Executive Summary
The purpose of this research is to try and examine factors that influence business performance of SMEs. The aim of this study is to give the seeing on how individuals ought to begin their business by taking an evaluation at all the elements affecting business performance. Thus help to lessen the danger of disappointment and expand possibilities of success. The study inspected eight variables that impact the SMEs business achievement. These components are SMEs trademark, administration and expertise, items and administrations. (SMEs) Is acknowledged internationally as an apparatus for enabling the citizenry and economic development. It has been connected with the quick financial development of nations in Asia and North America.
In UK, exertions have been made by progressive governments to diminish neediness and quicken monetary growth by expanding outside immediate speculation, enhancing the economy, authorizing strategy that support small business proprietorship and enterprise programs.
This study has a tendency to evaluate: how productive SME business is; whether infrastructural advancement could be credited to the vicinity of SMEs. If critical number of individuals are utilized inside the SME part; whether the SME market has pulled in banks and money related foundations with expansion in advances and impetuses. Whether there is built in technology related organizations because of the vicinity of SMEs. The method for working together and collaboration, assets and account, Strategy, and nature's turf. The hypothetical system has been drawn out, and survey was planned focused around the elements picked. The survey data provided information to figure out variables that are influencing Business Success of SMEs. The whole theories were adequately tried with SPSS, and five speculations were acknowledged. The relapse investigation result demonstrated that the most noteworthy factors influencing business accomplishment of SMEs in UK were SMEs qualities.
References53
Funding For New Business
1. Introduction
New company financing is a standout amongst the most imperative viewpoints in making another wander. By having a mixed bag of budgetary sources, the business visionary has an opportunity to pick the alternative that match with their plan of action. Be that as it may, constraint of monetary alternatives information of individuals in creating countries makes them restrict themselves with a couple of financing choices, which could perhaps not be the most ideal decision for the given wander. Small-To-Medium organizations (SME's) progressively contend in the worldwide commercial center, and Venture Capital trusts anticipate that organizations will develop rapidly. (Balling, Bernet, Gnan 2009) Understanding variables that affect the achievement or disappointment of development are critical, particularly at the firm level. One variable that in a broad sense influences how firms extend locally and universally is financing since it influences both the obtaining of assets and business operations.
Limitations on financial options knowledge, places challenges for finding the correct financing options for SMEs. (Ojeda, Lapwanich 2011) To precisely explore the influences of the strategy for financing, the value financed and obligation financed gatherings will be categorized. In making commitment to the research, this study decides to go past the financing of SME options that centers singularly on equity versus debt financing, and give another regard for financing strategies. In giving the unmistakable and measurable dissection of how strategies for financing influence execution and development this study will add to the SME literature. As stated in the introduction, the primary problem is evaluating the type of funding used in financing a new business, in regards to the use of equity or debt to fund. The three major objectives of this problem are (i) to gain a deeper insight into how new businesses are funded, (ii) the preferable type of financing that will be used for new businesses throughout different industries, and (iii) reveal the potential sources for funding a business based of primary and secondary data.
1.2 Research Problem
Funding a business is a complex issue. A new business owner should identify whether he or she is willing to finance the new business with the help of equity or debt. Each of the funding methods has its advantages and disadvantages. Equity financing allows business owners avoid making large loan payments. Investors may offer valuable business assistance to the new business owner in the case of need, as they are interested in the success of the venture. If all risks are clearly explained to the investors, they will understand if the business fails. However, the investors will own a part of business proportionally to their shares. Also, the new business owner will not be able to exercise full control over his or her own business. On the contrary, debt financing allows its owner to have control over business and the owner of the business can distribute profits by himself. Besides, loan payments are tax-deductible and can help lower tax liability. The lenders do not share the profits generated by the new business. However, there are certain disadvantages of debt financing as well. The main disadvantage is that the owner should make the loan payment when start-up costs are needed. If the new business owner fails to meet the schedule of payments, the credit rating of the new venture may decrease. Also, commercial banks may require additional guarantees in the form of personal assets from the small business owner to make sure the payments will be made at full or the body of the loan will be paid off in the case of bankruptcy. Besides, the use excessive debt financing increases the risk of bankruptcy. In this paper I will try to find out which type of financing is better for the new business. Also, preferable type of financing will be outlined for starting up new businesses in different industries.
The current research aims to reveal potential sources for funding a business based on analysis of primary and secondary data. Finding the financial sources for funding a new business is one of the most important stages of any venture. The main problem is to find out whether debt of equity financing is more appropriate for fulfilling organizational goals.
