Financial resources for startup firms in Vietnam

FINANCIAL RESOURCES FOR STARTUP FIRMS IN VIETNAM Nguyen Dinh Hoan*1, Phung Thu Ha, Dau Thi Ngoc Trang ABSTRACT: Financial resource is one of the most important parts for the business operation. The demand for financial resources is a vital issue for enterprises, especially for startups. Startup companies are newly born companies which struggle for existence. These entities are mostly formed based on brilliant ideas and grow to succeed. This paper presents the development of startup companies and potential financial resources for them in Vietnam. The expected scientific contribution supports the defining stages of development for startups, as well as their financial sources at each stage. Scientific and research contributions of the paper are reflected in the fact that there is a relatively small number of papers. Therefore, this research can contribute to a better understanding of the financing strategy of startup companies in Vietnam. Presented and interpreted results could be a useful basis and encouragement for a further research in this and similar topics related to the startup scene at the local as well as the global level. Key words: startups; financial resources; startup firms. 1. INTRODUCTION Startup firms are newly founded companies or entrepreneurial ventures which are in the first phase of its operations. They are funded by their own founders as they believe that a product or service provided is a trend of demand. There is a definition by NESTA (Dee at al., 2015) that defines startups as:“A young, innovative, growth-oriented business (employees/revenue/customers) in search of a sustainable and scalable business model”. This definition expands on Steve Blank’s (2013) definition of startups as organization formed to search for repeatable and scalable business models. Startup firms are usually, but not necessarily, associated with high-tech projects because they mostly concentrate on software which can be easily made and re-made. In addition, high technology projects, in their nature, can be powerful motivation for the growth. An interesting fact shown by the research is that technology-oriented startups are typically located in major urban centres. The reason is attributed to the need for a market that exceeds the local level (Baptista, Mendonça, 2009). However, there are more and more startup 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. The operation of startups is often risky. First, many startups fail in the very early stages and less than one third of them turn into companies- “high rate of failure” (e.g. see, Vesper, 1990). Second, failure occurs due to several reasons, such as lack of finance, team management problems, lack of enough business knowledge, technology lag, etc.-“startup problems” (e.g. see,Núñez, 2007). Third, most of startups that survive might turn into successful companies which play a significant role in economies- “success stories” * Academy of Finance, Hanoi City, Nguyen Dinh Hoan. Tel.: +84 906015059, E-mail address: nguyendinhhoan@hvtc.edu.vn 168 HỘI THẢO KHOA HỌC QUỐC TẾ KHỞI NGHIỆP ĐỔI MỚI SÁNG TẠO QUỐC GIA (e.g. see, Martinsons, 2002). Fifth, there is a black box called “valley of death” which is more of a metaphor than a well-defined stage (Hudson & Khazragui, 2013). Even if this black box is well studied, the startup itself is ignored as the level of analysis- “startup stage” (e.g. see, Van de Ven et. al., 1984). The product of startup firms is often very new and its first appearance can be very difficult as well as highly invested. Owing to limited revenue or high costs, most of these small-scale operations are not successful without additional funding from others financial resources (not only their owners). In Vietnam, innovative startup firm is one of three small and medium-sized enterprise groups which have more incentives following the new law no 04/2017/QH14. The role of startups are the businesses which can create the driving force for building and developing the economy in the digital economy era and the industrial revolution 4.0, startups deserve the attention and advocacy from the government and the society. 