on SMEs development and entrepreneurial activities. The findings have shed light on the impacts of the 12th Five- Year Plan over the bank financing sector – its influence over the banks’ policy in terms of increasing SME lending. In adopting the 12th Five-Year Plan, the results of this study have shown that banks tend to focus only on SME financing (bank loans) but not VC financing. However, the extent of credit lending differs among banks depending on each bank’s credit policy. 0 5 10 15 20
- 134. 25 30 35 40 2006 2007 20082009 2010 2011 2012 USA Europe Israel China India Source: Dow Jones Venture Source 2013 Figure 4. VC investments in China compared to other countries (units in USD million) 308 WJEMSD 11,4 At present, the government has emphasized the aspect of innovation strategy according to President Xi Jinping statement on the Chinese dream (focusing on patriotism, innovation, inclusiveness, morality). However, the VC policies, the financing mechanism that can contribute to the build-up of national innovative capacity, are still
- 135. weak. The studyhas shown that the Chinese economy is driven by the government intervention policies. The analysis also points out the challenge of the Chinese government in improving regulatory policies to support innovative businesses. It is argued that building national innovative capacity is highly regarded as an important factor to strengthen China’s position in the global competitive landscape. Thus, the VC financing should play an increasing role in supporting high-tech and innovative SMEs in the future since China’s VC industry is not yet fully developed at present. For the long term policy perspective to increase and sustain national competitiveness, it is necessary that the government policies should encourage the private sector to provide more VC and business angel investments to support high-tech business start-ups and SMEs. Arguably, effective financing mechanisms would increasingly open up new investment opportunities to support the rise of China in the world economy. The findings in this paper suggest important implications for practice in that for the developing countries with scarce resources and budgetary constraints, it is the government (not the private sector) that should play a major role in encouraging the provision of SME financing. However, the government financing should not crowd out private investments. The present study offers interesting avenue for future research in exploring the effectiveness of the government’s policies to
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- 143. INTERNATIONAL JOURNAL OFBUSINESS, 14(4), 2009 346 International Comparison of Entrepreneurial Sub-Cultures within Cultures: Effect of Territory on Entrepreneurial Strategies for Fundraising Katariina Rantanen a and Michel Bernasconi b a Ph.D. Student, Swedish School of Economics and Business Administration, Helsinki, Finland [email protected] b Professor, CERAM Business School, Sophia Antipolis, France [email protected] ABSTRACT Two technological hotspots: Silicon Valley (USA), and Sophia Antipolis (France) have been assessed for differences in entrepreneurs’ fund raising strategies. The study analyzed different stages in the venture capitalist’s (VC) investment decision process from the entrepreneur’s perspective, not from the frequently examined VC’s viewpoint. The qualitative study of nine cases compares the two different cultural contexts, where
- 144. the parties negotiatethe investment agreements. The results underline, that the different subcultures require markedly different entrepreneurial strategies for successful VC fundraising. The investment decision process leads to a faster investment in US companies than in the French examples. Entrepreneurs in both regions advised strongly against signing exclusivity agreements. An unfavorable bargaining position was seen by entrepreneurs to arise from an urgency of receiving funding, where a prolonged investment decision process would make the venture apt to accepting worsened financing terms offered by the VC, and would increase the risk of VC opportunism. JEL Classification: M13 Keywords: Entrepreneurship; Investment decision process; Venture capitalism; Opportunism; Fundraising; Culture; Territory mailto:[email protected] mailto:[email protected] 310 Rantanen and Bernasconi I. INTRODUCTION Environment seems to play a key role in entrepreneurship, as certain cultures seem to foster entrepreneurship astonishingly efficiently, and some domains within entrepreneurially oriented countries seem to flourish
- 145. particularly well. Withoutdoubt, Silicon Valley has been benchmarked as the top area for successful entrepreneurial activities world-wide. The “Regional Advantage” of Silicon Valley, as Saxenian (1996) called it, is built on a flourishing pool of available venture capital (VC) funding, strong communities of practice, and a concentration of university talent and previous success stories. The creation of the French technology cluster of comparison, Sophia Antipolis, was directly inspired by Silicon Valley, and the two have been compared in a previous study by Bernasconi et al. (2006) on communities of practice in high-tech clusters. What unites the two clusters is a similarity of industry activity within computer technology, semi-conductors, software, biotechnology, and air- space industry, though Silicon Valley boasts a higher level of activity, and a higher specialization in the mentioned sectors, and Sophia Antipolis a lack of communities of practice. The largest noted performance gap lies in the contrasts on the availability of risk capital funds in the two regions, and the ability for critical company growth, both in the favor of Silicon Valley. Given these territorial differences, this paper investigates the pathways an entrepreneur in each of the two domains must undertake with the goal of a successful funding outcome with VC s. II. THEORETICAL REVIEW The vast body of previous research on the VC-E relationship has
- 146. been rooted inagency theory, with the focus on the investors’ position in the relationship, and examining the agent’s own interest maximizing behavior. Numerous studies, such as Barney et al. (1994) have been conducted on the venture capitalist (VC) entrepreneur (E) relationship from an agency theory perspective, where the investor represents the principal and the entrepreneur the agent. Also the entrepreneur (the agent) can be an object of the investor’s selfish behavior, and object to the principal’s opportunistic defect, as suggested by Shepherd and Zacharakis (2001) and Cable and Shane (1997). A key focus of this article has been to introduce the demand side viewpoint, and the idea of context-bound negotiations, which are impacted by region, its communities of practice, and cultural diversity. Tyebjee & Bruno (1984) have depicted the classic model of the VC investment decision process to include stages of deal origination, screening, evaluation, structuring and post-investment activities. Also this process has been examined from a VC perspective by previous research, and an inclusion of the demand side view has been supported by Stuart (2007). The investment transaction represents an interesting point in VC’s and E’s relationship, because up until that point the two parties compete with each other on the terms of the shareholders’ agreement. Therefore, gaining a deeper insight of the entrepreneur’s position in the process, her
- 147. bargaining strength, andthe environment’s impact on the inception and duration of the process ex ante, is very important. INTERNATIONAL JOURNAL OF BUSINESS, 14(4), 2009 311 III. METHODOLOGY The research question of this paper can be stated as: “what is the effect of territory, and culture within the territory, on the entrepreneurial strategy in fundraising?” The research investigates, issues affecting the entrepreneur’s bargaining position with a VC investor in the investment decision process. Given a preference for inductive, rather than hypothesis testing research, this paper follows a qualitative case study methodology, as advocated by grounded theorists Glaser and Strauss (1967). Nine case companies have been gathered and analyzed for richness of data, and two selected cases are presented in narrative detail. Data collection has mainly relied on face-to-face semi structured interviews between Fall 2006 in France and Spring 2007 in the United States, and additional data has been collected over e-mail. Eisenhardt (1989) advises within- case analysis as a key, initial step in data analysis, which has been adopted. Each case has been told as closely as possible to the descriptive language used by the informant, and re-building the story (the investment decision process) in
- 148. chronological sequence of events.Participant feedback, peer review, negative case sampling (an inclusion of an unsuccessful case example to increase theoretical validity and solve the confirmation bias), and pattern matching strategies have been used to promote validity of this research as suggested by Johnson (1997). A. Description of Territory: Silicon Valley, USA The following sections draw together the distinctive elements of the region, which extant literature has found to play a role in its capacity to fuel entrepreneurship. Despite overall growth in the technology sector throughout the United States, Silicon Valley’s pace is unchallenged, and according to Lee et al. (2000), its edge arises from an entire environment, tuned for innovation and entrepreneurship. Saxenian (1996) portrays Silicon Valley as an industrial system; one which is based on networks, a strong culture of experimentation and sharing of information, toleration of failure and encouragement of risk-taking. The network view portrayed by Saxenian (1996) and the important shift towards understanding culture’s effect in the territory’s competitive strength is complemented by the industry cluster perspective by Lee et al. (2000). Together these perspectives allow for a framework of the region’s complex characteristics. 1. Introduction and brief history
- 149. Geographically speaking, SiliconValley is the southern part of San Francisco Bay Area located in Northern California, the Unites States. According to Rogers and Larsen (1986), Silicon Valley has been home to a fast growing electronics industry, and the region has earned a famous reputation for innovation and entrepreneurship. The structure of the area has evolved in steady decenniums starting from the 1950’s when there was an increased demand for electronics products for warfare, which initially supported entrepreneurial firms such as Hewlett-Packard. In the 1960’s and the 1970’s it was the semiconductor industry, which grew explosively after the integrated circuit was invented in 1959. More than 30 semiconductor firms were founded in the 60s, starting with Shockley Semiconductor followed by Fairchild and its many offspring, including Intel. The following wave of innovation was personal computers, which 312 Rantanen and Bernasconi followed in the 1980s including firms such as Apple. After the slump in economic growth due to diminishing defense spending, the wave of the 1990s begun with the commercial development of the Internet in 1993, and the creation of the Internet. With a distinctive strength in technology, the Silicon Valley region became leader in the Internet revolution and produced firms such as Netscape and
