Entrepreneurship

Sources of Financing
for New Ventures

McGraw-Hill/Irwin – 10th Edition

Copyright © 2013 by The McGraw-Hill Companies, Inc.
All rights reserved
 Module Focus
This module will focus on:

• Introducing the key sources of finance for a

new business venture

• Introducing the financing needs at different

business development phases

• Introducing debt and equity financing

implications for a new own venture
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 Financing New Venture
• In financing a new venture creation and growing the new
business, an entrepreneur can tap into two key financing
approaches:
– debt financing
– equity financing

• Debt financing involves the business owners borrowing

a fixed sum of money from a lender, which have to be
paid back over a period of time with additional charges
(interest or administrative fee)

• Qualifying for the borrowings often requires some form

of collateral (e.g. land, buildings) or ‘safety net’ to protect
the financier in case of non-payment. 3
 Financing Own New Venture

• Equity financing primarily involves the sale of

a percentage of the business to an investor, in
exchange for capital.
• Parties who provide equity financing expect to
earn:
– Yearly dividends from business profits
– High return on investment upon selling back the
shares after a period of business growth

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 Implications of Debt & Equity Financing

DEBT EQUITY
Requirements Profitability, collateral High growth potential

Ownership Keep 100% ownership Giveaway percentage of ownership

Rates Interest may be high; payment No pressure to make early returns

begins almost immediately

Predictability Predictable repayments Unpredictable payments and exit

Oversight Minimal oversight Investors need reporting, may get

involved in decision-making
Cash flow Monthly payments deplete cash Dividend payments depend on
flow profitability
Risks There’s always a risk of losing the Investors take on almost all the
assets pledged as collateral risks

©Fauziah Pawan, Sept 2012 (ENT 530) 5

 Sources of Finance
• Financing for a new own business can come from
both internal and external sources.

• Some of the key sources of financing are:

– Personal funds
– Family & friends
– Angel financing
– Bank Term Loans
– Venture capital financing
– Government loans & grants
– Bootstrap financing

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 Entrepreneur Own Funds

• All new ventures start with an initial capital

contribution by the entrepreneur(s)

• The entrepreneur’s own contribution or personal

funds is regarded as equity financing that is reflected
in the ownership of the business

• Most new ventures however need more capital to

operate than what the entrepreneur is able to
commit or make available.
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 Funds from Family & Friends

• It is not uncommon for a new entrepreneur to rely on family and

friends to raise more initial capital for a business start-up

• The contribution from family and friends are often limited but is
more easily obtainable at the early stages of business start-up
because :
– They know the entrepreneur and
– They want to support his undertaking especially when they think the
business has growth potential.

• Friends and family capital contribution is likely to be in the form

of equity financing that gives them ownership in the business
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 Business Angels

• Provide capital for a business start-up in return for equity

in the business

• Most angel investors are successful entrepreneurs and

retired executives that want to get involved in helping
small start-ups succeed, by offering private financing and
sometimes, valuable expertise & experience as well

• Angels assume high risks by providing capital at very early

stages of business start-up and normally look for a 30-
40% desired return on investment (ROI) or 5-7 times ROI

• Angels also have to have patience in realizing their ROI 9

 Business Angel…cont.
• Business angels invest their funds and sometimes
organize themselves into groups or networks to share
information & contacts (e.g. Virtuous Investment
Circle, MBAN - Malaysian Business Angels Network)

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 Venture Capital Financing

• Venture capital can be defined as a pool of

equity capital that come from different
individuals or groups of individuals who
want to invest in high growth businesses for
high returns

• Unlike angel investors that invest their own

funds, venture capital is invested by firms or
companies that use other people's money.
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 Venture Capital Financing…cont.
• While venture capital funds are found in a diverse
range of business sectors, they tend to focus on
high potential, innovation & technology-centered
businesses

