Strategic Entrepreneurial Finance

From Value Creation to Realization

Darek Klonowski

• Publisher: Routledge
• Year: 2014
• ISBN:
  9781136210709
• Edition: 1
• Topic: Business
• Subtopic: Business generale
• Index: Business

Entrepreneurial finance is a discipline that studies financial resource mobilization, resource allocation, risk moderation, optimization in financial contracting, value creation, and value monetization within the context of entrepreneurship. However, without proper strategic consideration the discipline is incomplete. This book examines how the activity of entrepreneurial finance can be enhanced via a concentration on value creation and through improved strategic decision-making.

The most unique feature of the book is its focus on value creation. For entrepreneurs, value creation is not a one-off activity, but rather a continuous cycle of incremental improvements across a wide range of business activities. Entrepreneurial value creation is described in four comprehensive stages: value creation, value measurement, value enhancement, and value realization, referred to as the C-MER model. This book focuses on what creates value rather than merely presenting value creation in a straight accounting framework.

At the same time, deliberate and tactical planning and implementation ensure that the firm does not ignore the components necessary for it to survive and flourish.Vigorous strategic deliberations maximize the entrepreneurial firm's chances of making the right business decisions for the future, enable the firm to manage its available financial and non-financial resources in the most optimal manner, ensure that the necessary capital is secured to progress the development of the firm to its desired development level, and build value.

While financial considerations are important, the field of strategic entrepreneurial finance represents a fusion of three disciplines: strategic management, financial management, and entrepreneurship. This orientation represents a natural evolution of scholarship to combine specific domains and paradigms of naturally connected business disciplines and reflects the need to simultaneously examine business topics from different perspectives which may better encapsulate actual entrepreneurial practices.

Part I

Introduction

1 An introduction to strategic entrepreneurial finance

Chapter objectives

After reading this chapter, you should be able to:

• describe the individual fields of financial management, strategic management, and entrepreneurship;

• define the field of study termed strategic entrepreneurial finance;

• discuss the concept of value at the intersection of finance, strategy, and entrepreneurship;

• define value in entrepreneurial firms.

Entrepreneurship is a process by which individuals convert a new (or existing) idea into a business venture in order to successfully pursue opportunities available in the marketplace. Entrepreneurship plays a key role in shaping economies throughout the world, and for several reasons it is imperative for economic growth. Six out of every ten new jobs are created by the entrepreneurial sector. In addition, the entrepreneurial sector is spearheading an industrial transformation from traditional industries to the high technology sector. Entrepreneurial firms are at the forefront of developing innovations with a clear competitive advantage, and entrepreneurship is believed to offset economic declines and moderate economic cycles. Entrepreneurial firms are also making significant inroads in developing global markets.

Entrepreneurial ventures also face many challenges, one of which is access to finance. It is widely understood that entrepreneurial firms struggle with access to finance – securing capital is the most challenging, exhausting, and time consuming task for entrepreneurial firms. Capital constraints are especially prevalent in the seed/start-up phases of development (entrepreneurial firms in this stage are focused on business survival and often described as “virtual” because there is only an idea or concept in place) and during the expansion stage (entrepreneurial firms at this stage are looking to migrate to a higher level of development). Entrepreneurial firms may also have to deal with liquidity gaps if they are unable to secure the necessary expansion capital (these gaps may also occur for supply and demand reasons). Second, entrepreneurial firms are often developed and operated in a haphazard manner; their internal processes are chaotic. The planning, forecasting, and budgeting processes for most firms are either poorly developed or non-existent. Many entrepreneurial firms – even those with sizeable operations and revenues – do not employ functional managers (especially in the areas of finance, accounting, and marketing); consequently, their management teams are often incomplete. In many cases, the founding entrepreneur will fail outright to build his or her organization in a systematic, orchestrated, and deliberate manner. Third, many entrepreneurial ventures struggle with making strategic development decisions. Entrepreneurial firms often pursue expansion strategies which “undercut” (rather than protect) the core of their business and shift their internal focus into areas in which they have limited expertise. Most importantly (often on the advice of external consultants), they pursue strategies involving external modes of expansion: mergers, acquisitions, partnerships, and so on. Many firms pursue these expansion modes instead of pursuing a slower, more determined growth pattern based on organic growth (i.e., internal development). Poor strategic planning often results in a difficult transition for the firm from the entrepreneurial stages of development to more professional organizational structures. Fourth, entrepreneurial firms often struggle with corporate governance. There are multiple areas in which the corporate governance functions of a firm may fail: conflicts of interest, related party transactions, inadequate advisory functions (i.e., informal committees or formal boards of directors are constructed on the basis of internal management, friends, and family), poor financial and information disclosure, and so on. Finally, entrepreneurial firms are often less agile than they should be. While many entrepreneurial firms aspire to be “learning organizations,” they do not solve their internal problems systematically, learn from their own mistakes, experiment with new business approaches and solutions, or transfer knowledge effectively within the venture.

