PHILIPPINE COLLEGE OF SCIENCE AND TECHNOLOGY
Old Nalsian Road, Nalsian, Calasiao, Pangasinan, Philippines 2418
Tel. No. (075)522-8032/Fax No. (075)523-0894/Website: [Link]
ISO 9001:2015 CERTIFIED, Member: Philippine Association of Colleges and Universities (PACU),
Philippine Association of Maritime Institutions (PAMI)
Module 4: The financial Aspect of
Entrepreneurship
Lesson 1: The Entrepreneurial Finance
What is Entrepreneurial Finance
Entrepreneurial finance is the process of making financial decisions for new ventures
(i.e. startups). New ventures are inherently different from established ventures, as are
entrepreneurs inherently different from conventional business managers. The financial
decisions faced by each are starkly different as well.
Entrepreneurs face very different finance challenges than do corporate
managers. The most obvious, which most entrepreneurs are familiar with, is
“financing." To the average entrepreneur, this means simply "finding money.” It is this
process of finding investors that tends to consume nearly all of the focus of most
entrepreneurs. While extremely important, it is not the only financial decision that an
entrepreneur face.
Corporations can sell financial claims (capital stock) in the public market at market
rates. They can also often fund projects through allocation of internally generated
funds. New ventures, on the other hand, do not have a market for their financial claims,
and thus must raise funds for projects from investors.
The Problem on Entrepreneurial Finance
Depending on the industry and aspirations of the entrepreneur(s) they may need to
attract money to fully commercialize their concepts. Thus, they must find investors –
such as their friends and family, a bank, an angel investor, a venture capital fund,
a public stock offering or some other source of financing.
When dealing with most classic sources of funding, entrepreneurs face numerous
challenges: skepticism towards the business and financial plans, requests for large
equity stakes, tight control and managerial influence and limited understanding of the
characteristic of growth process that start-ups experience.
On the other hand, entrepreneurs must understand the four basic problems that can
limit investors' willingness to invest capital:
1. Uncertainty about the future: in terms of start-ups development possibilities,
market and industry trends. The greater the uncertainty of a venture or project,
the greater the distribution of possible outcomes.
2. Information gaps: differences in what various players know about a company's
investment decisions.
3. "Soft Assets": these assets are unique and rarely have markets that allow for
the measure of their value. Thus, lenders are less willing to provide credit
against such an asset.
4. Volatility of current market conditions: financial and product markets can
change overnight, affecting a venture's current value and its potential
profitability.
PHILIPPINE COLLEGE OF SCIENCE AND TECHNOLOGY
Old Nalsian Road, Nalsian, Calasiao, Pangasinan, Philippines 2418
Tel. No. (075)522-8032/Fax No. (075)523-0894/Website: [Link]
ISO 9001:2015 CERTIFIED, Member: Philippine Association of Colleges and Universities (PACU),
Philippine Association of Maritime Institutions (PAMI)
Sources of entrepreneurial financing
Financial bootstrapping
Financial Bootstrapping is a term used to cover different methods for avoiding using
the financial resources of external investors. It involves risks for the founders but
allows for more freedom to develop the venture. Different types of financial
bootstrapping include Owner financing, sweat equity, Minimization of accounts
payable, joint utilization, minimization of inventory, delaying payment, subsidy finance
and personal debt.
External financing
Businesses often need more capital than owners are able to provide. Hence, they
source financing from external investors: angel investment, venture capital, as well as
with less prevalent crowdfunding, hedge funds, and alternative asset management.
While owning equity in a private company may be generally grouped under the
term private equity, this term is often used to describe growth, buyout or turnaround
investments in traditional sectors and industries.
Business angels
A business angel is a private investor that invests part of his or her own wealth and
time in early-stage innovative companies. It is estimated that angel investment
amounts to three times venture capital. Its beginnings can be traced to Frederick
Terman, widely credited to be the "Father of Silicon Valley" (together with William
Shockley), who invested $500 to help starting up the venture of Bill Hewlett and Fred
Packard.
Venture capital
Venture capital is a way of corporate financing by which a financial investor takes
participation in the capital of a new or young private company in exchange for cash
and strategic advice. Venture capital investors look for fast-growing companies with
low leverage capacity and high-performing management teams. Their main objective
is to make a profit by selling the stake in the company in the medium term. They expect
profitability higher than the market to compensate for the increased risk of investing in
young ventures. In addition to this, there are also corporate venture capitalists
(Corporate venture capital) that strongly focus on strategic benefits.
Key differences between business angels and venture capital:
1. Own money (BA) vs. other people's money (VC)
2. Fun + profit vs. profit
3. Lower vs. higher expected IRR
4. Very early stage vs. start-up or growth stage
5. Longer investment period vs. shorter investment horizon
Buyouts
Buyouts are forms of corporate finance used to change the ownership or the type of
ownership of a company through a variety of means. Once the company is private and
freed from some of the regulatory and other burdens of being a public company, the
central goal of buyout is to discover means to build this value*. This may include
refocusing the mission of the company, selling off non-core assets, freshening product
PHILIPPINE COLLEGE OF SCIENCE AND TECHNOLOGY
Old Nalsian Road, Nalsian, Calasiao, Pangasinan, Philippines 2418
Tel. No. (075)522-8032/Fax No. (075)523-0894/Website: [Link]
ISO 9001:2015 CERTIFIED, Member: Philippine Association of Colleges and Universities (PACU),
Philippine Association of Maritime Institutions (PAMI)
lines, streamlining processes and replacing existing management. Companies with
steady, large cash flows, established brands and moderated growth are typical targets
of buyouts.
There are several variations of buyouts:
1. Leveraged buyout (LBO): a combination of debt and equity financing. The
intention is to unlock hidden value through the addition of substantial amounts
of debt to the balance sheet of the company.
2. Management buyout (MBO), Management buy in (MBI) and Buy in
management buyout (BIMBO): private equity becomes the sponsor of a
management team that has identified a business opportunity with a price well
above the team's wealth. The difference is in the position of the purchaser: the
management is already working for the company (MBO), the management is
new (MBI) or a combination (BIMBO).
3. Buy and built (B&B): the acquisition of several small companies with the
objective of creating a leader (highly fragmented sectors such as supermarkets,
gyms, schools, private hospitals).
4. Recaps: re-leveraging of a company that has repaid much of its LBO debt.
5. Secondary Buyout (SBO): sale of LBO-company to another private equity firm.
6. Public-to-private (P2P, PTOP): takeover of public company that has been
'punished' by the market, i.e. its price does not reflect the true value.
In conclusion, the matter of financing for a startup is not the only issue that
distinguishes “entrepreneurial finance” from other more mature forms of business
finance. It is highly recommended you look into the matter carefully and conduct your
own research to learn about other financial realities faced by the entrepreneur when
contemplating a start-up.
