Literature review on entrepreneurial finance
Although it appears to be contentious whether availability of finance impacts on entrepreneurial entry to markets (Kim et al., 2006, p. 5), it is likely to be a critical factor in determining the early success or failure of any new start-up venture.
What is more, it has also been implicated as an important factor in determining the ongoing success of the business (Marlow & Patton, 2005, p. 717; Capelleras et al., 2008, p. 688). The literature would also appear to indicate that the balance between the availability to and uptake by entrepreneurs of different forms of finance may have wider effects on the national economy (Deidda & Fattouh, 2008, p. 6). Therefore it may be important to gain a better understanding of the level of availability of different forms of finance to start-up ventures, along with different factors affecting their uptake by entrepreneurs.
This section of the proposal provides a brief overview of the literature on the different financing options available to start-up ventures, focusing on bank finance and venture capital.
There is a lack of recent research available as to trends in funding of entrepreneurs in The Netherlands. Understanding of such trends in other countries, where extensive research has taken place in the field of entrepreneurial finance, could result in the understanding as well as the applicability of general findings to The Netherlands and any other country.
Evidence confirms that banks continued to provide a major source of finance for SMEs in the 1990s (Hughes, 1997, p. 151) although it would be expected that the recent financial crisis could have impacted this (Udell, 2011, p. 103). While relaxing financial constraints may allow greater access to bank financing for entrepreneurs, it may also encourage excessive entry to the market and may also undermine bank-monitoring incentives according to Arping et al. (2010, p. 26).
Evidence from developing nations such as South Africa suggest that access to formal bank financing is likely to be a determinant of start-up rates in any given region (Naude et al., 2008, p. 111). There was however, little consideration in this paper as to whether availability of venture capital had any moderating effect on this relationship, and other sources suggest that this may be less important than availability of human capital (Kim et al., 2006, p. 5).
There may not only be issues associated with availability of bank finance, but also access to it. There is some suggestion within the literature that women may be somewhat disadvantaged in securing bank finance when compared to their male counterparts (Marlow & Patton, 2005, p. 717; Carter et al., 2007, p. 427). Other authors have disputed this, although it is possible that these differences could be accounted for by different geographical foci (Sabarwal et al., 2009, p. 1). There is also some suggestion that differences may exist between ethnic groups in access to bank finance (Smallbone et al., 2003, p. 291) while other personal characteristics of entrepreneurs could also create barriers (Irwin & Scott, 2010, p. 245).
The relationship between banks and entrepreneurs could be key to enabling access. Research from Italy suggests that there could be trust issues between young entrepreneurial firms and bank managers. This may be particularly true where there is perceived to be heavy monitoring, and may lead to lower levels of demand for bank financing (Howorth & Moro, 2006, p. 495). There is some evidence that the ownership of the bank itself may influence the relationships it forms with businesses of all types, including start-ups. In particular, the evidence suggests that firms are more likely to maintain exclusive relationships with state-owned banks, which may indicate greater levels of trust than compared to foreign or privately owned banks (Berger et al., 2008, p. 37).
The literature identifies some strategies that may be effective in helping to overcome these barriers. For example in emerging economies, networking has been implicated as an important strategy in helping small to medium enterprises (SMEs) secure bank financing. This more specifically relates to networking with customers and government officials (Le & Nguyen, 2009, p. 867). There is some suggestion that firms in developed countries are more likely to incorporate in order to access formal bank financing (Acs et al., 2008, p. 10).
It has been speculated that young businesses may require more than just monetary input, but also require access to expertise. This argument has been proposed predominantly in the context of technology firms, who may lack experience in research and development. Such businesses may benefit from expertise provided by venture capital firms who possess expertise and skills in this area (Keuschnigg & Nielsen, 2005, p. 222). It would however be suggested that this may extend into some other sectors on the basis of research by Kim et al. (2006, p. 5) which found that availability of human capital was instrumental in determining entrepreneurial entry to markets.
Quantitative surveys conducted amongst start-up firms has suggested that various characteristics of those ventures may determine the structure and types of finance which are utilized, including size, assets, growth orientation and owner characteristics (Cassar, 2004, p. 261). When selecting venture capital, businesses must consider contracts carefully, as these will have a significant impact on how the firm is able to exit at a later stage (Cumming, 2008, p. 1947).
de Bettignies and Brander (2007, p. 808) argue that venture capital may be preferred to bank finance when venture capital productivity is high and entrepreneurial productivity is low. Winton and Yerramilli (2008, p. 51) suggest that there may be different criteria for determining preference, based on preference for risky or safe continuation practices and relative costs associated with finance options. For example, they suggest that if venture capital companies lower their cost of capital, this may entice some entrepreneurs to switch from safe continuation strategies utilizing bank finance, to riskier strategies utilizing venture capital.