- 150. Cisco Systems, seeLee et al. (2000). The dot.com boom, which then begun in roughly 1995 and lasted until 2001 saw a sudden rise in the Internet sector and produced a speculative bubble, which burst in 2001 and marked a relatively mild but lengthy early 2000s recession in the developed world. Contrasted with Route 128, and the US East coast area, Silicon Valley has emerged from industry slowdowns at a faster pace, due to its region’s distinctive elements, which were the focus of Saxenian’s (1996) thorough investigation on its regional advantage. 2. Tax and legal environment According to Lee et al. (2000), the U.S. government has had an enabling role in the rise of Silicon Valley by providing an extensive set of American laws and institutions regarding securities, employment, pensions, and bankruptcy, which have created an environment that enabled the Valley’s rise. These constructs provide incentives for risk taking not only for entrepreneurs, but also those who finance the risky ventures, namely venture capitalists and investors in the funds (enabling the existence of the venture capital industry). According to Lee et al. (2000:289 and 299), an important factor in augmenting the pool of venture capital funding available was due to a change in the interpretation of the Employee Retirement Income Security Act (ERISA) of 1974 in 1978, which allowed institutional investors to invest in high-
- 151. risk assets suchas venture capital. This change was combined with another incentive in favor of risky investments due to the change in the tax treatment of capital gains and of stock options, when the top capital gains tax rate was lowered from 49 percent to 28 percent in 1978 and then to 20 percent in 1981. Also, entrepreneurs benefit from bankruptcy laws, which do not burden failed entrepreneurs. Nor is there a requirement of a history of profits, for listing stocks of firms on public exchanges. In addition, options are taxed only when exercised, not when granted. Finally, the availability of skilled workforce via the Immigration Act of 1965, which is often called the Hart-Celler Act, according to Lee et al. (2000), increases high rates of job mobility, which spreads technology, promotes the recombination of skills and capital, and aids the region’s development. The labor laws of United States also make it easy to fire workforce, if necessary, while other countries make it difficult to fire workers, which creates a disincentive to hire them. 3. Social characteristics and social networks Lee et al. (2000) and Saxenian (1996) describe Silicon Valley as a prime example of a very dense network with many connections, one that makes information on the good and bad aspects of one’s reputation spread more easily, but also one with individuals having overlapping memberships. Saxenian (1996) presented an important argument
- 152. that it isthe network structure in Silicon Valley that differs significantly with that of the American East Coast Route 128, a distinction which translated into what she called in her book’s title a specific “regional advantage” for the Valley. Also, helping INTERNATIONAL JOURNAL OF BUSINESS, 14(4), 2009 313 competitors in this light is normal, when loyalty to one’s group (i.e., same professional identity) and disclosure of information is necessary for the collective, through exchange each individual draws benefit, and where collective learning takes place, see Saxenian (1996). It would be worthwhile labeling the region’s strength as something of systems intelligence. Also it follows a reputation structure rather than any formalized hierarchy or protocol. Saxenian (1996), also underlines that in order to have a flourishing economy that is driven by start-ups, it is necessary to encourage their formation by tolerating productive failure. 4. Communities of practice: A focus on venture capital Silicon Valley is marked with a dense concentration of specialized services, also called communities of practice. Bernasconi et al. (2006) defined 12 communities of practice, which are partly institutionalized in the organizations that are located within the cluster. This ranges from university institutions to VC firms, lawyer
- 153. firms and recruitment agenciesand consulting companies to name a selected few. The most famous of the mentioned communities of practice is the grouping of venture capital firms, which are especially important for entrepreneurial ventures as a source of not only financing, but help in shaping strategy and attracting talent to the venture, due to the VCs’ networks of contacts and expertise in the industry. The goal of VCs is to invest in start-ups that they believe have the potential to return five to ten times the invested capital in a period of five to seven years. According to Lee et al. (2000), surveys typically show Silicon Valley receiving 30 to 40 percent of all U.S. venture capital investment and the lion’s share of IPO proceeds. Contrary to popular belief, however, Silicon Valley’s venture capital industry emerged out of the region’s base of technology ventures and not vice versa. According to Saxenian, (1996), it was former successful entrepreneurs such as Fairchild’s founder Eugene Kleiner (who set up Kleiner & Perkins) who decided to reinvest their money and expertise in semiconductors into new ventures. Also the funds do not operate on a going concern principle, but have a lifespan of typically 10 years until maturity. After the fund is fully invested, the VC firm will raise another fund, and the reputation and past track record determines the success of the following funds. (Lee et al., 2000:287). VCs also gain significant additional experience and contacts in
- 154. the course ofpracticing their profession. The highest ranked Top 4 VCs in the Valley are considered as Accel Partners, Benchmark Capital, Kleiner Perkins Caufield & Byers, and Sequoia Capital. In this respect, the relationship between entrepreneurs and venture capitalists is symbiotic: they rely on each other for their survival and success. The experienced former entrepreneurs tend to act as VCs, and are able to provide “hands-on” help also in strategic issues to the ventures, if needed, in the form of non financial contributions as put forth by Gorman & Sahlman, (1989). While hands-on activity is important, so is geographic proximity due to this factor. Valley VCs rarely invest outside the valley, and the VCs’ emphasis on geographic proximity is thus one example of how a high level of interdependency creates agglomeration economies (Lee et al., 2000:292). The availability of the stock market affects the viability of venture capital, and Lee et al., (2000) describe, that it provides a source of funding, a tool for risk diversification, and a competitively determined valuation. It allows VCs to cash out their investment at a 314 Rantanen and Bernasconi certain stage of maturity and allows them to focus on investing in firms in early stages of development, see Lee et al. (2000:288).
- 155. 5. Full casestudy Silicon Valley, USA: Trulia Inc. Sami Inkinen, the second-time entrepreneur, co-founder and Chief Operating Officer of Trulia Inc, runs a venture, which is currently the fastest growing real estate website in the United States. It is headquartered in San Francisco, and the company has its sales office in New York, and software development in Delhi. Mr. Inkinen founded the company together with Pete Flint, both immigrants to the US and Stanford MBA graduates. In year 2000, when Mr. Inkinen realized the real estate industry had a very bad consumer experience, and after a year of research, and meetings with large real estate brokerage firms, the entrepreneurs decided to hire their first engineer employee. By 2005 the team consisted of two founders and two engineers, and at the end of September 2005, the company’s first on-line beta version was launched. The entrepreneurs closed their first financing round of 2.1 M $ just two days prior. The funding consisted of an angel round and institutional money in the form of a convertible note (a loan). The second round of funding, which is described in more detail, was raised before Christmas Eve 2005, which consisted of an 5,7M $ equity investment by Accel, a Silicon Valley top tier VC firm. To date, two rounds of VC funding has been raised, the latest of which was in the end of 2007. Once fundraising, the entrepreneurs had checked the VCs backgrounds and were looking at targeting the top VCs in the
- 156. valley: they wantedSecoya, Kleiner Perkins, Accel or Benchmark, because their partners have the best networks, and it is critical to find the best partner for the board seat. The entrepreneur perceived the first phase as getting to know the potential partner, Accel, a phase which started in March 2005, and which lasted seven months, when Mr. Pete Flint, the co-founder and COO of Trulia had been contacted by the VCs through existing contact networks. The two parties had already been discussing in summer 2005 at the time of the first non-VC round. At the end of September 2005 the venture was able to create competition, when Mike Morris from Secoya e- mailed them (invested in Yahoo!), and after this point more VC companies approached the entrepreneurs. At that point, since Benchmark had already decided to invest in a competitor, and Kleiner had already invested in a similar company, which had made an IPO, Accel was on the top of the list. The entrepreneurs told the partner at Accel, that they were interested in the situation, and that they wanted to minimize the courting period. Secoya, which had gotten introductions from business angels, said no in October 2005, once the decision got to the partnership meeting, which finally left the entrepreneurs with the option of choosing Accel as their VC partner. It took 10 days from the initial financing contact to complete the process. The investors were told that the terms were needed in five days. The entrepreneurs looked at the term sheet and it looked good, and replied that they
- 157. would take theVCs deal at the proposed time line. After signing the term sheet a legal due diligence was performed right before the signing the final contract documents. Subsequently, in five more days the money was in the bank. The very short period of time for the process was mainly thanks to the existing relationship, and the entrepreneurs managing to create competition between the VCs. Regarding documentation, there was no formal written business plan, which was sent to investors, and instead, a two page executive summary and a power point was used. The INTERNATIONAL JOURNAL OF BUSINESS, 14(4), 2009 315 relationship was marked by mutual trust: and the entrepreneur perceived that the Stanford MBA degree carried a lot of value. In terms of external advisors in negotiations, the entrepreneurs used a law firm, which was awarded with a one percent ownership. In addition, also the existing angel investors performed as advisors. The venture had already succeeded in an initial proof of concept, and had received customer feedback, with 1.5 million in the bank, so financially they were in a good negotiating situation. The majority of the ownership of the venture is still held by management and employees, the outside investors own close to half. He sums up that the process went so well that they could have raised funding later with a higher
- 158. valuation, “We didthe real work even better than we expected.” B. Description of Territory: Sophia Antipolis, France 1. Introduction and brief history Sophia Antipolis was developed as a project of a new science park, a techno pole, from the vision of a politician called Pierre Laffitte starting from 1968. He had observed the early Silicon Valley development, and envisioned the possibility to create a new Silicon Valley in the French Riviera region, between Nice and Cannes. The evolution pattern of Sophia Antipolis varies from that of Silicon Valley, but has distinct development phases, which can be observed. In its first period (1974-1990), the development of Sophia Antipolis, which was then essentially an empty space, was exogenous through successfully attracting French public research laboratories as well as subsidiaries of international companies. The accumulation of research and development activities made endogenous development possible, and was significant in two main areas. The first and most important relates to computers, electronics and telecommunications, which have been at the origin of the region’s development. The second area encompasses activities in life sciences and health. A continuous stream of SMEs has been set up, most of them, arising from a close relationship with companies or labs, acting as subcontractors in either services or research activities.
