Entrepreneurship Essay

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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:   

  1. Allen, Launching New Ventures,  4th ed.  (Houghton   Mifflin, 2006);
  2. Asheesh Advani,  “Startup Financing Trends  for 2007,” Entrepreneur.com (cited March 2009);
  3. Asheesh Advani, “Raising Money From Informal Investors,”   com   (cited   March 2009);
  4. Edelhauser, “Angel Investing  to  Grow  in ’07,” Entrepreneur.com (cited March 2009);
  5. K. Goel and I. Hasan, “Funding New Ventures: Some Strategies for Raising Early Finance,”  Applied  Financial Economics (v.14/11, 2004);
  6. A. Gompers, “Optimal Investment, Monitoring, and  the  Staging of Venture  Capital,” Journal of Finance (v.50/5, 1995);
  7. Kilby, Entrepreneurship and  Economic Development (The Free Press, 1971);
  8. 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);
  9. Pierce, How to Prepare and Present a Successful Business Funding Request (BusinessFinance.com,  2005);
  10. Webster, “Entrepreneurs and Ventures: An Attempt  at Classification and Clarification,” The Academy of Management Review (v.2/1, 1977).

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