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Sources of Capital for Entrepreneurs

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Sources Of Capital for Entrepreneurs

Introduction

Entrepreneurship is a broad concept that has surfaced in the eighteen centuries,

which many scholars have attempted to define from different perspectives. For example,

according to Richard Cantillon, entrepreneurship is a risk that a person undertakes at buying a

certain commodity or service at a certain price and selling it at an uncertain price. Jean

Baptiste goes further to define by including the factor of production in the equation (Aldrich

et al., 2018). By 1911, scholars like Schumpeter included innovation in defining

entrepreneurship, which implies innovation involving market, process, organization, among

other factors (Hirsch et al., 2017). In all definitions, they agree that entrepreneurship is a

process of creation, vision, and change, which require energy and passion for actualizing

these innovative solutions and ideas. However, according to shepherd, Hirsch, and peters,

financing is the most challenging part of starting an entrepreneurial venture.

In financing an entrepreneurial venture, one can rely on various sources of capital.

There are two sources of capital available for entrepreneurs, "equity of dept" and "external or

internal" sources, including personal funds, loans from the banks, or even family or friends'

funds. Other major financial sources for an entrepreneur include; corporate ventures

capitalists (CVCs), venture capitalists (VCs), and business angels (BAs) (Hirsch et al., 2017).

This paper discusses some of the approaches an entrepreneur can use in sourcing for finances

to start an entrepreneurial venture.

Debt financing

According to Hirsch, dept financing is getting funds from a venture by borrowing

and paying back in a certain period with interest. The most common debit sources include;
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Commercial banks

In the case of collateral availability, commercial banks are the main sources of funds

for entrepreneurs. Such funds are available for entrepreneurs if they provide tangible

collateral or a guarantee. This guarantee can be an entrepreneur's personal assets such as a

house, car, bond, stock, business assets, equipment, or a business building. In getting the

funds from the bank, the principle is that the collateral must be worth more than what the

entrepreneur is borrowing from the bank.

Trade credit financing

Trade credit is purchasing of goods and services from a supply through account by

which a customer pays the supplier later within a stipulated period. This period can be 30, 60,

or 90 days in most cases. Payment date extension is another approach for the buyer to sell the

products or services to pay the debt back.

Finance factoring

Finance factoring is considered one of the oldest forms of obtaining funds for an

ongoing venture. In this mode of financing, the account receivables are sold to a third party,

and one is entitled to a loan collecting it. In such a case, the owner of the business cannot

access a loan through it. This process is similar to account receivable financing based on

trading the account at a less value than the face value.

Financing from account receivable

This type of financing is based on obtaining the needed funds by selling goods or

services to customers who are credit worth then requesting repayment later. In some cases, an

entrepreneur may get an account receivable from the bank, especially when the government is

involved in the transaction (Wright,2018). This happens by trading the account at a value less

than the face value. In this scenario, the bank collects the money from the account, and in
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case of a loss or failure to collect the account receivable, the bank will incur the loss instead

of the entrepreneur.

Cash flow financing

Cash flow financing is another source of debt financing commonly provided to the

entrepreneur by financial institutions and commercial banks. Conventional bank loans are the

standard ways banks lend funds to entrepreneurs and businesses (Aldrich et al., 2018). Such

conventional bank loans cover installation loans, long-term loans, character loans, credit

financing, and straight commercial loans. Below is the explanation of these loans in

summary;

Installment loans

These funds are available for a venture with a clear record of sale and profit.

Installment loans are mainly used in working capital required for a particular period, such as

seasonal financing. Installment loans have a duration of as long as 30 to 40 days.

Long term loans

Such loans can last as long as ten years and are only available for big and mature

business ventures. The debt incurred in the business venture is repaid based on fixed interest

rates for a specific time and in constant schedules (Stevenson,2017). In most cases, the

schedule for repayment starts from the second or third year, and the profit is only on the first

year of the loan.

Straight commercial loans

This type of loan is similar to an installment loan and is self-liquidating. The loans

are used for a particular period, such as seasonal funding and giving inventory which goes

straight to the business for 30 to 9 days.

Character loans
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These loans are available for a venture if the business does not have the needed

assets to secure a loan. In this case, the entrepreneur must obtain a character or so-called

personal loan (Harrison, 2019). Under this type of loan, another person's or entrepreneur's

assets must be pledged in the bank to access the loan. The most commonly pledged assets

include lands, cars, and houses.

Personal funds, family, and friends

In funding a venture, entrepreneurs rely on different financing sources, which in

most cases prefer personal funds, which are less expensive in terms of control and cost.

Personal funds are very significant in attracting financial sources from external sources such

as private investors, banks, and venture capitalists. Some of the major personal fund's sources

include mortgage of cars or houses, personal savings, or life insurance. Venture capitalists

need to see entrepreneurs starting their own venture through personal funds. It guarantees the

commitment of the entrepreneur to the venture even after the capitalist has invested in the

business (Hirsch et al., 2017). Families and friends are another way of financing a venture. In

this mode of financing, the terms of repaying the debts are set in an informal setup. Such

investments from family and friends are referred to as informal investments.

Equity financing

Equity financing refers to obtaining funds for a venture in exchange for ownership.

This is selling the stock at the start-up of the venture. Most entrepreneurs prefer this mode of

financing to depts as one is not needed to provide collateral or even repayment

(Harrison, 2019). In addition, such funds do not attract interest, and they sound like free

money to many entrepreneurs.

Other advantages of equity financing are having trusted advisors and mentors, equity

investors' business lessons and experience, and good potential board members. The most

common source of funds is the internal sources that result from the sale of assets, extending
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payment periods, profits, and reducing the working capital and account receivables.