• The amount of capital can start at RM 1 million

for early growth financing and extend to RM20
million at later stages

• Provide managerial and technical expertise

alongside the capital investment
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 Bank Term Loans
• Commercial banks offer an important source of financing in
the form of term loans (short & long-term loans)

• Bank loan is a form of debt financing that requires the

business to repay the loan in progressive payments with
additional interest fees over a period of time

• Banks are generally cautious about approving loans

particularly to new ventures

• Once the business has progressed to a more stable stage with

definite financial records to show repayment capabilities,
banks will be a more viable source of finance
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 Bank Term Loans…cont.
• Entrepreneurs wanting to access bank loans need to have
some sort of tangible collateral or surety (guarantor)

• Collateral can be in the form of:

– assets of the business (e.g. land, equipment, business premise
or building)
– entrepreneur’s personal assets ( own house, landed property,
vehicles)
– guarantor assets

• In case of non-payment of any loans, the bank holds the

right to forfeit the collateral to cover outstanding
amounts
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 Government loans & grants

• Government offers financial assistance in the form of loans

& grants at all level of business development

• Government financial assistance serve more an economic

or social development purpose, than for the purpose of a
profitable return on investment

• For that reason, financing from government sources

normally incur a comparatively lower interest rate or fee
(for loans) or are in the form of one-time cash payouts with
no repayment necessary (grants)

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 Government loans & grants…cont.
• Government financial assistance are primarily channeled
through public agencies established to serve specific purposes
or sectors
– For instance, Cradle Fund Sdn Bhd (Cradle) is an agency under the
Ministry of Finance responsible to manage a RM100 million fund
dedicated to funding innovation & technology ventures in the country

• Government also tap into established financial institutions like

commercial banks to manage and distribute specific financial
assistance.
– For example, fund is channeled through commercial banks like
Maybank, CIMB Bank & Affin Bank in providing special loan schemes
like the ‘Skim Usahawan Siswazah (SUS)’ for graduate entrepreneurs
or ‘Skim PROSPER’ for entrepreneurs in the retail service sector
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 Bootstrap Financing
• Bootstrap financing is an internal financing approach that
is derived from conserving cash in the business operations
by utilizing various facilities offered by suppliers & vendors

• Bootstrapping is particularly important at the start-up &

early stages of the business when debt financing is
difficult to qualify for and too much equity financing can
erode entrepreneur control over the business

• This form of financing requires the entrepreneur to:

– understand what facilities are available
– be able to convince the various suppliers to grant you the
facility. 17
 Bootstrap financing…cont.
Some of the common facilities include:

• Trade credit
– Obtain goods from suppliers and only pay in 30, 60 or 90 days hence
allowing the business to trade with the goods without expanding valuable
cash upfront

• Supplier discounts
– Saving cash by taking advantage of discounts given for buying in large
amounts (bulk purchase), buying promotion items and for being a
frequent buyer

• Consignment financing
– An arrangement between a supplier and a seller of a product under which
the supplier only receives payment for the product after it has been
transported to, and sold by, the seller. Can save cost on storage and paying
up front 18
 Table 1: Summary of Sources of Financing
Sources of Description Category
Financing

Personal Entrepreneur(s) own contribution in cash or assets. Internal equity

Funds financing

Family & Contribution by individuals who know the founding Internal equity
Friends entrepreneur and invest mainly because of their financing
relationship with the entrepreneur

Business Wealthy individuals who invest their own funds in External debt
Angels businesses that are not yet attractive to conventional bank financing with
financing but display attractive prospects for growth and equity
significant success participation

Venture Capital investments made by professional fund managers External debt

Capital from an equity pool lodged with a registered venture financing with
capital company. VC investments are repaid when the VC equity
exits the business with a healthy profit at the end of the participation
specified time.

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 Table 1: Summary of Sources of Financing…cont.
Sources of Description Category
Financing

Bank Loans Time-based borrowings that need to be repaid with External debt
interest or administrative fees. Often involves having financing
collateral or sureties.

