Academic journal article Journal of Business and Entrepreneurship

Financing the Three Stages of the Small Business Life Cycle: A Survey

Academic journal article Journal of Business and Entrepreneurship

Financing the Three Stages of the Small Business Life Cycle: A Survey

Article excerpt

ABSTRACT

This paper reports survey results on how a small business goes about funding each of the three stages-seed, start-up, and expansion-of its life cycle. The survey indicates that a majority of sample firms use private sources, including personal loans, for funding. In terms of outside sources, bank commercial loans dominate and other types of external funding are almost non-existent. Small businesses are found particularly deficient in two areas: evaluation of the market potential for their products or services and developing a business plan. This finding may partially explain these firms' limited access to non-bank sources and occasional rejection of their loan requests by banks.

INTRODUCTION

In the early years of its existence, a business venture usually encounters a three-stage development process: (1) seed stage, (2) start-up stage, and (3) expansion stage. The seed stage brings into existence an organization through which a well-conceived idea, such as an invention, becomes operationally feasible. In other words, this stage makes it possible to transform what once was an idea into a realizable form. This stage is also referred to as the formative stage, pre-start-up stage, concept stage, or research-and-development stage. The second stage, the start-up stage, involves building a production facility and hiring personnel. The third stage, the expansion stage pertains to the growth and development of the business after initial market acceptance of the product or service. In this stage, companies increase manufacturing or service capacity and mount an expanded marketing effort.

One of the most crucial factors for the survival in each stage of the development process and for smooth transition from one stage to another is an entity's ability to fund its operation. Although a part of the required funding may come from an entrepreneur's personal savings, in most cases financing from outside source(s) become a necessity. In obtaining external financing, an entrepreneur faces many questions, including which one of the sources may be most advantageous in the long run and whether a specific source is best suited for a particular stage of the business. Outside sources are many: banking institutions, governmental agencies, formal venture capitalists, and private individuals (better known as "angels"), to name a few. Each of these sources has its respective advantages and shortcomings. Also, one source may be more appropriate for one stage of business development than for another.

This paper has three objectives: (1) to review how external financing is obtained by a small business entity, (2) to analyze such decisions for the purpose of isolating possible discernible patterns, and (3) to compile a "satisfaction index" of some sort based on business owners' ex-post evaluation of the funding source utilized. The review of the external financing decision will ascertain, among other things, how informed the decision maker was about competing financing sources. This aspect of the study is quite important in that not all sources of venture capital are equally accessible.1 The intent behind the second objective is to explore associations among some relevant variables (for example, between the source of financing and the stage of business, between the type of source and the nature of the industry, and between the business location and the type of financing source). Finally, the purpose of the third objective is to obtain feedback from entrepreneurs about their experience with the financing sources; the resulting "satisfaction index" will hopefully guide future entrepreneurs in their financing decisions.

LITERATURE SURVEY

The financing of small businesses has been an area of considerable research interest. The primary focus of this research, however, has been on the formal venture capital. Thus, studies have been done on the characteristics of venture capital investments (Hoban, 1981; Khan, 1987; MacMillan & SubbaNarasimha, 1986; Tyebjee & Bruno, 1984), on how venture capitalists evaluate loan proposals (Goslin & Barge, 1986; MacMillan, Zemann, & SubbaNarasimha, 1986; Tyebjee & Bruno, 1986) and on the future of firms who were funded (or not funded) by venture capitalists (Bruno & Tyebjee, 1983, 1986). …

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