Chapter 6

Business Financing
6.1 Introduction

Businesses require financing for various reasons, such as acquiring capital assets or funding new
product development. Financing may come from internal or external sources, including short-
term loans to manage cash flow.

6.2 Financial Requirements

Businesses need funds for different purposes, categorized into:

 Permanent Capital – Long-term funding from equity investment, personal loans, or

share sales, used for startup costs and expansions.
 Working Capital – Short-term finance to manage operational expenses and bridge cash
flow gaps.
 Asset Finance – Medium-to-long-term funding for purchasing tangible assets like
machinery and buildings.

6.3 Sources of Financing

Businesses obtain financing through equity (internal) or debt (external) sources:

6.3.1 Internal Sources (Equity Capital)

 Personal Savings – Entrepreneurs invest their own money.

 Friends & Relatives – Support from personal networks.
 Partners – Joint investments with business partners.
 Public Stock Sale – Selling company shares to the public.
 Angel Investors – Wealthy individuals investing in startups.
 Venture Capital – Private firms funding high-growth businesses.

6.3.2 External Sources (Debt Capital)

 Commercial Banks – Short, medium, and long-term loans based on the "Five C’s of
Credit" (Capital, Capacity, Collateral, Character, Conditions).
 Microfinance Institutions – Loans for small businesses and low-income entrepreneurs.
 Trade Credit – Suppliers offering credit for goods purchased.
 Equipment Suppliers – Vendor financing for asset purchases.
 Accounts Receivable Financing – Loans secured against outstanding invoices.
 Credit Unions – Cooperative financial institutions providing loans.
 Bonds – Debt securities issued for long-term funding.
 Traditional Sources – Community-based financial systems like "Idir" and "Equib" in
Ethiopia.
Effective financial management ensures adequate funding, cash flow stability, and business
growth.

6.4 Lease Financing

Lease financing is a method of medium- and long-term financing where an asset owner (lessor)
grants a user (lessee) the right to use an asset in exchange for periodic payments (lease rentals).
Ownership remains with the lessor, while the lessee has usage rights.

Types of Lease

1. Finance Lease
o Transfers risks and rewards of ownership to the lessee without transferring
ownership.
o Consists of a primary period (non-cancellable, where the lessor recovers
investment) and a secondary period (low rental payments).
o Lessee is responsible for maintenance, and the lease is generally non-cancellable.
2. Operating Lease
o Lessor retains ownership risks and rewards.
o Shorter lease term compared to the asset’s economic life.
o Lessor provides technical support and maintenance.
o Lessee can terminate the lease with short notice, and the lessor must lease the
asset multiple times to recover investment.

Advantages and Disadvantages of Lease Financing

Advantages for the Lessor:

 Assured regular income from lease rentals.

 Ownership of the asset is retained.
 Tax benefits through depreciation.
 High profitability and growth potential.
 Full investment recovery in finance leases.

Disadvantages for the Lessor:

 Fixed lease rentals may become unprofitable during inflation.

 Double taxation may apply (purchase and lease).
 Lessees may not handle assets carefully, leading to potential damage.

6.5 Traditional Financing in Ethiopia (Iqub & Idir)

Despite having one of the least-developed formal financial sectors, Ethiopia boasts a rich
tradition of community-based financial systems, with Iqub and Idir playing a crucial role in
savings, credit, and insurance.
Iqub – A Traditional Savings & Credit System

Iqub is an informal savings and credit association where members contribute regularly, and the
pooled funds are distributed to participants in a rotating manner. It serves as a financial lifeline,
particularly for the "unbanked" population, offering:

 Access to capital for business expansion and personal needs.

 Higher returns in an economy with negative real interest rates.
 An alternative to predatory loan sharks, who charge exorbitant interest rates.

Iqub is deeply embedded in Ethiopia’s economy, even funding major construction projects in
Addis Ababa, filling gaps left by the formal banking sector.