1.3. Problem Background
Funding a new business is a difficult issue. There are a lot of alternatives and options of funding a new business, but finding the best one is a difficult task. Starting a new business is usually connected with substantial financial resources. However, it can be inexpensive if a new entrepreneur knows how to organize financing and save on it. In order to find the right financial source for the new business one should possess certain skills and knowledge. I will undertake a research related finding financial sources for the new business by applying financial management approaches.
1.4. Hypothesis
In order to finance their SMEs, owners upon discussing their options have to choose if they need a debt or equity backing. On a monetary emergency conjuncture, new business owners will have more challenges in raising capital from external sources. Subsequently, a diminishment on the extent of outside capital is normal as deviated data issues build. (Ackah, Vuvor, 2011) Outside speculators will request more data, favor liquidity over non-fluid stakes and will give less subsidizing than in typical monetary periods. In addition, banks may be less ready to give subsidies as there is a lack of credit and monetary foundations battle to alter their budgetary and capital circumstance. Additionally, narrative confirmation recommends that general danger abhorrence climbs in times of budgetary imperative. Conversely, to adjust for the absence of outer trusts, shareholders will raise more finances from their sources. This gives business people the capability to indicator to the market that their new venture is of value by putting individual possessions in the firm. (Ackah, Vuvor, 2011) Based on this information, and based on theory and debt, the hypothesis formed:
H1: New SMEs choose debt financing based on difficulties in obtaining credit from banks.
H2: SMEs use equity financing as a last option, before distinguishing internal sources.
Obtaining credit could be an essential financing option of the account for new SMEs, giving extra subsidies in terms of deficiency of outer funding. Research (Mahomed, 2012) finds that organizations utilize more trade credit when credit from monetary foundations is not accessible. According to research, "they additionally contend that while transient trade credit may be routinely used to minimize transactions costs, medium-term acquiring against trade credit is a manifestation of financing of final resort." (Mahomed, 2012) Suppliers give cash to firms when banks and different organizations are hesitant to do thus, particularly in times of monetary emergency. Suppliers may have a near preference in getting data about the creditworthiness of purchasers. They can control the purchaser by debilitating to cut future supplies; they have a finer capacity to seize the products that are supplied on the off chance that the purchaser defaults, and they have a more noteworthy understood value stake in the SMEs survival.
1.5. Theoretical Background
A theory of debt and equity will be used in the current paper to examine which sources of financing are better for a particular venture. The calculation of funding for the new venture will be based on the relative benefits of debt and equity financing. The number of relevant literature was examined to work out an appropriate approach to the current research. Strauss (2011) provided a wide range of options related funding and raising capital for a new company in a highly competitive environment. Benjamin and Margulis (2013) touched upon the issue of how to organize private equity financing. Finkel and Greising (2009) compared advantages and disadvantages of debt and equity financing for the new enterprises. Debt market analysis was presented by Johnson (2013). Swanson, Srinidhi and Seetharaman (2003) provided a number of solution related balance between debt and equity financing. Marks,Robbins,Fernandez,Funkhouserand Williams (2009) offered a comprehensive research related capital structure. Finkel and Greising (2009) shed light on opportunities of fundraising, mastering private equity venture capital. The results of the theoretical research will be compared to the results of empirical study in terms of types of financing (debt or equity, internal or external). The conclusions will be based on the results of comparison of theoretical and empirical research. Also, the trends in funding the new businesses can be outlined. The tendencies in funding the newbusinesses depending on the industry they operate will be analyzed as well. The advantages and disadvantages of external and internal funding as well as debt and equity financing will be evaluated within the framework of the current research.
1.6. Research Aims and Objectives
The primary objective of the current research is to find out which funding method is better for the new enterprise. The secondary research objectives are to find out which funding sources are better for the different types of enterprises.
1.7.Research Questions
The current research will attempt to answer the following questions:
- What is the best form of funding a new business from cost minimization perspective?
- What are the advantages and disadvantages of debt and equity financing for a new business?
- Which type of financing is better for starting up new businesses in different industries?
These research questions are essential to answering the main question of how do new startup companies choose the best financing options for capital. In answering these questions, more research can be included in the literature on debt and equity financing.
2. Literature Review
2.1. Introduction of Funding of UK SME
The Intellectual Property Office (2013) stated that the UK government pays much attention to the development of innovation in UK. Intellectual Property Office (2013) presented a number of business supporting initiatives including funding that could help the companies maximize the value of their assets. Also, the authors succeeded to develop the model of funding new companies that started business in the field of innovations.Gleeson (2011) considered the problem of lending money to new businesses by banks in UK. Gleeson (2011) offered an overview of the current situation in funding the new companies and emphasized the need in equity capital. Also, Gleeson (2011) stated that the number of angel investors is increasing with economic recovery. On the whole, the tendency to invest directly in small companies is growing. The article presented by Gleeson (2011) can be used to give a general idea about angel capital and funding the new companies in UK. Wiltbank (2009) examined the opportunities of angel investment available for the new businesses in UK. Wiltbank (2009) stated that angel capital is a major source of funding new businesses. Also, Wiltbank (2009) provided an insight on investment results to angel investing, characteristics of business angel investors, and the strategies to improve angel investing outcomes.
