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Financing Entrepreneurship: What Matters?

Financing Entrepreneurship: What Matters?. Margaret Polski, Ph.D. Workshop in Political Theory & Policy Analysis Indiana University 4/3/00. Business Finance Life Cycle. Introduction Low sales, high investment, low ROTA IPO at end of introduction phase Growth

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Financing Entrepreneurship: What Matters?

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  1. Financing Entrepreneurship: What Matters? Margaret Polski, Ph.D. Workshop in Political Theory & Policy Analysis Indiana University 4/3/00

  2. Business Finance Life Cycle • Introduction • Low sales, high investment, low ROTA • IPO at end of introduction phase • Growth • Increasing sales, high investment, increasing ROTA • Maturity • High sales, low investment, maximum ROTA • Decline • Decreasing sales, no investment, decreasing ROTA

  3. Business Finance Life Cycle Decline Maturity Introduction Growth

  4. Financial Infrastructure • Business finance implies the existence of an enforceable set of institutional arrangements • Institutions (rules) create incentives for using particular mechanisms to solve problems related to: • Information • Time inconsistency • Adverse selection • Hazard

  5. Finance Strategies • Beg • Borrow • Loans and other forms of credit • Bonds • Steal • Share risk, rewards, control • Equity • Sweat • Cash • Cooperative/Communal

  6. Policy Considerations • Social dilemma: allocate surplus funds to those who have funds deficits. Efficiency and equity matter. • Costs of coordination nontrivial • Heterogeneous types • Asymmetric resources • Three types of coordination mechanisms • Markets: public/private • Intermediation • Hybrid

  7. Types of Small Business Finance • Internal • Insider (equity, loans, other credit) • Angel • External • Trade credit • Bank loans • Venture capital • private • government • Public equity or debt

  8. Small Business Finance: U.S.Source: Berger & Udell (1998) • Small business finance in general • Equity 50% • Owner 31% • Other members of startup team 13% • Angel 4% • VC 2% • Debt 50% • Financial institutions 27% • Nonfinancial institutions/government 18% • Individuals 6% • Introduction phase: Principal owner provides 70% of finance

  9. Business Finance Life Cycle: Source of Finance IPO Decline Maturity Introduction Growth VC Retained Earnings Debt Equity Payout Dividends Owner Angel Incubator R& D Seed funds

  10. Early Stage Investments in 1995Compiled:Gompers & Lerner, 1999; WDR 1997. Millions of 1997 dollars: Gross/PerCapita. • U.S. 3,374 12.8 • Israel 550 91.6 • Canada 182 6.0 • Germany 116 1.4 • Netherlands 100 6.7 • Italy 60 1.0 • Australia 54 3.0 • U.K. 36 .6 • France 35 .6 • Spain 24 .6 • Japan 11 .08

  11. U.S.: VC DisbursementsCompiled: Gompers & Lerner, 1999. Millions of 1997 dollars 1965-1996 • Total 1965-1996: $35,187 • 80% ($28,258) disbursed to 4 industries: • Office/computing machines $8,997 • Communication/electronic equip. $8,321 • Drugs $6,422 • Prof/Scientific instruments $4,518

  12. Discussion Questions • Most new ventures fail. Who should provide new venture finance and what are the implications of each alternative? E.g. • Owners • Banks or other institutional investors • Government • Private capital markets • Public capital markets

  13. Discussion Questionscont’d • In the U.S. data, what appears to be the relationship between net worth and the supply of new venture finance? • Who gets VC? Implications for growth? Contrast with industrial policy or other forms of targeting firms for growth. • In view of above, who are potential entrepreneurs?

  14. Discussion Questionscont’d • Different businesses have different finance needs in introduction phase. What are the implications of this? • Given the nature of entrepreneurship, how willing is a typical entrepreneur to relinquish control? • What are the institutional implications of the need to exit from a failing company? An equity stake? A debt contract?

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