Week One

hapter 1 The Entrepreneurial Challenge: A Global Perspective

Learning Objectives

· To understand the importance of entrepreneurial finance

· To introduce the different types of entrepreneurs

· To expose the challenges associated with being an entrepreneur

· To identify the traits of global entrepreneurs

· To understand what is different about entrepreneurial finance

Case: CEON Solutions Pvt. Ltd.

Abhay Panjiyar, a young engineer in his second year of engineering school, had an idea while he was creating an effective administration process for Bhopal, an India-based education nongovernmental organization (NGO). Along with three friends who “believed in creating everything out of nothing” (hence the name CEON), Abhay developed an analytical problem-solving software for use in India's schools. He started participating in business plan competitions with his revolutionary idea of educational process management (EPM) software and received an invitation from IIM Ahmedabad's Centre for Innovation Incubation and Entrepreneurship (CIIE) to be their first incubator company.

Improving the quality of education is an important issue in India and other emerging countries. Abhay saw the major obstacle being the nonsharing of information among teachers, students, and parents. He filled this gap by developing software that connects all parties and helps parents become involved effectively in their students’ success.

Education is a knowledge-driven sector, and it is a growing market with schools competing to improve education. In that competition, CEON's software enables better education process management for schools.

Abhay began his startup by borrowing money from his family. He ran his business at the lowest possible cost. He paid salaries out of borrowed money and got Rs. 1 lakh (USD $2,000) from his very first client. With the help of this funding, Abhay was able to double his client base and convinced GVFL, a venture capital firm, to invest additional money up to Rs. 3 crores (USD $600,000).

Today, with this software, parents are able to see whether their children have missed classes, how many questions they asked in class, whether they are showing more interest in sports than classes, and if there is a parent-teacher meeting at school. It allows personalized tools for assessment of a student with instant feedback to parents about their child's performance in school.

CEON Solutions now has two more products available—an NGO resource planning solution and police inventory management software—and is looking to expand its client base.

Abhay thinks that of the 1.2 million schools in India, at least 10% would benefit from his software. Even though CEON is creating this new market, its growth is difficult to predict. CEON's approach to use minimum resources, dedicated manpower, a research-oriented business structure, and direct marketing to quality schools is a key factor for its success.

The entrepreneurial landscape is rapidly changing. Fast-growing companies take longer to go public, secondary venture capital markets are flourishing, and new financing options such as crowdfunding are emerging. We are facing a new era in capital strategy. Private money has never been so abundant and is creating opportunity for innovation and faster company growth. In short, entrepreneurs and investors are facing both exciting and challenging times (Savitz, 2011).

However, after listening to hundreds of entrepreneurs pitching their ideas to attract funding for their business concept, we have come to understand that a large majority of entrepreneurs lack an in-depth understanding of financial management. Entrepreneurs make a wide variety of mistakes when trying to apply financial concepts to their nascent businesses. They attach an unjustified certainty to the valuation numbers that they generate and, as a result, irritate potential investors; they fail to understand the uncertainty that is inherent in the financial projections they make for their firms and, as a result, do not capture the full range of potential outcomes with respect to future revenue and cash flow needs; they think of financial ratios as being mere statements of numeric comparison rather than insights into management's style and capability, and when they do this, they lose the opportunity to use the ratio analysis to hold management accountable for its actions; and finally, they fail to appreciate that in an environment of uncertainty (as distinguished from mere statistical risk), the application of financial principles needs to be made in concert with a hefty dose of skill and judgment.

Our belief that financial principles are not given enough attention by entrepreneurs is what motivated us to write this book. Our objective is to provide entrepreneurs from all backgrounds and industries with a practical guide on how to use a better understanding of financial principles to raise capital, manage the firm, and negotiate effectively with investors or buyers. This book is targeted at both entrepreneurs and investors seeking to improve the financial lens through which they view a venture.

Before we explore in detail the financial aspects of entrepreneurship, we will briefly introduce the entrepreneurship field through a global lens.

Chart 1.1  presents a schematic representation of the material covered in this chapter.

Need for Entrepreneurial Finance

One of the most difficult aspects of starting and growing a business as occurred for CEON is finding initial capital to start a company as well as capital to grow the business further. In obtaining initial financing, the entrepreneur needs to consider the source of external funds as well as the type provided. Any external funds for the venture (those funds not personally provided by the entrepreneur) will be in the form of debt or equity. The initial source of funds almost always comes from individuals—family and friends or private individual investors often called angels. These sources provide over 80% of the funds for startups in most every country and are the key to bringing innovation to the market. Family and friends invest due to their relationship with and belief in the entrepreneur and are the most common source of financing at startup. This knowledge and familiarity help overcome part of the uncertainty and risk felt by other individual investors. Usually, this is a small amount of capital reflecting the capital needed for most new ventures. Private investors other than family and friends also provide this capital. As a part of the informal risk capital market, these individuals (business angels) play a very important role in the economy of every country by providing the capital needed to take innovation to the market through the creation of a new venture, which affects the gross domestic product and employment of the country.