Idir – A Community-Based Insurance System

Idir is a traditional burial society, ensuring financial support during family emergencies,
particularly funeral expenses. Some Idirs also provide assistance in cases of illness, home
destruction, or livestock loss, making them a vital social safety net.

The Significance of Traditional Financing

 Widely practiced – Iqub supports business growth, while Idir provides social security.
 Accessible & Trustworthy – These systems thrive where formal banks fail to reach.
 Drivers of Development – Iqub is financing Ethiopia’s small businesses and
infrastructure.
 Social Cohesion – Strengthens trust and cooperation within communities.

Despite being centuries old, Iqub and Idir remain cornerstones of Ethiopia’s financial system,
offering practical, reliable alternatives to modern banking.

6.6 Crowd Funding

Crowd funding is a modern way of raising capital through collective contributions from
individuals, primarily via online platforms. It contrasts with traditional financing, which relies on
banks, angel investors, or venture capitalists.

Benefits of Crowd Funding

 Wider Reach: Access to a broad network of potential investors.

 Better Presentation: Helps refine and clarify business goals.
 Marketing & PR: Creates awareness through social media and online campaigns.
 Concept Validation: Early feedback from potential backers.
 Efficiency: Streamlines fundraising through a single online platform.
Types of Crowd Funding

Crowd-funding has evolved into several distinct models, each catering to different needs and
objectives. Here’s a discussion of three popular types of crowd-funding: donation-based,
rewards-based, and equity-based crowd-funding.

1. Donation-Based Crowd-funding

In donation-based crowd-funding, individuals contribute money to a project or cause without

expecting any financial return or ownership stake. This model is often used to support charitable
causes, community initiatives, social projects, or personal needs.

Key Features:

 No Financial Return: Donors do not receive any monetary benefits; their contributions are
considered charitable donations.
 Social Impact: Typically geared towards projects that aim to create social good, such as
medical bills, disaster relief, or nonprofit initiatives.
 Emotional Appeal: Campaigns often rely on compelling storytelling to motivate people to
contribute, emphasizing the positive impact of their donations.

Examples:

Platforms like GoFundMe and JustGiving are popular for donation-based crowd funding,
enabling individuals and organizations to raise funds for various causes.

2. Rewards-Based Crowd-funding

Rewards-based crowd-funding allows backers to contribute to a project in exchange for non-

financial rewards, such as products, services, or exclusive experiences. This model is commonly
used by startups and creators who want to launch new products.

Key Features:

 Tangible Rewards: Contributors typically receive rewards related to the project, such as
early access to products, behind-the-scenes content, or branded merchandise.
 Incentives for Backers: The promise of specific rewards motivates individuals to pledge
funds, creating a sense of participation in the project.
 Market Testing: This model helps creators gauge market interest and gather valuable
feedback before full product launch.

Examples:

Kickstarter and Indiegogo are prominent platforms for rewards-based crowd-funding, where
creators showcase projects and offer tiered rewards based on contribution levels.
3. Equity-Based Crowd-funding

Equity-based crowd-funding allows individuals to invest in a company in exchange for equity or

shares in that business. This model enables startups and small businesses to raise capital while
giving investors a potential return on their investment.

Key Features:

 Ownership Stake: Investors receive equity, which means they can benefit financially from
the success of the business and may receive dividends.
 Regulatory Compliance: This type of crowd-funding is subject to securities regulations,
which can vary by country, often requiring businesses to meet specific legal standards.
 Access to Investment Opportunities: Individuals, including those who may not typically
qualify as accredited investors, can participate in funding startup ventures.

Examples:

Platforms like SeedInvest and Crowdcube specialize in equity-based crowd-funding, connecting

startups with investors who seek ownership stakes in promising businesses.

Conclusion

Each type of crowd-funding serves distinct purposes and caters to different audiences. Donation-
based crowd-funding focuses on charitable initiatives, rewards-based crowd-funding engages
backers with tangible benefits, and equity-based crowd-funding offers investment opportunities
in exchange for ownership stakes. Understanding these types can help project creators choose the
best model for their fundraising needs.