2. LITERATURE REVIEW Startups theories As mentioned earlier, startups are rarely considered as the main focus of theories in different domains. However, there are some theories which could be implicitly considered as “startup theories” in the existing literature. This paper categorizes these theories in three main areas: (i) organization, (ii) management, and (iii) entrepreneurship. Organization theories focusing on startups Van de Ven et al. (1984) were among the first scholars who considered three main approaches toward studying startup creation. They considered entrepreneurial, organizational and ecological approaches; and argued that prior research had only examined one of these three approaches without considering the others. As they pointed out: “The organizational approach argues the conditions under which an organization is planned and the processes followed in its initial development [phase, which] have important consequences on its structure and performance in later life”. Yet, organization theories are silent on the issue of organizational evolution, or more specifically on startup evolution (Salamzadeh, 2015a). However, there is limited research which investigates the startup phase (e.g. see Boekerb & Wiltbank, 2005). Moreover, most of the existing theories and perspectives in organization science are definedto answer organizational questions. Among these theories, the following are more relevant in studying startups: organizational ecology theory (e.g. see, Scholz & Reydon, 2009), organizational configurations (e.g. see, Miller, 1990), contingency theory (e.g. see, Tosi& Slocum, 1984), resource dependence theory (e.g. see, Davis& Cobb, 2010), uncertainty theory (Kamps & Pólos, 1999), etc. Among the existing theories, Gartner (1985) and Katz and Gartner (1988) are more specifically related to this category. Management theories focusing on startups According to its general definition (getting things done through the other people, or coordinating the efforts of people toward common goals), management is about people (Hofstede, 1999). On the other hand, management theories are either “perspectives” or “descriptions of the relationships among organizationalcharacteristics” (Dean & Bowen, 1994). Thus, according to this view, while management theories have less to do with startups in an organizational sense;theyhave more to do with those entities as individuals/teams that coordinate their efforts toward some common goals. Moreover, management theorists and scholars are becoming more interested in studying startups (Davila et al., 2003). Some of the main management theories which used in startup research are as follows: 169 INTERNATIONAL CONFERENCE STARTUP AND INNOVATION NATION strategic management (e.g. see, Pettigrew et al., 2001), small business governance (e.g. see, Ritchie& Richardson, 2000), human resource management (e.g. see, Miles & Rosenberg, 1983), team management (e.g. see, Kaiser& Müller, 2013), complexity theory (e.g. see &Lan, 2006), etc. However these theories are loosely connected to startup research and are mostly considering startups as their samples or cases. Entrepreneurship theories focusing on startups In Van de Ven et al.’s (1984) view, “the entrepreneurial approach argues the characteristics of the founder and promoter of a new organization”. Although this view holds a basic presumption regarding the existing theories, it lacks enough entrepreneurial focus on the phenomenon in question, i.e. startups. Although the founder is important, there are several issues to be discussed, described, and explained by entrepreneurship theories on startups. As Salamzadeh (2015b) argues, entrepreneurship theories on startups fall into two categories: (i) macro level theories (e.g. see, Schumpeter’s theory (Schumpeter, 1934), population ecology (Hannan and Freeman, 1977)), and (ii) micro and meso level theories (see e.g.Vesper, 1990; Lim et al., 2008; Bhaves, 1994; Veciana, 1988; Deakins and Whittam, 2000; Núñez, 2007; Serarols, 2008; Samuelsson and Davidsson, 2009).This category of theories is more focused on startups. This might be due to several reasons. First, entrepreneurship deals with idea, creativity, innovation, new product or service development, opportunity, and the like. Thus, entrepreneurship theories are more prone to be considered in the early stages of any business or organization. These concepts are integral parts of a startup (Radovic- Markovic&Salamzadeh, 2012). Second, going beyond entrepreneurship theories, theories of organization and management will emerge, which deal with managing people and organizations (Van de Ven et al., 1984). Third, startups are about turning ideas into businesses which is a critical point in entrepreneurship studies such as new venture creation, value creation, and opportunity recognition, evaluation and exploitation. Financial resources for startups Generally, the sources of startup capital are divided into two groups: insider funding (own capital, family funds); outsider funding through business angels, venture capital, bank loans or other funding sources. Soderbom and Samuelsson presented two main approaches used to explain the capital structure of business enterprises: (i) the pecking order theory; (ii) the lifecycle theory. The pecking order theory in capital choice