Entrepreneurial Financing
Handbook topic · Entrepreneurial Finance — innovative financing strategies for start-ups and growth
Every venture needs money before it earns enough to fund itself, and an international venture needs more of it, sooner. This week sorts the sources of finance into personal funds, bootstrapping, debt, equity (business angels, venture capital, IPOs), crowdfunding and other creative options, and shows what each one costs the founder in interest, ownership or control. You finish by turning that knowledge into the costed funding plan the Individual Report asks for.
The big question
Which mix of finance lets a young venture grow and go international without giving away more cost, risk or control than it must?
By the end of this week you can
- Explain why entrepreneurial firms need funding, using cash flow, capital investment and product development needs.
- Distinguish short-term from long-term finance and match each to the right business need.
- Tell apart personal funds, family and friends, bootstrapping, debt, equity and crowdfunding by what the provider receives and what the founder gives up.
- Compare business angels, venture capital and an IPO by stage, amount, expectations and involvement.
- Build a costed, staged funding plan for the Individual Report and justify each source with module theory.
Why international ventures need finance
Money arrives after costs do. Finance bridges that gap, and for a venture crossing borders the gap is wider.
“Finance is the lifeblood of every company.”
Zucchella, Hagen and Serapio (2018) argue that funding is particularly critical for international entrepreneurial ventures. Selling abroad adds costs before any foreign revenue arrives, and a young firm has little trading history to reassure lenders. Making the right financial decisions is therefore critical to the development, growth and sustained competitive advantage of the new venture.
The practical question is not only “how much money?” but “what kind of money, and when?” Different needs call for different sources, and each source comes with its own price: interest, a share of ownership, or a say in how the business is run.
Three recurring reasons push a young firm to raise money from outside its own sales.
Wages, rent and raw materials must be paid before customers pay for what they bought. Without cash to cover the gap, a firm with healthy demand can still stop trading.
Example — In the Week 9 tutorial scenario, retailers pay after 60 days while staff must be paid monthly, so production halts for lack of working capital.
Buildings, machinery and equipment cost more than a young firm generates from its operations, yet they are needed to produce at scale.
Example — The same start-up needs a USD30,000 automatic packaging machine to keep up with demand.
Some products take a long time to develop before they earn anything. The costs of that development period have to be funded in advance.
Short-term and long-term finance
- Overdraft, short-term loans, trade credit, hire purchase, leasing, factoring, invoice discounting and credit cards (Zucchella, Hagen and Serapio, 2018).
- Used to finance current activities such as day-to-day operations (Hofstrand, 2022).
- Trade credit means suppliers let you pay later. Factoring and invoice discounting both release cash tied up in unpaid customer invoices.
- Initial equity, retained earnings, long-term loans, external equities, business angel funding and venture capital funding (Zucchella, Hagen and Serapio, 2018).
- Used to finance assets such as buildings and equipment (Hofstrand, 2022).
- Retained earnings are profits kept in the business rather than paid out, so they only exist once the firm is profitable.
A cash shortfall that will clear when customers pay is a short-term problem; a machine that will earn for years is a long-term one. Funding a long-life asset with an overdraft, or a temporary cash gap with a permanent sale of shares, creates avoidable cost or dilution.
The first money: personal funds, family and friends, bootstrapping
Before outsiders invest, founders usually rely on their own resources, the people closest to them and sheer thrift.
Six broad routes to start-up money. The first three draw on the founder’s own circle and ingenuity; the last three bring in outside providers.
The founder’s own savings and assets. Used by the vast majority of founders.
The second line of funding for new ventures. It can take the form of loans, investments or outright gifts.
The third source of seed money: avoiding external finance through creativity, thriftiness, cost cutting or any means necessary.
Borrowed money repaid with interest, from banks, government schemes or peer-to-peer lenders.
Money invested in exchange for ownership, from business angels, venture capital or public share sales.
Leasing, strategic partners, grants and non-traditional channels such as crowdfunding.
Forms personal funds can take (Hofstrand, 2022)
- Savings: the first place to look.
- Profit-sharing or early retirement funds the founder can draw on.
- Home equity loan: a loan backed by the value of the founder’s home minus any mortgage still owed. A house worth $250,000 with $160,000 outstanding gives $90,000 of equity to borrow against.
- Borrowing against a life insurance policy with a cash value (not term insurance). The loan reduces the policy’s face value and must be repaid before beneficiaries receive anything.
Hofstrand (2022) advises that a loan from relatives or friends should be as formal as one from a commercial lender: a written loan document stating the amount, the interest rate, repayment terms based on the start-up’s projected cash flow, and collateral in case of default. If family members take a share of ownership instead, the investment should be made with the same formality as for outside investors.