Chart 1.1 Schematic of  Chapter 1

The capital provided by family and friends and other individual investors can be in the form of debt or equity, the two general types of financing available. Debt financing involves an interest-bearing instrument usually in the form of a loan, which carries the obligation to pay back the total amount of funds borrowed and a fee (the interest rate) for using these funds. Often, some form of collateral or asset, such as a car, house, machine, or land, is required.

Equity financing, the more common of the two, does not require this collateral, as the family, friend, or other individual invests in the entrepreneur and new venture and obtains an ownership position in the venture. The individual then shares on a pro rata basis in the profits and disposition of any assets, including the sale of the entire venture. The entrepreneurial financing need for the venture is often met by employing a combination of debt and equity financing.

Types of Entrepreneurs

The Global Entrepreneurship Monitor (GEM) identified three main types of entrepreneurs: (1) nascent entrepreneurs, (2) new entrepreneurs, and (3) established entrepreneurs (Acs, Arenius, Hay, & Minniti, 2005; Autio, 2007).

Nascent entrepreneurs are individuals between 18 and 64 years old who do not have a firm yet but are in the process of starting one. These individuals have been committing time and resources to founding a new venture over the past months and expect to become active owner-managers in the short term. They have assessed the opportunity and have already taken steps toward the creation of the startup company but have not yet paid salaries to anyone for more than 3 months. This means they might have already written their business plan or did marketing research and are serious about founding a new venture.

It is common to find nascent entrepreneurs at universities, and over the years, we have met plenty of them. They usually start developing a project or idea during their student years, with many building a successful business either before or after graduation. There are several famous examples of individuals who were nascent entrepreneurs at universities, such as Mark Zuckerberg, who launched Facebook from his dormitory room back in 2004 and today is among the 30 richest people in the world.

New entrepreneurs are individuals between 18 and 64 years old and are owner-managers currently managing a startup venture. They have paid salaries for more than 3 but less than 42 months. This period is usually the most challenging for entrepreneurs as it represents the time period where most ventures fail.

Established entrepreneurs are owner-managers of entrepreneurial firms who have been in business for more than 42 months and are currently managing a firm. They have survived the most difficult years of a startup company and may be looking to further grow their business or simply looking for an exit.

No matter the stage of entrepreneurship, this book will provide relevant information that will help the entrepreneur understand better the financial aspects of doing business in a global economy.

Becoming a Global Entrepreneur

More exciting international business opportunities are present today than any other time in the history of the world. The ability to be a global entrepreneur or to be born global is easier than ever due to the ability to communicate with and reach markets once considered impossible. What was once produced domestically is now done internationally. In fact, there is less and less distinction between foreign and domestic markets.

Global entrepreneurship creates wealth and employment benefiting individuals and countries throughout the world. International (global) entrepreneurship is “the process of an entrepreneur conducting business activities across national boundaries” (Hisrich, 2013, p. 7). It may take the form of exporting, selling goods from the Internet, opening an overseas sales office in another country, or establishing an entirely new operation. Being a global entrepreneur presents new problems but allows an individual to expand the sales/profits of a venture in ways previously not possible.

Is it the Right Time?

While an economic downturn can challenge many entrepreneurs, it doesn't mean it is not the right time to launch a new venture. In fact, history reveals that tough economic periods are appropriate for starting a new business. Out of 30 businesses from the Dow Jones Industrial Average, 16 were founded during a recession or depression: Walt Disney started in the mid-1920s and was a young startup during the Depression, Hewlett-Packard was launched in 1938 during the Great Depression, and Microsoft started to build its empire in the 1975 recession (Abrams, 2008). Instagram, a free photo-sharing application initially designed for mobile smartphones, was launched in the middle of the slowdown in 2010 (Waters & Nuttall, 2012). With only 13 employees, the company grew rapidly and acquired a large user base estimated at over 30 million in early 2012. Without ever generating any kind of revenue (their product was offered for free to users), the company was sold less than 2 years after its inception for $1 billion (Raice & Ante, 2012). At a time when companies do not even need to generate revenue in order to provide a successful exit for their founders and investors, it seems there has never been a better time than today to become an entrepreneur. Entrepreneurs look at problems as opportunities.

