Financing Entrepreneurship: The Best Sources to Approach for Funding for ActiComm - Research Paper Example

 Financing Entrepreneurship 1. Introduction This papers seeks to produce a report for the founders of ActiComm advising them on what would be the best sources to approach for funding they need to develop the opportunity and analysing their options as to which of the two alternatives they should pursue. This will also highlight the pros and cons of the various sources of funds considered in financing the two projects together with advice of any suitable assistance available to the business for the implementation of this researcher’s recommendations. Investment appraisal method used will be discussed. 2.1 Which of the two projects should be chosen? The two projects entail options that should be analysed in terms of feasibility and which is better for purposes of determining the sources of financing. Although ActiComm is a community based social enterprise, it does not mean that it needs not be profitable. That which is more profitable or that which would produce more wealth (Gitman, L. 2006) should be chosen as it has a chance of greater success in the long-run. From a market perspective, a business organization that will lose money will be only be closed eventually for failure to provide sufficient returns to stakeholders particularly the owners which must earn a sufficient return on their capital investment (Bodie, Kane and Marcus, Arnold, 2004). Case fact provides that the the business aims to provide young people with the opportunity to build confidence and discover themselves through various activities from sports to performance. Since the purpose of the business has its social dimension, the organization can be mainly categorized to be a non-profit oriented organization. This is supported by the fact that it has its members who pay fixed annual dues. Another proof is the funding in its activities in the past that came from local authority. As such the founders may also be classified as social entrepreneurs and as distinguished from business entrepreneurs. The two kinds of entrepreneurs have different orientations and ways of measuring value (Edwards et al, 2008). Social entrepreneurs have their missions which are not necessarily governed by the market. Their roles take the form of change agents in society by espousing a mission to create and sustain social value. As applied in the case of ActiComm founders, the latter wanted to develop the youth. This social value could sound different from private value as the social entrepreneurs recognize pursuing new opportunities in the attainment of their defined mission. They therefore normally engage in a “process of continuous innovation” (Edwards et al, 2008) while they adaptation, and learn. They do act confidently despite limited resources that they presently have in hand. Since entrepreneurs are also adventurous individuals the can help arouse economic progress by their discovery of innovative and improved ways of doing things. The value that they create could come from shifting resources of lower efficiency into an area of higher efficiency with greater return. Thus they are considered as catalysts and innovators behind economic progress (Edwards et al, 2008). Their mind-sets see the possibilities rather than problems. It was Peter Drucker who asserted and clarified that profit motive is not a requirement in entrepreneurship (Edwards et al, 2008). If applied to ActiComm then, it would appear that the accomplishment of the mission becomes the controlling factor if they have to weigh the options. If they choose the first option, that would mean serving the youth directly but choosing the second option may be just to go around first by engaging first in a commercial concern and then use the proceeds in the attainment of the their espoused causes. Being different from business entrepreneurs, the mission of impact-related entrepreneur is crucial criterion as contrasted to wealth creation for the former. This makes now wealth as just a means to attainment of social entrepreneurs’’ missions. This makes them not subject to market discipline and they cannot be simply driven out of business if they do not produce economically or profitably compared with business entrepreneurs (Edwards et al, 2008). Business entrepreneurs create value when customers could pay above cost of goods produced or service cost (Edwards et al, 2008). On the contrary, social entrepreneurs do not fully mind whether markets work well for them. They are looking for benefits for people who cannot afford to pay. This is one of the essential elements the concept of social entrepreneurship. This would cause difficulty to determine and measure social value that is being created as basis for justifying the use of resources. In the case of ActiComm, it would also be impossible measure the value of youth with improved skills in sports which may make the country proud in relation to other countries. For social entrepreneurs then, the persistence or movement of a social enterprise should not be the consideration for determining how efficient or how effective the same in humanizing social conditions. (Edwards et al, 2008). This does not mean that social entrepreneurs no longer operate in markets. However these markets are not the providers of the right punishment. Thus, it