Government Developmental loans and grants. Loans have to be External debt

Financing repaid with or without interest or administrative fees. financing or
Schemes Grants are one-time cash payouts that do not need to outright payout
be repaid.

Bootstrap Financing that comes in the form of internal savings Internal

Financing and conserving cash through supplier discounts and financing in the
deals form of savings
& cash
conservation

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 Business Development Phases
• While financing can come from several sources, at each
phase of business development different sources feature
more prominently than another

• In this course, the focus will be financing for the following

business phases:
– Pre-startup & start-up
– Early growth
– Full growth & expansion

• The financing source at each phase of development is

often influenced by the relative balance between risk and
potential return on investment at a particular phase 21
 Start-up Phases Financing

• The pre start-up phase is just before the business is

officially launched and funds are needed to create the
business entity and prepare basic resources

• The start-up phase is the point of time when the

business formally opens its doors for business & begins
operations

• The pre start-up and start-up phases are normally

periods of high expenditures, low sales, if any and no
profits. This make this early stages of new venture birth
very risky for not only the founding entrepreneur but
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more so for outside investors.
 Start-up Phases & Financing…cont.

• Financing at pre start-up phase is categorized as seed financing,

whereas financing at start-up phase is called start-up or 1st level
financing

• The main source of seed and start-up financing is primarily from the
entrepreneurs own funds and supplemented with funds from family &
friends

• May be able to attract angel investments but this more likely at the
start-up stage, and only after the founding entrepreneur and/or family
and friends have put in the initial investments as a show of
commitment to the business

• Government financing assistance will feature consistently throughout

the different stages of growth while bootstrap financing will start to
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play an important role from the start-up phase onwards.
 Early Growth Financing

• This is the phase where marketing efforts are intensified to

produce sales that can at least cover costs

• Financing at this stage is referred to as 2nd level financing and

it is the first point where total strangers are likely consider
financing or investing in the business

• A key to 2nd level financing source is the business angel

• Angel investors are valuable at this stage not only for the funds
but also for the business expertise, contacts and credibility

• Venture capital financing may also come in at this point

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 Full Growth & Expansion Financing
• At this stage, the business is poised to take off and is
showing profits from established operations and growing
market acceptance.

• With a much better capability to service loan payments

from growing sales & profits, the entrepreneur may now go
for 3rd level financing primarily in the form of bank term
loans

• Debt financing through bank loans will allow the

entrepreneur to finance growth without having to sacrifice
anymore control in the business through equity financing
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 Fig. 1: Summary of Sources & Stages of
Financing for New Venture

FULL GROWTH &

PRE-STARTUP START-UP EARLY GROWTH
EXPANSION

Seed financing Start-up or 1st level 2nd level financing 3rd level financing
financing
Own, Family & Friends Funds

Business Angels Financing

Venture Capital Financing

Banks Term Loans

Government Financing Schemes (loan, grants & govt. venture capital funds)

Bootstrap Financing

Adapted from ENT600 Teaching Slides, FBM, UiTM, 2009

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 References
• Hisrich, Robert D., Peters, Michael P. & Shepherd, D., (2006). Entrepreneurship, New York:
McGraw-Hill / Irwin, 7th Edition, International Edition, 2006.

• Entrepreneurship Dept., Faculty of Business Management, (2009), Teaching Notes for

Technology Entrepreneurship (ENT 600).

• UiTM Entrepreneurship Study Group (MEDEC), (2004). Fundamentals of Entrepreneurship,

Petaling Jaya: Pearson-Prentice Hall Sdn. Bhd. 2004

• http://www.malaysia.gov.my, Loans, Special Grants & Guarantees

• http://www.mavcap.com

• http://biz.thestar.com, Malaysia Venture Capital Industry Poised to Bounce Back

• http://www.sc.com.my/eng/htlm.../RVCC.pdf, Securities Commission 2012 List of Registered

VC Companies in Malaysia

• http://www.cradle.com.my
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