indicates a hierarchy of capital choices for firms when there was asymmetric information between firms and potential investors (Myers and Majluf, 1984). According to the traditional pecking order theory, information asymmetry arises when managers have more information about opportunities than investors, leading to risks for external investors investing in the company. As a result, investors may ask for an offset to this ambiguous information that makes the cost of external capital expensive. Therefore, managers often use internal capital if possible. Only when internal capital is insufficient to meet the capital needs of the enterprise, corporate executives use external capital. In this case, the loan will be more prioritized than the capital from investors because loans are less affected by asymmetric information. Initially, pecking order theory was developed to explain capital mobilization strategies of large and perennial companies. In the case of newly established small enterprises, Berger and Udell (1998) Cassar (2004) argued that this theory would be appropriate. However, some other studies suggest that the traditional order will be reversed for startups for two reasons: (i) experienced investors who understand the future of innovative products from startups more than its founders; (ii) external capital can be ranked higher if investors can add non-monetary values to the businesses they invest and this is often the case for investments for startups (Garmaise 2001, Carpenter and Petersen 2002). Another theoretical model used to study the determinants of capital structure of business is life cycle theory (Berger and Udell, 1998). The basic idea of this theory is that financial need and access to capital change when the business grows and gains more experience and becomes more transparent in terms of information. 170 HỘI THẢO KHOA HỌC QUỐC TẾ KHỞI NGHIỆP ĐỔI MỚI SÁNG TẠO QUỐC GIA Small and new businesses rely heavily on insider funding, commercial credit, and business angels. As businesses grow, funding will become more accessible from venture capital funds as well as from banks and other financial institutions. Even if businesses continue to grow, they can raise capital from the public through initial public offering (IPO). Figure 1 shows the possible sources of capital in the growth cycle of small enterprises in simple form. Both theories of financing for entrepreneurship are not always true, for example, where financial resources such as business angels or venture capital funds are not available or only in small amounts, startups will seek to mobilize from alternative sources of funds. Figure 1: The possible sources of capital for startups Source: Berger and Udell (1998) Insider funding: Own capital invested in the enterprise by founders of startups. This is the largest source of capital in the first phase of startup lifecycle. GEM’s survey indicates that more than 60% of the capital for startups is equity (GEM, 2004). Similarly, Berge and Udel (1998) showed that owner’s equity accounts for about 50% of the capital mobilized by startup firms. Campbell and De Nardi (2009), Bates and Robb (2013) both pointed out that family and friends were the second to third parties who provided financial funding. However, the total value of these funds is quite limited. Outsider funding: Governmental financial support is often in the form of public investment in the startup firms. However, this support is generally small. Berger and Udell (1998) Robb and Robinson (2010) calculated that less than 1% of the total capital of startups is from governments’ support. Many studies have shown that commercial banks are an important external source of finance for startups. According to Berger and Udell (1998), commercial loans account for about 30% of the total external capital of newly established US firms. Robb and Robinson (2010) show that about 40% of American startups are financed by commercial loans. Business angels can be considered as an important source of financing for startups in the early stages of development. These are individuals with large capital, operating independently or in a group, investing their capital directly in an unlisted company and, after investing, will usually stick with the company, for example, with role as consultant or executive board member (Mason and Harrison, 2008). The investment value per transaction is small but a number of business angels are usually large (Soderblom and Samuelsson, 2014). 