Out on your own
Article Date: Dec 04 2006
Evan Davis, presenter of BBC TWO's Dragons' Den and the BBC economics editor, believes there is no use complaining about the struggle to raise finances when starting up a new company. For Davis, it's simply part of the entrepreneur’s lot.
Money moves around in quantities too large for most of us to comprehend. The annual turnover on the London Stock Exchange is about £2.5 trillion, (over £40,000 for every man, woman and child in the country). UK banks have assets of £5.5 trillion. Currency worth £1.2 trillion is traded every day.
And by taking small commissions on transactions involving such large volumes of money, the City makes billions for its well-paid staff, and for the economy more generally.
Even though a lot of the money handled by Britain’s financial sector is international, the UK financial institutions still operate at the core of Britain’s national financial system, that is, the real economy. There’s no point in trading shares if there are no companies in which it’s worth owning them.
So, the flourishing financial sector has to sit on the foundation of non-financial wealth creation. Old businesses producing things, and above all, new businesses inventing them. And yet, compared to the sums handled in the city, the scale of investment in new businesses is surprisingly small in the UK.
According to the British Venture Capital Association, only 491 new businesses were given venture capital finance in Britain in 2005. It amounts to a total of £382 million - about three quarters of a million pounds per company - either as start-ups, or as early stage investments.
Now that is not very much funding for start-up businesses. £382 million amounts to 0.03 per cent of our national income, or £6 pounds for each person in the country. Not much relative to the £5.5 trillion in the banks.
Sure things
In fact, even the venture capital industry itself invests most of its money in management buy-outs and private equity investments that do not finance early stage companies at all, but merely change the ownership structure of established firms.
Clearly, money is a binding constraint on the ambitions of most entrepreneurs. Some would read all this and assume something is wrong. The economy is mis-directing its resources, they would say, and failing to support entrepreneurs.
And it’s certainly true that Britain needs more than 491 new businesses a year. Fortunately, there are other ways to start up a company than to secure several hundred thousand pounds from venture capitalists.
Young entrepreneurs find the money to get going from sources other than professional investors. They beg from friends and family, they spend their inheritance, (or their children’s inheritance); they use their lavish divorce settlements; they re-mortgage the house; they subscribe to one of the three thousand government support schemes for small firms.
Or, they go on Dragons’ Den.
Many of these alternative routes to securing start-up finance can raise their own challenges. Spending one’s own capital is a big risk, because the first lesson of sound financial management is not to put all your eggs in one basket; and yet entrepreneurs routinely open themselves to financial ruin by putting all their eggs, and those of their family and friends, in one basket of their own making.
So it’s back to the basic point that money is the most binding constraint on the ambitions of an entrepreneur.
Now, there are two responses to this unfortunate fact of life. One is to feel sorry for entrepreneurs and to argue they need more help; the other is to remember that part of the skill of being an entrepreneur is to overcome and manage the financial constraint.
Winning strategy
And there are three obvious things that the likely winners inevitably do to manage capital. First, they sequence their early activities to ensure they economise on capital. This means spending small amounts of money early, to gain information as to whether its worth spending large amounts later.
They don’t order 100,000 widgets when, for a much smaller sum, they can order 100 and get some useful information as to whether the next 99,900 will sell.
Second, they put their own money into the business. Not because it’s sensible, but because only by doing that can they persuade other people they believe in their business. It’s a down-payment on their commitment.
And third, they raise some money externally when they need it, preferably from an investor who can add a bit of value to the business. (Investors may grab a third of the company, but that will not matter much if they’re going to help make it several times more profitable.)
Many entrepreneurs fail on one point or another. They think they need more money than they do, so they don’t economise on capital (unless they can’t get any). Or, they ask for other people’s money without committing enough of their own. Or, they fail to accept external finance, in the expectation they can run the business alone, without having to share it.
All classic entrepreneurial mistakes that testify to the fact, it should never be made too easy to finance a business. If money is the problem, the answer is not for the world to lower the bar for entrepreneurs; it is for entrepreneurs to jump higher.
If you are an entrepreneur with a fantastic business idea, the Dragons’ Den team would like to hear from you. For an application form, email: dragonsden@bbc.co.uk, visit their website at: bbc.co.uk/dragonsden or call: 09011 110 825 (calls cost 25p).
