Executive Summary
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Entrepreneurs and small and medium-sized enterprise (SME) managers capitalize their firms with debt equity investments, or a combination of both.
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Equity investments such as venture capital can erode executive control but can enable access to the investor’s knowledge, advice, and networks.
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Venture capital can be provided by business angels, independent venture capital firms (IVCs1), corporations, or universities.
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The sources’ differing investment objectives, backgrounds, and control mechanisms deliver varying levels of added value to the SME.
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Companies seeking venture capital should select investors whose objectives, potential to add value, and expectations of control mesh most closely with those of the entrepreneur.
Introduction
Entrepreneurs and SME managers face two key choices when financing their ventures: debt or equity. Debt in the form of personal loans (including credit cards) and bank loans, key sources for most nascent ventures, gives efficient incentives for managers to exert effort and allow entrepreneurs to maintain control. The availability and utility of debt vary significantly with economic conditions, which, in turn, will have an impact on the supply and cost of capital. To a lesser extent, entrepreneurs rely on equity financing,2 in which parties external to a venture obtain partial ownership (and control) in exchange for financial capital, thus diluting managers’ incentives to expend effort. Equity financing is particularly important for high-growth ventures, since the amount of debt financing available may not permit sufficiently rapid growth in volatile industries (for example, technology). Objectives and incentives that are well aligned between investor and manager are the most efficient and facilitate additional value for the venture.
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