This topic provides an overview of the financing process for entrepreneurial firms. For these types of businesses there is likely to be an equity finance gap due to a lack of available risk capital. Sources of financing can include banks, financing firms, insurance companies and trade creditors that provide debt financing against either tangible assets or cash flow.
One of the most common sources of financing is bootstrapping, or the funding of growth via retained profits and cash flow. A critical issue for entrepreneurs is to ensure that they have sufficient working capital (e.g. liquid assets and cash) within the business to fund daily operations and growth.
Debt financing is typically obtained from banks while equity financing is secured from investors who can be either private, informal sources such as family and friends, or business angels (high net worth individuals willing to invest in a small firm). Bootstrapping offers lower risk and greater control than debt financing and does not dilute equity as is the case with equity financing. Entrepreneurs seeking to fund using bootstrapping need to understand the difference between cash and profit. A business might be profitable, but if it cannot access good cash flow it might still face financial ruin.
Debt financing can be short, medium or long term in nature and usually requires the borrower to show a good trading history, strong cash flows and the ability to underwrite any borrowings against collateral such as property or fixed assets. Banks are competitive and borrowers should shop around but should also cultivate a good working relationship with their banker before they need to raise money.
Entrepreneurs seeking to raised venture capital need to prepare a sound business case and be willing to surrender equity and control over their business in order to secure faster growth. Equity financing is not usually available to entrepreneurs unless they have a strong technology base or the ability to grow rapidly.
A venture financier takes equity in the business with the expectation of a high rate of return. Venture capital moves through a series of distinct stages, usually with higher levels of actual funding but lower levels of risk and return.
A major problem facing small, entrepreneurial firms is a lack of early-stage seed capital investment. This is typically available only from informal sources such as family and friends, or perhaps business angel investors. Venture capital remains highly important to economic growth.
Textbooks and readings
Golis, C. (2002). Enterprise and Venture Capital: A Business Builder's and Investor's Handbook, 4th edn. Sydney, Allen & Unwin.
Jones, A. (2008). "Venture Capital in Australia." Chemistry in Australia 75(6): 12-14.
Mason, C. and Stark, M. (2004). "What do Investors Look for in a Business Plan?: A Comparison of the Investment Criteria of Bankers, Venture Capitalists and Business Angels." International Small Business Journal 22(6): 227-248.
Sapienza, H. J., and De Clercq, D. (2000). "Venture Capitalist-Entrepreneur Relationship in Technology-Based Ventures." Enterprise & Innovation Management Studies 1(1): 57-71.