6.7 Microfinance

Microfinance refers to financial services such as loans, savings, insurance, and fund transfers
provided to individuals, small businesses, and entrepreneurs who lack access to traditional
banking services. It plays a crucial role in financial inclusion, particularly for the economically
underserved.

6.7.1 What is Microfinance?

Microfinance provides small loans and other financial services to individuals and businesses
without requiring high collateral. It helps marginalized communities, particularly in developing
countries, by offering:

 Microloans – Small loans for business or personal needs.

 Savings Accounts – Secure places to store money.
 Insurance – Protection against financial risks.
 Fund Transfers – Facilitating transactions and payments.
Dr. Mohammad Yunus pioneered modern microfinance by offering small loans to women in
Bangladesh to break their dependence on predatory lenders. His efforts led to the establishment
of Grameen Bank in 1983 and earned him the Nobel Peace Prize in 2006.

6.7.2 Importance of Microfinance Institutions (MFIs)

MFIs provide financial resources to underserved populations, reducing reliance on high-interest

loans and informal borrowing. Key benefits include:

 Financial Inclusion – Access to banking for marginalized individuals.

 Business Growth – Enables entrepreneurs to expand their ventures.
 Poverty Reduction – Supports self-employment and income generation.
 Women Empowerment – Women constitute the majority of microfinance borrowers,
particularly in rural areas.

However, microfinance faces criticism:

 Some argue it has lost its original mission, with borrowers using loans for daily expenses
instead of business investments.
 In some cases (e.g., South Africa), a high percentage of loans are used for consumption
rather than income generation, leading to a cycle of debt.
 Despite challenges, microfinance has a high repayment rate, indicating its potential
effectiveness when implemented correctly.

6.7.3 Microfinance in Ethiopia

Ethiopia’s microfinance system evolved from informal savings and credit practices to formal
institutions established under Proclamation No. 40/1996. As of 2018, Ethiopia had more than
38 MFIs, making it one of Africa’s success stories in microfinance. The industry focuses on
poverty alleviation by providing sustainable financial services to those excluded from
traditional banking.

Major Ethiopian MFIs (holding over 90% market share):

1. Amhara Credit and Savings Institution (ACSI) S.C.

2. Dedebit Credit and Savings Institution (DECSI) S.C.
3. Oromiya Credit and Savings Institution (OCSCO) S.C.
4. Omo Credit and Savings Institution S.C.
5. Addis Credit and Savings Institution (ADCSI) S.C.

6.7.3.1 Activities of Ethiopian MFIs

Under Ethiopian law, MFIs can engage in the following:

 Accepting voluntary and compulsory savings, as well as deposits.

  Providing credit to small-scale rural and urban entrepreneurs.
 Offering micro-insurance services.
 Investing in income-generating financial instruments (e.g., treasury bills).
 Acquiring and managing property for business operations.
 Supporting income-generating projects for micro and small enterprises.
 Providing business advisory services (marketing, management, finance).
 Managing funds for micro and small businesses.
 Facilitating money transfer and financial leasing services.

Microfinance in Ethiopia continues to grow, supported by government policies and

developmental organizations. While challenges remain, the sector has significantly contributed to
financial inclusion and poverty reduction in the country.

CHAPTER 7

MANAGING GROWTH AND TRANSITION

7.1 Introduction
This chapter addresses the transition of entrepreneurs from resource mobilization in the initial
stages to more formal management and leadership as their businesses grow. Success hinges on
both controllable and uncontrollable factors, especially in challenging environments like
Ethiopia. Key themes include managing growth, business ethics, and corporate social
responsibility.

7.2 Timmons Model of Entrepreneurship

The Timmons model, developed by Jeffry Timmons, emphasizes three critical components for
entrepreneurial success: opportunities, teams, and resources.

