Meaning of Entrepreneurial Financing
Financing is believed by entrepreneurs to be the major constraint in starting and operating a business venture of their own. A lot of entrepreneurs get discouraged when they envision the amount of money they would require to start the business of their dreams, given their relatively low money income. Raising seed capital is believed by some potential entrepreneurs to be synonymous with borrowing from financial institutions. This is perhaps the greatest mental blocks of most Nigerian entrepreneurs. On the basis of this assumption, they immediately proceed to the financial institutions only to discover that the financial institutions require that certain procedures should be followed and in any case, the funds are not there just for the asking. They (the entrepreneurs) quickly become frustrated. Some of the entrepreneurs resort to the informal financial market which, though more expensive, does not require a great deal of documentation and elaborate procedures.
Entrepreneurial finance is the study of value and resource allocation, applied to new ventures. It addresses key questions which challenge all entrepreneurs: how much money can and should be raised; when should it be raised and from whom; what is a reasonable valuation of the start-up and how should funding contracts and exit decisions be structured.
In other words, entrepreneurial financing refers to the various ways an entrepreneur can raise funds to run his/her small/medium scale business. Raising funds requires some basic knowledge and planning from the entrepreneurs. This is to ensure that there is essential funds to run the business and curb any incidence of ill-timed financing, securing the wrong type of loan, miscalculating or underestimating the cost of borrowing.
Sources of Entrepreneurial Financing
There are several sources from which the entrepreneur can raise funds.
(i) Personal Resources: This is divided into two parts namely savings or inherited wealth. There is significant evidence in Nigeria and the rest of the world that most entrepreneurs depend on personal savings to start their businesses. The research also showed that as the size of business increases, the proportion of capital accounted for by personal savings declined. Personal resources can be augmented by sale of personal assets. The willingness of an entrepreneur to sell off his or her personal assets in order to raise funds is considered by financial institutions and other stakeholders as the strongest indicator of the entrepreneur‘s belief and commitment to the success of the business venture. Personal assets such as buildings, cars, plant and machinery, estate etc can be sold in order to raise funds to starting a business.
(ii) Entrepreneurial Teams: Two or more persons may start a business venture as partners and all the partners constitute an entrepreneurial/partnership team. More capital can be raised when a partnership team is formed as a result of the financial contributions of the partners. However, caution must be exercised in selecting co-partners as emphasis must be laid on skills and experience they can contribute to the business.
(iii) Sales of Shares by Private Placement: Incorporated companies can raise fund through the sale of stock or equity to interested stakeholders who are willing to invest on long term basis and become part owners of the business. The sale of shares in private limited liability company can be arranged by finance houses for a free to their clients.
(iv) Business Angels: These are wealthy individuals who have money and are willing to provide equity fund to an entrepreneur for business start-ups in exchange for equity stakes in the business. They are not partners and as such do not take part directly in the management of the business. They may offer advice from time to time but in most cases, they prefer to remain anonymous.
(v) Rotating Credit Scheme/Osusu/Money Lenders: These are informal institutions that provide small loans to owners of small and medium scale enterprises (SMEs). They are commonly found in Nigeria and other developing countries. The entrepreneur can be a member of this group popularly called Osusu/Esusu to raise funds. Rotating credit scheme can be a popular and convenient source as they do not demand collateral other than personal guarantors (in case of huge amount of money). However, to benefit from such a scheme, you must be a member of the saving scheme.
(vi) Cooperative Societies: This is another way of raising relatively large amount of money to starting a business. Many people are able to save gradually and to obtain loans to starting their own businesses, by becoming a member of the savings and loans cooperative societies.
(vii) Loans from Family, Friends and Relations: Entrepreneurs in Nigeria and other developing countries usually depend on family members, friends and relations to provide them with the needed funds in order to start their businesses. One of the conditions for the would-be entrepreneur to access the fund is, if he or she has the pre-requisite skills and experience to manage the new business successfully.
(viii) Trade Credit and Accruals: Trade credits are created when the new business enterprise buys raw materials, supplies and other component parts meant for production or resale on credit terms with or without signing any formal agreement for the debt. Trade credit is an interest free source of funds for the length of the credit period.
Accruals refer to trade credit on an intangible goods or services. The ability of an entrepreneur to secure credits from suppliers or down payment by customers depend largely on the creditors perception of the credit rating of the entrepreneur.
Reasons why Loans may not be Granted to an Entrepreneur
With respect to the nature and behaviour of entrepreneurs, it is often suggested that their inability to source funds from financial institutions is due to:
(i) Lack of knowledge of the roles of the different financial institutions and the scope of services they provide.
(ii) Lack of skill in presenting their proposals and business plans to the financial institution.
(iii) Inadequate financial commitment on the part of the entrepreneur to the project.
(iv) Lack of adequate collateral securities that will guarantee the repayment of the loan.
(v) Poor accounting records which make it difficult to ascertain the true financial position of the firm.
(vi) Inadequate lead time between when the entrepreneurs need the money when the requisition is made to the financial institution and the time required by the financial institutions to process the request.
(vii) Poor quality of business plans and feasibility study on the part of entrepreneurs are the factor inhibiting their access to loans.