Entrepreneurship Development

Chapter-8 [Part-B]
Getting funding for new venture

★ The Importance of Getting Financing or Funding for new venture [Sli+Syll]

Financing or funding is crucial for new ventures as it provides the necessary capital to start
and sustain business operations. It allows entrepreneurs to cover initial costs such as
product development, equipment, marketing, and hiring staff. Adequate funding ensures
smooth cash flow, enabling the venture to meet operational expenses and invest in growth
opportunities. It also increases the venture’s credibility, helping attract customers, partners,
and additional investors. Without proper funding, a new venture may struggle to survive,
scale, or compete effectively in the market, making access to finance a key factor for
business success.

★ Why Most New Ventures Need Financing or Funding [Sli]

Financing or funding is the process of obtaining money to start, operate, and grow a new
business. Most new ventures cannot rely solely on personal savings, so external funding
becomes essential to cover costs, manage operations, and ensure growth.

There are three reasons most new ventures need to raise money during their early life.
These are:
1. Cash Flow Challenges: New ventures often face timing differences between cash inflows
and outflows. While expenses such as salaries, rent, utilities, raw materials, and other
operational costs occur regularly, revenue from sales may take time to arrive. Without
sufficient funding, these cash gaps can disrupt operations, cause delays, or even threaten
the survival of the business. External financing ensures that the venture can maintain
smooth cash flow and operate without interruptions during its early stages.

2. Capital Investment: Starting a business typically requires substantial investment in

physical and intangible assets. This includes machinery, equipment, office or factory space,
technology, software, and initial inventory. Entrepreneurs rarely have enough personal
savings to cover all these costs. External funding provides the necessary capital to acquire
these resources, allowing the venture to operate efficiently and professionally from the
beginning. This investment is crucial for setting up a strong foundation for the business.

3. Lengthy Product Development Cycles: Certain businesses, particularly in technology,

manufacturing, or pharmaceuticals, require extended periods for research, development,
and testing before the product can reach the market. During this time, the venture may not
earn revenue, but expenses continue to accumulate. Funding helps support ongoing
development activities, pay staff, and cover operational costs until the product is launched
and starts generating income. This ensures that the venture can complete its development
phase without financial disruption.

★ Alternatives for Raising Money for a New Venture / Sources of funding [sli+syll]

Raising money or funding for a new venture refers to obtaining financial resources from
various sources to start, operate, and grow a business. New ventures can use internal or
external sources depending on their needs, stage of development, and availability of funds.

There are four types of sources for raising money or funding for a new venture:
1.Personal Funds
2.Equity Capital
3.Debt Financing
4.Creative Sources

1.Sources of Personal Financing: Personal financing refers to funds that an entrepreneur

generates from their own resources or personal network to start or grow a business. It is
often the first source of capital for new ventures, as it requires no formal approval or
repayment to external investors.

Sources of Personal Financing:

(i). Personal Savings: Entrepreneurs often use their own money to fund initial business
activities. This could include savings from previous employment, sale of personal assets, or
retained earnings from other ventures. Using personal savings reduces dependency on
external lenders and avoids interest costs. However, it is limited by the entrepreneur’s
financial capacity, and over-reliance on personal funds can pose personal financial risk.

(ii). Family and Friends: Funds from family or friends are another common source of
personal financing. They may provide loans or invest in the business in exchange for equity.
This source is usually faster and less formal than institutional funding. While it helps fill
funding gaps and may come with flexible terms, there is a potential risk of damaging
personal relationships if the venture does not succeed or repayment is delayed. Three rules
of thumb that entrepreneur should follow when asking F&F for
capital:
1. Be Transparent: Clearly explain your business idea, the risks involved, and the potential
returns. This ensures F&F understand what they are investing in and reduces
misunderstandings.

2. Use a Formal Agreement: Even with loved ones, set clear written terms for repayment,
equity, or interest. This keeps the arrangement professional and helps prevent conflicts.

3. Ask Only What You Need: Request funds strictly for the venture’s needs. Avoid
over-borrowing to protect both the business and your personal relationships.

(iii). Bootstrapping: Bootstrapping involves starting and growing a business with minimal
external funding, relying primarily on personal savings, early revenue, and careful cost
management. Entrepreneurs using this method often reinvest profits, limit expenses, and
use creative strategies to operate efficiently. Bootstrapping encourages discipline,
innovation, and complete control over the business, but growth may be slower due to limited
capital.

Preparing to Raise Debt or Equity Financing

Preparing to raise debt or equity financing is the process by which a business plans and
organizes the resources, strategies, and information necessary to secure funds from
investors (equity) or lenders (debt) to support its growth and operations.

The process can be broken down into three key steps to ensure effective planning and
successful fundraising:
Step 1: Determine precisely how much money is needed: Before seeking funding, the
business must calculate the exact amount of capital required. This includes estimating costs
for operations, marketing, equipment, staffing, and any contingencies. A clear financial
requirement ensures the entrepreneur does not underfund or overfund, which can affect
control and financial health.

Step 2: Determine the type of financing or funding that is the most appropriate: Once
the funding need is clear, the business must decide whether debt (loans, credit) or equity
(selling shares of the business) is most suitable. This decision depends on factors like the
cost of capital, repayment ability, desire to retain ownership, and risk tolerance. Choosing
the right type avoids unnecessary financial strain or dilution of control.
Step 3: Develop a strategy for engaging potential investors or bankers: After
determining the funding type, the next step is to plan how to approach lenders or investors.
This includes preparing a compelling business plan, financial projections, and a persuasive
pitch. A structured engagement strategy increases the chances of securing favorable
financing terms and building trust with funders.
2.Sources of Equity Funding: Sources of equity funding are the various channels through
which a business can raise capital by selling ownership shares to investors. Equity funding
does not require repayment like a loan, but investors gain a stake in the company and share
in its profits and risks.