Is it Risky to Become an Entrepreneur?

Interestingly, there seem to be two predominant attitudes in the world toward entrepreneurs. One view is that entrepreneurs are some kind of heroes who shape the course of history and achieve tremendous success. Steve Jobs with Apple, Mark Zuckerberg with Facebook, Stelios Haji-Ioannou with easyJet, and Ratan Naval Tata with the Tata Group are inspirations who motivate others to follow their dreams and create their own ventures. Conversely, certain cultures may give merit to established entrepreneurs yet discourage nascent or new entrepreneurs to follow suit. In fact, nearly all graduates from college who visit their career centers in Europe will be offered advice on how to apply and seek a job, not advice on how to register a brand or form a company. Entrepreneurship still seems to be in most parts of the world a deviation from the norm and perceived as a risky career choice. For example, in Southern Europe, it is nearly impossible for banks to approve mortgage loans to self-employed entrepreneurs, even if their early stage venture income seems to justify a favorable decision (DaSilva, Janezic, & Hisrich, 2012). Banks prefer to give a loan to someone who has a lower salary but a “secure” job at a large corporation. This conventional position from banks and society does not seem to make sense nowadays, but still the practice prevails.

Given the mass layoffs of the past few years, is entrepreneurship riskier today than working at a big bank or law firm? A Harvard Business Review blog (Gibney & Howery, 2012) reveals that 215,417 jobs for attorneys will be available between 2008 and 2018, while over 430,000 new legal graduates will come out of universities during that same period. Those numbers indicate that only half will get a chance to get a job in their chosen field. There will be so many lawyers on the market for jobs that even those who get a job will probably have compensation packages that differ from the ones presently on the market. By contrast, the Kauffman Foundation did a survey of 5,000 entrepreneurial ventures started in 2004 in the United States (Robb & Reedy, 2012). Their results show that nearly 56% were still in business in the beginning of 2010 despite the world financial turmoil. Now if we consider financial rewards, entrepreneurs do have the possibility to make real money. Statistics from the venture capital industry reveal that 25% of first-time venture-backed firms are acquired for at least $50 million or file for an initial public offering (IPO) (Gompers, Kovner, Lerner, & Scharfstein, 2008).

Another positive feature of entrepreneurship is that motivated and happy people will usually perform better than individuals simply looking forward to their paycheck. In today's highly competitive market, only those who enjoy what they do and how they do it perform at a higher level.

This book will provide insights that will contribute to the success of any entrepreneur or investor seeking practical advice on how to measure performance and improve the financial state of an entrepreneurial venture in a global economy. Additionally, we will provide advice on how to reach and negotiate with investors to obtain the vital cash necessary for a venture to grow and eventually exit successfully.

Traits of a Global Entrepreneur

Several traits are common among entrepreneurs worldwide. These include cultural diversity, a strong desire to achieve, internal locus of control, clear vision, tolerance for ambiguity, integrity, and a global sense of responsibility. 1  We will cover each briefly over the next pages.

1 For a thorough discussion of these traits as well as the need for global entrepreneurs, the topic of the next section, see Hisrich (2013) and Hisrich, Peters, and Shepherd (2013).

Cultural Diversity. Global entrepreneurs are individuals who are usually well traveled and who embrace cultural diversity both in and out of the workplace. They are not afraid of change or to face different sociocultural environments. They constantly seek challenges and new experiences with an “out of the box” feeling.

Desire to Achieve. Global entrepreneurs are willing to go the extra mile and face difficult and uncertain conditions to excel. Their desire to achieve allows them to go beyond cultural barriers and develop the set of skills required to succeed in an international environment.

Internal Locus of Control. Global entrepreneurs believe they and their team can intervene and influence the outcome of events and situations in a positive manner. They take responsibility for what happens and keep an open mind toward new ideas and potential solutions.

Clear Vision. Global entrepreneurs develop and maintain a clear vision as to where they are heading and make sure to share their vision with all stakeholders they interact with. They know employees must feel their work is essential for the success and prosperity of the global organization they integrate. Global entrepreneurs are positive, energetic, and confident individuals with both short- and long-term goals that express the vision of the venture.

Tolerance for Ambiguity. Global entrepreneurs face adversity with an optimistic mind-set and a willingness to learn. They have the ability to deal with contradictory or unexpected events while keeping an open mind and a focus on what their goals are.

Integrity. Integrity is critical for getting and keeping the support of employees, investors, and partners. Global entrepreneurs walk the talk by being honest, being morally upright, and meeting their commitments. Integrity is one of the most sought-after traits by customers, vendors, and investors. Without integrity from the top, the entrepreneur, the venture will soon falter.