Strategic entrepreneurial finance

Disciplines in business

Business is an exciting field of study. Business studies have traditionally examined disciplines such as finance, management, human resources, marketing, operations, and accounting – these reflect the functional areas most commonly found in businesses. There are also other disciplines, often not classified as related to business (such as law, sociology, science, psychology, and so on), which have been making a mark on the business field. Over the years, there has been a movement to pursue interdisciplinary separation and division within business studies. Consequently, a number of new, narrower fields of business study have emerged such as entrepreneurship, business ethics, strategic management, risk management, supply chain management, purchasing, corporate governance, and real estate management. As academic evaluations of business evolve, academics attempt to gain more comprehensive insight and a greater understanding of each specific business topic. The benefits of such a high level of specialization include more detailed descriptions of business activities, new theoretical models and paradigms, and the emergence of new fields of business. There are also some drawbacks to this disciplinary separation and disaggregation: limited interdisciplinary linkages, increased competition between business disciplines, decreased predictability of existing business theories, and, most importantly, limited ability to explain more complex business phenomena.

For the purposes of this book, we propose that business is a symbiotic ecosystem of integrated disciplines. We believe that many business disciplines are connected, interrelated, and interwoven – they are a part of the same decision-making environment. We also conjecture that there are some disciplines in the business domain that fit together as a single field of study; these disciplines serve to jointly explain rudimentary business behaviors, actions, and activities. Some branches of business study have common themes, universal and mutual purposes, unified perspectives, and shared backgrounds. In this book, we offer a cross-disciplinary perspective focusing on three specific branches of business study: financial management, strategic management, and entrepreneurship. We discuss these concepts in the context of a single unifying concept.

Before we discuss the connections between financial management, strategic management, and entrepreneurship, let’s clarify what each of these three disciplines denotes on a stand-alone basis.

Strategic management

We define strategic management as a systematic set of management decisions and activities (i.e., investigations, commitments, and actions) that impact the long-term performance of a firm (i.e., the next three, five, or ten years). Strategic management answers a basic question: What does a business venture do to achieve its long-term plans? By contrast, business policy is a general management orientation which provides an integrative look inside the firm and determines how different functions of the business work together. Business policy answers another fundamental question: How do we organize our activities within the organization? Strategic management is a continuous effort aimed at channeling internal resources to develop, identify, and capture outstanding business opportunities available in the marketplace in the context of the firm’s visions, missions, goals, and objectives; in short, it is about planning and execution. A strong competitive advantage for the firm is secured when superior internal capabilities match outstanding external conditions and prospects; this “internal strengths–external opportunities” fit is critical and must be sustained. Strategic management also involves the implementation and execution of the management’s master game plan through a compendium of programs, budgets, and procedures. Last, strategic management requires performance evaluation and corrective actions. The reward for exceptional strategic planning and management is a superior and sustainable market position, strong revenue growth, robust profits and cash flows, continuous value creation, and above-average returns.

It is important to note that strategic management does not have to be a formal process; it can be somewhat informal, even chaotic and unstructured. Strategic management ideas first tend to germinate in the entrepreneur’s mind, and over time these crystallize to become clear strategic goals. The strategic vision for the entrepreneurial firm is often refined at multiple junctures through informal discussions with employees, staff, managers, consultants, business partners, and other stakeholders. The discrepancy between how the entrepreneurial firm operates in the present and the strategic vision for the entrepreneurial firm in the future sets up a “strategic tension” which is subsequently converted over time into a “how-to” program. While written plans are always more powerful than strategic considerations captured in thought, entrepreneurs often carry their strategic visions in their mind for some time before “inking” them on paper. Of course, once entrepreneurs write their plans down, they are accountable for achieving them. Other stakeholders can also better align their actions against written plans.

Strategic management offers many benefits for entrepreneurial firms. Firms that embrace the strategic management process often have clearer long-term goals and are more acutely aware of what is of strategic importance to their venture. Firms engaging with strategic management considerations also tend to have a sharper focus and more business awareness. Entrepreneurs also become acutely conscious of changes in the firm’s external environment as a result of strategic management practices, allowing them to make better tactical and strategic choices. Entrepreneurial firms with a strong strategic orientation also tend to develop back-up plans for their development; they have more robust and achievable contingency plans and are less surprised when unexpected events occur inside and outside of the firm. Last, a sharper strategic focus makes it relatively effortless for these firms to decline business opportunities that do not align well with their intended goals and visions. Entrepreneurs become much better at saying “no” to opportunities that are not along their desired growth path and development velocity.