Bootstrapping methods (Zucchella, Hagen and Serapio, 2018)
- Buying used rather than new equipment.
- Leasing equipment instead of buying it.
- Minimising personal expenses and avoiding unnecessary business expenses.
- Sharing office space with other businesses and coordinating purchases with them.
- Obtaining payments in advance from customers.
- Applying for and obtaining grants.
In a funding plan, bootstrapping is not a source of cash so much as a reduction in the cash required. State which methods you will use and roughly what they save; the external amount you ask for then looks disciplined rather than inflated.
Debt financing: borrowing without giving up ownership
Debt keeps the business in the founder’s hands, but the lender must be repaid whatever happens.
Borrowing funds from creditors on condition that the amount borrowed is repaid, plus interest, at a specified future time. The lender’s reward is the interest.
Sources of debt
- Commercial bank loans and an overdraft facility (Zucchella, Hagen and Serapio, 2018). Most banks require a solid business plan, a positive track record and plenty of collateral, which start-ups rarely have. Once profit and loss statements, cash flow budgets and net worth statements exist, borrowing becomes easier (Hofstrand, 2022).
- Government loans to small businesses (Zucchella, Hagen and Serapio, 2018). Often the government guarantees repayment of a loan from a conventional lender, giving the lender assurance when the business has little collateral (Hofstrand, 2022).
- Peer-to-peer lending: lending directly between individuals that bypasses banks and other financial institutions, operated mainly on online platforms (Zucchella, Hagen and Serapio, 2018). It developed after the financial crisis, does not require collateral, and lower interest rates might be available.
- Commercial finance companies: an option when other commercial sources say no. They rely more on the quality of the collateral than on the firm’s track record, and their money usually costs more (Hofstrand, 2022).
- Bonds: debt issued by the company itself, which sets the interest rate and the maturity date. No principal is repaid until maturity, so the firm can apply the funds before paying them back (Hofstrand, 2022).
Secured and unsecured debt (Hofstrand, 2022)
- Backed by collateral: a valuable asset the lender can claim if the borrower defaults.
- Safer for the lender, so easier to obtain if the firm owns assets.
- No collateral behind it.
- Leaves the lender in a less secure position if the borrower defaults.
Advantages and disadvantages of debt financing (Zucchella, Hagen and Serapio, 2018)
- The founder retains ownership of the business.
- Debt can fuel growth.
- A high degree of flexibility.
- The business must repay the lender even if it runs into trouble.
- Qualifying for debt financing is sometimes very difficult.
If you propose a loan, show you can qualify for it: point to the collateral, trading record or government guarantee that makes it realistic, and show that projected cash flow covers repayments. A start-up with no history that simply “takes a bank loan” will look unconvincing.
Equity financing: angels, venture capital and going public
Equity is never repaid; instead the investor becomes a part-owner who shares in the profits and often in the decisions.
Exchanging a portion of the ownership of the business for a financial investment in it. The investor shares in the company’s profits; the investment is permanent and is not repaid by the company at a later date.
Three forms of equity investor
- Usually wealthy individuals who invest in entrepreneurial start-ups, in exchange for convertible debt or equity (Zucchella, Hagen and Serapio, 2018).
- Super angels invest in a portfolio of start-ups, for example Ashton Kutcher and Reid Hoffman.
- Can connect founders with venture capitalists, industry experts and professional managers.
- Often invest at an earlier stage and in smaller amounts than venture capitalists, sometimes with a mission or local economic development focus, yet still expect profitability and security and may make similar demands (Hofstrand, 2022).
- A professionally managed pool of equity capital (Zucchella, Hagen and Serapio, 2018).
- Brings high-value and industry-specific expertise, helps recruit capable management, and positions the venture for a strategic exit such as a buyout or IPO.
- Usually avoids initial financing unless management has a proven track record; prefers firms with significant founder investment, often already profitable, with a patent, proven demand or a protectable idea (Hofstrand, 2022).
- Hands-on: typically requires a seat on the board and sometimes the hiring of managers. Seeks substantial returns, can focus on short-term gain, and its objectives may conflict with the founders’.
- A company’s first sale of stock to the public, after which its shares trade on a major stock exchange (Zucchella, Hagen and Serapio, 2018).
- Reasons to go public: to raise capital, raise the company’s public profile, let existing shareholders cash out, and achieve business growth.
- Used when a firm has profitable operations, management stability and strong demand, which generally takes several years and one or more private funding rounds first (Hofstrand, 2022).