However, before adopting this kind of financing, it is important to evaluate it based on the

three factors; the amount of cost involved, the period the funds will be available for the

venture, and the amount of control lost over the business. An ethical dilemma is the greatest

hindrance in obtaining such funds, especially with potential institutions and stakeholders

(Aldrich et al., 2018). Therefore, various considerations should be evaluated before making

such an agreement to avoid future confrontation on the company's control.

Venture capitalist

According to Greathouse in Forbes magazine, he defines venture capitalist is a

professional investor who provides funds that are considered third part in the early stages of

the Forbes company. A venture capitalist invests in start-up bossiness by providing the

required capital to start and run the business before making the profits. Such funding is

provided to ventures that have no sufficient funds to run the business in obtaining high

fortune returns. In most cases, venture capitalists are always looking for a big potential

market that is ready to accept the product in the venture, a strong management team, and a

unique product or service that is marketable (Wright,2018). In addition, venture capitalists

target ventures that are promising in the hope of obtaining a chance of owning a huge

percentage of the market to control such market directly. Venture capitalists spend most of

their time evaluating how many businesses they should invest in and which type of venture

they should engage in since this is the basis of their business.

The venture capitalist can invest outside equity from a professionally managed pool

of money. Venture capitalists get their finances from various entities and parties, such as

institutional investors who perform in venture capital organizations. A venture capital

organization consists of venture capitalists who co-manage one or more venture capitalist

funds (Stevenson,2017). They limit the number of partners due to the limited liability of the
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business nature, and they do not participate in the direct decision-making of the venture.

Therefore, venture capitalists decide what to invest in based on the entrepreneur's portfolio.

Since the life span of a venture capitalist is only limited to 10 years, they usually

possess more than one capital fund under the management in the entire firm's life. According

to Robbie and wright, venture capitalist invests in seed financing. In such investments,

venture capitalists usually plan for an exit before the investment as they try to instill the

contract details with the business owner (Harrison, 2019). The exit plan is a strategy to

minimize the personal animosity between themselves and the entrepreneur.

Initial public offering

According to Hirsch, the initial public offering is the first sale of stock to the public

by the business and equity owners in addition to small and young companies through the sale

and offer of some of the company's shares in the public market through registration statement

with a country's security commission in raising funds on the public market to expand. This is

more common to people as debentures or bonds. The initial public offering has various

advantages, including increased chances of a company to get future funds, a realization of

enhanced valuation through liquidity provision, and ease of obtaining When a venture gets

public, it is entangled in public trading. In the end, it gains value, which allows it to be

transferred and traded with ease among parties, leading to its availability at a wide range of

new equity capital.

The ease of being value transferable makes the business immediate to liquidate.

Consequently, the ease to liquidate makes the company's value higher than those ventures

that do not trade in the public market. However, the initial public offering has some

disadvantages: shareholders and disclosure pressures, high expenses, regulation of corporate

governance procedures and policies, and increased liability risk.

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Business angels

Business angels are friends, families, and other individuals who can be wealthy and

become private investors. These are people looking for new opportunities to invest in and

they usually use experts and advisors to make decisions on investments. According to Clercq,

business angels invest in new ventures. Most entrepreneurs are willing to invest their money

and have liquidated their businesses or are retired executives of huge organizations (De

Clercq et al., 2019). Business angels are interested in the development and expansion of

equity and share venture capitalists' profit (Hirsch et al., 2017). However, some of the

business angels are directly involved in the venture's operations to get an opportunity to

leverage their industry expertise and contacts or hatching expansion of a potential venture.

The most significant point here as an entrepreneur is to determine whether the business

angels' interest is to get profit or act as interest a mentor.

According to Clercq, business angels can either invest in a business that has a slow

growth rate which does not attract venture capitalists, or they can invest in a business in the

seeding stage with the hope of making the venture attract capital in the future with the

venture capitalist (De Clercq et al.2019). However, business angels do not compete with

venture capitalists o business deals. Business angels can be divided into professional,

micromanagement, enthusiast, corporate, and entrepreneur angels. A typical deal size of

$250,00 is ideal for a state with a time frame determined by the cash out of about 5 to 7 years

and an expected return of 35 to 50% at last (Harrison, 2019). The exit plan for such as

investment is usually traded sale since the growth rate for a backed business angel is low.

During such a strategy, the trade sale is mainly negotiated directly between the business angel

and the entrepreneur.

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Conclusion

For any entrepreneur who wishes to seek funding for a venture, whether an existing

or new one, deciding on the source of funds is vital as it determines the future existence of

such a venture. An entrepreneur must decide on such a vital step by evaluating alternatives in

the current market environment funding environment and observing the prototypes and

patterns that exist for a business environment. In adopting a funding strategy, it is also

important to consider the stage of the business life cycle. Therefore, an entrepreneur needs to

determine the availability time span and amount of funds present together with the growth

and sales of their venture. Thus, well seeking to source for finances, it is very key to make a

choice that aligns with the beliefs and strategies of the company to avoid future challenges

ethically.

In cases where an entrepreneur wants to remain in control of the venture, it is

important to consider sources of capital that do not interfere with the company's control. In

general, the funding of a business can be determined in three stages; financing at an early

stage, development or expansion stage of financing, and acquisition and leveraged buyout

stage of financing. The early stage of a venture includes; start-up and seed capital, followed

by development or expansion, which entails setting a few stages that need to be achieved. It

aims to develop profit and capital and prepare to go public. Acquisition and leveraged buyout

financing of a venture is the final stage in which a mature and grown company is owned and

controlled by another company. This happens when the company is bought from the present

owners, and all the outstanding stocks are also bought to take full control of the venture.
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