Informal investors and entrepreneurs
Self-funding by entrepreneurs and funding from informal investors (family, friends, colleagues, neighbours and strangers) are the lifeblood of an entrepreneurial society. Informal investors are first and foremost close family relatives of the entrepreneurs (49.4%). Friends and neighbours provide 26.4 percent of informal investment, followed by other relatives (9.4%), work colleagues (7.9%), and strangers (6.9%).
Entrepreneurs should look to themselves or seek other entrepreneurs for funding. Aside from providing 65.8 percent of the start-up capital for their own companies they are four times as likely as non-entrepreneurs to be informal investors in another entrepreneur's business. Entrepreneurs are wasting valuable time by prematurely seeking seed capital from business angels and even from formal venture capitalists - searches that come up empty-handed almost every time.
Informal investors supply more than the external capital needs of entrepreneurs. The average informal investment is $24,202 - more than the average amount of external financing necessary ($18,678).
Entrepreneurs' ambitions, countries of origin and type of businesses will determine how much capital they need. For all GEM nations, the average capital needed to start a business is $53,673. More is needed for an opportunity-pulled venture ($58,179 for venture created from opportunity) than a necessity-pushed one ($24,467 for venture started where options for work are absent or poor). Start-ups in the business-services sector also require more funding than those in the consumer-oriented sector.
Gender matters when it comes to capital. Businesses started by men require more than those started by women ($65,010 vs. $33,201), partially because women start more consumer-oriented businesses that need less initial capital.
Entrepreneurs are overly optimistic about their ROIs. 51 percent of informal investors expect a negative or zero return and only 22 percent expect a return of 100 percent or more; in contrast, only 13 percent of entrepreneurs expect a negative or zero return but 53 percent expect a return of 100 percent or more.
Venture capital and entrepreneurs
By far the rarest source of capital for nascent entrepreneurs is classic venture capital. So rare is it, that even in the US, which has more than two-thirds of the total venture capital in the entire world (74% VC among G7 nations in 2003), far fewer than one in ten thousand new ventures receive their initial financing from VC firms. US companies received $8.1 million VC funding compared to an average of $1.2 million per company in other G7 nations in 2003.
Advantage in the global market place? US companies own it. High-level VC funding accelerates the commercialization of their new products and services; and eventual initial public offerings in the stock markets. Ninety-one percent of VC invested in the US finances high technology companies, in contrast to only 29 percent in other G7 nations.
There is an upward trend in VC backing of superstar companies. Recent VC backing of IPOs combined with Google's spectacular IPO in the third quarter of 2004 has boosted the confidence of the venture capital industry. In 2005, industry leaders predict a new cycle of VC spending with more money targeted to seed, start-up, and early-stage businesses.
Research into informal investment should be encouraged. Before the GEM studies, almost all research on informal investments focused on business angels who invest comparatively large sums of money in entrepreneurial ventures with the potential to become substantial companies. It is probable that studies of investments by business angels miss not only, as expected, micro-companies that are destined to stay tiny, but also many, perhaps most, companies that grow to become superstars.
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