Entrepreneurship can be defined as the practice of starting a business or “breathing life” into an existing business. One can do so by exploring and pursuing new business initiatives that have the potential to make the organization grow.
Basic Categories
Although many do not attempt to distinguish the different types of entrepreneurs, Webster (1977) classified the title into five different categories. He believed that the distinctions between the different categories allowed one to understand the different terminology in the field and practice. His five different categories of entrepreneur included the following:
- The Cantillon Entrepreneur. Richard Cantillon introduced the term entrepreneur in the early 18th century to denote a person who is treated as one of the four factors of production (i.e., land, labor, capital, and the entrepreneur). The entrepreneur is considered the catalyst in the role of innovator, and is responsible for fueling growth in a capitalist economy. Entrepreneurs can be successful and make a profit when they have the ability to create an opportunity where they have a temporary monopoly to change market products and processes before the competition has an opportunity to dilute industry profits. Many economists do not view the entrepreneur as a real person. Rather, the entrepreneur is seen as a “silent theoretical entity that makes rational decisions, strives for profit maximization as defined by the economists, and assumes managerial and other uninsurable risks in exchange for profits.”
- The Industry Maker. Traditional management research views the entrepreneur as an industry maker, or someone who builds the nation’s economic system, is hard-working and willing to take risks, and invests personal assets. According to this school of thought, the entrepreneur establishes the foundation for an organization, and then builds it into an industry leader.
- The Administrative Entrepreneur. The entrepreneur role is viewed as an executive who establishes a new company, or a reorganization of an existing corporation, and becomes a permanent leader of the management team. Although there are similarities, there is a distinct difference between an industry maker and an administrative entrepreneur. Administrative entrepreneurs are usually associated with an individual organization (e.g., Henry Ford); whereas industry makers are usually considered as manipulators (e.g., Jack Welch) of an entire industry or of a large segment of an industry.
- The Small Business Owner/Operator. During Webster’s time, small business owners were perceived to be the local merchants, and tied predominantly to the retail and wholesale industry. Many scholars believed that these vendors were limited in scope in regard to sales, geographical outreach, and profit potential. However, technology, such as the internet, has allowed service businesses as well as retail businesses to reach an international market.
- The Independent Entrepreneur. An individual who creates ventures from scratch, and does not generally commit to long-term managerial responsibilities to one venture. These individuals tend to be very creative and get a thrill with developing the business, and they tend to be loners.
Current Categories
All five types can be seen in the system, but they have different roles. Webster’s work was written in the 1970s and times have changed. As noted with the small business owner category, the increase in technology and globalization have changed the way that business is conducted as well as how entrepreneurs are categorized. Allen’s categories (2006) are reflective of how business is conducted in the 21st century, and the new categories include:
- The Home-Based Entrepreneur. According to the American Association of Home Based Businesses, more than 24 million people operate home based businesses. Although many of these businesses start out as sole proprietors, many have grown to the point that they can compete against large, well-known businesses. Technology has made it possible for businesses to operate from any location, and home-based businesses are able to tap into resources via the internet. Home-based businesses are usually the starting point for many businesses.
- The Cyber Entrepreneur. This type of entrepreneur enjoys the fact that he or she is able to run a full fledged business without a brick-and-mortar location. Cyber entrepreneurs are able to process all of their business transactions with customers, suppliers, and strategic partners over the internet. In addition, their businesses tend to be digital products and services that do not require a physical infrastructure such as a warehouse.
- The Serial Entrepreneur. These entrepreneurs enjoy creating businesses, but have a desire to move on when the business is up and running. They are motivated by the hype of the pre-launch and start-up phases of the business, but do not have a desire to handle management responsibilities.
- The Traditional Entrepreneur. Traditional entrepreneurs are classic entrepreneurs. They start brick-and-mortar businesses and stick with them as they begin to prosper. Traditional entrepreneurs will be around as long as there is a need to build sustainable businesses, especially in industries such as food services, manufacturing, and retail.
- The Nonprofit Entrepreneur. Nonprofit entrepreneurs have a passion for work that involves socially responsible themes such as education, religious, and charitable initiatives. Many seek their 501(c) status so that they can solicit funding and donations from organizations and individuals who believe in the mission. Their businesses are allowed to make a profit as long as the profits are used for business purposes and not distributed to the owners of the company.
- The Corporate Venturer. Corporate venturers are individuals who seek out new ventures while working within established large organizations. Organizations create skunk works so that they have a unit to explore potential opportunities. Skunk works are autonomous groups that are given the mandate to find and develop new products for a company that may be outside of the organization’s core competencies. However, many have found this a difficult task due to the bureaucratic structure of many large organizations. In order to be a successful corporate venturer, it is important that the following factors are present: senior management commitment; corporate interoperability, meaning that the work environment must support collaboration and provide resources; clearly defined stages and metrics so that the organization can decide whether or not to continue to pursue the initiatives; a high-performance work team; and finally, a spirit of entrepreneurship. Although success is the goal, failures may occur. Organizations must support the team as they explore the opportunities, even when efforts are failures.
