Sources Of Funding For Businesses – Finance Options for Businesses in Ireland Jane Power College of Business and Law – Department of Economics, UCC
Starting a business is a complex process that requires multifaceted organization and planning. An entrepreneur starts with an idea that must be immediately tempered with the need to justify the creative concept, choose a business location, evaluate the competition and, above all, identify ways to finance it. This last function is the most crucial because, without capital, there would be no business. Most entrepreneurs face a basic problem; They rarely have the amount of capital needed to implement their ideas. Funds are needed to set up a business and execute a business plan. Given the global credit crunch, it is worth looking into the financing options available to entrepreneurs. An entrepreneur has numerous funding sources to choose from. These range from loans from family or friends to debt and equity financing.
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The purpose of this research is to explore corporate finance in Ireland, providing a deeper understanding of the sources of finance used. The study is currently in the data-gathering phase, gathering information on the types of finance used by businesses across Ireland.
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In the current economic climate, the flow of innovative start-ups into the economy is crucial for future growth. However, funding is needed to build and expand these innovative businesses. It is important to raise the necessary capital. In an economic environment where credit has become increasingly scarce, it is important that businesses have a clear understanding of the different types of credit options available.
Creating a business plan and finding your niche is the first hurdle – raising the money to make your business a success can be an even bigger struggle. There are basically two categories of financing options for businesses: internal and external. Internal capital comes from the firm while external capital comes from peripheral sources. The different types of financing options in each category are described in Figure 1 below.
One type of internal financing is personal capital, in which the entrepreneur either invests his own money in the business or invests his salary. Therefore, business lending often begins with the entrepreneur investing personal capital in setting up the business. Common personal assets include cash, stocks, houses, and land. For example, Apple founders Steve Jobs and Steve Wozniak started the company with $1,300 of personal capital when Steve Jobs sold his Volkswagen Microbus and Steve Wozniak sold his Hewlett-Packard Scientific Calculator. To finance additional growth, an entrepreneur may seek capital from “family and friends” who, as a group, will typically invest relatively small amounts. A third source of internal funding is retained earnings (or profit) which is unpaid income that is reinvested in the business. However, businesses need to continue operating before they can use retained earnings. An alternative here would be working capital. This is essentially the money needed to run the day-to-day business. When large amounts of capital are required, entrepreneurs may try to obtain financing from outside sources.
Externally, there are three options for raising capital. First, there are different sources of debt. For example, a business loan or mortgage is a secured bank loan for use by a business. Other sources of debt include overdrafts, trade receivables, leases and hire purchase. Debt factoring (or discounting invoices) is also an option and involves a business selling its accounts receivable (i.e. what it owes customers) to a bank or financial institution which then advances funds on such a basis.
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Another source of external capital is public money from government funding programs. County Enterprise Boards provide a variety of financial support, including business start-up grants, expansion/development grants and feasibility/innovation grants. Enterprise Ireland provides financial support to businesses in the form of grants. For example, feasibility scholarships are available to businesses to study the feasibility of producing a new product or process, or to develop a new service. Enterprise Ireland also runs an Innovation Voucher Scheme, which will run from 1 to 31 October 2010 and provides €5,000 towards research support. There are a number of such support schemes offered by public bodies across Ireland.
A third external option is equity finance, a financing method in which a company receives cash in exchange for ownership. Raising equity is very different from raising debt like a bank loan. For example, banks usually require collateral such as a charge on the company’s assets, will charge interest on the loan and demand repayment. Equity capital is invested in exchange for company shares, and as shareholders, equity investors’ returns depend on the company’s growth and profitability. One of the main advantages of equity financing, especially over debt, is that investors assume the risk: if the business fails, they lose their money. Stock investments are unsecured, completely risky, and usually have no defined repayment terms.
Modern equity capital has its origins in America. In 1946, Harvard University professor George Doriot formed American Research and Development (ARD) along with Massachusetts Institute of Technology President Carl Compton, Massachusetts Investors Trusts President Merrill Griswold, and Federal Reserve President Ralph Flanders. Bank of Boston. ARD was created to raise money from individual and university grants and invest in technology-based manufacturing start-ups. Now, more than half a century later, equity has become the form of financing associated with entrepreneurial start-ups, especially in high-tech industries such as biotechnology, computer hardware and software, e-commerce, information technology, and telecommunications. Many of today’s most successful companies have been funded at least in part by equity, including the Irish company Lily O’Brien Chocolates, Amazon, Dell, eBay, Google, Intel, and Yahoo. There are numerous forms of equity financing available to entrepreneurs.
The main source of capital is venture capital. This is the provision of growth and expansion finance to companies with undeveloped or developing products, usually in the early stages of their business life cycle, or the provision of growth capital to mature companies at an early stage. Next. Venture capital is an investment made by professional investors, known as venture capitalists, who invest capital on behalf of third parties. Venture capitalists raise money from third parties such as insurance companies, banks, pension funds and private investors, and in Ireland, venture capitalists raise significant capital from government sources such as Enterprise Ireland. Along with raising capital, venture capitalists create a fund and, over the life of the fund, make equity investments. Venture capitalists often take an active role in the companies they invest in, mentoring and monitoring investors. As Sean Gallagher of Dragon’s Den describes it “Banks make loans and then ask for interest payments. VCs [venture capitalists] invest and then provide expertise and guidance.”
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Angel financing is also an important source of equity financing. Business angels are wealthy individuals, many of them former entrepreneurs, who invest their capital in emerging companies. Angels typically invest in young companies, at an early stage of their development, and can invest alone or as part of a group, typically for amounts ranging from €10,000 to €500,000. For example, in its initial phase Amazon received a total of $54,400 from two angels separately and $937,000 from an angel syndicate of twenty angels. Evidence suggests that angel finance is the most significant, frequent and critical source of early-stage funding in the most dynamic entrepreneurial markets.
Another source of equity is public equity through government programs. The Irish government is actively involved in equity financing of local companies. Business Expansion Scheme (BES) is a programme. BES is the initial source of funding and has been in place since 1984. The scheme allows the investor to get tax relief on investments up to €150,000 per year. Enterprise Ireland also provides equity finance for manufacturing or service companies and high-potential businesses. Enterprise Ireland funds a number of equity programs through its Seed and Venture Capital Programme. The program has pledged €175 million to fund eight venture capital funds, which are themselves raising multiples of this amount from private investors.
Finally, corporate equity programs provide capital to innovative small businesses, usually at an early stage of their development. For example, Intel Corporation and Johnson & Johnson both operate venture capital funds that focus on making equity investments in innovative young companies. Corporate venture capital involves a subsidiary of a large company making an equity investment in a small, usually young, innovative company.
The Irish stock market has grown tremendously in recent years. In 1997, total holdings in Irish-based companies amounted to €39 million. By 2007 this had risen to €226 million, an increase of around 580%. Interestingly, Ireland appears to have weathered the fundraising storm brought on by the financial crisis better than its neighbors in the UK and Europe. Equity investment in Ireland continued to grow in 2009, totaling €288m, 18% more than in 2008.
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