This is a report on the various options of sources of fund relevant for TREE, the new business venture designed especially for customers to learn about the Chinese culture in UK. In this report, the varieties of sources of fund will be discussed, whereby the pros and cons of the different methods of financing will be discussed. Then, a critical evaluation upon the various financing methods will be performed, so to select the best options to finance the start-up of TREE.
There are several attractive points of TREE. Firstly, as the economy of China is booming, more and more people would like to learn about the Chinese cultures. This is especially true for multinational corporations in UK, as these multinational are going to send many expatriates to China for business dealings, and therefore, need to have some agency to educate their workforce. Then, as TREE offers a variety of lessons or areas for the customers, such as Chinese cuisine, Chinese calligraphy, Chinese language as so on, this business is actually a one stop solution for the customers. Furthermore, due to the class nature that emphasise on interaction between tutor and students (i.e., total student limit in a class is below 20 person), the business is likely to attract positive word-of-mouth as the students are likely to received high attentions and assistance from the tutors. Lastly and perhaps more importantly, as there is no such businesses in UK currently, TREE is actually a pioneer in the ‘education’ industry. With that, it is highly likely that TREE will receive findings from external party.
One of the common sources of financing is from bank loans or overdraft facilities. There are some advantages of employing bank borrowings. First of all, bank will not demand any stake of equity or share of profits in the new start-up, which may be in the interests of the entrepreneur (Slavec & Prodan, 2012). Then, to get financing from bank is quick if the new start-up meet the criteria deemed important to the bank.
However, to leverage on bank borrowing may be hard for the new start-up that has no track records (Atherton, 2012). For that, an entrepreneur may have to resort to take personal loans to fund the new start up. In other cases, the entrepreneur may also need to refinance his property to fund the new start-up. Asides, bank may be very conservative and will not finance risky business operation (Colombo & Grilli, 2007); which in the case of TREE, it may be considered as risky due to the fact that it is the first of its kind in the industry. Then, due to the high interest rate charged by banks; that may increase the likelihood of solvency issues for new businesses (Mukherjee, 1992). Yet, banks also demand a lot of paperwork, which may not be within the area of expertise by an entrepreneur. Perhaps more importantly, banks may become very conservative during the times that a company need fund the most, such as during the time of monetary tightening (Baran & Smiljanié, 2008).
One of the most common sources of fund is to obtain it from family members or friends (Sequeira & Rasheed, 2006). This method is common as a new start-up may not meet the various requirements by providers of fund (Islam, 2010). This method has the advantage that an entrepreneur may not need to have experiences and track records to get financing from friends or family members (Mukherjee, 1992). Indeed, the funding process may be easier (i.e., many rooms for negotiation), and straightforward. Indeed, the payback requirements may also be quite lenient.
However, not all entrepreneurs can have easy access to such source of fund, as the friends or relatives must have great trust on the entrepreneur as well as have excess capital (Degryse, Lu & Ongena, 2013). Then, the family members and friends may not add any value to the entrepreneur, aside from the financial capital provided to fund the start-up.
It is also possible to get funding from business incubators, which can be either privately or publicly owned. The government business incubator has the intention to spur growth and create jobs, while the private business incubator intended for profit making (Gadhia, 2010). One of the benefits from getting fund from business incubators entities is that the criteria may not be so stringent. However, it is true also those different business incubators may prefer different types of businesses (Chandra & Fealey, 2009). For the case in UK, majority of the business incubators are tailored to fund technology-related startup (Gadhia, 2010). It may be difficult for TREE to get funded from business incubators, as the business idea is not related to technological innovation.
There are also many wealthy and often already successful business people that are willing to fund startup, and these people are called the business angels (Mason, 1999; DeGennaro, 2010; Sudek, 2007). More relevant information on getting funded by angel investors can be obtained from these institutions (specific for UK): London Business Angels Ltd (LBA), Beer and Partners, London Seed Capital (LSC) as well as British Business Angels Association (BBAA) (Gadhia, 2010). Usually, for a very new startup without any track records, angel investors are the main channel to get funded, as compared to more sophisticated channel such as through venture capital (Morrissette, 2007; Brinlee, Franklin, Bell & Bullock, 2004). One benefits from getting funded by angel investors is that the angle investors often able to offer valuable experiences and guidance for the entrepreneur (Hague, 2004; Moses & Adebisi, 2013). In other words, the angle investor can be the mentor (Morrissette, 2007). Furthermore, another benefit is that as compared to many other sources of fund, to finance via angel investors can be relatively quick and simpler (which dependent a lot on the relationships and personal character of the entrepreneur to the angel investors) (Moses & Adebisi, 2013). Other than that, the angel investors have relatively low return rate requirement, and that do have more flexible business agreements (Matthew & Bryant Chen, 2007). All of these allow greater flexibilities for the entrepreneur when get funded from angle investors – rather than as compared to the case when get funded by other sources such as through venture capital.