1. Opportunities: Entrepreneurs should prioritize identifying viable market opportunities over

creating perfect business plans. Successful ventures arise from recognizing and capitalizing
on these opportunities.

2. Teams: Forming a strong, diverse team is essential to leverage identified opportunities. Each
member's strengths and roles contribute to the team's overall effectiveness.

3. Resources: Managing both tangible and intangible resources is crucial for success.
Entrepreneurs must balance these elements creatively and effectively to transform
opportunities into viable businesses.

The model promotes an opportunity-driven approach, highlighting that the entrepreneurial

process is dynamic and interconnected.
7.3 New Venture Expansion Strategies
As businesses grow, they face both opportunities and challenges, including increased financial
prospects, managerial complexities, and the need for new strategies. Effective management of
growth requires a clear understanding of long-term objectives. Common methods for small
business expansion include:

 Acquisitions of smaller businesses

 Franchising
 Licensing intellectual property
 Establishing distributorships
 Exploring new marketing avenues
 Joining industry cooperatives
 Public stock offerings
 Employee stock ownership plans

Successful growth begins with assessing strengths and weaknesses, identifying market
opportunities, and developing structures and processes to enhance capabilities, leading to
strategic long-term planning.

7.3.3 The Ansoff Matrix – Growth Strategy

The Ansoff Matrix is a strategic tool for developing growth strategies by examining existing and
new markets and products. Created by Igor Ansoff, it outlines two main approaches for growth:
product growth (changing what is sold) and market growth (changing who it is sold to).
Companies often pursue suboptimal paths when seeking growth, as illustrated by Bill Ford's
reflections on diversification.

Four Growth Strategies in the Ansoff Matrix:

1. Market Penetration/Consumption:
 Focuses on increasing market share with existing products in current markets.
 Low risk due to familiarity with the product and market.
 Strategies include promotions, pricing adjustments, and enhancing distribution. For
example, increasing toothpaste usage by modifying toothbrush design to encourage
more purchases.
2. Market Development:
 Involves selling existing products to new market segments.
 Medium to high risk; assumes existing markets are saturated.
 Approaches include entering new geographical markets, using new distribution
channels (e.g., e-commerce), repackaging products, or adjusting pricing strategies. An
example is Guinness expanding its market from colder climates to African countries.
3. Product Development:
  Introduces new products or modifies existing products for current markets.
 Medium to high risk due to uncertainty about new product acceptance.
 This strategy can involve enhancing product features or introducing complementary
products, like car manufacturers offering new parts to existing customers.
4. Diversification:
 The most risky strategy, involving new products for new markets.
 There are two types:
 Related Diversification: Staying within the same industry, e.g., a cake
manufacturer branching into fresh juice.
 Unrelated Diversification: Entering completely different industries, like Richard
Branson's Virgin Group expanding into entertainment, travel, and food.

Businesses must carefully assess the risks and potential gains before pursuing diversification,
ensuring they have a clear understanding of their objectives and the market dynamics involved.

7.3.4 Expansion Issues

As businesses pursue growth, they encounter various challenges that can complicate their
expansion efforts. Understanding and managing these issues is crucial for sustainable success.

I) Growing Too Fast

Rapid growth can overwhelm entrepreneurs, leading to operational difficulties. When demand
outpaces production capacity, businesses may struggle to maintain quality and service. Effective
research and long-term planning are essential to mitigate the risks associated with hyper-growth.

II) Recordkeeping and Infrastructure Needs

Expanding businesses must establish or upgrade systems for cash flow monitoring, inventory
management, financial tracking, and human resources. Improved communication systems are
also necessary to support various operations effectively.

III) Expansion Capital

Growth often requires additional financing, which can be challenging to secure without proper
planning. Revising the business plan annually and updating marketing strategies can help
entrepreneurs secure funding on favorable terms.

