Entrepreneurial finance

What is Entrepreneurial Finance, why it is difficult and why it is so important for scaleups to have a understanding of this? Read our blog to get some insights on how to approach entrepreneurial finance from an entrepreneur’s perspective.

Entrepreneurial finance

At INNFLOW, we dedicate much of our time to the field of Entrepreneurial Finance, a term coined in academics that you don’t come across every day and might sound like a contradictio in terminis to you. In this blog we will discuss what it is, why it is important and how to best approach this as an entrepreneur.

What is entrepreneurial finance?

In their book Fundamentals of Entrepreneurial Finance by Marco da Rin and Thomas Hellmann, Entrepreneurial Finance is defined as: “the provision of funding to young, innovative, growth-oriented companies.[1]

Young, innovative and growth-oriented companies refers to companies that are younger than 10 years, that introduce innovative products or business models, and most importantly, are growth oriented. The last point might seem obvious for a young company, but this is actually an important differentiator that sets them apart from small businesses or SME’s as studies have shown that less than a quarter of small businesses have the ambition to grow big[2]. In practice we often refer to these companies as scaleups.

By definition, Entrepreneurial Finance is at the center of two opposing worlds: the financial world and the world of entrepreneurship. Finance is a structured and logical world, focused on calculated risks, looking for track-record and comparing returns. This is related to the left side of our brain. Entrepreneurship, on the other hand, is a chaotic and creative world, focused on creating new ideas and taking a leap into the unknown, which is related to the right side of our brain. In our daily work we try to bring both worlds together and by combining both perspectives, we aim to support scaleups in realizing their goals.

Left vs right side of the brain

Da Rin and Hellmann state that: “at the core of entrepreneurial finance there is a transaction between entrepreneurs and investors, where the entrepreneur receives capital and in return gives the investor a claim on the company’s future returns”. This claim is embedded in a contract between both parties, which can take many forms, such as an equity stake, a loan or anything in between (we will discuss differences between different forms and deal structures in a later blog).

As is often the case in finance, many terms exist to describe the same principles. When we talk about Entrepreneurial Finance from the perspective of the entrepreneur, we refer to all challenges an entrepreneur faces with regards to resource allocation. We often talk about the fund or capital raising capabilities of a firm to describe how well a company can deal with this.

Why is entrepreneurial finance difficult?

Da Rin and Hellmann state: “when two worlds crash, this is bound to be turbulent”. Entrepreneurs and investors face challenges in finding each other and communicating their respective needs and interests. For an entrepreneur, providing clear and thorough documents that outline all the assumptions made for the business to the counterparty is crucial and requires much preparation. Think about a set of consistent documents such as a business plan, a financial model and a pitch deck. Bringing these documents up to standard is often referred to as investor readiness or becoming ‘bankable’.

For entrepreneurs, finding a suitable investor is often one of the hardest challenges that they need to overcome. There is a multitude of options available and getting at a table with the right person is not always easy. Investors will ask all sorts of question and can seem quite critical. Having convinced some investor, being through their due diligence process, the deal making phase starts, with discussions about the valuation of a company and term sheets full of confusing lingo. Having closed the deal you are not done, fund raising is something that you should be doing continually and in a structured way, planning far ahead to reduce the risks of running out of funds.

For investors, the experience is not less demanding. They receive pitches on a daily basis, and finding the right project, at the right valuation and the right time, is extremely difficult in a market where many actors compete to make the best investments. After completion of a deal a long process starts with many challenges along the way, all with the risk of no or unsatisfactory returns.

Why is entrepreneurial finance key to scaleup?

For entrepreneurs it is crucial to attract funding to realize their ambitions. The amount of funding, the conditions and the type of investor will for a large part contribute to their chances of success. Funding is crucial to access the resources they need, to plan ahead, to realize their ambitions and so on. The type of investor secured is also crucial, as this provides a quality stamp that has a strong signaling effect to other investors. Moreover, it can make a huge difference whether or not they are a long term partner that is able to participate in a sequential financing round. Being able to secure sufficient funding is crucial to sustained growth, and failing to do so can mean the end for many scaleups, even when the business at its core is profitable.

For investors, it is key to realize the returns that they require. Institutional investors might depend on VC’s to find high returns and to diversify their portfolio. Large corporates seek ventures to participate in, to access new technologies and to expand their innovation capabilities. Private investors might invest in start-up ventures to use their experience to create value and earn money or to return something back to society. Public investors, at last, look for investments to solve societal problems or to boost the economy.

How to approach entrepreneurial finance as an entrepreneur?  

We always advice our clients to take a structured approach to fund raising and to build a financial strategy in advance. This will help you to plan ahead and to take timely action when things don’t work out as you planned. It also forces you to think ahead and to switch from a reactive to a proactive approach to fundraising.

Another tip is to draft a business plan and supportive documents such as a financial model early and  updating this along the way. This might seem as a dreadful use of precious time, but it is eventually bound to save you a lot of time in the fundraising process. Another advantage is that it gives you insights into your financing needs.

Are you an entrepreneur yourself and is financing a pressing topic at your company? INNFLOW supports scaleups from a first finance strategy to financial close. With a network including both public and private investors, we can help you navigate the financial market and get access to the funding that fits your company.

Source used: Da Rin, M., & Hellmann, T. (2020). Fundamentals of Entrepreneurial Finance. Oxford University Press.

[1] Da Rin, M., & Hellmann, T. (2020). Fundamentals of Entrepreneurial Finance. Oxford University Press.

[2] Hurst, E., & Pugsley, B. W. (2011). What do small businesses do? (No. w17041). National Bureau of Economic Research.

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