Research from Mason and Harrison (2013) examined the impact of economic decline on funding new SME. Mason and Harrison (2013) stated that the economic decline made an adverse impact on venture capital and bank lending. According to Mason and Harrison (2013), government intervention in the field of financing new companies made a positive impact on the availability of debt and equity capital. The authors also offered comprehensive statistics on venture investments and angel capital. Also, Mason and Harrison (2013) described investment activity in UK targeting angel business supporting their arguments with empirical evidence. Mason and Harrison (2011) characterized investment activity in UK including investments in the new ventures for the period from 2008 to 2009. Mason and Harrison (2011) stated that equity financing is preferable in funding the new companies. Equity financing brings good returns to the investors. Mason and Harrison (2011) emphasized that the investors tend to invest in a business that do not relate their families and prefer to be involved in these businesses.
Research from Deloitte LLP (2013) presented an overview of market trends in angel investing. Deloitte LLP (2013) examined all regions where angel companies were launched and given appropriate statistics and trend analysis regarding funding angel businesses. A survey conducted by Deloitte LLP (2013) interviewed 62 angel companies thus offering vast information for analysis. McKaskill (2009) emphasized a vital role of angel capital in funding new businesses and developed recommendation for future business owners. McKaskill (2009) also stated that not only funding is crucial for developing new businesses, but mentoring and strategic decisions provided by investors. Howells, Miller and Fox (2012) emphasized the importance of angel capital in starting new businesses and analyzed risk level when funding the new companies. Howells, Miller and Fox (2012) stated that funding new businesses is motivated by expected returns and opportunity to take part in the management of the new companies. Mason and Harrison (2002) argued that the supply side of the capital market is not a problem. On the contrary, the problem relates the constraints connected with meeting investment criteria. Mason and Harrison (2002) concerned about quality of investments and emphasized the role of government in financing start-ups. Harrison, Mason and Smith (n.d.) extended the literature related decision-making process in the field of investments. The outcomes of Harrison, Mason and Smith (n.d.) were based on entrepreneurial learning theory. Harrison, Mason and Smith (n.d.) stated that business angels can be divided into three groups presenting some evidence.
Harrison and Mason (2000) devoted their research to formal and informal markets of venture capital. The study explored the interaction between the informal and formal capital for the new start-ups and revealed the opportunities for further collaboration. Harrison & Mason (2000a) presented evidence from surveys of angel businesses and managers of capital funds related the types of collaboration available to formal and informal sources of funding.
Mason and Harrison (2000b) attempted to identify the size of the new companies financed through informal capital using three methods of valuation. Mason and Harrison (2000b) used market-based, firm-based, and capture-recapture approaches to estimating the size of the companies. The author offered an insight on the market of informal capital. Mason and Harrison (2000b) revealed that in UK the new companies raise more capital from informal venture market than from institutional funds of venture capital. Harrison & Mason (2008) measured the activity of business angel in UK market. They used the following approaches to measuring business angel activity including extrapolations, supply- and demand-side approaches, investment-oriented and hybrid approaches, angel syndicates, and tax incentives strategies. Harrison & Mason (2008) emphasized the necessity of publishing data related investment activity to enable policy-makers to monitor the results of government interventions in the market of investments. Peters (2009) shed light on exit strategies that contribute to increasing capital for angel companies. Also, Peters (2009) described the changes in exit strategies that recently occurred and explained the benefits of shareholders from exit transactions. In addition, Peters (2009) stated that the management of an investment company is given full control over venture capital. Thus, the fluctuations in the investment in SME in the UK are an indication of the changing trends and behaviors of investors at various periods. We can derive and deduce implications from this trend analysis to analyze what are the factors for UK investors; internal as well as external in deciding to invest in new and progress startups.
