PDF Analysis Of Financing Sources For Start-up Companies

ANALYSIS OF FINANCING SOURCES FOR START-UP COMPANIES

Marina Klacmer Calopa* Jelena Horvat**

Maja Lali***

Received: 6. 12. 2013 Accepted: 21. 10. 2014

Original scientific paper UDC 658.14(497.5)

This paper presents the development of start-up companies, their types and potential sources of financing with special emphasis on financing ventures in Croatia. The expected scientific contribution supports the defining stages of development for start-ups, as well as their financing sources at each stage. The goal of the research was to investigate whether Croatia has made a shift from traditional to newer methods of financing. Scientific and research contributions of the paper are reflected in the fact that there is a relatively small number of papers, especially in the domestic literature, that address these issues. Therefore, this research can contribute to a better understanding of the financing strategy of entrepreneurial ventures. Presented and interpreted results could be a useful basis and encouragement for a further research in this and similar topics related to the start-up scene at the local as well as the global level.

1. INTRODUCTION

Start-up companies are newly founded companies or entrepreneurial ventures that are in the phase of development and market research. They are usually, but not necessarily, associated with high-tech projects because their product is mostly software which can be easily produced and reproduced. Additionally, technology-oriented projects, by their very nature, have the

* Marina Klacmer Calopa, PhD, Assistant Professor, Faculty of Organization and Informatics, Pavlinska 2, Varazdin, Croatia, marina.klacmer@foi.hr

** Jelena Horvat, Assistant, Faculty of Organization and Informatics, Pavlinska 2, Varazdin, Croatia, jelena.horvat@foi.hr

*** Maja Lali, Student, Faculty of Organization and Informatics, Pavlinska 2, Varazdin, Croatia

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Management, Vol. 19, 2014, 2, pp. 19-44 M. Klacmer Calopa, J. Horvat, M. Lali: Analysis of financing sources for start-up companies

greatest potential for growth (, 2013). An interesting fact shown by the research is that technology-oriented start-ups are typically located in major urban centres. The reason is attributed to the need for a market that exceeds the local level (Baptista, Mendon?a, 2009). However, there are more and more start-up companies in traditional industries and business sectors. At the international level, there is more and more research associated with the importance and ways of financing entrepreneurial ventures (formal and informal), especially in the period of intense globalization. A research by Korostelevae and Mickiewicz (2010) proved that financial liberalization affects the overall financial investment in start-ups, using either external or internal financing sources. The data from the GEM (Global Entrepreneurship Monitor) research from 2001 to 2006 showed at the level of 54 countries that the total investment in start-up companies depended on the economic development of the country. As GDP per capita increases, greater financial opportunities for investment in entrepreneurial activities are being created.

1.1. Research questions, research methodology and expected scientific contribution

Primary data collection was conducted through questionnaires that were sent by e-mail to previously selected start-up companies in Croatia. A problem, which also presents the main limitation of the research, is that there is no registered database of start-up companies. Starting from the collected and analyzed previous research data on a global level and a defined set of research problems, several research questions and hypotheses were formed:

1. What are the financing sources used by Croatian start-up companies? 2. What stage are the Croatian start-up companies at, and do they use

different financing sources at various developmental stages? 3. Which financing opportunities do start-up entrepreneurs in Croatia

prefer: informal or formal, traditional or modern?

The hypotheses are as follows:

H1. There is a statistically significant relationship between the level of development of the company and financing mode used by Croatian start-ups.

H2. There is a significant relationship between professional experiences in entrepreneurship of the start-up managers and the choice of financing methods.

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Management, Vol. 19, 2014, 2, pp. 19-44 M. Klacmer Calopa, J. Horvat, M. Lali: Analysis of financing sources for start-up companies

The hypotheses are observed under the assumption that more experienced managers, recognizing the potential of their project and product opt for different methods of financing.

The data was gathered using a questionnaire containing questions on financing, development and business activity of Croatian start-ups. The questionnaire, designed using Google Docs, was sent along with a cover letter to the previously selected Croatian start-up addresses. Content analysis, descriptive statistical analysis and Chi-square tests were used to analyze the gathered data. These methods helped process the gathered data and establish the basic characteristics of the sample. Data analysis was performed using Microsoft Office Excel and statistical software package SPSS 19.0.

The expected scientific contribution helps to define development stages of start-up companies as well as the source of their financing at each stage. The research goal was to show whether in Croatia the shift from traditional to newer ways of financing entrepreneurial ventures has been achieved. The contribution is reflected in the fact that there are a relatively few papers, especially in the domestic literature, which explore these issues. Therefore, the conducted research can contribute to a better understanding of the financing strategy of the entrepreneurial ventures. The presented and interpreted results could be a useful basis and impetus for further research on this and similar topics related to the start-up scene at the local as well as the global level.