- 159. At the sametime this trend of new business creation has been impeded by a reverse spin-off effect, due to the substantial human resources and technological skills demands of big companies. In the second period (1991-1994) the unique model of building up the region through attracting companies no longer worked. A slowdown in the economy and in the computer industries forced big companies to restructure, to reduce people, and even to leave, during which a new spin-off wave was observed, which arose from engineers who had been made redundant from big companies. According to Longhi, (1999), the non- academic spin-offs did not represent a positive process but were the result of a process of restructuring and outsourcing of activities, and many were established to carry out subcontracting for their parents. In the third period (1995-2000) the development of the techno pole was driven by a double dynamic process: the investment in development by local companies and the attraction of companies in software and telecommunications activities, as well as a strong flow of new business creation driven by the new economy phenomenon. In that period, and particularly since 1997, the number of new ventures increased significantly (Observatoire Dynamis, Bernasconi and Moreau, 2003). More than 90% of the new company creations were in information technologies, and less than 5% in the life and health sciences. In that
- 160. 316 Rantanen andBernasconi period, in order to attract more VCs to Sophia Antipolis, a yearly event, the International Venture Capital Summit (IVCS) was active between 1997 and 2005. It was very helpful to present the local entrepreneurs to international investors. In the last ten years, 50 companies have raised more than 370 million Euros in venture capital money from French or foreign investors. In that period new incubation initiatives were undertaken by research labs and universities (Eurecom and Incubateur Paca Est) to facilitate the creation and the development of academic spin- offs. The fourth period (2001-2007) began with the aftermath of the interned bubble, when subsidiaries of major telecommunications companies were closed, reduced, or relocated like Nortel, and Cisco. The disappearance of potential markets and the crunch of investors pushed many new ventures to failures. 2. Tax and legal environment France is not necessarily well known for its favorable environment for entrepreneurs and investors. But in the recent years, the situation improved significantly for entrepreneurs, the new ventures and for investors. For entrepreneurs, a recent law allows the entrepreneur to exclude one’s home from the creditors. The previous
- 161. situation was excessivelyrisky in case of failure. Significant evolutions are available for entrepreneurs in order to obtain favorable legal and tax conditions for their new ventures. Since 2004, a new innovative company can access the status of “Jeune Enterprise Innovante” and therefore it obtains a total or partial tax rebate for the next 5 years, in addition to a social cost reduction. The new regulations improve significantly the competitiveness of new ventures. However, legal constraints prevent investors to be actively involved in their investment, and provides the French entrepreneurs with far less strategic steering than in the Silicon Valley contexts. Its explanation lies more in the regulations than in the culture. In fact, in case of failure, if the company has more liabilities than assets, the investors could be pursued to pay for the difference, if they have taken part in management decision of the company. 3. Communities of practice: A focus on venture capital A comparison by Bernasconi et al. (2006) between Sophia Antipolis and Silicon Valley, shows that one of the growth hinders in Sophia Antipolis is related to the lack of certain communities of practice (in particular venture capitalists, company lawyers and merchant banks). According to Bernasconi et al. (2006), due to the systemic interdependence of the efficiency of communities of practice, an absence of certain communities of practice, hinders the efficiency of those, which are present (research
- 162. laboratories, universities etc.)and, more globally, handicaps the endogenous growth of the cluster. Sophia Antipolis has only one early stage VC, which means entrepreneurs have to look for venture capital elsewhere. To the contrary with the US venture capital industry, which has been set up by entrepreneurs, the French VC industry originated from the bank industry. Traditionally the VC industry in France is geographically concentrated in Paris, which largely omits this community of practice from Sophia Antipolis. The VC industry in France, however, is the second largest in Europe, after the UK. In 2006, more than 10 billions have been invested by French venture capitalists, which put France in the third place worldwide after the USA and United INTERNATIONAL JOURNAL OF BUSINESS, 14(4), 2009 317 Kingdom. If money is available for investment, the amount dedicated for early stages is insufficient. The amount invested in 2006 in seed and creation is 536 million Euros with an 11% increase compared with 2005. Regarding the pool of funding, Sophia Antipolis has very little money locally available for the young ventures. Today, there are only two VC offices located in Sophia Antipolis: a French (Sophia Eurolab), and a Dutch (IFEX). The funding of the early stage phases is long and difficult to obtain like elsewhere in France.
- 163. 4. Full casestudy example: Open plug Eric Baissus, co- founder and chief executive officer of Open Plug, has successfully raised two rounds of VC funding. The firm creates and commercializes open software framework for mass-market phones. The first round was completed in July 2003, raising 1.6 million Euros and the second round raising 15 million dollars in September 2006. The venture is based in Sophia Antipolis, with testing and development performed in Romania, and sales and support are in Taiwan. The entrepreneur’s personal funds and consulting revenues financed them before the VCs were involved. In addition, they had a few rounds of grants from Anvar. For the seed capital round the entrepreneurs worked with a CERAM business school department, which helped identify potential VCs in 2003. The entrepreneurs were contacting both French VCs and international VCs (with presence in France), but only the French VCs participated, four in all. Initially, the venture sent the executive summary as a teaser to awaken interest for the VCs. Then they met with the VC and provided the information memorandum, financial model forecasting revenue, after which the whole business plan was given. For the first round, an expert from CERAM functioned as an external advisor in negotiations. Eric adds, “In the negotiations there are lots of conflicts and you need to have your own advisor.” Even though the
- 164. entrepreneurs were onlytwo people with just an idea and a patent, what strengthened their bargaining position was their consulting revenue, and regardless of the VCs investment, they could still continue with the business. Eric adds, “If you really want to negotiate, you have to be in a good position. If you are desperately looking for money it is bad.” In July 2003 the team used one of the top French lawyers as their advisor, because for the first round, they had several VCs in one contract, which was a complex difficult situation. For the second round of funding, the venture was seeking expansion funding in terms of life stage of the venture. The venture used a fund raising advisor for the second round as an external advisor in negotiations, which checked VCs track records, and whether they had already invested in the same kind of products, and also ranking different reputations. The entrepreneurs had the choice of VCs in Europe or US, but the ones not having offices in Europe (US based firms) were difficult with laws. The final solution was a syndicate of Baytech (German VC, no premises in France), and also a new French VC. There were six investors all together, two in addition to the four previous investors. The round was closed in September 2006, and the ownership division is a majority holding by the VCs (2/3), and a minority ownership owned by founders and employees. Open Plug had several term sheets on the table, then a period of exclusivity for due diligence and the final contract. This period took six weeks. In the second
- 165. round, however, they couldhave gone back to the other VC candidates if needed. The only difference between the first and subsequent rounds was the position of negotiation strength. In the 318 Rantanen and Bernasconi second round, the entrepreneur already had the former VCs in his camp helping on advice and actively helped in the fundraising. IV. RESULTS AND CONCLUSIONS The results underline regional differences in entrepreneurial strategies for successful VC fundraising. The American (Silicon Valley) style investment decision process can be described as a fast, flexible and informal network based process, where word of mouth, reputation and informal networks play an important role for receiving information about potential investment candidates. There is no mandatory need for a formal business plan, but proof of concept (market feedback) and an exciting revolutionary idea were deemed a “must-have”. A strategy adopted by the successful American entrepreneurs was to create fierce competition among the VCs, and select the best match based on interpersonal compatibility, proposed terms and deal, as well as perceived marketing (PR) value based on the VC firm’s reputation. Obtaining the most
- 166. appropriate VC partnerwas highly valued, as it plays a key role in recruiting top quality managers, and opening networks. The French entrepreneurs, in contrast, focused heavily on obtaining the desired capital amount. Regarding deal sourcing, the US investors seem to rely on a very proactive approach by favorable referencing (investment tips from existing portfolio companies, friends and contacts), rather than a more passive review of incoming flow of investment proposals. Clearly, the network structure put forth by Saxenian (1996) aids investors with information flow from several communities of practice (lawyers, investment banks etc.). The American entrepreneurs relied almost solely on Silicon Valley VC firms within close proximity of the venture’s location, due to a local abundance of funding, and signaling (if a need to search further than the valley, the venture may not be top quality). To the contrary, the French style is more reliant on entrepreneur contacts towards the prospect VCs, sending out business plans and making presentations to the VCs. This approach gradually leads to advancement in the VC investment decision process. The successful French entrepreneurs approached a wide pool of VC candidates, and the investment deal often consisted of a syndicate of international (but European) VC investors. In the entrepreneurs’ favor, Silicon Valley’s communities of practice, i.e. experienced investment lawyers, may work for entrepreneurs on an equity basis, which helps the