Financing
One of the greatest challenges for new ventures is the ability to secure capital for investments that will allow the company to grow. All projects will reach a crossroad where sufficient cash flow is necessary in order to go to the next level. It could be after a period of time or it could be because the venture was so popular and the company is growing at a rapid rate due to demand. Regardless of the situation, the company’s management team will need to determine when and how they will invest in items such as purchasing new equipment, hiring new staff, and putting more money into marketing initiatives. Raising money can be a difficult task if the company has not established a reputation or is still new.
When determining the amount of capital needed, the decision makers must analyze the situation and decide how much and what type of capital is required.
Since the situation is not the same for all businesses, there is no magical formula. Some businesses may only need short-term financing for items such as salaries and inventory; whereas, other businesses may need long-term financing for major items such as office space and equipment. Each business must develop a customized plan that will meet its unique needs.
Securing capital is a choice made after weighing the pros and cons of various options. There are three popular sources for obtaining funding for new ventures: borrowing from financial institutions, partnering with venture capitalists, and selling equity/ownership in exchange for a share of the revenue. All financing options can be classified into two categories—debt financing and equity capital.
Debt financing includes bank loans, personal and family contributions, and financing from agencies such as the Small Business Administration. Loans are often secured by some type of collateral in the company and are paid off over a period of time with interest. On the other hand, venture capitalists and angel investors provide funding in the form of equity capital. Both are given ownership in the company in exchange for money. Pierce (2005) offers some advice which may be of assistance when assessing which option may be best for the company. Some of the tips include:
- A Small Business Administration program may not be the best option if the company needs less than $50,000.
- Debt financing is usually cheaper and easier to find than equity capital. Financing the venture via debt leads to the responsibility of making monthly payments whether or not the business has a positive cash flow.
- Equity investors expect little or no return in the early stages of the business, but require more reporting about the company’s progress. In addition, they expect the company to meet the established goals and milestones.
- Debt financing is usually available to all types of businesses. However, equity capital tends to be reserved for businesses with fast and high growth potential.
- Angel investors tend to invest money in companies that are within a 50-mile radius, and the amounts of funding tend to be in the range of $25,000 and $250,000. Angel investors may be friends, family, customers, suppliers, brokers, and competitors.
- It is difficult to secure venture capital funding, even in a good economy.
Debt financing and equity capital options both require the business owner to complete detailed documentation prior to the award of financing. The owner should be prepared to produce quarterly balance sheets, background information on the company, and projections.
Debt Financing
If a company cannot finance its expansion through personal investments, the management team will need to develop a business plan that meets the criteria for potential lenders. Commercial banks may be the first choice, especially if the owner has a relationship with a specific lender. Since traditional lenders tend to be conservative, good rapport and an established relationship will be beneficial when applying for a loan. According to the University of Maine’s Cooperative Extension, a 1980 Wisconsin study of small businesses found that 25 percent of the businesses interviewed were initially denied, but 75 percent of these groups were approved when they submitted their proposal to another group.
If a commercial bank is not an alternative and the entity is a small business, the Small Business Administration may be another option. The business must satisfy the agency’s criteria and not be able to secure financing from other sources. The Small Business Administration (SBA) is an independent agency of the Executive Branch of the federal government, and it is responsible for assistance to small businesses in the United States. There are four types of assistance this agency can offer: advocacy, management, procurement, and financial assistance. Financial assistance can be granted through the agency’s investment programs, business loan programs, disaster loan programs, and bonding for contractors.
There are three loan programs, and the Small Business Administration sets the guidelines and other entities such as lenders, community development organizations, and micro-lending institutions make the loans to small businesses. In order to reduce the risk to these entities, the SBA will guarantee the loans. When a business applies for an SBA Loan, they are actually applying for a commercial loan with SBA requirements and guaranty.
In 1958 Congress created The Small Business Investment Company (SBIC) program. SBICs, licensed by the Small Business Administration, are privately owned and managed investment firms. SBICs partner with the government and use their own capital with funds borrowed at reduced rates to provide venture capital to small businesses.
The Surety Bond Guarantee (SBG) Program was developed to provide small and minority contractors with contracting opportunities for which they would not otherwise bid. The Small Business Administration (SBA) can guarantee bonds for contracts up to $2 million, covering bid, performance, and payment bonds for small and emerging contractors who cannot obtain surety bonds through regular commercial channels.
