Most entrepreneurial ventures must find funding at some point during their existence. For this reason, developing a clear understanding of the various forms of funding available is essential to the success of an entrepreneurial business. A variety of financing alternatives exist, corporate venture capital, private venture capital, angel financing, and debt financing (Barringer & Ireland, 2008). Entrepreneurs need to have an understanding of when and what type to pursue based on the pros and cons. This presentation intends to illustrate what mode of financing is best for different models and when to initiate securing each type of investor.
Ventures that need cash flow to buy supplies and pay salaries early may need financing as well as those ventures that require capital investments (Barringer & Ireland, 2008). The last category of venture that requires outside capital financing is those that have a lengthy product development period.
Cash flow challenges are instances when an increased amount of cash is needed to serve customers properly (Barringer & Ireland, 2008). Spending exceeds income at the start of a business cycle. To prevent running out of money as the venture strives for profitability capital may be required.
Along the same lines, some ventures have large capital investment demands at their onset. If leasing or renting is not feasible a new firm may wish to secure alternative financing to buy equipment with debt financing before they can afford it outright on their earnings (Getzen, 2007).
The last reason a firm may need alternative financing is a lengthy product development cycle (Barringer & Ireland, 2008). This occurs with newly founded pharmaceutical companies developing new medicines. There may be a long period between when they open their doors to when they create can produce a profitable medicine.
Once a firm recognizes that they will need outside financing, they need to develop a plan (Barringer & Ireland, 2008). Many new business owners use their personal savings, tap into family and friends, or try to be very thrifty. For those that cannot do it on their own and need more money than they have available, a plan is in order. By analyzing cash flow statements and projected run rates, an owner can obtain a good estimate of the amount of money he or she will need. Then the owner has to determine whether to use equity financing, exchanging partial ownership of the company for funds, or debt financing, which is obtaining a loan.
If a new business venture decides on financing his plan should involve three steps (Barringer & Ireland, 2008). The first is to develop a short pitch to entice potential investors. The second is to develop a list of potential investors to engage. The last step is to prepare a presentation of the business plan to present for the investors if engaged. The presentation will be personalized for the type of business started, and for the type of financing sought after. Money early in the cycle of a business can be procured with equity financing, and a company later in the business cycle that is more developed can seek debt financing.
Private venture capital is money from individuals who invest in start-ups that offer high potential returns (Barringer & Ireland, 2008). The typical businesses that venture capital firms (VCs) invest in claim to have the potential for 30 to 40% annual returns. The typical venture capital firm is a limited partnership of money managers who have funds for investment. To qualify for a venture capital investment, a new business owner has to have a solid business plan that will offer the potential for high returns, and be willing to sacrifice partial ownership for the money. The advantages of venture capital investment is that large sums of money for a start-up can be obtained, compatible styles of management and personality can be sought, and risky ventures can receive financing. The disadvantages to venture capital money is that part of the ownership of the company and the potential profits has to be given up, and a detailed plan and model have to be and sold to the venture capital firm to receive any money.
Corporate venture capital firms are investments held by businesses (Barringer & Ireland, 2008). They typically invest in industries and start-ups that they are already involved in. Corporate venture capital firms typically do not loan money to outside entrepreneurs, but instead to those ventures that they are already involved in.
Business angels are individuals who invest their personal money in start-ups (Barringer & Ireland, 2008). This is similar to private venture capital firms, but on an individual basis and not as part of a separate business. The advantages of business angels are that they are willing to invest smaller amounts of money in smaller ventures. The disadvantage is that they also want partial ownership in the company, and will be rewarded for the firm’s success without actually doing any of the work.
Debt financing is obtaining a loan (Barringer & Ireland, 2008). Loans can be obtained from the small business association (SBA) and banks. Loans are money that is borrowed and has to be repaid with interest. Banks are not interested in risk. They will loan money to firms that have good cash flow, reviewed financial statements, good management, and assets. The advantages of loans are that a variety of interest rates can be negotiated and no ownership is forfeited. The disadvantage of debt financing is that start-ups are likely not to meet the requirements that the bank has established to loan money.
A variety of means of obtaining financing exists. Companies in the planning stages tend to seek out equity financing, as they are selling potential returns and plans (Getzen, 2007). Debt financing is better suited for existing businesses that have good financial histories and are low risk ventures. Each requires a well planned model and sales job of pitch to the investor/loaner to be successful. As a business owner, knowing when, how, and who to see when money is needed is half the battle. The other half is owning a successful idea and model.
References
ï§ Barringer, B.R. & Ireland, R.D. (2008). Entrepreneurship: Successfully launching new ventures. Upper Saddle Creek, NJ; Pearson Prentice Hall. ï§ Getzen, T. (2007). Health economics and financing (3rd ed.). Hoboken, NJ; John Wiley and Sons, Inc.