Global Sense of Responsibility. Global entrepreneurs care about their employees and environment where they operate. They are sensitive to their employees’ and customers’ needs. Their goals are to not only build a profitable global venture but also contribute toward the sustainable development of the community in which they operate.

The Need for Global Entrepreneurs

In the past, companies ventured abroad only after having established and grown a strong business at home. They would start by approaching nearby countries and progressively establish partnerships. For example, Johnson & Johnson only decided to enter a foreign market 33 years after its inception. The country they chose to enter was an easy choice, Canada, as it could be easily reached by simply driving across the border (Isenberg, 2008). Walmart went global first in Mexico, rather than Canada, despite the language difference due to its closer geographic proximity to the company's headquarters in Bentonville, Arkansas.

Nowadays, companies are born global. From outsourcing manufacturing in China, employing a team of programmers in India, seeking funding on international platforms such as  Kickstarter.com , and even selling their products internationally through the Internet, entrepreneurs and investors seek the best deals worldwide with little to no boundaries.

The world has changed, and today's ventures do business in several countries before dominating their local markets. Two main explanations justify entrepreneurs crossing borders: (1) defensive and (2) offensive motivations (Isenberg, 2008). Defensive motivation leads entrepreneurs to go overseas to produce products that are competitive in the global market. When one of the authors produced his first mobile software application for the iPhone, he requested budgets from several development teams in Europe and the United States using  elance.com . The average fee for a U.S.-based production was $20,000 at the time. In Western Europe, the price for the same project would fluctuate between $9,000 and $15,000. He ended up recruiting a developer from Southeast Europe who charged $3,000, which included several rounds of revisions and testing. Before he had even started the venture, he had out-sourced the software development of the upcoming product at a fraction of the price it would have been to develop it in the United States.

An offensive approach occurs when entrepreneurs discover a new business opportunity that involves maintaining a presence beyond their country's boundary. This was the case of the now famous mobile game Angry Birds, created by Rovio (Kendall, 2011). While their roots are in Finland, home of Nokia Corporation, they decided to pass on the opportunity to do business locally and target their upcoming game to iPhone users predominantly present in the United States. In December 2009, Rovio launched the game Angry Birds through Apple's iPhone app store. It rapidly became a best seller, and since then, the game has been downloaded more than a billion times by smartphone owners from all over the world.

Being global is not a choice anymore for entrepreneurs. Entrepreneurial ventures need to be able to leverage the global economy and its advantages to become competitive both locally and globally.

What is Different about Entrepreneurial Finance?

Finance for entrepreneurs is somewhat different from either corporate- or investment-oriented finance. When we consider traditional financial techniques and concepts, we see that the discipline is based on a number of key assumptions. These assumptions include readily available data, efficient markets, diversification as a way to control risk, and statistical analysis as a means to measure risk. These are the key assumptions or techniques that underlie both the theory and practice of traditional finance.

When we deal with entrepreneurs or entrepreneurial ventures, especially startups, there are two key points to consider:

1. there is usually a paucity of any historical data, and

2. entrepreneurs do not have the ability to diversify or even measure their risk in the normal way.

Thus, entrepreneurial finance is considerably different from main-line finance. We acknowledge that entrepreneurial finance requires an in-depth knowledge of finance theory and technique and an understanding of the strengths and weaknesses of these theories and techniques. However, the final element that needs to be equally weighted in the entrepreneurial environment is the application of skill and judgment in selecting and applying the appropriate theory or technique given the problem at hand. We do not deny that this is also important in the areas of traditional finance, but we assert that it is more acute with entrepreneurial firms. In the entrepreneurial setting, it is not just a matter of calculating the answer (which is what is usually done in the more traditional areas of finance). The entrepreneur must know:

1. What to do if historical data are not available

2. What techniques may be used when certain data are missing

3. How to compute ranges of outcomes rather than focusing on specific outcomes

4. How to use projections that are based on data that are not historical

Summary

There has never been a better time to explore international opportunities and become a global entrepreneur. Becoming an entrepreneur today is less of a trade-off than it used to be. Between corporate layoffs, foreign competition, and the decline of labor unions, the typical employee may no longer assume that his or her job will be there for the next 3 to 5 years. Entrepreneurs need to have a global mind-set to face a highly competitive global economy. Common traits identified among global entrepreneurs are cultural diversity, desire to achieve, internal locus of control, clear vision, tolerance for ambiguity, integrity, and a global sense of responsibility. Companies are born global, and internationalization is no longer a choice but a requirement for today's global competitive business environment.