2.2.Existing Forms of Funding a New Business:Friend and Family Capital
Hancock ISBE 2009 Conference (2009) investigated the opportunities of friends and family capital (F&F) for new start-ups. Based on the theory of agency costs, pecking order theory, static trade-off theory, and information asymmetry theory, Hancock ISBE 2009 Conference (2009) added to the development of the theory of F&F investments. Mason (2005) paid attention to two sources of financing start-ups including family and friends capital and financing by other individuals. Mason (2005) conducted a global research that revealed the following: approximately 3.4% of the population tried to invest the businesses of their friends and relatives informally. Interestingly, approximately 1.1% of GDP of the countries examined provide capital for the new companies. According to Mason (2005), family and friends are the primary providers of capital for the new companies. Centre for Strategy & Evaluation Services (2012) provides the general overview of an investment market and its characteristics. Centre for Strategy & Evaluation Services (2012) offered an assessment of the programs targeting the development of angel investment. The study examined the market for investments in EU and UK in particular. Centre for Strategy & Evaluation Services (2012) touched upon the advantages and disadvantages of using friends and family capital to invest in angel companies.
Terjesen (2011) considered equity financing issues in developing seed companies. Equity financing was divided by Terjesen (2011) into four stages explaining its role on every stage. Also, Terjesen (2011) distinguished between different forms of investments in terms of timing, amount, ownership type, contract type, payback, monitoring of decisions, and expectations related timing. Terjesen (2011) discussed the issue of friend and family capital in details. Harper and Kelly (2003) considered the issues of using social capital including friends and family capital for investing in new start-ups. The issue of social capital was examined before using various approaches measuring the different aspect of social capital. Harper and Kelly (2003) provided statistics of ONS related measuring social capital within the UK. This work helped assess volume of social capital in UK in comparison to other forms of angel investments.
Foxton and Jones (2011) paid attention to the idea of social capital as capital for raising funds for the new start-ups. Also, Foxton and Jones (2011) offered statistics related the volumes of social capital in UK. In addition, Foxton and Jones (2011) attempted to measure social capital available in UK. As well as Foxton and Jones (2011), Edwards, Franklin and Holland (2003) researched the issue of forming family and social capital. Edwards, Franklin and Holland (2003) described how family capital is integrated with social and economic structures. Basu and Parker (n.d.) stated that in UK borrowing from family and friends is the second source of financing after bank loans. Basu and Parker (n.d.) identified the primary determinants of family and friends capital. The research is based on empirical data related Asian entrepreneurs starting up businesses in the Great Britain.Thus, borrowing from friends and family is one prominent source of financing for new firms. This might have various implications in different backgrounds; both positive and negative. The availability of funds in these forms may be tapped as an opportunity whereas it also increases the personal liability of the starters of businesses in the long run.
2.3 Bank Capital
According to Vistage International Ltd. (2013), traditional means of financing new companies give in the place to the means that used to be considered less traditional. Also, the changes in the banking field were also outlined. Thus, before the crisis of 2008, the large banks dominated at the financial market of UK. The large banks used a traditional approach to lending when loans were supported by the borrower’s assets. The approaches to taking risks were significantly re-considered after the financial crisis of 2008. Davis (2012) stated that banks do not meet funding needs of UK SME anymore. There is a tendency of large insurance companies to invest in new large corporations directly. Besides, Davis (2012) stated funding the new companies will help revive the UK economy. However, SME market was ignored by the providers of the new sources of funding. Davis (2012) aimed to identify the gap in funding the new start-ups in UK and reveal the problems that exist in this area. Gray (2013) shed light on the problem related unwillingness of the banks to finance new enterprises including SME. However, Gray (2013) examined several studies stating that SME received external funding without any constraints. The outcomes developed by Gray (2013) are based on the national survey of 2012 related the responses of SME owners. From 90% of SME attained bank loans in 2008 only 74% remained as of 2011. As well as Davis (2012) Gray (2013) marked out the importance of finding new sources of funding the new businesses.
Mason, Michie and Wishlade (2012) also concerned the problem of alternative financing of new SME in UK. Mason, Michie and Wishlade (2012) focused on the research of new financial instruments that could help develop appropriate funding of new SME in UK. Besides, Mason, Michie and Wishlade (2012) analyzed the accessibility of new financial resources to new SME. In addition, the research conducted by Mason, Michie and Wishlade (2012) showed that regionally-focused instruments are not oriented on venture capital. Korosteleva and Mickiewicz (2010) presented a study examining start-up financing processes in 54 countries of the world. The surveys for 2001-2006 were used in this research. As the results, the researchers found that a financial liberalization increased financial size of the new companies in spite of the sources of financing. The impact on total volume of financing start-ups was also examined by the authors. Sameen and Quested (2013) stated that the results of their research showed the tendency to financing assets through equity. The firms that are growing fast tend to finance their assets through either long-term or short-term debt. Sameen and Quested (2013) emphasized the necessity to finance intangible assets using the new models of business. Nofsinger and Wang (2009) considered angel investing and initial capitalization stages based on the survey of the firms from 27countries. Nofsinger and Wang (2009) examined types of financing, amounts, and the sources of financing. It appeared that informal investments are often used to fund the new start-ups. Thus, Bank Capital has been the most traditional source of fund for startups. In various countries and at different periods of time, however, there have been problems for new businesses in procurement of funds by this source. There have been attempts to identify the reasons for these and we have the results that give a somewhat direction on what the causes might be. Based on such findings, the bridge between starters and bank capital shall be narrowed to solve the financial resource acquisition problem of companies.