- 167. entrepreneur’s bargaining processeconomically. An absence of communities of practice, in contrast, disfavors the Sophia Antipolis entrepreneurs, as there are very few support pillars in the fund raising process. The French investment decision process, was clearly much slower, and was more reliant on planning (business plan) than market feedback. Entrepreneurs in both regions advised strongly against a weak bargaining position by means of urgency of funding. In such cases, a prolonged investment decision process could make the venture apt to accepting unfavorable financing terms offered by the VC. The slow investment decision process in the Sophia Antipolis cases, poses risks for the cash dry entrepreneurial venture. French VCs are also characterized by a lower risk taking and failure tolerance than their American counterparts. The funding rounds are smaller than in Silicon Valley, and there is a clear need for subsequent follow-up rounds of funding. Also the legal hinders impede VCs from actively taking part on managerial aspects of the venture. The strategic path for both Silicon Valley and Sophia Antipolis entrepreneurs is mainly to avoid the risks imposed INTERNATIONAL JOURNAL OF BUSINESS, 14(4), 2009 319 by exclusivity agreements and urgency of funding, and the Sophia Antipolis entrepreneurs’ additional risk lies in a very slow investment
- 168. decision process. Themain differences of the two cultures’ effects on entrepreneurs’ fundraising have been summarized in Figure 1. A. Suggestions for Further Research Classically the non financial contributions of VCs, as described by Gorman and Sahlman (1989) have included an installment of considerable business knowledge necessary in turning the venture to a successful enterprise. Because the French legislation largely impedes this option, we propose an explorative study into its entrepreneurial implications. Figure 1 Model of cultural effect on entrepreneurial negotiation success France USA Sophia Antipolis Silicon Valley Business Plan Formal plan required Business plan not required Availability of VC funding No local VC funds Abundant local VC funds Investment Decision Process Slow Fast Communities of Practice Limited Abundant Risk tolerance of VCs Moderate High VC proactivity Low High
- 169. Entrepreneur proactivity HighHigh Networks Limited Abundant Size of Investments Moderate Large VC background Investment background Entrepreneur background 320 Rantanen and Bernasconi R E F E R E N C E S Barney J., L. Busenitz, J. Fiet, and D. Mosel, 1994, “The Relationship between Venture Capitalists and Managers in New Firms: Determinants and Contractual Covenants”, Managerial Finance, 20, 19-30. Bernasconi, M., L. Dibiaggio, and M. Ferrary, 2006, “High- Tech Clusters: Network Richness in Sophia Antipilis and Silicon Valley”, in Bernasconi, M., S. Harris, and M. Moensted (ed.), High Tech Entrepreneurship, Managing Innovation, Variety and Uncertainty, London and New York, Routledge. Bernasconi, M., and F. Moreau, 2003, Observatoire Dynamis, www.ceramexpert.net. Cable, D.M., and S. Shane, 1997, “A Prisioner’s Dilemma Approach to Entrepreneur- Venture Capitalist Relationships”, Academy of Management
- 170. Review, 22 (1),142- 177. Eisenhardt, K., 1989, “Agency Theory: An Assessment and Review”, Academy of Management Review, 14, 57-74. European Venture Capital Association, France. Visited December 2007. EVCA. www.evca.fr Gorman, M., and W. Sahlman, 1989, “What Do Venture Capitalists Do?” Journal of Business Venturing, 4, 231-248. Glaser, B.G., and A.L. Strauss, 1967, The Discovery of Grounded Theory: Strategies for Qualitative Research. New York: Aldine Publishing Company. Johnson, R.B., 1997, “Examining the Validity Structure of Qualitative Research”, Education.118 (2), 282-292. Lee, C-M., W.F. Miller, M.G. Hancock, and H.S. Rowen, 2000, The Silicon Valley Edge: A Habitat for Innovation and Entrepreneurship. Stanford, California. Stanford University Press. Longhi, C., 1999, “Networks, Collective Learning and Technology Development in Innovative High-Tech Regions: The Case of Sophia Antipolis”, Regional Studies. 33 (4) 333-342.
- 171. Rogers, E.M., andJ.K. Larsen, 1986, Silicon Valley Fever: Growth of High-Technology Culture. New York: Basic Books, Inc., Publishers. Sahlman, W., 1990, “The Structure and Governance of Venture- Capital Organizations”. Journal of Financial Economics, 27, 473-521. Saxenian, A., 1996. Regional Advantage: Culture and Competition in Silicon Valley and Route 128. 2d ed. Cambridge, Mass.: Harvard University Press. Shepherd, D., and A. Zacharakis, 2001, “The Venture Capitalist-Entrepreneur Relationship: Control, Trust and Confidence in Co-Operative Behavior”, Venture Capital, 3, 129-149. Stuart, P.G.W., and J. Wyper, 2007, “Towards a Model of Business Angel Investment Process’ Venture Capital, 9 (2), 107-125. Tyebjee, T., and A. Bruno, 1984, “A Model of Venture Capitalist Investment Activity”, Management Science, 30, 1051-1066. http://www.ceramexpert.net/ www.evca.fr Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
- 172. Cases of start-upfinancing An analysis of new venture capitalisation structures and patterns Andrew Atherton Enterprise Research and Development Unit, University of Lincoln, Lincoln, UK Abstract Purpose – This paper seeks to understand the dynamics of new venture financing across 20 business start-ups. Design/methodology/approach – A total of 20 cases were explored, via initial discussions with the founder(s), and follow-up contact to confirm sources of financing acquired during new venture creation. This approach was adopted because of the challenges associated with acquiring full details of start-up financing, and in particular informal forms of new venture financing. Findings – Significant variation in, and scale of, new venture financing was identified. In multiple cases, funding patterns did not tally with established explanations of small business financing. Research limitations/implications – The primary limitation of the analysis is the focus on a small number of individual cases. Although this allowed for more detailed analysis, it does not make the findings applicable across the small business population as a whole. New ventures acquired very different forms of finance, and in different configurations or
- 173. “bundles”, so creatinga wide range of start-up financing patterns and overall levels of capitalisation. This suggests that multiple factors influence founder decisions on start-up funding acquisition. It also indicates the wide divergence between highly capitalised and under-capitalised start-ups. Practical implications – Many of the new ventures were started with low levels of capitalisation, which as the literature suggests is a strong determinant of reduced prospects for survival. This suggests a possible “financing deficit”, rather than gap, for a proportion of business start-ups. Originality/value – The paper provides an alternative methodology for considering new venture financing, and as a result concludes that standard, rational theories of small business financing may not always hold for new ventures. Keywords New venture, Business start-up, Business formation, Financing, Entrepreneurship Paper type Research paper Introduction From a policy maker’s perspective, a lack of funding discourages people from starting businesses (Bank of England, 2003, 2004; EC, 2003; OECD, 1998). There is empirical support for the policy assertion that small businesses can face difficulties in acquiring finance that constrain their prospects for venture creation, survival and growth (Binks and Ennew, 1996; Harding and Cowling, 2006; Holmes and Kent, 1991; Hughes and
- 174. Storey, 1994; Landstromand Winborg, 1995; Lopez-Gracia and Aybar-Arias, 2000; Reid, 2003), although there are studies that question the existence of funding gaps (Uusitalo, 2001). Theoretically-based arguments for and against funding gaps mostly conclude that small firms face finance constraints (Ang, 1992a, b; Binks et al., 1992) or are discouraged (Kon and Storey, 2003), although some propose that such issues are trivial or non-existent (Cressy, 1996; Parker, 2002). Access to external equity, in particular, has long been identified as a development constraint for many small firms (Binks and Ennew, 1996; Bolton Report, 1971; Harrison et al., 2004; Mason and Harrison, 1996). The current issue and full text archive of this journal is available at www.emeraldinsight.com/1355-2554.htm IJEBR 18,1 28 Received 21 November 2010 Accepted 22 November 2010 International Journal of Entrepreneurial Behaviour & Research Vol. 18 No. 1, 2012 pp. 28-47 q Emerald Group Publishing Limited
- 175. 1355-2554 DOI 10.1108/13552551211201367 Financing constraintsare likely to be particularly acute for start-ups, given their lack of trading history and the risks associated with funding a new venture (Verheul and Thurik, 2001). Bhide (1992) argued that funding is a central concern for new ventures, even though most do not pursue “big money” models of start-up financing. Insufficient financing of new firms leads to a greater likelihood of failure (Basu and Parker, 2001; Cassar, 2004; Chaganti et al., 1995; van Auken and Neeley, 1996). Conversely, sufficient capitalisation at the outset improves future prospects for growth (Alsos et al., 2006; Chandler and Hanks, 1998). Initial capitalisation structures therefore offer insight into the entrepreneurial process of business formation and future prospects for both survival and growth (Smallbone et al., 2003; Storey, 1994). The aim of this paper is to examine the relevance and applicability of established explanations of capitalisation structures of small businesses to business start-ups. Whereas the majority of studies of capitalisation structures have used large-scale surveys or publicly-available financial information, this paper uses in-depth analysis of a small sample of new ventures. The reasons for this are two- fold. Firstly, direct and
- 176. ongoing engagement withthe founders of these businesses is more likely to lead to full divulgence of all financing sources than less engaged methods of data acquisition. And, secondly, case approaches are a useful means of exploring theoretical propositions (Yin, 1989). An initial review of pecking order and debt-equity trade-off considerations of small firm funding suggests that these approaches may not provide a comprehensive or sufficient explanation of start-up financing (Atherton, 2009). The findings in this paper indicate that new ventures do not always or necessarily follow these established explanations of financing structures and patterns. Research questions Accounts of the financial structures of firms have been particularly influenced by two alternative explanations of capitalisation patterns; namely debt- equity trade-offs (Modigliani and Miller, 1958) and pecking order theorisations (Myers, 1984; Myers and Majluf, 1984). When applied to small firms, the former proposes a trade-off between the tax advantages of debt financing over equity and increased risk of possible bankruptcy arising from financial stress if debt levels become too high (Verheul and Thurik, 2001). Pecking order theorisations, on the other hand, posit a preference for internally-generated retained earnings over externally acquired finance, and for debt over equity when external finance is sought out. Both approaches have since been used to examine and seek