171 INTERNATIONAL CONFERENCE STARTUP AND INNOVATION NATION 3. FINANCIAL RESOURCES FOR STARTUP BUSINESSES IN VIETNAM Startup has become the wave which strongly developed in Vietnam for recent years. According to unofficial statistics, Vietnam currently has about 15.000 startups operating mainly in 2 major city centers: Hanoi and Ho Chi Minh City (Office Project 844). Global Entrepreneurship Monitor - GEM devides countries into 3 groups corresponding with 3 stages of development: resource-based countries (stage 1); efficiency-based countries (stage 2); innovation-based countries (stage 3). Countries will advance from stage 1 to stage 2 & 3. Vietnam is classified in the group of resource-based countries, it means the initial stage of development. In Southeast Asia, Vietnam is in the same group with the Philippines, while Malaysia, Thailand and Indonesia are classified as stage 2 development. The assessment of a country’s startup level should be compared to the countries which have the same level of development (GEM, 2016). Figure 2: Number of startups invested by business angels in Vietnam Source: Topica Founder Institue, 2018 The assessment of GEM startup ecology in Vietnam over the years shows that in the 12 indicators, the financial index for business is relatively low. In 2017, this index of Vietnam reached 2.27 / 5 - the fourth lowest index . However, this index has improved significantly compared to 2015. In 2015, the financial index for business in Vietnam reached 2.12 / 5, the second lowest index, only higher than the index of business education in the general level. More concretely, about venture, according to statistics from the Market Development Department, Science and Technology Business (Ministry of Science and Technology) now has about 40 venture capital funds which have been operating in Vietnam, up about 30% compared to 2016 (Office Project 844). Typical foreign funds are IDG Ventures Vietnam, Cyber Agent, Mekong Capital, DFJ Vina Capital, ESP Capital and Innovatube. In addition, in the 2016-2017 period, many local venture capital funds were formed and involved in venture capital markets such as SeedCom, FPT Ventures, CMC Innovation Fund, VPBank Startup, VIISA, ESP, VSV, 500 Startups Vietnam ... The fund from business angels was relatively limited in previous years as individual investors in Vietnam still do not see investment in startup business as an investment model that can make a profit. However, in 2017, the first ecological startup Vietnam recorded a significant number of domestic business angels. The activity of business angels in Vietnam has begun to be more systematic, more professional, 172 HỘI THẢO KHOA HỌC QUỐC TẾ KHỞI NGHIỆP ĐỔI MỚI SÁNG TẠO QUỐC GIA through the connection, formed a number of clubs, investment networks for startups. Some typical examples include VIC Impact, Hatch! Angel Network, iAngel Vietnam or Angel4us. The Shark Tank Program also finalized 22 investments in initial startups with a total investment about 100 billion VND. The statistics of Topica Founder Institute showed that the number of being invested startups has increased significantly over the years. In 2017, 92 transactions were received the investment with a total capital of 291 million USD (about 6.500 billion VND). In particular, business angels and local venture capital funds contributed 49 deals, equivalent to 46 million USD (Figure 2). Organizational model promotes business has proved the effective and realizable in vietnam. According to the statistics of National Agency for Technology Entrepreneurship and Commercialization Development, in 2017, Vietnam had about 10 Organize business promotion and 30 Incubin facility, which increased 6 nurseries compared to 2016. Business Organizations such as Vietnam Silicon Valley Accelerator, Viettel Accelerator, Microsoft Class Expara, VIISA...and recently Lotte Accelerator and Hebronstar are actively operating although they are only in the initial state. In 2017, the percentage of people intending to start a business in Vietnam is 25%, the startup rate of business in Vietnam is 23.7% and the level of innovation of startup businesses is 21%. Nowadays, there are about 30 existing nurseries in Vietnam, which contains 10 incubators under state agencies or non-business units; 7 nurseries of universities and 13 nurseries are established by private or foreign organizations, some of names are well-known such as Hoa Lac High Tech Enterprise Incubator; Incubator of hi-tech enterprises Ho Chi Minh; Da Nang nursery; Supporting young startups Center ... The nursery business is also in the process of research to transfer the model to the organization Promote business (Office Project 844). 