IV) Personnel Issues

Hiring new staff is essential to meet the demands of expansion, but it requires careful selection to
ensure a good fit. Growth can create opportunities for existing employees to advance, but it may
also lead to the departure of those who prefer the previous, more intimate company culture.
V) Customer Service

Maintaining high-quality customer service during growth is crucial but can be challenging as
workloads increase. Overwhelmed staff may struggle to respond promptly to clients, risking
customer retention and new business opportunities. Adequate staffing is key to sustaining service
levels.

VI) Disagreements among Ownership

As businesses grow, ownership dynamics can become strained. Divergent visions for the
company’s future or differing contributions from co-founders may necessitate tough decisions,
including the departure of partners who no longer align with the company’s needs.

VII) Family Issues

Aggressive expansion often requires significant time and financial investment from owners,
which can strain family relationships. Entrepreneurs must balance their commitment to business
growth with family responsibilities, especially as their personal lives evolve.

VIII) Transformation of Company Culture

As companies expand, maintaining the foundational values established in the early days can
become challenging. Owners must actively communicate and reinforce these values to prevent a
shift in company culture that diverges from its original mission.

IX) Changing Role of Owner

With growth, the owner’s role must evolve from hands-on management to strategic leadership.
Entrepreneurs need to delegate day-to-day operations and may require external expertise in areas
like accounting and legal matters to navigate the complexities of a larger business.

To conclude, navigating the challenges of business expansion requires foresight, adaptability,

and a willingness to evolve both personally and organizationally. By addressing these issues
proactively, entrepreneurs can foster sustainable growth while maintaining the core values and
culture that contributed to their initial success.

7.3.5 Choosing not to Grow

Small business owners often decide against expanding their operations, even when ample
opportunities are available. For many of these entrepreneurs, the greatest joys of owning a
business—such as close interactions with customers and employees—tend to diminish as the
business grows and the owner's role evolves. Many would rather limit growth than sacrifice
those joys. Additionally, some successful small business owners prefer to avoid the challenges
that come with increasing staff size and other complications. Many also choose to keep their
operations at a certain level to allow time for family and other interests that would otherwise be
dedicated to expansion efforts.

Small business owners may opt not to expand despite having opportunities due to the
diminishing satisfaction from customer and employee interactions as the business grows. Some
prefer to avoid the challenges that come with increased staff and complexity, while others choose
to maintain their current operations to prioritize family and personal interests over expansion.

7.4 Business Ethics and Social Responsibility

7.4.1 Introduction

Business organizations are expected to operate sustainably and ethically, guided by evolving
theories that reflect changes in business practices and societal expectations.

7.4.2 Three Approaches to Corporate Responsibility

Traditionally, corporations have focused primarily on profit-making, driven by stockholder

theory. However, as businesses recognize their broader responsibilities, business ethics expand to
include various social and civic obligations. Three key theoretical approaches emerge:

1. Corporate Social Responsibility (CSR):

CSR encompasses both the obligation to generate profit and the commitment to engage
ethically with the community. It includes producing reliable products, charging fair prices,
paying fair wages, and addressing environmental and social concerns. CSR consists of four
main obligations:

 Economic Responsibility: Businesses must generate profits to survive, as profitability is

essential for sustainability.
 Legal Responsibility: Companies should comply with laws and regulations, viewing
these as proactive duties rather than mere boundaries to be tested.
 Ethical Responsibility: Businesses should act ethically, doing what is right even when
not legally required, fostering a corporate culture that views the business as a societal
citizen.
 Philanthropic Responsibility: Companies are encouraged to contribute to societal
projects beyond their immediate business interests, supporting community welfare
through voluntary acts of generosity.

These approaches illustrate the evolving expectations of businesses to balance profit-making

with ethical and social responsibilities, recognizing their role in the broader community.