- 177. to understand thefinancing structures of small firms, and in particular whether such explanations hold for smaller enterprises, with varying results (e.g. Berggren et al., 2000; Chaganti et al., 1995; Hamilton and Fox, 1998; Holmes and Kent, 1991; Jordan et al., 1998). However, the results have been variable; with some studies supporting these explanations of funding patterns (e.g. Norton, 1991, when examining high growth firms), whereas others have found either no corroborating evidence (e.g. Chittenden et al., 1996), or limited support; generally because funding for new ventures is “constrained” due to a lack of access to one or more forms of financing (Howorth, 2001). A key feature of pecking order explanations of firm financing that is lacking in debt-equity trade-off considerations is the existence of information asymmetries due to varying levels of information about the venture held by the founder and by prospective funders. Supporting this, some studies have established evidence of pecking order patterns, but not of static debt-equity trade-off explanations of choice of financing by Cases of start-up financing 29 small businesses (Watson and Wilson, 2002). Information
- 178. asymmetries-based explanations of firmfinancing seem to be highly relevant to new ventures, because they are more likely to be “opaque” due to a lack of trading history and the practical barriers to undertaking due diligence on new and unproven ventures (Cassar, 2004; Verheul and Thurik, 2001). Information asymmetries are likely to increase the cost for new ventures of raising external finance, as lenders seek higher interest rates and greater equity shares to compensate for the additional risk of funding an unproven new venture. Despite the apparent relevance of information asymmetries to the new venture, and the extensive literature on small business financing that adopts this perspective, it has been noted that there is a relatively small literature focusing on the effects of such asymmetries on new ventures (Paul et al., 2007). There is also a growing body of work that that has identified additional factors that affect small business capitalisation structures, such as: national differences in institutional frameworks (Hall et al., 2004); sensitivity to cost of debt, and to an extent equity (Reid, 1996, 2003); personal preferences of the entrepreneur (Gibson, 1992; Kuratko et al., 1997; Petty and Bygrave, 1993); and the particular characteristics of the new venture (Cassar, 2004). Some of these additional explanatory factors have a cognitive dimension, such as personal propensity to take on different levels of risk and the experientially-framed preferences of owner-managers, so
- 179. suggesting subjectivised influences onpatterns of new venture financing. Others, such as different institutional frameworks from country-to-country, are contextual. This has led to an emerging view that the determinants of new venture financing patterns will be affected by a wide variety of factors, only some of which are related to financial markets and rational economic decision-making consideration (Atherton, 2009): RQ1. To what extent do either debt-equity trade-offs or pecking order approaches explain patterns and structures of start-up financing? There are indications that new firms are more likely to rely on debt, and in particular short-term debt, than equity financing during start-up and in their early years of operation (Hughes, 1997; Titman and Wessels, 1988; Dwyer and Lynn, 1989). Reluctance to lose control over their own business is seen as a reason why many founders of firms do not seek out external equity finance (Howorth, 2001). Capital markets and other forms of larger-scale equity investment typically are not available to new firms (Ang, 1992b; van Auken and Neeley, 1996; Coleman and Cohn, 1999). New firms are likely as a result to be pushed towards debt capital when founding a new venture, generating a “large debt service” requirement (van Auken and Neeley, 1996) and increasing the likelihood of liquidity problems during the early trading period following on from start-up (van Auken and Carter, 1989):
- 180. RQ2. Is thereevidence of greater use of debt than equity amongst new firms? Start-ups and new ventures, unlike established small businesses, have no substantive trading history and so are unlikely to have generated sufficient levels of retained profit to fund development internally (Sjogren and Zackrisson, 2005). Even when trading for an initial period, new ventures will have to cover establishment costs through revenue generation and so are unlikely to generate retained earnings that can be re-invested in the new venture: RQ3. Is internal finance generated from retained earnings a source of funding for new ventures? IJEBR 18,1 30 Constraints to internal as well as external finance suggest that the funding options for new ventures are limited. Founders of new ventures are likely, as a result, to seek out alternative financing mechanisms, in the form of bootstrap or “supplementary” financing (van Auken, 2005; Hughes, 1997). Bootstrap finance, i.e. funding other than that acquired from personal savings or external debt and equity,
- 181. has been foundto be an important source of start-up finance in many successive studies (Bhide, 1992; Carter and van Auken, 2005; Ebben, 2007; Ebben and Johnson, 2006; Lam, 2010; van Auken, 2005; van Auken and Neeley, 1996). This paper follows on from Carter and van Auken (2005, p. 135) in defining bootstrap financing as funding other than personal funds from non-formal sources, including: personal loans applied to the venture; credit card debt; delaying payments; minimising accounts receivable; sharing resources. It allows the new ventures to secure “resources at little or no cost” (Harrison et al., 2004), and so may be preferred during start-up when access to funding is likely to be constrained: RQ4. To what extent do start-ups acquire and deploy “supplementary” bootstrap funding as an alternative to formal debt and equity or internally generated funds? The predominant form of financing for many, if not most, new ventures is the founder or founding team (Berger and Udell, 1998; Carter and van Auken, 2005; Cassar, 2004). Personal investment “signals” to investors and lenders that the founder or founding team are committed to and confident about the future development of the venture, and so provides a basis for justifying external financing of a new venture (Myers and Majluf, 1984; Prasad et al., 2000). Insider finance is likely, as a result, to account for a
- 182. significant proportion ofstart-up funding and can help the founder(s) to acquire financing from sources outside the new venture: RQ5. Are personal funds a significant proportion of start-up capitalisation, and are they associated with external funding by other actors? Methodology A case-based approach to data collection and analysis is suitable for examining a particular issue or phenomenon (Chetty, 1996). Detailed analysis of specific cases via direct interaction with new venture founders will be particularly important for understanding the “opaque” capitalisation structures of new ventures (Cassar, 2004), as well as the evolving and often improvised structures of business start-up funding (Atherton, 2009). The data presented are financial in nature, given the specific research propositions and questions that are the focus of this paper. Although not consonant with current approaches in the small business literature, which tend to view case-based data analysis as qualitative (Chetty, 1996; Perren and Ram, 2004; Romano, 1989), Eisenhardt (1989) noted that case approaches relate to the ways in which the data are extracted, rather than to a particular types of data: [. . .] evidence may be qualitative (e.g. words), quantitative (e.g. numbers), or both (Eisenhardt, 1989, pp. 534-535). Many case-based approaches in the small business and
- 183. entrepreneurship literature have concernedthemselves with one or a small number of ventures (e.g. Atherton and Hannon, 2000; Rod, 2006; Vinnell and Hamilton, 1999). A larger sample of cases was used for this study in order to provide for sufficient variation in the scale, sector and Cases of start-up financing 31 nature of the start-up and the possible diversity of types of start-up financing postulated in this paper’s review of the literature. A wide range of industries and types of new venture were included in the study, as can be seen in Table I. This provided a stronger base on which to draw conclusions from the analysis, as the sample although not statistically relevant, was sufficiently broad to encompass different industries and experiences of new venture creation. This follows a previous analysis of small firm demand for finance, which used 13 case studies (Howorth, 2001), and is based on the tenet that a greater number of cases allow for improved pattern recognition during data analysis (Eisenhardt, 1989; Yin, 1989). A total of 20 new businesses that had been operating for less than two years at the time of interview were identified through recommendations from publicly-funded agencies based in the
- 184. North of Englandthat offered counselling, advisory and training services to new business start-ups (Table I). These businesses varied in terms of sector and also size. Amongst the sample were: sole traders (ventures 8, 13, 15, and 16); micro-enterprises (ventures 6 and 18), some of which were family-owned and run (ventures 3 and 20); new ventures that grew rapidly to become established small businesses with between 20 and 30 employees (ventures 7, 8 and 14); and one large-scale start-up that rapidly grew to over 50 employees, and continued to grow beyond the initial start-up period (venture 2). Referrals from professional advisers were seen as likely to identify new venture founders who will be more disposed to seek out assistance and resources when establishing a new business, and so would be likely to acquire multiple forms of finance from different formal and informal sources. It is recognised, however, that this sample is more likely to have taken up publicly-funded sources, such as the small firms loan guarantee scheme (now enterprise guarantee fund), and responses as a result will show a tendency towards such subsidised forms of public support for business start-up. Initial contact and interviews predated the current economic downturn, and consequent constraints on Venture Nature of business Key characteristics 1 Car dealership Franchise 2 Branded snack foods Team start limited company
- 185. 3 Pharmacy Co-ownedby husband and wife 4 Engineering 3rd business started by founder 5 Water management 3rd business started by owner-manager 6 Scaffolding Two directors, limited company 7 Industrial flooring Owner-manager acquired company 8 Organic chemicals Started as sole trader 9 Media post production Directors started venture following redundancy 10 Communications Prototype product developed over four years 11 Glass design Started as sole trader 12 Industrial components Limited company set up following redundancy 13 Hairdresser Started as sole trader 14 High tech composites High tech applications developed with university 15 Modelling agency Started as sole trader 16 Retail Started as sole trader 17 Engineering Launched business to sell new paint product 18 Electrical contractor Limited company set up by two partners 19 Nursing agency Franchise 20 Lighting supplier Co-owned by husband and wife Table I. Summary profiles of new ventures IJEBR 18,1 32 credit from banks and other sources that characterise current