Financial management

Financial management is a descriptive, analytical, and dynamic discipline that represents an amalgamation of the fields of accounting and economics. Financial management concerns the study of financial practices employed by managers when using financial and non-financial information to analyze, forecast, and allocate resources within the entrepreneurial firm. Financial management also involves financial decision making with respect to assessing and determining the impact of risk, evaluating and selecting investments, determining how much money is required and when, locating external sources of financing, and recommending the most optimal capital structure (i.e., debt-to-equity mix). Financial management requires efficient management and the proper allocation of the firm’s financial resources to accomplish goals and objectives. In short, it involves applying financial tools, obtaining capital, and cash flow management.

Financial management is based on using the appropriate systematic frameworks, models, and structures for financial analysis and decision making. At the center of financial management is the present value model, a simple framework that determines the value of assets, projects, or firms. Present value calculations are performed on the basis of internal cash flows. Strong financial analysis can easily assist in better decision making – and better decisions can enhance value. For example, managing working capital keeps the business alive and allows it to create value by raising capital efficiently, which, in turn, avoids unnecessary dilution to current shareholders. Employing robust financial management techniques also allows the firm to invest in cash-generative assets that can enhance the firm’s value.

Many of the benefits of financial management are similar to those accruing from participation in the strategic management process: better planning, clearer focus, better choices, more appreciation of risks, and so on. In addition, financial management provides a platform where various strategic scenarios can be tested “on paper” before they are implemented in reality. Financial management and analysis can illuminate areas of value creation and point to activities that may result in value destruction.

Entrepreneurship

Entrepreneurship is the process of converting ideas into business ventures in pursuit of opportunities available in the marketplace. Specifically, entrepreneurship is about generating a business idea (or relying on an existing one), developing it into an entrepreneurial venture, and overseeing its subsequent development. Entrepreneurship is not only about new business formation, but also the continual and systematic “migration” of the entrepreneurial venture through its subsequent developmental phases. Entrepreneurship also involves generating value and above-average returns to the entrepreneur and other investors and stakeholders who have supported the venture along the way. Entrepreneurship requires creativity in order to reform patterns of innovation, production, operation, promotion, and distribution. Resources must be aggregated (whether the entrepreneur currently possesses them or not) and assembled in a new and innovative manner in order to achieve higher productivity and a higher yield. Inherent to the field of entrepreneurship is the acceptance of risks and failures in exchange for potentially extraordinary financial rewards. Time, effort, passion, and devotion are all prerequisites for a successful entrepreneurial venture.

Business owners perpetuate entrepreneurship. Entrepreneurial finance, value creation, and divestment create ample opportunities for future entrepreneurial engagement. Through the continual re-use of cashed-out proceeds by exiting entrepreneurs, the use of stock options by employees of public firms (which are converted into cash), the exodus of talented people from successful entrepreneurial firms or corporations, corporate spin-offs, or improved access to entrepreneurial finance, individuals become first-time entrepreneurs and existing entrepreneurs become second-time and serial entrepreneurs. Furthermore, over time, entrepreneurs may become investors themselves and eventually build a portfolio of entrepreneurial ventures. Such entrepreneurs are typically more cognizant when detecting, realizing, capturing, and navigating through new business opportunities. When business owners re-engage into entrepreneurship through subsequent business ventures, they create a “snowball” effect for business formation and create a culture of entrepreneurship. These continuous activities produce wealth creation and redistribution potential for a larger group of individuals.

Interdisciplinary combinations

Interdisciplinary connections are not a new academic phenomenon – academics have made interdisciplinary connections between strategy, entrepreneurship, and finance to define such business fields as strategic entrepreneurship and entrepreneurial finance (strategic financial management has not been formally defined). It is important to note that these interdisciplinary fusions are relatively recent and their definitions are still evolving. In the following paragraphs, we discuss these two-construct fusions and spotlight contemplative evolutions in these concepts. More importantly, we highlight that the blending of the two disciplines is incomplete from the value creation perspective. In other words, excluding one of these critical disciplines from our building blocks (i.e., strategic management, entrepreneurship, and financial management) would significantly compromise the value creation, measurement, enhancement, and realization process.

Entrepreneurial finance, one of the first conceptual fusions among the three disciplines, is a field that studies financial resource mobilization, resource allocation, risk moderation, optimization in financial contracting, value creation, and value monetization within the context of entrepreneurship. The concept recognizes that flourishing entrepreneurship relies on the meticulous administration and supervision of financial resources. Entrepreneurial finance deals with multiple issues such as how much capital to raise and when (this is one of the most challenging issues facing entrepreneurial firms), how to increase the chances of successfully raising capital, how to structure financial contracts, how to generate and increase value, and how to make exit or harvesting decisions. Appropriate financial decisions must be undertaken throughout the entrepreneurial firm’s life cycle; initially, the most critical issues are fundraising, cash optimization, and financial management. These decisions need to be made on the basis of the ri...