is said that a big number of social-purpose organizations have their members to pay membership fee or other fees for their service rendered although the fee does not recover the cost of benefits provided. This would then cause them to vie for volunteers, donations and other kinds of support to fund their projects or activities. As the discipline of the markets is not normally aligned with the mission of social entrepreneur’s measurement of created social value becomes a challenge (Edwards et al, 2008). Donors and volunteers for this kind of organization should really have the heart for the mission. It is therefore a normal thing to happen if big donations could come to the organization as source of funding because of the worthiness of their cause. The operation of a social-purpose organization can be comparable to that of government function which is not generally profit oriented but it cannot survive without taxes so there must be a way to move resources to attain the greater end of governance. Thus in the ActiComm can opt to generate income to sustain operation. This is the concept of a social enterprise which is described as “a strategy to engage in social purpose activities that generate income” (Agard, 2010 citing Dees & Economy, 2001). 1.1 The first option – to use the property as a base and performance area The first option will have the to use the property offered by a local private developer as base to run the project of the owners whereby young people in the area would be able to drop in to class and sessions put on ActiComm as well as developing a performance area. Using this alternative may have to be evaluated on the basis of projected cash flows for the project and discounting the same with an assumed discount rate. Under this option, the cash inflows would come from the annual membership fee from members and the charges that it charges annually. Cash outflows would come from those that would be spent for the renovation at £23,000 to the property as offered by the developer and monthly rental cost of £3,000. An analysis using the NPV method produced a net present value of £1,647,047. The net present value is noticeably high because of the doubling of the membership for the first three years and the 150% annual growth of the total charge that ActiComm had last year. See Appendix A. 1.2 The second option – to use as commercial space The second alternative is to use the space as a commercial concern with a cost of £58,250 with a forecast profit of £13,750 growing at 8% p.a. might be a better option. Compared to the first option the NPV generated was £24,619. See Appendix A. This means that this is less preferable than the first option although the project may appear to be acceptable. Since the two are mutually exclusive where the acceptance of one project results to rejection of the other, the mode of financing for the first would be given more discussion and analysis. From the context of a business, the different sources of funds could be either generally classified as equity financing or debt financing. The equity financing implies that funds could come from owners. On the other hand debt financing could come from creditors. The case fact provides in the last two years, the main funding has been from the local authority. This would mean that source may have come from the government sources which may have been in form of donation. 2. The investment appraisal methods to be used? To assess which of the two projects is better is to use investment appraisal methods. The four investment appraisal method could include the following, the payback, the accounting rate of return (ARR) and the NPV. Each method has its advantages and disadvantage. After evaluation that the NPV was most applicable method, option 1 came out as better option using an assumed discount rate of 10% for both options. Sources of finance would also be discussed for the other option but emphasis should be given to the better option for purposes of implementing the recommendation of this paper. One method investment appraisal is the payback which measures how long will the investment is recovered by in terms of cash inflows. This appears not appropriate for ActiComm since their orientation is non-profit and recovery in the short-period is not a major concern. Another method is the Accounting Rate of Return (ARR) which can be computed by dividing the average net cash inflow by the initial investment. Net cash inflow is by derived by deducting the initial investment from the total cash inflows for the seven-year period. It was problematic to apply ARR because cash outlays happened over the seven-year period and not only initially. Thus initial investment cannot be used as based to compute the same. Theoretically however, the ARR appears can have some advantage of knowing the profitability as measured by rates or percentages of an option compared to the Payback method as the measurements. The accounting profit is best term to apply this method (Meigs, Meigs, & Meigs,1995; Kieso, et al, 2007). This makes then the discounted cash flow technique of Net Present Value, the most logical appraisal method as it considers the time value of money (Brigham, and Houston, 2002, Droms, 1990; Higgins, 2007). The future cash flow should be discounted as a discount rate or cost of capital to bring them to their present