Equity Capital
The first venture capitalist firm was established in the 1940s with the purpose of providing financial and business support to entrepreneurs in exchange for repayment in capital gains. They tend to gravitate toward technology initiatives because of the potential for high returns. In addition, these organizations were interested in promoting their services nationally and internationally. During the last two decades, venture capitalism has expanded to the global marketplace.
Venture capital is usually available for start-up companies with a product or idea that may risky, but has a high potential of yielding above average profits. Funds are invested in ventures that have not been discovered. The money may come from wealthy individuals, government-sponsored Small Business Investment Corporations (SBICs), insurance companies, and corporations. It is more difficult to obtain financing from venture capitalists. A company must provide a formal proposal such as a business plan so that the venture capitalist may conduct a thorough evaluation of the company’s records. Venture capitalists only approve a small percentage of the proposals that they receive, and they tend to favor innovative technical ventures.
Funding may be invested throughout the company’s life cycle with funding being provided at both the beginning and later stages of growth. Venture capitalists may invest at different stages. Some firms may invest before the idea has been fully developed while others may provide funding during the early stages of the company’s life. However, there is a group of venture capitalists who specialize in assisting companies when they have reached the point when the company needs financing in order to expand the business.
Many firms receive some type of funding prior to seeking capital from venture capitalists. Angel investors have been identified as one source that entrepreneurs may reach out to for assistance. As Edelhauser (2007) puts it:
In a nationwide survey of more than 3,000 individual angel investors conducted by the Angel Capital Association, more than 96 percent predict they’ll invest in at least one new company in 2007. Also, 77 percent expect to invest in three to nine startups, and five percent think they’ll fund 10 or more new companies.
Including angel investors in the early stages of financing could improve the chances of receiving venture capital financing. A 2005 study of small businesses found that 57 percent of the firms that had received angel investor financing had also received financing from venture capitalists. Firms that did not receive angel investing in the early stages (approximately 10 percent of the firms in the study) did not obtain venture capital funding. It appears that angel investor financing is a significant factor in obtaining venture capital funding. Since obtaining venture capital tends to be difficult, businesses can benefit from the contacts and experience of angel investors in order to prepare for a venture capital application and evaluation. The intervention of an angel investor may make the company appear more attractive to the venture capitalists.
Regardless of how a company decides to finance the venture, it often has to make an agreement that is beneficial to the investors since investors are providing the capital. Therefore, it is important to select a choice that benefits the business in the long run. Initial decisions may set the tone for future deals. Advani (2006) has provided some recommendations to consider when determining what will work best. These suggestions include the following:
- Don’t give pro-rata rights to your first investors. If your first investor is given pro-rata rights, chances are your future investors will want the same agreement. It would be wise to balance the needs of your early investors to protect their stake in the company with how attractive the company will be to future investors.
- Avoid giving too many people the right to be overly involved. If too many people are involved, it could create a bureaucracy and make it difficult for decisions to be made in a timely manner. In addition, the daily tasks of a business may be prolonged due to the need for multiple authorization signatures.
- Beware of any limits placed on management compensation. Some investors may place a cap on the earning potential of senior management personnel. This type of action could create a problem with human resource needs such as attracting and hiring quality talent to run and grow the business.
- Request a cure period. Many investors will request representation for every legal agreement to protect themselves if the management of a company is not in compliance with laws, licenses, and regulations that govern the operation of the business. Although all parties may have good intentions, errors do occur. If a “cure period” is added to the financing agreement, the entrepreneur will have the opportunity to find a solution to the problem within a given period of time (e.g., two to four weeks).
- Restrict your share restrictions. Having unrestricted shares is often a good negotiating factor with future investors. Therefore, it would be wise to evaluate any requests to restrict the sale of shares owned by the founders and/or management team.
Bibliography:
- Allen, Launching New Ventures, 4th ed. (Houghton Mifflin, 2006);
- Asheesh Advani, “Startup Financing Trends for 2007,” Entrepreneur.com (cited March 2009);
- Asheesh Advani, “Raising Money From Informal Investors,” com (cited March 2009);
- Edelhauser, “Angel Investing to Grow in ’07,” Entrepreneur.com (cited March 2009);
- K. Goel and I. Hasan, “Funding New Ventures: Some Strategies for Raising Early Finance,” Applied Financial Economics (v.14/11, 2004);
- A. Gompers, “Optimal Investment, Monitoring, and the Staging of Venture Capital,” Journal of Finance (v.50/5, 1995);
- Kilby, Entrepreneurship and Economic Development (The Free Press, 1971);
- Madill, G. Haines Jr., and A. Riding, “The Role of Angels in Technology SMEs: A Link to Venture Capital,” Venture Capital (v.7/2, 2005);
- Pierce, How to Prepare and Present a Successful Business Funding Request (BusinessFinance.com, 2005);
- Webster, “Entrepreneurs and Ventures: An Attempt at Classification and Clarification,” The Academy of Management Review (v.2/1, 1977).
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