Study Aims and Objectives
It would appear that many of the studies discussed in the previous section have much to contribute to a better understanding of how entrepreneurs select between bank and venture capital financing. However, most have focused on only limited aspects of the issue. A literature review that aims to take a wider perspective may therefore be useful in providing a better understanding of what may be a relatively complex decision-making process. In particular, most of the evidence available has examined the availability and access to bank financing, with much less information available on comparison to venture capital availability and access. Yet contrasting the benefits and limitations of the two may be important in enabling entrepreneurs to make an informed decision when structuring their start-up finance arrangements.
The research aims to conduct a review of the literature that will enable comparison of benefits and limitations of bank finance and venture capital.
The following research questions will be addressed by the review:
Are there differences in the availability of and access to bank financing and venture capital to businesses
Does the availability and access to different types of finance impact choices made by entrepreneurs
Are there common barriers to bank finance and venture capital or are some barriers specific to one option
When successfully answered, the findings from the previous questions should give answer to the following question by means of a recommendation: Are there any strategies that may enable entrepreneurs to overcome these barriers?
Acs, Z.J., Desai, S. & Klapper, L.F. (2008) What does ‘Entrepreneurship’ data really showA comparison of the global entrepreneurship monitor and world bank group datasets. World Bank Policy Research Working Paper No. 4667. Accessed 13 May 2011, from: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1233043.
Arping, S., Loranth, G. & Morrison, A.D. (2010). Public initiatives to support entrepreneurs: Credit guarantees versus co-funding. Journal of Financial Stability, 6(1): 26-35.
Berger, A.N., Klapper, L.F., Peria, M.S.M. & Zaidi, R. (2008). Bank ownership type and banking relationships. Journal of Financial Intermediation, 17(1): 37-62.
Capelleras, J.-L., Mole, K.F., Greene, F.J. & Storey, D.J. (2008). Do more heavily regulated economies have poorer performing new venturesEvidence from Britain and Spain. Journal of International Business Studies, 39(4): 688-704.
Carter, S., Shaw, E., Lam, W. & Wilson, F. (2007). Gender, entrepreneurship, and bank lending: The criteria and processes used by bank loan officers in assessing applications. Entrepreneurship Theory and Practice, 31(3): 427-444.
Cassar, G. (2004). The financing of business start ups. Journal of Business Venturing, 19(2): 261-283.
Cumming, D. (2008). Contracts and exits in venture capital finance. The Review of Financial Studies, 21(5): 1947-1982.
de Bettignies, J.-E. & Brander, J.A. (2007). Financing entrepreneurship: Bank finance versus venture capital. Journal of Business Venturing, 22(6): 808-832.
Deidda, L. & Fattouh, B. (2008). Banks, financial markets and growth. Journal of Financial Intermediation, 17(1): 6-36.
Howorth, C. & Moro, A. (2006). Trust within entrepreneur bank relationships: Insights from Italy. Entrepreneurship Theory and Practice, 30(4): 495-517.
Hughes, A. (1997). Finance for SMEs: A UK perspective. Business and Economics, 9(2): 151-168.
Irwin, D. & Scott, J.M. (2010). Barriers faced by SMEs in raising bank finance. International Journal of Entrepreneurial Behaviour & Research, 16(3): 245-259.
Keuschnigg, C. & Nielsen, S.B. (2005) ‘Public policy for start-up entrepreneurship with venture capital and bank finance’. In V. Kanniainen & C. Keuschnigg (Eds.) Venture Capital, Entrepreneurship, and Public Policy. Cambridge, MA: The MIT Press, pp. 221-250.
Kim, P.H., Aldrich, H.E. & Keister, L.A. (2006). Access (not) denied: The impact of financial, human, and cultural capital on entrepreneurial entry in the United States. Small Business Economics, 27(1): 5-22.
Le, N.T.B. & Nguyen, T.V. (2009). The impact of networking on bank financing: The case of small and medium-sized enterprises in Vietnam. Entrepreneurship Theory and Practice, 33(4): 867-887.
Marlow, S. & Patton, D. (2005). All credit to menEntrepreneurship, finance, and gender. Entrepreneurship Theory and Practice, 29(6): 717-735.
Naude, W., Gries, T., Wood, E. & Meintijies, A. (2008) Regional determinants of entrepreneurial start-ups in a developing country. Entrepreneurship & Regional Development, 20(2): 111-124.
Sabarwal, S., Terrell, K. & Bardasi, E. (2009). How do Female Entrepreneurs PerformEvidence from Three Developing Regions. World Bank. Accessed 15 May 2011, from: http://siteresources.worldbank.org/INTGENDER/Resources/336003-1240628924155/Sabarwal_Terrell_Bardasi_Entrep_All_CWE.pdf.
Smallbone, D., Ram, M., Deakins, D. & Aldock, R.B. (2003). Access to finance by ethnic minority businesses in the UK. International Small Business Journal, 21(3): 291-314.
Udell, G.F. (2011). SME financing and the financial crisis: A framework and some issues. In G. Calcagnini & I. Favaretto (Eds.) The Economics of Small Businesses: An International Perspective. London: Springer Heidelberg, pp. 103-113.
Winton, A. & Yerramilli, V. (2008). Entrepreneurial finance: Banks versus venture capital. Journal of Financial Economics, 88(1): 51-79.