There might be some disadvantages on getting funded by angel investors. For example, some angel investors may want to have a (relatively big) stake on the future profits (DeGennaro, 2010; Sudek, 2007). Yet, some other angle investors may want to have some roles in the new business – which can bring both positive and negative impacts to the new startup (Maula, Autio & Arenius, 2005). Then, it is typical that funds provided by angel investors are not big. In that case, a new start-up may need to look for venture capital (which will be discussed further below).
Venture capital is a very structured way to get funded, and for the case in UK, a new start-up can consult British Venture Capital Association (BVCA) to get introduced to the relevant venture capital or private equity fund the new start-up need (Gadhia, 2010). There are some benefits if a business able to get funded by venture capital. First of all, the venture capital funds are very established, and they do have the network and social capitals to bring a business idea to realization (i.e., higher likelihood of succeeding) (Alexy, Block, Sandner & TerWal, 2012; Mullins, 2012; Chen, Yao & Kotha, 2009). In certain cases, the transaction costs for commercialization can be reduced through the assistance provided by venture capitalists (Hsu, 2006). Aside from that, the venture capital does advise start-up entrepreneurs and thereby add value to new firms (Keuschnigg, 2004; Colombo & Grilli, 2007). As the executives in venture capital tend to have more experiences and business acumen, any entrepreneur that need to have access to human capital can seek out help from them (Satyanarayana, 2005). Aside from that, as compared to angle investors, the funds available to venture capital tend to be much larger (Pepin, 2005).
However, there are some drawbacks from the use of venture capital as source of fund. First of all, while venture capitalists may be willing to put in large fund, they do demand huge stake in the equity or share of profits in the new start-up, of which the shareholdings of the entrepreneur or founder may be diluted significantly (Alexy, Block, Sandner & TerWal, 2012). Yet, the requirements by venture capital can be very strict, and they aim for high returns from investment (Alexy, Block, Sandner & Ter Wal, 2012; Satyanarayana, 2005). Track records may be deemed very important by the venture capitalists (Chandra & Sarkar, 2012). In other instances, they may want to interfere and control the business, when something is not happening as they expect (Dos Santos, Patel & D’Souza, 2011).
There are many different types of grant provided by the government. For the case in UK, that include: The London Development Agency (LDA), National or European grants, The London Technology Fund, Knowledge Connect, as well as Creative Capital Fund (CCF) (Gadhia, 2010). One of the benefits of getting grants is that the costs of financing can be low, and yet the entrepreneur may get free advice from lawyers or accountants (Gadhia, 2010). However, grants provided by government may be available to certain sector in the economy, such as towards helping start-up in the technology and communication industry (Mehrotra, 2011).
From the discussion presented above, the more relevant source of fund for TREE can be analysed and determined. Firstly, bank borrowing is hard, as the business does not have solid track records. This is a very new business, and hence from the bank’s point of view, it is risky. For that, to get funded via bank borrowing is not relevant.
Then, to get funded from friends and family members can be viable. However, it is unfortunate that the founder does not have rich relatives and friends, and therefore, financing from friends and relatives can be relatively daunting (i.e., need to get the capital from many different parties). Aside from that, as many of these friends and relatives do not have business experiences; they will most likely be a passive stakeholders in the case of investing in TREE.
Business incubator can be a viable choice. However, the new start-up’s business idea is less favoured by those business incubators, as they are not related to technology or innovation. Rather, the business idea is about filling a gap in the marketplace. In other words, getting funded by business incubators may not be very relevant.
Then, it is noted that venture capital can provide solid financing and assistance (in terms of social capital, business processes and network). However, as TREE has no track records, and that the business idea is not those idea that can be leveraged for exorbitant returns, it is likely that venture capital investment fund will not be attracted at all by TREE.
Yet, government grant can be a relevant source of financing for TREE. However, the amount may not be sufficient. It is thereby valid to conclude that financing via government grant can at best be treated as the secondary options.
The most suitable choice is perhaps to get angle investor. While angel investors may not provide huge capital for TREE, this is okay as TREE only requires moderate capital for start-up and growth. Then, to seek assistance form angle investor can also lower business risks faced by TREE, s the entrepreneurs can seek guidance and mentorship from the relevant angle investors. In a way, if even the angle investor demand some returns or stake of equity in TREE, that is justifiable and acceptable, given that it is rational to exchange shareholding for long term commitment and collaboration with an experienced and already successful business person (especially one in the educational industry). There are many possibilities for synergy. Aside from that, the requirements by angle investor are more lenient. That will be advantageous for TREE. Considering that, the main source of fund is to finance TREE via angle investors.
Overall, it is proper to conclude that each sources of fund has pro and cons, but the most suitable source of fund selected is to finance TREE via angle investors.
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