2. DEVELOPMENT STAGES AND FINANCING OF START-UP COMPANIES

According to Maurya (2012), start-up companies throughout their life cycle go through three stages of development. The first stage is the Problem/Solution Fit which investigates whether the market even has a problem that needs to be solved. In this case, the idea is not the most important element. It can even be quite cheap, but its implementation can be expensive. It is important to align the solution to the associated problem, as well as to see if the start-up wants to develop something that the customers/users need and something they will actually use and whether they are willing to pay for it, and finally whether the problem can be solved at all. The second phase Product/Market Fit has to answer the question of whether the implemented idea is really what the users need. After the first phase, in which it is necessary to investigate the existence of the problem, the purpose of solving the problem and the possibility of building a prototype or a partial solution, in the next phase it is essential to test and analyze different metrics to determine the extent to which the new product

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Management, Vol. 19, 2014, 2, pp. 19-44 M. Klacmer Calopa, J. Horvat, M. Lali: Analysis of financing sources for start-up companies

addresses specific customer issues. The third phase is Scale and it involves the expansion and growth of start-up companies, which leads to an increase in the number of employees, to an increased market shares or to higher income. The ideal time for fundraising is after phase 2 (Product/Market Fit), or once the market has been tested to see the potential for future start-up growth (scaling follows in the third stage). After the second phase, the start-up's founders as well as potential investors have the same goal - the expansion of the business.

According to Nivi and Naval from Venture Hacks1 (Maurya, 2012): "Traction is a measure of your product?s engagement with its market. Investors care about traction over everything else". The term traction, therefore, implies either that the company has a ,,good" number of users, or that their number is growing every day (though perhaps start-up is still not profitable) or the startup's income increases daily.

As opposed to Maurya who distinguishes three stages of development in start-up companies, according to Marmer, Hermann and Berman (2011), there are 6 stages of start-up development. The first stage is Discovery and its aim is to check whether it makes sense to solve the problem detected on the market, and whether there will be any interested parties for using the solutions which the start-ups plan to develop. This phase lasts from 5 to 7 months. The second phase is Validation, where start-ups try to get confirmation of whether the users are interested in their product. This phase lasts from 3 to 5 months. The third phase is Efficiency, in which start-ups enhance their business models and seek to increase the number of users. This phase lasts from 5 to 6 months. The fourth phase is Scale (7 to 9 months), which coincides with the third phase according to Ash Mauryau. There are also the fifth phase Profit Maximization, and the sixth phase Renewal or Decline. Going through many phases of development, the company ceases to be a start-up when it becomes profitable and goes public (by the first issue of shares) (Skoi, 2011).

According to Cvijanovi, Marovi and Sruk (2008) financing the development of the company can be displayed according to the phases of development. They distinguish five phases, namely: 1. experimental or seed; 2. start-up; 3. expansion; 4. recapitalization, and 5. buyout - selling a majority stake of the company. In the experimental phase, entrepreneurs often use their own funds or funds received from family and friends. In the initial phase of the development possible sources of financing are as follows: loans, business angels, and venture capital funds. In the expansion phase, the most common

1 Venture Hacks () is a blog written by Nivi and Naval, the initiators of startups, investors in new entrepreneurial ventures, students, and blog advisors.

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Management, Vol. 19, 2014, 2, pp. 19-44 M. Klacmer Calopa, J. Horvat, M. Lali: Analysis of financing sources for start-up companies

sources of funds are venture capital funds and loan funds. At the buyout stage, private equity funds play an important role.

High

Level of investment

Risk assumed by

investor Low

Founders, friends, family

Business angels

Venture capitalists

Non-financial corporations

Equity markets Commercial banks

Seed Start-up Early growth Established

Source: Vasilescu (2009).

Figure 1. Financing sources according to company's development phases

The whole concept of start-ups has enabled the creation of the so-called cyberspace or virtual reality space, which facilitated companies to invest and establish an online business at minimal cost. Minimum investments reduce the risk and enable a faster adaptation or even liquidation of companies. On the other hand, online business allows the establishment of passive start-ups that still do not have a product or service ready for the market, but are present on the Internet and have their own websites. This approach is good because it allows the entrepreneurs of start-up companies to analyze the market state, whether there is a need for their product or service, and whether it is worth investing in it (Kiskis, 2011).

A research carried out by Startup Genome Report2 showed that more than 90% of young companies (start-ups) failed. Among 3,200 respondents, only 1 out of 12 companies survived and succeeded introducing their product or

2 See: Marmer, M., Hermann B.L., & Berman R. (2011). Startup Genome Report 01, A new framework for understanding why startups succeed. resources/Startup_Genome_Report.pdf. Accessed 20 April 2013.

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