All entrepreneurial activity has to be funded in order to convert the business concept into a viable business. The financing strategy of the start up has a huge bearing on the success and viability of the concern. Most considerations of raising capital for entrepreneurial ventures focus on initial capital only. It is my belief that a consideration of entrepreneurial capital should include the capital requirements throughout the business lifecycle. Many entrepreneurial ventures may be successful in raising initial capital but fail in subsequent efforts and hence the venture fails. Financial constraints cited as some of the reasons why entrepreneurial ventures fail include undercapitalisation, poor demand forecasting and poor handling of finances. The next few postings will analyse the challenges faced by Zimbabwean entrepreneurial bankers in adequately financing their ventures. We therefore learn from those who have gone before us. These postings are extracts from my recently published book – Entreprenuership On Trial obtainable from www.lulu.com as both hard copy or soft copy.
Financing Gap in Entrepreneurial Ventures
The pioneer entrepreneurial bankers faced significant challenges in raising funds for their ventures. There was a funding gap as sources of funds were hesitant to lend to new start unproven entrepreneurs. A major potential source of funds was the established banks but these were not eager to fund the emerging competition. It therefore appeared as if these entrepreneurial bankers were being discriminated against in terms of access to and availability of capital sources. However this was not confined to them alone, as these restrictions occur with any start up.
In entrepreneurial literature the supply side of the financing gap, often called the MacMillan Gap after the UK Commission which first identified it, is often attributed to the following:
- · Unwarranted prejudice from capital markets.
- · The requirement to accept punitive rates or provide huge collateral security caused by the perception of being high risk investments. Considering the failure rate of start ups, these fears are indeed justified.
- · Credit rationing which discriminates unfairly against the entrepreneurial firms, irrespective of viability of venture. (Beaver 2002).
Information asymmetry implies that the project promoter may not make sufficient information available or may hide certain undesirable facts in the business plan and this may lead lenders into adverse selection. Since the choice of which project proposal is of good quality is difficult to establish a priori, many financiers simply choose to avoid funding entrepreneurs rather than expose themselves to undue risk. Others would still fund entrepreneurs and minimise the information asymmetry risk through:
- · Closer working relationship with the entrepreneurs and establishing a good commercial understanding of the business and its environment. However, this entails heavy and costly monitoring activities which other funders resent.
- · Demanding significant collateral cover for the loan. The logic is that the entrepreneur will be prepared to assume some reasonable risk if he is convinced of the prospects of his venture succeeding or that it is low risk.
Capital structure can be defined as the proportion of the company’s capital that is obtained through debt and equity. After much debate, most writers seem to concur that there is no optimal capital structure that can be recommended i.e. each differs depending on the environment, the preference, perceptions and attitudes of the founders, and the prospective cash flow position of the start- up. From an analysis of the Zimbabwean banking sector it appears that there was no single approach to the capital structure.
An optimal capital structure for any entrepreneurial venture strikes a balance between risk and return, thereby maximising the share price while minimising the cost of capital.