- 186. financial markets. These ventures,in other words, enjoyed superior prospects of acquiring finance to those available to new venture founders today. For each venture, data collection involved: . an initial interview, lasting between 11 2 to 2 hours; . at least one, and typically two to three, follow-up telephone and email contacts to confirm the analysis; and . integration of secondary data, including company reports acquired during or after the initial interview. The focus throughout was on identifying the types of funding they acquired and used to start their ventures. Results Types and sources of start-up finance Start-up financing can be considered in terms of type, i.e. form, as well as source (Chaganti et al., 1995; Bank of England, 2004). Seven types, and ten sources, of start-up finance were identified amongst the interviewed businesses (see Tables II and III). External equity was the most valuable type of finance, totalling £2 million or 48.1 per cent of all funding secured. Almost all of the external equity came in the form of venture capital investment and most of it was acquired by one
- 187. business, reflecting the frequentlyreported tendency for low levels of venture capital investment in all but a small proportion of start-ups (Bank of England, 2003; Mason and Harrison, 1996; Reid, 1996). Two of the businesses received venture capital equity investments of £100,000 each. Formal loans (debt) came primarily from banks, although other sources of loans, mostly offered at subsidised rates and on special terms, were also evident as was widespread use of the Small Firms Loan Guarantee Scheme. The total value of formal loans greatly exceeded the value and frequency of start-up financing by bank overdraft, and more long-term debt was acquired than short- term debt. Informal debt and equity, including the founder’s own savings and funding provided by family and friends, accounted for around one- seventh of the total value of all start-up funding acquired, but was used widely by three- quarters of the sample. Fourteen businesses had invested their own savings and one had taken out a personal loan to help finance start-up. In most cases, the investments were relatively low, with ten founders investing between £1,000 and £10,000. The take- up and use of grants was common in the sample. Local government grants were small, ranging from £750 to £5,000. Central government grants ranged from £15,000 to £40,000, and mostly were for innovation or R&D purposes. Hire purchase, leasing and factoring accounted for
- 188. £48,000 of allfinancing acquired by the start-ups, and were only used by two of the businesses, both of which had a relatively high capitalisation value. Although significant in value terms, external equity was an uncommon form of funding for most new ventures. In contrast, loans and informal finance were common across the sample. None of the respondents indicated that they had started trading prior to formal launch of the venture, and so were not able to use retained profits to finance the business. Tables II and III therefore indicate a propensity to fund business start-up through informal finance and debt funding, rather than through external equity and retained profits, with a very small proportion acquiring equity investment from venture capitalists. Cases of start-up financing 33 F in a n ce ty
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- 205. 5 6 £ 1 2 2 ,6 0 4 £ 1 7 ,3 2 1 £ 2 4 9 ,5 7 1 Table II. Types ofstart-up finance acquired IJEBR 18,1
- 206. 34 Capitalisation values The capitalisationvalues of each start-up are summarised in Table IV. The total capitalisation value varied significantly across the cases, from a high of £2.2 million to a low of £3,050. The majority of capitalisation values at start- up were below £50,000 (12/20), and only one was above £550,000. The mean capitalisation value was £207,912.50, reflecting start-up number 2, which had a total capitalisation of £2.2 million. Without this outlier, the mean fell to £97,912.50. The median was between £43,200 and £33,000, indicating that total capitalisation across the group was dominated by a small number of highly capitalised start-ups, and that total start-up Co. Total Number of funding transactions Average per transaction 2 £2,200,000 5 £440,000 1 £550,000 3 £183,333 3 £370,000 2 £185,000 6 £305,000 4 £76,250 10 £182,000 7 £26,000 4 £153,000 7 £21,857 14 £106,750 5 £21,350 5 £80,000 3 £26,667 9 £46,750 4 £11,688
- 207. 7 £43,200 3£14,400 8 £33,000 4 £8,250 19 £22,000 2 £11,000 18 £20,000 3 £6,667 20 £10,000 1 £10,000 16 £10,000 3 £3,333 11 £10,000 5 £2,000 15 £5,000 3 £1,667 12 £4,500 4 £1,125 13 £4,000 2 £2,000 17 £3,050 3 £1,017 £4,158,250 3.65 £56,962 Table IV. Total and average funding for each business Source Total Frequency Transaction average Venture capitalist £2,000,000 4 £500,000 Own funds £517,500 15 £34,500 Business partner £525,000 1 £525,000 SFLGS £276,000 6 £46,000 Other loan guarantee £220,000 1 £220,000 Bank £208,000 9 £23,111 Family/friends £152,500 3 £50,833 Central government grant £135,000 5 £27,000 Non-bank loan £44,500 6 £7,417 Local government grant £17,200 10 £1,720 Other £62,550 12 £5,213 Total £4,158,250 72 £57,753 Table III.
- 208. Sources of start-up financingacquired Cases of start-up financing 35 capitalisation for most cases was below the mean. The variation in total capitalisation values at start-up therefore was very wide; ranging from large- scale new ventures with significant funding to micro-enterprises and sole traders with very low levels of start-up capital. The four start-ups with the highest capitalisation values (businesses 2, 1, 3 and 6) accounted for 82.4 per cent of all capitalisation across the 20 new ventures, pointing to high levels of concentration of funding in a small number of new ventures. Conversely, the remaining sixteen new ventures accounted for around one- sixth of the sample’s total capitalisation value only – highlighting low levels of capitalisation for these new ventures. This indicates that a small number of new ventures were highly-capitalised, but the majority had low levels of capitalisation below both the mean and median for the sample. “Bundling” patterns in start-up financing Most of the new ventures acquired multiple forms of finance, so
- 209. creating “bundles” of newventure finance. All but three new ventures secured their start-up capitalisation from between two and five different sources, with the mean number of sources being 3.65 and the median and mode both 3. Only one new venture started with funding from one source only (perhaps not surprisingly founder’s savings), and only four of the 20 secured finance from fewer than three sources, whereas almost half (9/20) secured start-up funding through four or more transactions. On the whole, start-ups with higher capitalisation acquired finance from more sources than those with low capitalisation. Table V indicates that overdrafts, venture capital investment and other forms of finance (hire purchase and leasing) were evident almost exclusively in higher capitalised new ventures. This suggests a greater awareness of (case 2), or willingness No. Personal O/D Loan VC HPL Grant Total No. sources Mean/source 2 * * * * £2,200,000 5 £440,000 1 * * £550,000 3 £183,333 3 * * £370,000 2 £185,000 6 * * * £305,000 4 £76,250 10 * * * * * £182,000 7 £26,000 4 * * * * £153,000 7 £21,857 14 * * * * £106,750 5 £21,350
- 210. 5 * ** £80,000 3 £26,667 9 * * £46,750 4 £11,688 7 * * * £43,200 3 £14,400 8 * * * £33,000 4 £8,250 19 * * £22,000 2 £11,000 18 * * * £20,000 3 £6,667 11 * * * £10,000 5 £2,000 16 * * * £10,000 3 £3,333 20 * £10,000 1 £10,000 15 * * £5,000 3 £1,667 12 * * * £4,500 4 £1,125 13 * £4,000 2 £2,000 17 * * £3,050 3 £1,017 Table V. Patterns in “bundling” of start-up financing IJEBR 18,1 36 to explore (cases 4, 6 and 10), funding options by founders of more capitalised new ventures. The founders of seven of the eight most capitalised new firms also had clear growth plans for their businesses (cases 1, 2, 3, 4, 5, 10, 14). Debt-equity distributions across the cases Table VI lists debt and equity funding for each of the 20 new ventures, in order to compare patterns of debt-equity distributions across the 20
- 211. cases. The totalvalues of grants and other forms of public subsidy obtained by the start- ups are also included because they cannot be categorised as either debt or equity. Grants are defined as non-repayable provisions of, typically public, finance to new ventures that do not result in an equity stake or other claim over the business and its profits and value by the funding provider. Grants have been included because they are a distinctive form of finance with different characteristics and terms than debt and equity, and because of their extensive use by most of the businesses included in the sample. Of the 20 businesses, 15 acquired grant funding during start-up ranging in value from £50,000 to £1,000. Grants accounted for a large proportion of total financing amongst new ventures with a low overall capitalisation value. However, they were also evident amongst businesses with higher start-up capitalisation values, indicating that they are not acquired only by new ventures that have difficulties in acquiring other forms of start-up funding. The debt, equity and grant distributions summarised in Table VI indicate that propositions of debt-equity trade-offs, or businesses funded solely by debt, as optimum financing structures do not hold across the cases (Modigliani and Miller, 1958, p. 294; equations 32 and 33). Indeed, no clear patterns on debt-equity funding are evident across the ventures. Instead, many patterns can be identified,
- 212. including funded solely CompanyDebt Equity Grant Total 2 £50,000 £2,100,000 £50,000 £2,200,000 1 £550,000 0 0 £550,000 3 £370,000 0 0 £370,000 6 £220,000 £85,000 0 £305,000 10 £55,000 £107,000 £20,000 £182,000 4 £98,000 £30,000 £25,000 £153,000 14 0 £102,000 £4,750 £106,750 5 £15,000 £40,000 £25,000 £80,000 9 £31,000 0 £15,750 £46,750 7 £35,000 £6,000 £2,200 £43,200 8 £5,000 £21,000 £7,000 £33,000 19 £20,000 0 £2,000 £22,000 18 £10,000 £8,000 £2,000 £20,000 11 £1,500 £4,000 £4,500 £10,000 16 £5,000 £4,000 £1,000 £10,000 20 0 £10,000 0 £10,000 15 £2,500 £500 £2,000 £5,000 12 £1,000 0 £3,500 £4,500 13 £2,500 £1,500 0 £4,000 17 0 £1,000 £2,050 £3,050 Total £1,471,500 £2,520,000 £166,750 £4,158,250 Table VI. Debt-equity-grant distributions across the cases Cases of start-up
- 213. financing 37 by debt (1,3); funded solely by equity (20); funded by debt and grant (9, 19, 12); funded by equity and grant (17); funded predominantly with equity (2, 5, 14, 8); funded predominantly by debt (4, 6, 9, 19, 13). Overall, half the new ventures were funded with a combination of debt, equity and grant, and 60 per cent with both equity and debt. The very different distributions of debt and equity demonstrate that stable patterns of debt-equity trade-offs are not evident across the sample. There is, in other words, no indication of a common pattern of debt-equity distributions across the 20 new ventures. Bootstrap, informal and intermediary financing The literature suggested that bootstrap, informal and intermediary funding may be important to business start-ups, particularly when not successful in or discouraged from acquiring formal finance (Kon and Storey, 2003) or when strong social ties provide access to bootstrap finance ( Jones and Jayawarna, 2010). Table VII indicates, however, that only two of the firms used non-business personal funding, in these cases personally secured loans, as a form of bootstrap finance during business start-up (although the majority invested their own savings as capital to secure equity in their