Venture capital firms build portfolios of high-risk, high-growth businesses. Many follow a 2-6-2 rule of thumb: of ten investments, two yield high returns, six yield moderate returns or just return the original investment, and two fail. To make the whole portfolio return the 25–30% a year they may look for, each investment must promise 50% or more (Hofstrand, 2022). A steady, modest business is simply the wrong fit.
How funding typically follows a venture’s growth
- 1Seed
Personal funds first, then family and friends, then bootstrapping to stretch them (Zucchella, Hagen and Serapio, 2018).
- 2Early stage
Business angels, who tend to invest earlier and smaller amounts than venture capitalists; debt becomes possible once assets or a guarantee exist (Hofstrand, 2022).
- 3Growth
Venture capital, which prefers proven management, significant founder investment and often existing profitability (Hofstrand, 2022).
- 4Maturity
An IPO, once operations are profitable, management is stable and demand is strong, usually after several years (Hofstrand, 2022).
Other equity details from the reading (Hofstrand, 2022)
- Common and preferred stock: common stockholders usually vote but are last in line for assets in bankruptcy; preferred stockholders generally cannot vote but receive a predetermined dividend first.
- Equity offerings: selling stock directly to the public; can raise substantial funds but needs careful legal oversight.
- Warrants: the right to buy stock at a pre-set price before an expiry date. Start-ups use them, for example in management pay packages, to encourage investment by limiting downside risk while keeping upside potential.
Crowdfunding and other creative sources
Non-traditional channels reverse the usual logic: many people giving small amounts instead of a few giving large ones.
Raising finance by asking a large number of people each for a small amount of money. It is a growing source of funding for start-ups and an example of a non-traditional channel for new venture funding.
Traditional finance asks a few people for large sums. Crowdfunding uses the internet to reach thousands of potential funders: the venture sets up a profile on a platform, then uses social media and its existing networks of friends, family and work contacts to draw backers in (UKCFA, n.d.). The type of crowdfunding decides whether backers become donors, lenders or owners.
| Type | What backers receive | Closest traditional source |
|---|---|---|
| Equity crowdfunding | Shares, or a small stake in the business, whose value rises or falls with its success. | Equity financing: the founder gives up ownership. |
| Reward-based crowdfunding | Rewards such as acknowledgements, event tickets, news updates or free gifts; returns are considered intangible and backers support a cause they believe in. | None: no repayment and no ownership given up. |
| Donation crowdfunding | Nothing in return; donors have a social or personal motivation. | Similar to a gift from family and friends. |
| Loan (debt) crowdfunding | Their money back with interest. Also called peer-to-peer lending; it bypasses banks. | Debt financing: repayment is required. |
Sources: Zucchella, Hagen and Serapio (2018); UKCFA (n.d.). The lecture lists four types; the UKCFA page groups donation and reward crowdfunding under one heading. Platforms named in the lecture: Kickstarter, Indiegogo, RocketHub, Companisto, Crowdcube, FundedByMe and Fundable.
Other creative sources
- Leasing: a written agreement under which a property’s owner lets others use it for a set period in exchange for payments (Zucchella, Hagen and Serapio, 2018). It gives use of an asset without debt or equity financing and without tying up funds; at the end the asset is returned, the lease renewed or the asset bought (Hofstrand, 2022).
- Strategic partners: a growing number of corporations run funding units or investment vehicles that take equity positions in entrepreneurial ventures. They may offer a longer-term horizon and strategic help such as branding and channel development; Unilever Ventures, for example, invests in promising new personal care ventures (Zucchella, Hagen and Serapio, 2018).
- Government grants and incentives: grants or tax credits for start-up or expanding businesses, and incentives to locate in certain communities or enter particular industries (Hofstrand, 2022).
Writing that a venture will “use crowdfunding” is imprecise. Say which type (equity, reward, donation or loan), what backers receive, and why it suits the venture. A consumer product with an enthusiastic community might suit reward-based crowdfunding; a venture ready to share ownership might suit equity crowdfunding.
