The Role of Entrepreneurial Finance in Entrepreneurial Life Cycle - Essay Example

The Role of Entrepreneurial Finance in Entrepreneurial Life Cycle April 22, Introduction Entrepreneurial finance plays an integral part throughout the venture life cycle as it provides the foundation for starting a business. It address core issues during the entrepreneurial life cycle; market opportunity, competitive position, composition and sources of financing. Entrepreneurial life cycle consists of five major phases; startup, startup breakout stage, the emerging growth, the lower middle market, the middle market which doubles up as the exit phase. The startup is the birth of the venture where the entrepreneur’s inventiveness, drive and creativity bring the idea or concept to life. However, Rosen (1998) emphasizes the importance of initial finance in ventures of small businesses. On the other hand, Santarelli& Vivarelli (2006) found a positive correlation between the choice of financing and the growth and survival of a venture. This paper explores the role of entrepreneurial finance in the entrepreneurial life cycle. The development and Startup Stages According to Leach & Melicher (2003), the early phases of the entrepreneurship life cycle, the venture exhibits undercapitalization and in effect the entrepreneur must grab the different sources of capital. Mason (2007) discusses the role of informal sources of finances, which are often ignored in class room environment, but have significant role in the entrepreneurial life cycle. According to Preston (2007), angel investors are high net worth persons who inject funds in the early stage companies. Reminiscent of an American program, Shark Tank, that features high net worth individuals who are looking for investment opportunities in television. Kerr, Lerner & Schoar (2010) found out that angel investments improve entrepreneurial success. These opportunities for tapping capital at such early stages must occur as the venture progresses from startup through the survival stage. The major objective of the entrepreneurial finance is to assist the entrepreneurs through the life cycle of the venture to continually make better investment and financing decisions. The process covers the entire venture life cycle from startup to exit and inquires into issues such as deal structures, incentives, business models and valuation to a greater degree than normal equity management. Winton & Yerramilli (2008) in a comparison between bank and venture capital financing delved into the metrics of the choice between these two methods of financing a venture. According to N Berger & F Udell (1998), entrepreneurial finance plays an important role in small business as opposed to the large business. The small business have access to a huge large pool of financing options, however, the small business, particularly the small venture business are constrained by the size of their business. Survival and Rapid Growth Stage Smith, Smith & Bliss (2011) asserts that the choice of financing method is critical to the success of the venture, and this does not substantially depend on whether the idea or even the product reaches the final destination, which is the market. Further, Smith, Smith & Bliss (2011), remark that the importance of incentive and information problems that face participants in the market for entrepreneurial finance.   The endeavors of addressing the issues often lead to the characteristics of the market, such as staging of investments, terms of financing contracts, reputations, trade practices and valuation approaches. Entrepreneurs after the break through with their ideas are often confronted with certain questions, not only at the beginning of their projects, but continually throughout the life of the business, for instance; how much funds should be raised at each stage, the reasonable valuation of the company, when should the money be raised, how should funding be conducted, employment contracts and exit decisions be structured. Continually, and through the next three phases of the project life cycle, entrepreneurial financing must focus on a number of financing models so as to tap into the incentives of each unique investor, plus the relative costs and benefits that may accrue from each source of funding and the inter-linkages between a ventures financing strategy and the product market strategy. Denis (2004), stated important areas in the study of entrepreneurial finance during the life cycle and these consists of alternative sources of capital, financing contracting issues, public policy and the dynamics of private equity returns. A Case Study Analysis Johnston is a 32 year old graduate of a fabric design school who intends to set up his own design business after quitting a company job. The questions of location, finance and other important factors preoccupy his mind in the quest to make the idea a reality. The push to found his own firm was fuelled by his desire to reap from the huge outlay his company was earning on his toil. He began by retreating back to his home city, and established an office studio, this allowed to keep low his overhead costs and maintain flexible working hours. Moreover, there was a sizable market for his products in his hometown. The initial work took a lot of his time and was provided with state of the art computer by his client. However, he realized that he could not rely on a single client to push his company to better growth and that he faced several other huddles and these included: he was new in the business and realized that he needed more contact to achieve his desired target. He plans to put his work in exhibitions to further market them beyond the borders of his hometown. The question of financing the venture at the startup stage, seed financing becomes key. This is the primary form of finance at this stage and primarily involves the entrepreneur utilizing personal assets. Similarly, Johnston shall use his personal computers, savings, credit cards, equipments and furniture for the development of the idea. After the seed form of financing the next component involves the use of startup financing and it coincides with the development stage of the entrepreneurship life cycle, and this is financing that occurs when the