value. The case facts do not provide for any discount factor. Thus it was necessary to assume the same in order to apply the model. The cost of capital can be compared to the opportunity cost where one cannot just have money for free. There is cost of money because of the alternative use of resources. Thus under this method, option 1 produced the higher NPV and this would make the same as the better investment option compared to option 2. It may be noted again that both of the options are acceptable using their positive NPV generated. However need to make appropriate recommendations on which option should be taken means that they are mutually exclusive. NPV method is not without its limitations. One limitation is obviously observed in the estimates made in the cash flows and which is normally assumed also. These are given in the case facts and they were just used for the discounting. Another limitation it the discount rate estimate. It may be difficult to measure the same and as such it could just be an estimate. For decisions like this, however, it does not make a big difference if the same discount rate is assumed for the two options. Despite these limitations, NPV as the preferred method is justified to be used for evaluating investment projects because of its advantages over other methods. 3. The possible sources of funds for the two projects with the pros and cons of each source The sources of finances for a business would depend primarily on purpose of the financing. The company appeared to have derived its sources from its members in the form of membership fees, the charges it generated from its activities and events as well as funding from the local authority . The company can continue to avail of the same as revealed in the cash flows. The generated NPV for option was high enough assuming that the cash flow is realistic. Under both options, which generated positive NPV, the real finance problem is how to manage year zero for the initial cash outlay of £23,000 for the renovation cost for option 1. Option 2 could be finance the same as Option 1 but focus should not be directed to option 1 because of the higher NPV. Donations could be resorted to as mode to finance the £23,000 initial outlay for the renovation cost. This could come from present or prospective members who could identify with the promotion of the interest of the youth. It would not be difficult to convince other sources to donate if the social value created is perceived by donors as something beneficial to society. The advantage of equity financing when membership dues are increased as members double for the first three years includes the fact the company’s finances do not get risky or it has less chance of becoming problematic because of less debts. Its disadvantage however is that it more members may demand more services and this could be more costly. They founders could also borrow from banks for a loan for the renovation after preparing a feasibility study of their upcoming events. The banks could agree if the owners can show proof that they were able to successfully generate funds from previous projects which could be repeated. The prepared cash flows could be used as evidence to show to a local bank to finance the £23,000 at year 0. It would not be difficult to convince a local bank to lend assistance with a reasonable interest. The advantage for this is not to burden the members and to address uncertainty of receiving immediate donation in the meantime. The disadvantage is that they should have to pay for interest charges for the loan. 4. Conclusion and Recommendation This paper recommends option 1 because it is more feasible and therefore more practical because it has the greater chance of success. The growth in charges of 150% and membership fees would be more than enough to cover the cash flow requirement of the project for seven years. Option 1 is also closer to the realization of the objective of the founders as social entrepreneurs rather than business entrepreneurs. This paper recommends borrowing from a local bank to take advantage of the available space for renovation. Show the projected cash flows to the bank the loan of this amount would not be difficult to be granted. Appendix A – NPV Computations References: Agard, K. (2010). Leadership in Nonprofit Organizations: A Reference Handbook. SAGE Arnold, Glen (2004). The Financial Times Guide To Investing: The Definitive Companion to Investment and the Financial Markets. London: FT Prentice Hall Bodie, Kane and Marcus (2007). Essentials of Investments, Sixth Edition, The McGraw−Hill Companies Brigham, E. and Houston, J. (2002). Fundamentals of Financial Management, London: Thomson South-Western Case Study – Acti Comm Dees & Economy (2001). Enterprising nonprofits: A tool for social entrepreneur. New Yor: John Wiley Droms (1990). Finance and Accounting for Non-Financial Managers. England: Addison-Wesley Publishing Company Edwards, et al (2008). Hybrid Organizations: Social Enterprise and Social Entrepreneurship. Lulu.com Gitman, L. (2006). Principles of Managerial Finance. London: Addison Wesley. Higgins (2007). Analysis for Financial Management, Eighth Edition. The McGraw−Hill Companies Kieso, et al (2007). Intermediate Accounting. John Wiley and Sons Meigs, R,. Meigs, W., & Meigs, M. (1995) . Financial Accounting. New York: McGraw-Hill Read More