The finance industry is a necessary and important part of the entrepreneurial ecosystem.
Entrepreneurs in general, and young innovative companies in particular, play a key role in providing new jobs, creating radical innovations and accelerating productivity.
Availability of finance allows entrepreneurs to invest in innovative projects, improve productivity, finance growth and cover working capital requirements while meeting market demand.
The difficulties faced by entrepreneurs in raising funds in the wake of 2008-09 financial crises, in combination with changes in technological opportunities, product markets, regulations and globalization, have substantially changed the landscape of entrepreneurial finance.
This change, together with severely asymmetric information and agency problems, requires new, more sophisticated solutions from lenders and investors for financing entrepreneurs.
My work at Shippensburg University and its involvement in entrepreneurship has given me a vantage point to observe the changing landscape in entrepreneurial finance, and I’d like to mention three major trends in the financing of entrepreneurs in the current era:
• First, the nature of entrepreneurship has changed as the economy has changed to services, away from capital investments in machinery. This represents a real dilemma for entrepreneurs, as traditional finance models based on tangible collateral and proven business models are becoming obsolete.
• Second, as subscription-based business models have become common, the income stream for entrepreneurs has become prolonged. On one hand, this model demands more from financing. On the other, it also improves the predictability of cash flow, which in return makes financing of such businesses more attractive from a lender’s perspective.
• The third change concerns globalization and winner-takes-all type of tournaments in technology businesses. The necessity of market dominance dictates the need for extremely rapid growth in new ventures, especially in digital-solutions-based businesses. This growth is only possible through the availability of daring finance with high risk tolerance.
The traditional sources of funding for entrepreneurs vary across the stages of business development.
During the seed and startup stages, finance is typically sourced from family, friends, and in some cases, seed investment funds.
In early stages, overcoming information asymmetry is difficult, and so finding a lender or investor is rare. Subsequently, a proven track record alleviates the information asymmetry, and funding from angel investors, and in some cases from venture capitalists, becomes more readily available.
In the later expansion stage, entrepreneurs generally require increasing the amount of capital for research and development, marketing and sales activities, and therefore rely on private equity as well as public lending.
However, new channels of finance have also emerged.
Some of the prominent new financing sources include crowdfunding, accelerators, corporate venture capital, peer-to-peer business lending and family offices.
Technological and regulatory development allows crowdfunding to rely on small investments from private individuals, either in return to equity or a reward, such as a product, acknowledgement or discount.
There are many changes in entrepreneurial finance. However, some aspects also remain important from decade to decade.
One of them is that a distant dream about an initial public offering is still working as a strong magnet to inspire new startup entrepreneurs and to motivate current ones to work harder.
By combining appropriate practices from the past with new financial innovations, the future of entrepreneurship in the Crossroads region looks brighter than ever.
Otso Massala is an associate professor and director of the Charles H. Diller Jr. Center for Entrepreneurial Leadership and Innovation in the John L. Grove College of Business at Shippensburg University in Shippensburg, Pa. Email him at OAMassala@ship.edu.