venture moves from a viable business opportunity to the level where the point of initial production and sales. After an assembly of a solid management team, then this form of financing can seem suitable, and more importantly external equity financing becomes important. Sources of external venture can occur in the form of business angels or venture capitalist. After preparing the business plans and targets, Johnston approached a venture capitalist to sell to them the idea of the business and the available market. He secured funding for the business at this stage and moved to a more central office in an up market district and reached out to the former clients of the former company that he used to work for. They had an arrangement with the venture capitalist that he will be allocated 35 percent ownership of the company and the rest would be taken by the investors. First Round Financing At this stage, revenue from the venture begins to drip; however, financing may be needed to cover marketing expenditures and organizational investments needed to bring the business to full operation in the firms’ commercial market. Such financing means such as trade credit becomes important sources of financing at this phase in the life cycle. Grants from the authorities can also serve as important means of financing the going concern. The company approaches the local government so that they may get a piece of grants set up each financial year for youthful projects; however they are turned down as they have secured high profile investment from the venture capitalist. The company resolves to use the trade credit form the suppliers and revenue generated from sales to cover its meeting expenses. The case above provides an intricate illustration of the process of entrepreneurship, offering an array of questions and answers to the complex concept of entrepreneurship. It exposes inherent characteristics of new venture creation outlining three dominant perspectives; functional, personality and behavioral. Entrepreneurial behavior is seen as actions that cope to merge innovation, risk-taking and proactiveness. The functional viewpoint involves the economic purpose of the launch of the venture; this simply implies the force towards profit. Second Round Financing At this third stage, the major sources of financing during the rapid growth stage come from the company’s operations, suppliers and customers, banks, and financing aided by investment bankers. These streams of financing are important as the rapid revenue growth stage are unable to rely on inadequate financing that can match the company’s desired growth. An opportunity existed to him and after utilizing important information at his disposal, he carefully began to plan and organize the venture process. Successful launch of the venture involved hard work, and the anticipated huge financial reward, and for Johnston the expected returns from designing the fabrics were the turning point. He possessed the relevant training and skills important in the business he was attempting to go into, and the only rebound is his lack of significant knowledge in running a business and managing the business. It must be the inventiveness and the capabilities of the Johnston to stimulate the sustainability of the business venture into the future. Generally speaking people with the embedded hunger and capability to meet the burden of entrepreneurship are at a higher level off creating a sustainable and successful business venture than those people who lack this skill. Various research findings indicate that an entrepreneur’s personality is directly related to the success of the business, and this if the business is setup in a startup situation. In most of these situations, the owner assumes several roles; he is the accountant, the designer, manager, amongst other roles and though, this may be straining, this enables him to directly oversee various segments of the new venture. The last Phase As the company has grown in leaps and bounds, Johnston realizes that going public may be a problem. The company that he used to work for has opted to acquire the company and that majority of the shareholders at the company have passed a resolution to that effect. He is the minority shareholder and he is bound by the decision of the majority shareholders. Conclusion Financing forms an important component in the growth of the venture and at every stage of the life cycle. At every stage of the venture life cycle a different form of financing style may be needed; a t the development stage, the startup stage, the rapid growth stage and the maturity stage. A venture started by Johnston typically follows the life cycle process from the novel stage to maturity stage, in which the firm he started is eventually acquired by a stronger market competitor. Reference List Denis, D. J. (2004). Entrepreneurial finance: an overview of the issues and evidence.Journal of Corporate Finance. 10, 301-326. Kerr, W. R., Lerner, J., & Schoar, A. (2010). The consequences of entrepreneurial finance a regression discontinuity analysis. Cambridge, Mass, National Bureau of Economic Research. http://papers.nber.org/papers/w15831. Leach, J. C., & Melicher, R. W. (2003). Entrepreneurial finance. Mason, Ohio, Thomson/South- Western. Mason, C. M. (2007). Informal sources of venture finance. In The life cycle of entrepreneurial ventures 259-299. N Berger, A., & F Udell, G. (1998). The economics of small business finance: The roles of private equity and debt markets in the financial growth cycle.Journal of Banking & Finance, 22, 613-673. Rosen, H. S. (1998). The future of entrepreneurial finance. Journal of Banking & Finance. 22, 1105. Preston, S. L. (2007). Angel financing for entrepreneurs: early stage funding for long-term success. San Francisco, Jossey-Bass. Santarelli, E., & Vivarelli, M. (2006). Entrepreneurship and the process of firms entry, survival and growth. Bonn, IZA. http://d-nb.info/988728737/34. Smith, J. K., Smith, R. L., & Bliss, R. T. (2011). Entrepreneurial finance: strategy, valuation, and deal structure. Stanford, Calif, Stanford Economics and Finance. Winton, A., & Yerramilli, V. (2008). Entrepreneurial finance: Banks versus venture capital☆. Journal of Financial Economics. 88, 51-79. Read More