G20 Funding the future
Pre-seed and seed stage
"Money without mentorship for new innovators, especially young entrepreneurs, is not a formula for return on investment." Randall L. Tavierne, Partner, Global Strategic Growth Markets, Ernst & Young LLP
Companies at the very earliest stage of their development continue to face challenges in securing access to funding, but innovative new channels have the potential to improve the situation.
At the pre-seed and seed stage of growth, the entrepreneurial business is just being established. It is likely to be focusing on research and development to determine its product or service, or working on a prototype model to assess the viability of the venture.
In many cases, financing needs will still be reasonably small and are possibly even lower than they were a few years ago, thanks to the reduced cost of technology and new innovations, such as cloud computing.
At this stage, the cost of development can often be covered by the entrepreneur’s own savings, government grants, R&D tax credits, or the intervention of friends and family. New technologies, such as Facebook, Twitter and other social media, can extend the opportunities to acquire finance from friends and family because they broaden the entrepreneur’s network.
Most formal investors, such as VC firms, are unwilling to make equity investments at the seed stage. Seed investments are high risk and are likely to take many years before generating a return. They are also very difficult to value because the revenue potential remains uncertain. Even business angels are typically reluctant to invest at the seed stage.
Microfinance service intermediary
Founder and CEO,
CreditEase is China’s inclusive finance and wealth management services company. Set up in 2006 by TANG Ning, Founder and CEO, the company utilizes innovative models such as support group and peer-to-peer lending for risk control and funding, in urban and rural areas of China where there is a dearth of available finance. Today it has a 200,000-strong customer base, across 50 Chinese cities and 20 rural locations, with expansion in a number of new cities expected in the coming months.
The company’s target market is micro-entrepreneurs who cannot access traditional sources of finance due to a lack of collateral. Ning estimates there are between 50 million and 100 million micro-entrepreneurs in Chinese cities, with a further 100 million to 200 million in rural areas, all looking for credit.
CreditEase has developed its proprietary credit-scoring system, which assesses an applicant’s creditworthiness and makes a recommendation in terms of the amount, duration and interest rate. Lenders receive a rate of 8% to 12%, while borrowers pay a total cost averaging about 20%, once additional charges and CreditEase fees are added. The average loan duration is two years, with losses of about 2%. CreditEase has attracted a number of world leading private equity investors.
With seed capital increasingly difficult for entrepreneurs to source, a number of alternative funding mechanisms are emerging that could help to fill the gap.
In rapid-growth markets, microfinance has become established as a way of lending to small-scale entrepreneurs in a way that bypasses traditional lending channels. Peer-to-peer lending is also emerging as a feasible route to meeting demand that cannot be filled by the traditional banking sector.
These peer-to-peer channels are not unique to rapid-growth markets. One particularly interesting approach that is emerging in more developed G20 countries is crowdfunding, which is a way of attracting small amounts of funding or donations directly from multiple investors using social media and internet channels.
In the past few years, crowdfunding has become increasingly popular, particularly in creative industries, such as film and publishing, and in social enterprises. It is typically a form of debt finance, rather than equity, as there may be restrictions in some countries on providing equity stakes through crowdfunding mechanisms.
The sector is still at an early stage of development, but it does show potential to fill some of the gap left by the decline in availability of traditional seed capital.
Crowd-sourced funding platform for entrepreneurs
Launched in February 2011, Crowdcube is a UK-based online funding platform that allows companies to raise equity funding directly from members of the public. To date, 15 small businesses have raised some £2.8m via the Crowdcube platform — including the company itself, which recently raised £300,000 from 162 investors.
At its core, Crowdcube seeks to match entrepreneurs with investors. Entrepreneurs create an online pitch and then promote it to people who might want to invest in their business — from traditional funders such as friends and family, to colleagues, customers and suppliers. The site also allows companies to spread the word about a pitch using social networking tools, such as Facebook and Twitter.
Entrepreneurs can define their funding target and how long pitches should last and offer different levels of non-financial rewards to incentivize investors. Crowdcube operates an all-or-nothing funding model so that, if entrepreneurs do not reach their funding target, investors get their money back. It now has almost 6,000 registered members looking for investment opportunities in growing and innovative British companies.
Incubator for developing early stage entrepreneurs
Although Silicon Valley dominates the headlines, many other promising ecosystems for tech start-ups are emerging: from London and New York, through to Paris and Berlin. Many emerging markets are trying to follow suit, such as in Turkey’s capital, Ankara, where a fledgling ecosystem is now emerging. The local Bilkent University has developed courses in technology innovation and entrepreneurship, while a technology park now has more than 180 technology-oriented tenants. Furthermore, reverse migration of Turks from the US is helping to develop a start-up culture.
But early-stage Turkish entrepreneurs have faced a particular challenge with regards to funding. Most start-ups are funded through government grants, which can be onerous to apply for, although the process has eased in recent years. However, traditional routes such as venture capital or business angels remain very limited today, although both funds and angels are emerging. Other approaches, such as crowd-funding, are mooted as potential ideas, but are dependent on legal reforms. To help fill this gap and provide an interim level of support for entrepreneurs with an idea and little else, Viveka Incubation Center has been set up. It began life as a start-up in 2008, with a government grant, but has since evolved into a hybrid business: part software developer for corporate clients, part technology incubator for new ventures.
The premise right now is that cash-flow from the corporate side of the business can in turn be used to help provide working space, project support, mentoring and advice, as early-stage entrepreneurs develop and refine their ideas. This essentially acts as early seed capital, while entrepreneurs develop their concepts into a viable concept product. The hope is that some of these ventures will take off, either directly through potential clients or else by securing venture capital, which can give a return to the incubator. “Our mission is to add value to entrepreneurs, and take them through to investors,” explains Emin Okutan, one of the three main company partners, alongside Baris Okur and Ece Kasap. So far, Viveka has supported a total of 15 ventures, of which about seven are at a stage where they can start pitching to investors. One of these recently secured a telecommunications firm as its anchor client, which may in turn deliver the incubator’s first returns—and a potential future angel investor.
- Entrepreneurs should manage cash carefully to minimize the need for external finance and assess innovative funding models, such as crowdfunding.
- Governments should put in place appropriate regulatory frameworks to support innovative funding mechanisms, help companies that help start-ups and offer tax breaks for investors
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