4. RECOMMENDATIONS For startup firms Explore options for managing work capital such as invoice finance: Cash flow problems cause the untimely demise of many startups, no matter how strong the concept and management team. Although not suitable for every company, working capital solutions such as invoice factoring and discounting, can help to overcome of these challenges. The startup firms should choose carefully, however invoice discounting can be expensive, so they should be prepared to shop around for a service is flexible and transparent. Tap into networks of business angels: With venture capital firms increasingly focusing on the later- stage ventures, business angels are becoming a more important source of funding for startups in some sectors. They should seek out business angel networks, which are becoming more commonplace as a means of bringing startups and investors together. Although angel investors will consider companies at an earlier stage than most venture capital firms, they will still except to see a business plan that is convincing and promising. Startup firms should seek out angels who are active in their sector and deal size. This may include current customers of the business. For government Ensure that regulation does not block the growth trajectory of startups: An IPO is a critical stage in the growth trajectory of the startup business. This highlights the importance of having a regulatory framework that does not deter companies with the right potential to consider a public listing. In the US, the cost of regulatory compliance and litigation are often cited as a contributing factor to the slowdown in IPO volumes. Vietnam should likewise ensure that Vietnamese securities legislation strikes the right balance between protecting investors while enabling startups to grow their business. 173 INTERNATIONAL CONFERENCE STARTUP AND INNOVATION NATION Learn from successful markets and replicate their approach: In recent decades, many governments have tried to implement junior markets as a stepping stone to major exchanges, but only a few have been successful at attracting listings. Common problems include a lack of listings, insufficient liquidity and the “adverse selection” problem, whereby the most successful companies on junior markets migrate to main exchanges, leaving the weaker companies behind. Government should learn from the mistake of past and considers whether they can launch their own version of junior markets. Attracting overseas and local listings can be one way of overcoming the challenges of liquidity and a lack of potential candidates. 5. CONCLUSION It is well known that a very small number of startup companies succeeds, and continues to develop and make a profit after the market launch of products and services. Startup companies which are mainly defined as newly founded companies are usually associated with high-tech projects, and are often lost on the way from the founding the startup to achieving a business success. This paper has shown compliance with the ways of financing startups in the world as well as in Vietnam. After surviving the first experimental phase, the entrepreneurs gain enough courage to find financial support from other funding sources, such as business angels and seed investments, although the level of company development and the experience of entrepreneurs are not necessary associated with the financing methods. 6. REFERENCES Office project no. 844, 2018, ngày 12/2/2018; Bates T., Robb A., 2013, Greater access to capital is needed to unleash the local economic development potential of minority-owned businesses, Economic Development Quarterly, 27(3): 250-259; Berger A.N., Udell G.F., 1998, The economics of small business finance: The roles of private equity and debt markets in the financial growth cycle, Journal of Banking and Finance, 22(6-8): 613-673; Campbell J., De Nardi M., 2009, A conversation with 590 nascent entrepreneurs, Annals of Finance, 5(3-4): 313-340; Carpenter R.E., Petersen B., 2002, Is the growth of small firms constrained by internal finance? Review of Economics and Statistics, 84(2): 298-309. Cassar G., 2004, The financing of startups, Journal of Business Venturing, 19(2): 261-283; Garmaise M.J., 2001, Informed investors and the financing of entrepreneurial projects. Working paper, EFMA 2001 Lugano Meetings; GEM, 2017, Global Report 2016/2017, Global Entrepreneurship Research Association; Mason C., Harrison R., 2008, Measuring business angel investment activity in the United Kingdom: A review of potential data sources. Venture Capital, 10(4): 309-330; Myers S.C., Majluf N.S., 1984, Corporate financing and investment decisions when firms have information that investors do not have, Journal of Financial Economics, 13(2): 187-221; Robb A.M., Robinson D.T., 2010, The capital structure decisions of new firms, Working paper; Soderblom A., Samuelsson M., 2014, Sources of capital for innovative startup companies: An empirical study of the Swedish situation, Naringspolitiskt Forum Report; Topica Founder Institute, 2017, ngày 12/2/2018.