2.4 Approaches to Making Capital Investment Decisions
Chittenden, F. and Derregia, M. (n.d.) offered an insight related to the problem of capital investment at the firms of different sizes. The study revealed differences between capital budgeting practices used by average performing enterprises and entrepreneurial firms. Chittenden, F. and Derregia, M. (n.d.) found out that the majority of the companies use discounted cash flow method together with the payback method when making investment decisions. The use of the payback method is conditioned by the fact that modern business requires quick payback period. This method if often used to calculate the payback period for the new companies as it helps indicate payback period. Loudermilk and Steinberger (2002) argued that the identification of productive investment opportunities is crucially important when starting-up a business. Loudermilk and Steinberger (2002) offered a comprehensive framework for choosing appropriate investment methods. It could be useful when starting a new company and help choose the financing approach.
GAO (1998) offered several approaches to the decision-making process in capital investment. Also, the issues of increasing efficiency of capital investments were raised. GAO (1998) presented the analysis of the processes of selection, evaluation, and monitoring of investment decisions on government basis. These practices can be used for evaluation of capital investment decisions and developing strategies. It is mandatory that new businesses can satisfy the needs of lenders in the form of desirable returns in the future, in order to gain the required funds. It is also necessary on the side of the investor to analyze the scope and interest in the new startup using appropriate measures of capital investment decisions.
3. Theoretical Background of the Research
3.1 Overview of Theories
The issue of problems faced by new companies is not a new one and there are several theories that could help understand them. Theories such as the theory of agency costs, pecking order theory, infant industry theory, and trade-off theory are considered with respect to the issues that arise when launching the new companies. These concepts deal with various dimensions of a new startup ranging from the relationships between investors, shareholders, and managers and the issues that could potentially arise as a result of conflict of interests, asymmetrical information issue (The theory of agency cost), selection of sources of financing to achieve positive financial outcomes for each stakeholder (Pecking order theory), the importance of economic protection (Infant industry argument) to the use of debt and equity for efficiency maximization(Trade-off theory). The explanation of the main concepts of the theories can be found below.
3.2 Agency Costs Theory
A fundamental concept of the agency costs theory is that a principal employs an agent to perform the tasks on the behalf of a principal. Agency reflects the relationships between the principal and agent. Principals incur agency costs after observing the behavior of agency based on monitoring of agents’ performance. Agents are accountable to principals who employ these agents (Grigore and Ştefan-Duicu, 2010). With respect to the problem examined in the current research, agency costs can be associated with the conflicts of interests between senior management of a new company and shareholders of this company. Shareholders require that the management of the company generate returns from investments and maximize shareholder value. Meanwhile, the management of the company may run a business in a way to maximize their power or wealth that may not coincide with the interests of the shareholders. Thus, conflict of interests arises. Agency costs usually comprise of material incentives for principals like stock options or performance bonuses and moral incentives for agents. Thus, the interests of principals and agents can be aligned (Grigore and Ştefan-Duicu, 2010).
Jensen (1986) concerned agency costs theory about funding new businesses. Jensen (1986) stated that debt financing benefits reducing agency costs could be used in financing new start-ups. Also, Jensen (1986) considered the influence of programs of diversification on income and losses from the perspective of the agency costs theory that could be also helpful when starting a new company having limited financial resources. Jensen (1986) touched upon the issue of offering bids and abnormal performance of the companies before takeover. Bankman and Cole (2001) explain the problem of agency costs when launching new enterprises. Also, Bankman and Cole (2001) concerned the relationships problem between business owners, investors and management of new companies. In addition, Bankman and Cole (2001) stated that venture capital-backed investments cannot bring extraordinary returns, but it may seem that they do.