2. The Triple Bottom Line

The triple bottom line is a corporate social responsibility framework that encourages businesses
to evaluate their performance not only in economic terms (profits vs. costs) but also in social and
environmental contexts. This approach emphasizes three key areas, each requiring separate
reporting and sustainable outcomes:

1. Economic Sustainability:
 Focuses on long-term financial stability rather than short-term profits. Companies are
encouraged to create sustainable business plans that prioritize enduring success over
speculative ventures, which may lead to quick gains but also significant risks.
2. Social Sustainability:
 Advocates for balance in society, ensuring that wealth and opportunities are
distributed more equitably. It highlights the importance of fair trade practices and
maintaining dignity in work, emphasizing that businesses should contribute positively
to the communities they affect. Social sustainability also involves fostering healthy
relationships with community members and addressing their needs.
3. Environmental Sustainability:
 Recognizes the finite nature of natural resources and the necessity for conservation.
Companies are urged to minimize pollution and actively participate in restoring and
maintaining the environment, ensuring that future generations can enjoy a healthy
planet.

The triple bottom line promotes the idea that businesses should act as responsible citizens in their
communities, balancing profit-making with ethical considerations and sustainable practices.

3. Stakeholder Theory
Stakeholder theory, proposed by Edward Freeman, shifts the focus from the corporation to the
individuals and groups affected by its actions. It emphasizes that stakeholders—those impacted
by a company’s operations—have legitimate claims and rights regarding business decisions. Key
aspects include:

 Identifying Stakeholders: Stakeholders can include company owners, employees,

customers, suppliers, local communities, creditors, and government entities. Their interests
must be considered in corporate decision-making.
 Collective Bottom Line: The purpose of a firm, under this theory, is to maximize overall
human welfare rather than just profits for shareholders. Managers are tasked with balancing
the interests of all stakeholders and ensuring that decisions benefit the broader community.
 Transparency: Stakeholder theory advocates for clear communication about corporate
actions and their potential impacts, ensuring that stakeholders are informed and can
participate in decision-making processes.
Overall, stakeholder theory encourages businesses to recognize their broader responsibilities and
engage with those affected by their operations, fostering a more inclusive approach to corporate
governance.

7.4.3 Business Ethics Principles

Business ethics principles guide managers in ethical decision-making, establishing standards for
acceptable behavior in the corporate environment. Here are the key principles that leaders should
adhere to:

1) Honesty: Ethical executives are truthful and transparent in all dealings, avoiding deception
through misrepresentation or selective omission.
2) Integrity: They act with personal integrity, standing firm in their convictions even under
pressure, and ensuring their actions align with their principles.
3) Promise-Keeping & Trustworthiness: Ethical executives honor their commitments,
communicate openly about relevant information, and avoid technicalities to rationalize non-
compliance.
4) Loyalty: They demonstrate loyalty to colleagues and the organization, maintaining
confidentiality and making independent judgments free from conflicts of interest.
5) Fairness: Ethical leaders are just and equitable in their dealings, showing commitment to
justice, equal treatment, and openness to admitting errors and adjusting their views.
6) Concern for Others: They exhibit compassion and kindness, adhering to the Golden Rule by
helping others and striving to achieve business goals with minimal harm.
7) Respect for Others: Ethical executives uphold the dignity and rights of all stakeholders,
treating everyone with courtesy and respect, regardless of their background.
8) Law Abiding: They comply with all laws, regulations, and industry standards governing
their business activities.
9) Commitment to Excellence: Ethical leaders pursue excellence by staying informed,
prepared, and continually improving their proficiency.
10) Leadership: They recognize the impact of their leadership role and strive to be ethical role
models, fostering an environment that values principled reasoning.
11) Reputation and Morale: Ethical executives work to protect the company’s reputation and
maintain employee morale, taking action to address any misconduct.
12) Accountability: They acknowledge their responsibility for the ethical implications of their
decisions and actions, holding themselves accountable to their colleagues, the organization,
and the community.

By embodying these principles, corporate leaders can cultivate ethical cultures within their
organizations and positively influence their stakeholders and communities.