Three Sources of Equity Funding:

(i). Business Angels: Business angels are wealthy individuals who invest their personal
money into early-stage startups in exchange for equity. They often provide not only capital
but also mentorship, industry connections, and strategic advice. This type of funding is ideal
for startups that need initial funding and guidance before attracting larger investors.
Business angels are difficult to find.

These investors generally invest between $10,000 and $500,000 in a single company. Are
looking for companies that have the potential to grow between 30% to 40% per year.

(ii) Venture Capital (VC): Venture capital refers to investments made by professional firms
or funds that pool money from multiple investors to invest in high-growth potential startups.
VCs provide larger sums than business angels and often take an active role in the
company’s management and strategic decisions. They expect significant returns and usually
invest in companies with scalable business models.

Rounds (or Stages) of Venture Capital Funding:

Venture capitalists invest money in start-ups in “stages,” meaning that not all the money that
is invested is disbursed at the same time. These stages are:

1. Seed Funding: Seed funding is the initial capital used to develop a business idea,
conduct research, and create a prototype. It is usually small and comes from founders,
family, friends, or angel investors. Example: Early-stage funding for Dropbox to build its first
product.

2. Startup Funding: Startup funding is provided to companies that have a business plan
and prototype but need money to launch operations, hire staff, and market the product.
Example: Funding for Airbnb to start operations and attract its first customers.
3. First Stage Funding: First stage funding is given to companies that have started
operations and need capital to increase production, expand marketing, or develop new
products. Example: Funding for Uber to expand into new cities after proving its business
model.

4. Second Stage Funding: Second stage funding supports companies that are generating
revenue but need funds to scale further, enter new markets, or increase capacity. Example:
Funding for Spotify to expand globally and improve its platform.

5. Mezzanine Financing: Mezzanine financing is a hybrid of debt and equity provided to

mature startups to prepare for an IPO or acquisition. It often includes equity warrants or
options. Example: Funding for Tesla before its IPO to strengthen operations and scale
production.

6. Buyout Funding: Buyout funding is used to acquire a controlling stake in an established

company, often by private equity firms, to restructure or improve profitability. Example: The
acquisition of LinkedIn by Microsoft involved buyout-style investment strategies before the
final deal.

(iii). Initial Public Offerings (IPO): An IPO occurs when a private company offers its shares
to the public for the first time on a stock exchange. This allows the company to raise
substantial funds from a wide range of investors. IPOs provide liquidity to early investors and
can significantly increase a company’s visibility and credibility, but they also require
compliance with strict regulatory and reporting requirements.

Example: Facebook (now Meta) raised billions of dollars by going public through its IPO in
2012.
3.Sources of Debt Financing: Debt financing refers to raising funds for a business by
borrowing money that must be repaid over time, usually with interest. Unlike equity financing,
the lender does not get ownership in the business, but expects timely repayment.The source
of debt financing is:

(i).Commercial Banks: Commercial banks are financial institutions that provide loans to
businesses for various purposes, such as working capital, equipment purchase, or
expansion. They usually require the borrower to provide collateral, a solid business plan, and
proof of repayment ability. Interest rates, loan terms, and repayment schedules are agreed
upon before disbursing the funds.

Example: A small manufacturing startup takes a loan of $50,000 from a local bank to buy
machinery, agreeing to repay it over 5 years with interest.

4.Creative Sources of Financing or Funding: Creative financing refers to unconventional

or innovative ways to raise funds for a business beyond traditional debt or equity. These
methods often provide flexibility, reduce risk, or leverage external networks to support
growth.

Some common creative funding sources include:

(i). Crowdfunding: Crowdfunding is a method of raising small amounts of money from a

large number of people, usually through online platforms. It not only provides funds but also
validates the market demand for a product or idea. Crowdfunding can be reward-based,
donation-based, or equity-based, depending on whether contributors receive products,
perks, or ownership stakes. This method is especially useful for startups and small
businesses that may struggle to obtain traditional financing. It helps build a community of
early supporters and promotes the product before it officially launches.

Example: A wearable tech startup raises $100,000 on Kickstarter by offering early-access

devices and branded merchandise to supporters, generating both capital and a loyal
customer base.

(ii). Leasing: A lease is a written agreement in which the owner of a piece of property allows
an individual or business to use the property for a specified period of time in exchange for
payments. The major advantage of leasing is that it enables a company to acquire the use of
assets with very little or no down payment. Leases can be short-term (operating lease) or
long-term (financial lease), depending on the arrangement. This approach also allows
businesses to upgrade or replace equipment easily, keeping them competitive and flexible.
Leasing is often preferred by small businesses that want to avoid tying up funds in expensive
equipment.

Example: A small catering company leases commercial kitchen equipment for five years,
enabling it to start operations without a large initial investment while paying manageable
monthly installments.

(iii). Strategic Partners: Strategic partners are other companies or organizations that invest
money, resources, or expertise in a business in exchange for mutual benefits. These
partnerships can include co-marketing, joint ventures, revenue sharing, or access to
distribution channels. Collaborating with strategic partners reduces financial risk and helps
businesses expand more rapidly. It also provides access to expertise, technology, or market
reach that the business might not have independently.

Example: A health drink company partners with a national retail chain. The retailer invests in
production capacity, and in return, it receives exclusive distribution rights, benefiting both the
startup and the retailer strategically.