- 214. own ventures). Whenfinancing options were discussed with the founders, both in the initial interview and when feeding back and discussing the results, the author asked each respondent about which, if any of the following forms of bootstrap finance had been used (following Carter and van Auken, 2005): personal loans applied to the venture; credit card debt; delaying payments; minimising accounts receivable; sharing resources. Informal funding from family and friends was particularly significant for business number 3, accounting for almost half of the capitalisation secured for this new venture. Overall, however, informal finance was only found in three of the Bootstrap Informal Intermediary Co. Personal loan Family/friend HP/leasing Factoring Total capitalisation 2 £2,200,000 1 £25,000 £550,000 3 £50,000 £100,000 £370,000 6 £305,000 10 £2,000 £182,000 4 £20,000 £15,000 £8,000 £153,000 14 £106,750 5 £80,000 9 £46,750 7 £43,200 8 £33,000 19 £22,000
- 215. 18 £20,000 11 £10,000 16£10,000 20 £10,000 15 £500 £5,000 12 £4,500 13 £4,000 17 £3,050 Totals £70,000 £102,500 £40,000 £8,000 £4,158,250 Table VII. Bootstrap, informal and intermediary financing by business IJEBR 18,1 38 20 businesses. Moreover, only three of the new ventures secured intermediary funding in the forms of hire purchase, leasing and factoring. These forms of financing were particularly evident in the cases where total capitalisation values were high (over £100,000). Of the ventures with the six highest capitalisation values, four used these forms of financing when starting up. In three of these cases, informal and intermediary funding mechanisms accounted for only a small proportion of total capitalisation. Business 4 was funded by one form of bootstrap
- 216. financing – apersonal loan taken out by the founder – and by both leasing and factoring agreements with funders. There is also little evidence of bootstrap financing as a recourse should formal sources of funding not be acquired. For lower capitalised ventures, other forms of funding were acquired instead; in particular own funds and formal loans (i.e. external debt). Signalling effects Myers and Majluf (1984) argued that the use of own funds in a start-up is a “signal” of commitment to and confidence in the new venture. Money invested by the founder in the new venture provides external funders with a degree of reassurance that the starter is committed to, and confident about, the prospects of, the business (Prasad et al., 2000). Signalling as a result helps to convince funders that the new venture is a viable prospect for financing, in part because the risk is shared with the founder who is committing their own capital. For the business founder, commitment of own funds therefore has the potential to leverage in external funding and so creates opportunities to increase the capitalisation value of the start-up. Table VIII identifies possible signalling effects, based on the premise that where businesses are funded by both own funds and either external debt or equity (formal debt, formal equity) then signalling effects may have occurred and checking this against the individual cases for corroborating evidence. Individual cases were reviewed to
- 217. determine whether founders weredeploying personal investment to attract or secure other forms of financing. In each case where signalling was corroborated, the founder indicated that they sought to “match” their own funding with bank lending, in particular, in order to maximise the value of start-up capitalisation and, significantly, to persuade lenders to offer larger loans. In the cases where venture capital was secured, founders deliberately invested a larger sum to attract the desired amount of external equity investment (case 2) or committed all their available savings, even though meagre, to “signal” commitment (cases 10 and 14). Clear evidence of signalling could only be found in nine of the 20 cases. In some cases, external funding was used to capitalise the new venture without personal investment by the funders (businesses 1, 3, 9, 12, 19). In cases 1 and 3, formal debt values are high (£525,000 and £220,000 respectively). Debt was sourced from a “sleeping” business partner in the case of new venture 1, with whom the founder had a long-standing personal as well as business relationship. The loan guarantee acquired by the founder of new venture 3 was secured against an equity investment by members of the founder’s family, suggesting a leverage effect (rather than signalling) if the notion of own funds is extended from the founder to the founder’s family. Signalling can also be seen not to occur where own funds are invested, but
- 218. external debt and equityare not (cases 17 and 20). These two businesses had low start-up capitalisation values, of £10,000 and £3,050 respectively, and were cautious about the scale of the Cases of start-up financing 39 C o . O w n fu n d s F o rm a l d
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- 262. g Table VIII. Likely signallingeffects IJEBR 18,1 40 new venture and in particular the potential future risk of repayment and liability that external borrowing and investment may produce. Business 17 relied solely on their own funds as the only source of start-up funding, and business 20 combined a small personal investment with a small grant and funding from a matching government grant (Enterprise Allowance Scheme). These two founders could be characterised as averse to securing external funding that they may need to repay in the future even if the new venture does not succeed, which can in turn be taken as a “signal” of a lack of confidence in the ventures they were starting. Data discussion The three most common forms of finance across the 20 cases were grants, external debt and informal finance, with all three being used extensively by most new ventures within the sample. Overdraft facilities were less common than loans, indicating greater
- 263. levels of acquisitionof longer-term lending than shorter-term credit. Grants were used most extensively (24 times across 15 of the 20 cases). However, their total value was low and their overall significance to total capitalisation was high in only two cases (12 and 17, both of which had amongst the lowest total capitalisation values in the sample). Although venture capital investment (equity) accounted for almost half the total start-up capitalisation value for all 20 businesses, this form of finance was acquired by only three businesses. Almost all ventures acquired “bundles” of multiple forms of start-up financing from different sources, and there was some indication that more capitalised new ventures used a wider range of financing options that extended beyond loans and grants to include overdraft credit, formal venture capital investment, hire purchasing and leasing. Across the sample, therefore, the most significant forms of start-up funding, when value and frequency of acquisition were both considered, were externally acquired debt and personal funds. Research question 1 explored the extent to which new venture financing patterns confirmed either debt-equity trade-offs or pecking order sequences. Across the sample, there was no clear or definitive alignment of financing patterns with either debt-equity trade-off configurations or pecking order sequences; even though some new ventures did follow these patterns. Instead, the key observation arising from the analysis is that
- 264. patterns of start-upfinancing varied widely from new venture to new venture, in terms of multiple parameters including: total capitalisation value at start-up; types and sources of finance acquired; numbers of financing transactions undertaken; numbers of financing sources used; average values of each transaction; nature and structure of financing “bundles” acquired. As per research question 2, there was greater use of external debt than equity across the sample, even though the value of equity was particularly significant for a small number of start-ups. Internal finance was not used (research question 3), as the firms were not yet trading, and there was little use of informal, bootstrap and intermediary funding (research question 4). This latter finding is somewhat surprising, given the incidence of bootstrap finance cited in many studies, and this may reflect the nature of this sample of new ventures, which were referred by business support agencies and so can be assumed to be more likely to use formal sources of finance as well as their own funds. This supports research question 5, which suggests the importance of own savings and funds from close family and friends as a starting point for funding business start-up. Cases of start-up financing 41
- 265. Conclusions and implications Thesefindings indicate that the underpinning assumptions of debt-equity trade-off theorisations of financing do not apply universally to the new ventures examined in this paper. Instead, this paper has found multiple cases where new ventures are funded by equity alone, or by a combination of equity and grants, i.e. instances where there is no evidence of debt-equity trade-offs because no debt has been acquired to finance business start-up. Pecking order theorisations do not appear to apply fully to the sample either. Firstly, none of the cases used internal funds, i.e. retained earnings, to finance new venture creation, reflecting their lack of trading history. This indicated that pecking order approaches are internally, as well as externally “constrained” or “truncated” (Howorth, 2001). In other words, even though new firm founders may prefer internal finance in the first instance, their lack of trading history removes this funding option. Secondly, shorter-term debt in the form of bank overdraft was used less than longer-term loan debt: only five instances of bank credit through overdraft were reported, compared with ten instances of commercial lending and seven guaranteed loans. A preference for short-term over long-term debt (Howorth, 2001, p. 79) was not evident in this sample. The extensive use of loan guarantee debt funding
- 266. suggests that publicintervention, particularly through the Small Firms Loan Guarantee Scheme, has provided access to external debt on quasi-commercial terms that may not have been available on a commercial basis. Overall, therefore, there were no common or clear debt-equity distributions across the sample. Instead, there was noticeable variation in financing patterns within the sample. The scale and nature of start-up funding was also highly variable, with significantly different capitalisation structures and values evident across the sample. These variations in new venture capitalisation highlight two important themes that may inform our thinking on how founders finance their new ventures. The first is the extent to which many of the new ventures were started with low levels of capital, and so with the prospect that they are likely to be under-capitalised and, as a result, vulnerable to pressures such as lack of investment funding for staff, equipment and business development as well as a greater risk of cash flow problems once trading. This suggests that many new ventures are started without sufficient capitalisation and so will be more likely to grow more slowly as well as being more vulnerable to closure. Conversely, a greater propensity to use more and a wider variety of types of finance can be seen in new ventures with higher capitalisation. This appears to be influenced by the founder’s understanding of funding options, i.e. their
