ENTREPRENURIAL FINANCE
Entrepreneurs say the most difficult part of starting a business is raising money.
These difficulties include: -
1) Information Unevenness Problems
The fact that entrepreneurs have or recognize information about their business opportunities that investors don't
have or can't recognize creates three problems for raising money.
i) Entrepreneurs are reluctant to disclose information to financiers requiring investors to make
decisions on limited information. Entrepreneurs need to keep the information that they have
about their opportunities and their approaches to exploit them.
If other people learned this information, then they could pursue their opportunities. So
entrepreneurs: don't want to tell investors much about their opportunities or ways of exploiting
them lest the investors exploit the opportunities without them.
ii) The information advantage that entrepreneurs have makes it possible for them to take; advantage
of investors. Entrepreneurs can use their superior information to obtain capital from investors and
use it for their own benefit instead of the benefit of the company.
iii) The investors limited information about the entrepreneurs and the opportunity creates the potential
problem called adverse selection — Adverse selection occurs when. someone unable to distinguish
between the people, one who has a desired ability, and the others who doesn't because it’s
not possible to distinguish between the two people. The on without the desired quality has an
incentive to misrepresent her attributes and say that she has the desired quality. e.g. some
entrepreneurs have what it takes to build a success new company and some don't. If investors
can't tell one from the other those without the ability to build successful companies will minimize
the behaviour of the others to get. financing for instance they will pretend to possess skills,
information or experience that they really don't have. To protect themselves, investors have to
charge a premium to pay for the losses incurred from backing the wrong people because
talented entrepreneur don't want to pay the premium, they withdraw from the financing
1
, market leaving only the entrepreneurs that investors don't want to back, creating adverse
selection.
2) Uncertainty Problems
Investors also face a variety of problems because new ventures are very uncertain.
i) First, they have to make judgments about the value of opportunities and the ability of entrepreneurs
on the basis of very little actual evidence. The factors that determine those ventures that will become
valuable investments like the demand for the new product and the financial performance of the
firm. The ability of the entrepreneur to manage the company cannot be known for certain until after
entrepreneurs obtain financing and exploit their opportunities because these things cannot occur without
the investment of someone's capital. If the entrepreneur doesn't have a potential technology or along
track record of building successful businesses (which most ventures don't have), then the investor has
to make a decision about the venture on the basis of very little hard evidence. Making the financing
decision very risky.
ii)Secondly, entrepreneurs and investors often disagree about the value of new ventures because new
ventures are uncertain. No one really knows for sure how profitable a new venture will be. So
investors make their financing decision on. The basis of their own perceptions about the
profitability and attractiveness of ventures which are always lower than those of the entrepreneur.
iii) Thirdly, investors want to make sure that entrepreneurs will pay up if their ventures prove not to be
valuable, especially if they are lending money to the venture that way, the investor is risking less.
So investors ask entrepreneurs to provide collateral, or something of value that can be sold if the ventures fail.
Solutions to Venture Finance Problems
The solutions to venture finance problems are as follow:
1) Self-Financing
When you raise money to finance a new venture, investors will want you to invest your own
money in the venture as well. One needs to put his own money in a venture before rising from the
other investors.
2
Entrepreneurs say the most difficult part of starting a business is raising money.
These difficulties include: -
1) Information Unevenness Problems
The fact that entrepreneurs have or recognize information about their business opportunities that investors don't
have or can't recognize creates three problems for raising money.
i) Entrepreneurs are reluctant to disclose information to financiers requiring investors to make
decisions on limited information. Entrepreneurs need to keep the information that they have
about their opportunities and their approaches to exploit them.
If other people learned this information, then they could pursue their opportunities. So
entrepreneurs: don't want to tell investors much about their opportunities or ways of exploiting
them lest the investors exploit the opportunities without them.
ii) The information advantage that entrepreneurs have makes it possible for them to take; advantage
of investors. Entrepreneurs can use their superior information to obtain capital from investors and
use it for their own benefit instead of the benefit of the company.
iii) The investors limited information about the entrepreneurs and the opportunity creates the potential
problem called adverse selection — Adverse selection occurs when. someone unable to distinguish
between the people, one who has a desired ability, and the others who doesn't because it’s
not possible to distinguish between the two people. The on without the desired quality has an
incentive to misrepresent her attributes and say that she has the desired quality. e.g. some
entrepreneurs have what it takes to build a success new company and some don't. If investors
can't tell one from the other those without the ability to build successful companies will minimize
the behaviour of the others to get. financing for instance they will pretend to possess skills,
information or experience that they really don't have. To protect themselves, investors have to
charge a premium to pay for the losses incurred from backing the wrong people because
talented entrepreneur don't want to pay the premium, they withdraw from the financing
1
, market leaving only the entrepreneurs that investors don't want to back, creating adverse
selection.
2) Uncertainty Problems
Investors also face a variety of problems because new ventures are very uncertain.
i) First, they have to make judgments about the value of opportunities and the ability of entrepreneurs
on the basis of very little actual evidence. The factors that determine those ventures that will become
valuable investments like the demand for the new product and the financial performance of the
firm. The ability of the entrepreneur to manage the company cannot be known for certain until after
entrepreneurs obtain financing and exploit their opportunities because these things cannot occur without
the investment of someone's capital. If the entrepreneur doesn't have a potential technology or along
track record of building successful businesses (which most ventures don't have), then the investor has
to make a decision about the venture on the basis of very little hard evidence. Making the financing
decision very risky.
ii)Secondly, entrepreneurs and investors often disagree about the value of new ventures because new
ventures are uncertain. No one really knows for sure how profitable a new venture will be. So
investors make their financing decision on. The basis of their own perceptions about the
profitability and attractiveness of ventures which are always lower than those of the entrepreneur.
iii) Thirdly, investors want to make sure that entrepreneurs will pay up if their ventures prove not to be
valuable, especially if they are lending money to the venture that way, the investor is risking less.
So investors ask entrepreneurs to provide collateral, or something of value that can be sold if the ventures fail.
Solutions to Venture Finance Problems
The solutions to venture finance problems are as follow:
1) Self-Financing
When you raise money to finance a new venture, investors will want you to invest your own
money in the venture as well. One needs to put his own money in a venture before rising from the
other investors.
2