Comparing sources and building your funding plan
Put the sources side by side, then match them to your venture’s costs and stages.
| Source | What it costs the venture | Control given up | Best stage fit | Pros | Cons |
|---|---|---|---|---|---|
| Personal funds | The founder’s own money at risk; interest if borrowed against a home or life policy. | None. | Seed: the first place to look. | Used by most founders; no outside claims on the business. | Limited by personal wealth; personal assets may be put at risk. |
| Family and friends | A low-interest loan, an ownership share, or a gift. | None for loans and gifts; some if they take equity. | Seed: the second line of funding. | Accessible when outsiders will not invest. | Needs the same formality as a commercial loan or outside investment. |
| Bootstrapping | No external cost; relies on thrift and creativity. | None. | Seed: the third source of seed money. | Avoids external finance entirely. | Stretches resources rather than adding large sums. |
| Bank loan or overdraft | Interest; collateral for secured loans. | None: ownership retained. | Once trading, with financial statements and collateral. | Retains ownership; flexible; can fuel growth. | Must be repaid even in trouble; hard for start-ups to qualify. |
| Government loan schemes and grants | Interest on guaranteed loans; grants are not repaid. | None. | Start-up or expansion. | A guarantee helps firms with little collateral borrow. | Limited to certain activities, communities or industries. |
| Peer-to-peer or loan crowdfunding | Interest to individual lenders; possibly lower rates. | None. | Start-up needing to bypass banks. | No collateral required; runs on online platforms. | Still has to be repaid with interest. |
| Business angels | Equity or convertible debt. | A share of ownership; may make demands similar to a venture capitalist. | Early stage; smaller amounts than VC. | Contacts with venture capitalists, experts and managers; sometimes mission-focused. | Dilutes ownership; still expects profitability and security. |
| Venture capital | An ownership share; high expected returns (50% or more per investment). | Board representation; sometimes hiring of managers. | Growth: proven management, often already profitable. | Expertise, management recruitment, positioning for a strategic exit. | Objectives may conflict with founders’; often focused on short-term gain. |
| Strategic (corporate) partner | An equity position for the corporation. | A share of ownership. | Ventures that fit the corporation’s field. | Longer-term horizon; help with branding and channel development. | Gives equity to a corporation with its own strategic interests. |
| Equity crowdfunding | Shares sold to many small investors. | A share of ownership spread across many backers. | Start-up and early stage. | Raises many small sums through online platforms and social networks. | Gives away ownership, like other equity. |
| Reward or donation crowdfunding | Rewards or nothing; no repayment. | None. | Start-up with a cause or product people want to back. | No repayment and no dilution. | Depends on persuading backers who believe in the cause. |
| Leasing | Lease payments, often due at the start of each year. | None. | Any stage needing equipment or premises. | Use of an asset without tying up funds. | The asset is not owned unless bought at the end. |
| Initial public offering | Shares sold to the public, with legal oversight. | Ownership spread among public shareholders. | Maturity: several years of profitable, stable operation. | Raises capital and profile; lets shareholders cash out. | Out of reach for start-ups. |
Built from Zucchella, Hagen and Serapio (2018), Hofstrand (2022) and UKCFA (n.d.). Where a cell interprets rather than quotes the sources (for example “stretches resources rather than adding large sums”), it follows directly from the source’s definition.
Building a funding plan with estimated amounts
- 1List what the money is for
Itemise the costs of your plan: set-up, equipment, working capital to cover the gap before customers pay, market entry costs for your chosen entry mode, and marketing. Hofstrand (2022) says to start with how much money you need and when you will need it.
- 2Estimate each amount honestly
Base figures on your own costings, supplier quotes or cited sources. Never invent market statistics; if a number is your estimate, say so and explain how you reached it.
- 3Split the plan into stages
Show what is needed at launch, for growth in the home market, and for the international step. The Week 7 entry mode you choose drives the size of the last stage.
- 4Separate short-term from long-term needs
Working capital suits short-term finance such as trade credit or an overdraft; equipment and premises suit long-term finance or leasing.
- 5Start with internal sources
State what personal funds, family and friends and bootstrapping will cover, and what bootstrapping saves.
- 6Match an external source to each remaining gap
Choose debt where you can show collateral or a guarantee, angels or crowdfunding for early-stage equity, venture capital only if the venture has high growth potential and a proven team, and grants where you qualify.
- 7State the price of each source
Say what each provider receives (interest, an equity share, board influence) and why that trade-off is acceptable for your venture.
- 8Present uses and sources in one table
One column lists uses of funds, the other sources of funds; both totals must match. Cite module theory for every choice.
The brief asks how you will fund your global expansion, naming sources such as angel investors, venture capital, crowdfunding and innovative funding platforms, with estimated amounts. In the module’s Good Sample 2, the writer itemised start-up costs to a total of £70,000 and matched them to an angel investor (£60,000) and crowdfunding for the rest. In Good Sample 1, the writer justified venture capital by its expertise and networks and acknowledged the equity it costs, but gave no amounts. Combine both: amounts plus a reasoned trade-off, supported by Zucchella, Hagen and Serapio (2018) rather than outside sources.
Listing every source “just in case”; proposing venture capital for a small firm with no high-growth story; assuming a bank will lend to a business with no trading record; and quoting a total without showing what it pays for.