Thus, the use of capital-backed investments should be considered closely when starting-up the new companies. Grigore and Ştefan-Duicu (2010) aimed to explain a behavioral aspect from the perspective of agent costs theory. Additionally, Grigore and Ştefan-Duicu (2010) considered the optimal capital structure for the new companies based on the perspective of agency costs theory. As well as Bankman and Cole (2001), Grigore and Ştefan-Duicu (2010) paid much attention to emerging conflicts between investors and managers. It is necessary to take these issues into account when launching the new companies. Like Bankman and Cole (2001), Grigore and Ştefan-Duicu (2010), and Jensen (1986), Frank and Goyal (2005) shed light on agency conflicts, bankruptcy and transactions costs. Frank and Goyal (2005) explained the problems arising between agents by use of debt financing. The outcomes of Frank and Goyal (2005) are based on pecking order theory of leverage and the trade-off theory. Also, Frank and Goyal (2005) reviewed the evidence related these theories. The evidence is related different forms of ownership of the companies including private firms, small and large public companies. Typically, small public firms tend to use equity financing. On the contrary to small public firms, large public firms tend to use corporate bonds and retained earnings. Frank and Goyal (2005) considered the impact of transaction and bankruptcy costs on the choice of financing.
3.3 Pecking Order Theory
Pecking order theoryalso called pecking order model, is an approach that helps define the capital structure of the companies. The primary goal of this theory is to explain priorities in choosing financial sources. The idea of the theory is that the company tends to follow the course of least resistance by obtaining available sources of funding and then moving to use the financial sources that are difficult to use. For example, when starting a business, owners can use available internal sources, such as own financial sources and capital borrowed from friends and family. After the primary sources of financing are exhausted, the founders start to seek for investors or lenders. When other options are not available, the new businesses may use the equity in the assets held by the business (Frank and Goyal, 2005).
3.4 Infant Industry Argument
An infant industry at the early stage of development cannot compete against mature competitors in the industry. Infant industry argument also called infant industry theory advocates the protectionism for new industries fierce competition until maturity. The protection of newly established companies is exercised by governments in the form of tariffs, quotas, import duties or exchange rate control procedures. These measures aim to prevent competitors from beating or matching the price level of the infant industries in the international markets. These security measures help infant industries stabilize and develop in the privileged environment (Krueger and Tuncer, 2003).
Krueger and Tuncer (2003) considered an application of the principle of the infant industry arguments in practice. They developed an empirical test for the validity of the infant industry argument and used that analysis on Turkish Data. Krueger and Tuncer (2003) concluded that at least in the Turkish case, protection did not draw out the sort of growth in output per unit of input on which infant industry proponents supported their claims for protectionism. Melitz (2005) emphasized the necessity to protect new companies based on infant industry protection theory. Also, Melitz (2005) considered functioning of new companies on national and international markets. Melitz (2005) compared the efficiency of different tools in choosing an appropriate funding policy.
3.5 Trade-off Theory
Trade-off theory states that a company can choose the proportions of using debt and equity financing by balancing the benefits and costs. Trade-off theory offsets the cost of debt relatively to its benefits. The theory describes the following concepts of corporate finance: agency costs and cost of financial distress. Also, the theory explains why the new companies are financed partly by debt and partially by equity. Debt financing has certain advantages in the form of tax benefits while debt financing is also associated with higher costs (bankruptcy and non-bankruptcy costs) in comparison to equity financing. The theory states that a further increase in debt decreases the marginal benefit of this increase thus raising marginal costs. Thus, a firm should focus on its trade-offs by maximizing the overall value when choosing the debt or equity financing (Frank and Goyal, 2005).
Thus, existing theories are what we base our assumptions on for further practical experiments and deductions. With growing competition at domestic levels and increasing globalization at international levels, all these concepts exhibit the apt significance even at present times. They address the various factors related to decisions of different forms of resources; mainly economical.
3.6 Risk Analysis in Capital Investing
Despite the analysis of Sykianakis (2007) relates Balkanas, it is based on the examples of a large UK and US companies. The primary focus of the work is risk analysis, assessment, and management. The most important conclusion of the article was that the political risk influences capital investing process, but can be hardly estimated. Sykianakis (2007) considered foreign direct investments. Therefore, this source of information can be used as supplementary for purposes of the current research. Sanders Thomas Ltd (2012) provides an assessment of the methods of investing in new ventures and growth opportunities. This work will help evaluate these practices and make appropriate conclusions related effectiveness of using investments and assessments of the associated risks.
The Fund that was examined provides investments for the companies at different stages of the development including the initial stage. The analysis presented by Sanders Thomas Ltd (2012) can help assess the sources of funding new companies. There are new sources of funding that are being assessed in the current age and can be tapped by new businesses. There are risks involved at both the sides: the investors and the creditors. Given the researches and the experiments, it is fair for companies to assess the level of risks of investing in a new company before deciding to do so.