- 267. overall “financial literacy” inrelation to resourcing business start-up, and their aspirations for the new venture; with more “financially literate” and more ambitious founders generating higher levels of start-up funding from a wider range of sources and types of finance. This suggests in turn that prospects for survival and growth once a new venture is created are influenced by the capability of the founder to start a well- resourced new venture with future growth ambitions, i.e. to establish larger-scale, more growth-focused new ventures (as measured by capitalisation). However, the financial “literacy” of the founder in gauging the funding needs of a new venture and that founder’s ability to secure these resources and apply them to growing the business did not provide a definitive account of the drivers for securing new venture finance across the sample. A pattern of incremental “bundling” of various forms of finance across all but one case attests to this in several ways. For many of the IJEBR 18,1 42 new ventures, a single source of finance did not provide all the funding the founder was seeking, so forcing them to either start the venture under-
- 268. capitalised – ashappened in several cases – or to seek the outstanding financing need from other sources. In some cases, such as business 6, an external funder was reluctant to lend the full amount sought by the founder because the start-up was informationally “opaque” as a result of it being unproven and having no track record in trading profitably. In addition, funding was secured in bouts, or waves, initially as the founder was planning the new venture’s future establishment and was still exploring how this would be achieved and seeking to understand how the new venture would operate. As the founder moved through planning to launch of the new venture, unanticipated additional costs were often identified or discovered, so demanding more funding and a need to seek out additional sources of start-up finance. This was particularly the case for technologically-focused new ventures seeking to mass produce or commercialise proprietary knowledge or technology (cases 5, 8, 10, 14). An additional reason for incremental raising of start-up finance was a desire by the founder to not become overly dependent upon a single source of funding. In these cases, multiple forms of finance were sought from different providers (venture 2 acquired funding from two different venture capitalists when either would have funded the full value sought). Incremental acquisition of start-up finance also occurred because of what could be termed “cumulative incrementalism”, where personal funding
- 269. was used initiallyto secure or “match” against other forms of finance. Over time, several new venture founders accumulated larger financing “bundles”, and deployed these enhanced capitalisation values to secure further external finance (businesses 10 and 14 acquired loans against founder equity initially, and then approached venture capitalists to secure further funding once a first “bundle” of funding was in place). Combined, these various factors suggest that start-up capitalisation values and structures are influenced by a variety of factors, as follows: (1) The overall ability of the founder(s) in terms of their: . financial literacy; . success in negotiating to acquire funding; and . expertise in planning business start-up and launch effectively. (2) The financial constraints experienced by most new ventures, in particular how funders respond to and deal with: . the opacity of a new and as yet unproven new venture; and . the additional risk associated with funding new and unproven ventures. (3) The incremental and unpredictable dynamics of starting a new business, in particular the: . uncertainty generated by iterative development of the new venture; and . experiential learning of the founder as he/she deals with this iterative
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- 280. Yin, R. (1989),Case Study Research, Sage, Beverley Hills, CA. About the author Andrew Atherton is Professor of Enterprise and Entrepreneurship and Senior Deputy Vice Chancellor at the University of Lincoln. At Lincoln, he established the Enterprise Research and Development Unit (ERDU), which has undertaken more than 30 commissioned policy studies since 2003. Before joining Lincoln, he was Director of the Foundation for SME Development at the University of Durham, the successor department to the Small Business Centre, a leading international centre for enterprise and SME development. While at Durham, he established the Policy Research Unit, which undertook commissioned research and policy analysis on enterprise development and entrepreneurship. He has degrees in Chinese and Economics from the School of Oriental and African Studies, University of London, and Yale University. His current research is concerned with enterprise policy, entrepreneurship in China, and new venture creation. Andrew Atherton can be contacted at: [email protected] Cases of start-up financing 47 To purchase reprints of this article please e-mail: [email protected] Or visit our web site for further details: www.emeraldinsight.com/reprints
- 281. Reproduced with permissionof the copyright owner. Further reproduction prohibited without permission. Editors’ Corner Jill Kickul* and Thomas S. Lyons Financing Social Enterprises DOI 10.1515/erj-2015-0006 In this Special Issue of the Entrepreneurship Research Journal, we examine emerging and evolving strategies and tools for financing social enterprises. This is a very young subfield of social entrepreneurship; one that has been dominated by practitioners and only recently has attracted scholarly interest. However, it is a vital topic because of the need for more and better resources to bring scale to the pursuit of social and/or environmental mission. It is an immensely fertile field for research. Dees, Emerson, and Economy (2001) remind us that financing for social entrepreneurship should be driven by the human and physical resources required to deliver on the social value proposition (SVP) of the enterprise, which, in turn, must be guided by the activities necessary to accomplish the
- 282. mission. As SVPsbecome more ambitious and activities more sophisticated, more capital is required in forms that are appropriate to the organizational structure and life cycle stage of the enterprise. Traditional forms of financing for social entrepreneurship are no longer adequate to the task. They are often short-term, categorical, and transactional in nature (Wei-Skillern et al. 2007), when what is needed are financial resources that free the social entrepreneur to focus on mission achievement (not fundrais- ing) at a scale that yields transformation. This has led to experimentation that has pushed the boundaries of traditional financing, such as Crowdfunding and program-related investments. However, even this has not proved to be enough. The newest idea in good currency in the social entrepreneurship financing arena is social impact investment, which combines financial investment and social and/or environmental impact. Social impact investors seek both financial *Corresponding author: Jill Kickul, Stern School of Business, New York University, New York, NY, USA, E-mail: [email protected] Thomas S. Lyons, Baruch College, City University of New York, 55 Lexington Avenue B9240, New York, NY, USA, E-mail: [email protected] Entrep. Res. J. 2015; 5(2): 83–85
- 283. and social returnon investment. As the Monitor Institute notes, some may value ROI over SROI (financial-first investment), while others put SROI first (impact-first investment) (Kickul and Lyons 2012). Social impact investment addresses many of the limitations of traditional social enterprise financing and makes it possible for social entrepreneurs to pursue double and triple bottom line activities. One of the challenges presented by social impact investing is increased pressure to measure and monetize social impact. If investors are seeking SROI, they rightfully want a clear idea as to exactly what they are getting for their investment. This has opened yet another related research frontier for exploration. The editorials and papers in this Special Issue represent forays into this under-studied realm of social enterprise financing. In their invited editorial, Brandstetter and Lehner raise important considerations regarding the compat- ibility of mixed (traditional and social impact) financing portfolios. They intro- duce a four-step process for aligning the social and the financial perspective, which requires the quantification of social impact. Maximilian Martin, in a second editorial, advocates for what he calls “synchronic”
- 284. hybrid financing approaches. Hesuggests a combination of debt and equity capital, mezzanine capital and grants. He ties the appropriate mix of these capital forms to the legal structure, life cycle stage and business model of the social enterprise in ques- tion. Raith, Dohrmann and Siebold provide a framework for categorizing and analyzing the business models of social enterprises that permits correlating social value monetization and revenue generation. They find a positive relation- ship between the two and suggest that modest changes in an enterprise’s business model can significantly impact both monetization and financial per- formance. Meyskens and Bird look at Crowdfunding as a viable alternative for social enterprises that are not yet in the position to generate ROI. They identify the different types of Crowdfunding models and platforms and link each to the social value creation goals of the social entrepreneur, helping the latter to make more informed decisions about the model and platform to utilize. All of these perspectives assist us in pushing forward the boundaries of our knowledge with regard to financing social enterprises. As the field continues to evolve, we offer the following research questions for scholars and practitioners interested in social enterprise financing: – How do social entrepreneurs align their mission-driven
- 285. activities and goals withtheir funding strategy and financial sustainability objectives? – In what ways can new funding models (e.g., social impact bonds) spur on how social enterprises measure and scale their impact? – How do successful social entrepreneurs overcome funding challenges? How do they use existing resources to do “more with less”? 84 J. Kickul and T. S. Lyons – In what ways beyond providing capital can impact investors assist social enterprises to further innovate their business models? – Given the new forms of social organizations (e.g., hybrid firms, B Corps), what new forms of financing options will become available? – What tradeoffs do social enterprises encounter during the early stages of funding as they try to achieve their social mission and objectives? Hopefully, these questions along with the articles included in this special issue will inspire further investigation in this space. References
- 286. Dees, J. G.,J. Emerson, and P. Economy. 2001. Enterprising Nonprofits: A Toolkit for Social Entrepreneurs. New York: Wiley. Kickul, J., and T. S. Lyons. 2012. Understanding Social Entrepreneurship: The Relentless Pursuit of Mission in an Ever Changing World. New York: Routledge. Wei-Skillern, J., J. E. Austin, H. Leonard, and H. Stevenson. 2007. Entrepreneurship in the Social Sector. Thousand Oaks, CA: Sage. Financing Social Enterprises 85 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.