Tutorial activities
Case Study 1: financing a manufacturing start-up
You have just graduated and, with help from family and friends, founded a start-up making fast-moving consumer goods (FMCGs). You bought machinery, rent a mini-factory and employ production, marketing and accounting staff and a cleaner, all paid monthly. Demand is high, but wholesalers and retailers buy on credit and pay after 60 days. A few months in, working capital has run out: production has stopped for lack of raw materials and month-end wages are due. You also need a USD30,000 automatic packaging machine, but banks have refused a loan because you cannot show five years of audited accounts. Read the tutorial resource “Sources of Finance for Start-up Businesses” first.
- 1.Discuss your options to address the immediate working capital challenge of the business. Note that you have already received support from family and friends.
- 2.You have now addressed the immediate working capital challenge. Explain how you will address the challenge of purchasing the USD30,000 packaging machine to help speed up your production process.
- 3.Given the high growth potential of the business, explain how you will finance the local expansion of the business at this early stage of the venture.
- 4.Explain your strategies for internationalising the venture. How will you finance this, and what market entry mode will be most appropriate in the short run and in the long run?
Case Study 2: The Ryla case
Read “The Ryla Case Study”, an investment case written by SJF Ventures about the US call-centre company it backed from 2002 until its exit in 2010.
- 1.Discuss the role of venture capital funding in the growth of Ryla. In your own opinion, would Ryla have achieved such remarkable growth without venture capital funding?
- 2.Explain why you think the CEO of Ryla was sceptical in the first place.
Video: What is crowdfunding?
Watch the UK Crowdfunding Association’s short video “What Is Crowdfunding?” shown in the tutorial, then read the UKCFA page it comes from.
- 1.How does crowdfunding reverse the traditional way of financing a venture?
- 2.What does a backer receive under each of the four types of crowdfunding?
- 3.Which type, if any, would suit the venture in your Individual Report, and what would you give up by using it?
Cases
Key terms
- Working capital
- The cash a business needs to run day-to-day operations, such as buying materials and paying wages, while waiting for customers to pay.
- Short-term finance
- Finance for current activities, such as an overdraft, trade credit, factoring, invoice discounting or credit cards.
- Long-term finance
- Finance for lasting assets and growth, such as initial equity, retained earnings, long-term loans, business angel funding and venture capital.
- Bootstrapping
- Avoiding external finance through creativity, thriftiness, cost cutting or any means necessary; the third source of seed money for a new venture.
- Debt financing
- Borrowing from creditors and repaying the amount plus interest at a specified future time; the founder keeps ownership.
- Secured debt
- Debt backed by collateral, an asset the lender can claim if the borrower defaults. Unsecured debt has no collateral.
- Equity financing
- Exchanging part of the ownership of a business for investment; permanent, not repaid, and shares in profits.
- Business angel
- A usually wealthy individual who invests in start-ups for equity or convertible debt, often earlier and in smaller amounts than venture capital.
- Venture capital
- A professionally managed pool of equity capital invested in young, high-growth businesses in exchange for ownership and usually board representation.
- Initial public offering (IPO)
- A company’s first sale of stock to the public, after which its shares trade on a stock exchange.
- Crowdfunding
- Raising finance by asking a large number of people each for a small amount of money; can be equity, reward, donation or loan based.
- Peer-to-peer lending
- Lending directly between individuals through online platforms, bypassing banks; also called loan or debt crowdfunding.
- Strategic partner
- A corporation that takes an equity position in a venture through its own funding unit, offering a longer-term horizon and strategic help.
- Lease
- An agreement giving use of an asset such as equipment or a building for set payments, without using debt or equity financing.
Check your understanding
Which statement defines equity financing precisely?
Flashcards
References and sources
As cited in the module materials. Check each against the original before using it in an assignment.
- Barringer, B.R. and Ireland, R.D. (2016) Entrepreneurship: Successfully Launching New Ventures. Upper Saddle River, NJ: Pearson.
- Hofstrand, D. (2022) Types and Sources of Financing for Start-up Businesses. Ag Decision Maker File C5-92 (reviewed March 2022). Available at: www.extension.iastate.edu/agdm.
- SJF Ventures (n.d.) Ryla: Investment Case Study. SJF Ventures.
- UKCFA (n.d.) What Is Crowdfunding? UK Crowdfunding Association. Available at: https://www.ukcfa.org.uk/what-is-crowdfunding/.
- Zucchella, A., Hagen, B. and Serapio, M.G. (2018) International Entrepreneurship. Cheltenham: Edward Elgar Publishing.
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External pages used