3.7 Analysis of Efficiency of Capital Markets in UK
CRA International (2009) assessed the effectiveness of regulation of the securities markets in UK. The research relates the evaluation of the current situation in the capital markets in UK. The assessment of the efficiency of the capital markets helps provide sustainable growth of UK economy. CRA International (2009) linked between market regulation and cost of equity, valuation, and protection of shareholders. This article can be used for evaluation of the practices related the theories used in the current research.
Mishra (n.d.) presented an evaluation of the global financial markets including the markets in developed and developing countries. Mishra (n.d.) shed light on the contemporary state of the financial markets of the world including UK from the perspective of efficient resource allocation. Also, Mishra (n.d.) considered the availability of innovative financial products for the new companies in UK. A favorable financial market condition paves ways for further investments and financing. In the UK particularly, healthy capital market defines efficient resource allocation that can mobilize funds to invest in innovative ideas, products and services, giving impetus to funding for new businesses.
3.8. Long-Term Financing of New Companies in UK
Mullen (2012) explained that obtaining an appropriate source of financing is a kind of challenge because of lack of funding in the post-crisis period. Besides, the problem is worsened by the fact that new business owners and managers do not have enough experience to manage the financial sources. Mullen (2012) described the patterns that could be used to find the sources of financing for the new companies. Also, Mullen (2012) turned the attention of the potential business owners to the opportunities offered by government to support the new start-ups. Mullen (2012) emphasized the long-term financing as one of possible alternatives to financing the new start-ups. Mills (n.d.) concerned the issues of raising capital for new companies. Mills (n.d.) analyzed changes in building capital patterns in a contemporary business environment. Mills (n.d.) stated that it has become more difficult to raise capital for SME because of consequences of the financial crisis of 2007-2008.
Raising capital has become more costly and time-consuming than before. Also, Mills (n.d.) made conclusions related success factors of raising capital for the new companies.
Financial crisis has not only been a problem for existing businesses, but it has also halted the various opportunities that could have entered in the scene for prospective starters. The observations suggest that long-term financing in new businesses is also being considered as an issue, despite the recession phase. Though risks are involved, the future prospects look good and so we might expect long term financing as one of the means of funds for new startups.
3.9. Summary
The current literature review section consists of eight parts including theoretical background, the analysis of the practices of funding SME in UK, and analysis of financing new business in UK. The capital investment patterns, identifying features of the UK capital market, risk analysis in capital investing, the analysis of efficiency of capital markets in UK, and long-term financing patterns in UK. Theoretical elements present framework for evaluation the relationships between shareholders and management of the new companies. The patterns used by the new companies to choose from several investment sources, the legal framework for the new companies, and the optimal combination of equity and debt that could be used by the new companies.
The part related funding of SME seeks to describe the typical patterns of funding in UK while the part related funding the new business evaluates the sources of financing that could be used by the new companies. The part related the capital investment patterns in UK aims to identify the types of investment that are used by the new companies in UK. Learning distinguishing features of the capital markets in UK help shed light on the sources of capital that could be used when launching new start-ups. Risk analysis in capital investing help evaluate potential risks and mitigate their negative effect on the new companies. The analysis of efficiency of the capital markets in UK help assess the most efficient markets and analyze their success factors to further use when developing the investing strategies for the new companies in UK. The analysis of the long-term investment patterns could help range the sources of financing and identify the sources that could be used on initial stages of launching the new companies.
4. Methodology
This chapter will focus on how the research questions presented in this study were evaluated, in regards to the usage of data presented from the samples used in this study. The following methodology conducted in this study relies on the measurable variables and issues dealing with equity and debt financing for small and medium new businesses. (De Haan, Poghosyan, 2011, pg. 3) The previous chapters covered the literature review and theoretical framework in which helped to guide the study. Within this chapter it discusses the detail of the choice of methodology, and the research design used in regards to the research perspective, and research questions. This chapter specifically clarifies why the mixed methods techniques is appropriate for this study, and the potential realizations of the benefits obtained, and the limitations of the study. This chapter describes the method of collection, source of data utilized, and the summary of the results in which were carried out.
4.1 Measurement variable and issues
The tested variables within this study includes focusing on small and medium sized businesses that utilized either debt or equity options for financing. In trying to analyze the results the variables that will be used includes; profitability and growth, in which the ratio of the profits to the sales turnover, will correlate to the change in the percentage of sales turnover. (Mahomed 2009)In looking at the variables used, there were nearly seven hundred outcome indicators that have been used to describe each of the companies examined in the data collection section. Some examples of the outcome indicators used include but may not be limited to the total amount of liabilities owned by the business; total amount of assets owned by the business; total net worth of owner or principal owner; and whether the business is run on a for profit basis or as a social enterprise. Because of the sheer number of outcome indicators used in the data gathering portion plus the sheer number of the companies that has been reviewed and analyzed, it would be impossible to conduct an individual analysis for each outcome indicator or each company. So, for the purpose of this study, only the most relevant findings, which the researchers can use to answer the primary and secondary research goals and objectives will be the focus of the discussion for the entire data analysis section.While the variables of size and age will be defined by the total assets, and the date of the survey. The questionnaire will provide variables of: industry, age, occupation, and the choice of equity or debt for financing their SMEs. Based on the research the variables includes:
- Region
- Report Results
- Legal Status of Business
- Origin of Business
- Years Established
- Source of Financing for Small Businesses vs. Medium Businesses
- Owner’s Demographics
- Management Experience
- Principal Source of Money Used
- Support or Advice Source
4.2. Research Model
This study will focus on the discussion on the differences and the similarities between equity and bank loan financing options for funding a new small business. The objective of this paper is to be able to determine the major similarities and differences between these two new business funding options. The use both qualitative and quantitative research methods, will work best in achieving the research goals and objectives. (Lei, 2012) For the qualitative methodology, the author of this paper will use an exploratory research design to gather information from the subjects. There were over 250 nationally recognized businesses assessed, focusing on their business structure and organization, and the way how they manage and receive their funds for their business operations, expansions, and ventures. For the quantitative research, the analysis will not use a sample population that is sized at 250, but gather data from the 2004 UKSurvey of Finance for SMEs. Instead of focusing on 250 SMEs, it will take data from 2500 SMEs in the UK. Additionally the sample population will be composed of the business owners or any executive level personnel (e.g. general manager, or business director, etc.) of the respective businesses that have been chosen to represent the sample population for this research’s qualitative portion.
The research questions that are presented will be solved using the survey questionnaire for the quantitative. (Kaar, Muller 2011, pg. 42) This includes the possible effects of having a particular type of business legal status in choosing funding decisions, such as in the case of corporations, sole proprietorships, partnerships, and cooperatives, among others. The effects of the company’s being for profit organization or a social enterprise on its decisions that are related to funding and or financing options. The effect of the number of employees, the size of the organization based on the coverage of its operation, the origin of the business, and the process of making funding option-related decisions. The quantitative methodology will focus on answering these types of questions. After completing both the quantitative and a qualitative, the results for both will be compared and correlated.
The legal status of the business was also an important part of making any decision that may be related to funding options. A company that has chosen to offer its shares to the public in an event called an IPO (Initial Public Offering), or in cases wherein the company already has a history of doing an IPO before, a FOO (Follow-on Offering), would automatically be legally classified as a corporation. A corporation can be defined as a business entity that is not only owned by a person or a small group of person who established the company or the founders. Rather, the owners will be comprised of all the people who owns a certain amount of the company’s outstanding shares, with individuals having the largest block of shares having a controlling stake over the company. In the case of the survey that was done in the paper, there were four possible choices when it comes to the businesses’ legal status: sole proprietorship (single owner), partnership, limited liability partnership, and Limited Liability Company.
Of the 2500 companies reviewed, 814 had sole proprietorship (single owner) as their legal status; 431 were partnerships; 45 were limited liability partnerships; and 1,210 were Limited Liability Companies.
Among other positive outcomes of any particular business venture, would not have to be shared to the public, which is what would happen in case the funding option that was chosen was equity financing. In this case, 841 companies were owned by a single owner only. This means that approximately 30% of the total number of companies reviewed is owned by a single owner. As mentioned in our most recent explanation, most of these single proprietorship businesses would prefer to raise capital by themselves or if not, to borrow a certain amount of money from the bank, often by requesting for a loan with either a fixed or fluctuating interest rate. The equity financing option for funding is often chosen as the last resort because sharing the company that they own wholly or has inherited from their parents is, in fat, the last thing that the real and original owners or the founders want. On the other hand, 1,210 companies had a legal business status of Limited Liability Company. A Limited Liability Company is a form of business venture that, in terms of business ownership, blends various elements of a partnership and a corporation. In a Limited Liability Company, it may already be hard to protect the ownership interests of the owners and some of the most prominent members and owners of the company. The owners would not be reluctant to do an IPO if that is what is needed because the company’s ownership has already been distributed to the owners in the first place.
The results of the analysis for the 2500 UK was testing on the best type of financing option for a small and medium startup company. It is based on a number of factors, and the multiple regression model that was used on finding the profitability in explaining the causality between the capital structure and the various variables throughout the study.
The following model was used:
Yi = Xi β+μi +εi
Xi= vector of independent variables (short-term debt, long term debt, trade credit), or regressors
Yi= dependent variables (business performance)
μi= unobserved company specific aspect
β= vector of unobserved parameters
