International Business Research; Vol. 8, No. 5; 2015 ISSN 1913-9004 E-ISSN 1913-9012 Published by Canadian Center of Science and Education 30 Does Microfinance Fill the Funding Gap for Microentrepreneurs? A Conceptual Analysis of Entrepreneurship Seeding in Impoverished Nations James C. Brau 1 , Sunshine N. Cardell 1 & Warner P. Woodworth 1 1 Marriott School of Management, Brigham Young University, Provo, Utah, USA Correspondence: James C. Brau, Professor of Finance, Marriott School of Management, Brigham Young University, 620 TNRB, Provo, Utah, 84602, USA. Tel: 1-801-318-7919. E-mail: jbrau@byu.edu Received: February 11, 2015 Accepted: March 12, 2015 Online Published: April 25, 2015 doi:10.5539/ibr.v8n5p30 URL: http://dx.doi.org/10.5539/ibr.v8n5p30 Abstract We address the role microfinance institutions (MFIs) play in funding entrepreneurial ventures and present a distinction between the types of entrepreneurs that seek MFI and traditional venture funding. We argue that microfinance can serve successfully as seed financing for microentrepreneurs in under-developed economies around the world. By comparing bootstrapping and private equity seed-financing in developed economies to microfinance seed-financing in impoverished economies, we show that the different entrepreneurial characteristics in the two economies have similar funding gaps but are solved with different sources of funding. Keywords: microfinance, funding gap, seed financing 1. Introduction Entrepreneurs of new ventures often do not have enough of a concept, historical earnings, or assets to justify bank-funding in early stages. This lack of access to capital is commonly referred to as a funding gap for entrepreneurs. In mature economies, this funding gap is often filled from many sources such as cash from friends and family, bootstrapping via credit cards, personal savings accounts, and second mortgages on homes. After the start-up phase, a relatively small percentage of potential high-growth ventures will qualify for investments by private equity (PE) investors, that is, angel groups and venture capitalists. These seed-stage companies in established economies are thus able to draw on the resources of a well-established market and various funding sources to obtain the capital needed for development and growth. Developing economies, though, often lack sources of seed capital. In particular, microentrepreneurs, those at or near the bottom of the social-economic pyramid, do not have access to bootstrapping methods or private equity. Due to higher poverty levels and lower excess income, entrepreneurs often do not have their own financial capital nor can they readily borrow from impoverished peers and family. The nature of virtually all microenterprises is that they will not have a large harvest or lucrative financial exit, and as such, they do not attract private equity. Such seed capital for entrepreneurs starting companies with little collateral, in a fluctuating and uncertain market, naturally warrants significant risk with very little financial upside. In these impoverished economies, historically this funding gap for seed financing has been filled by street “ loan sharks” who accept the risk of this seed financing but in tur n demand extreme profit margins–commonly 100 percent daily rate. For example, a microentrepreneur will borrow $2 in the morning to buy inventory and must repay $4 at night after selling on the street all day. Recognizing that many individuals cannot afford these exorbitant rates and that this situation often perpetuates local poverty, non-governmental organizations (NGOs) such as the Grameen Bank in Bangladesh began to establish an alternative solution to the funding gap in the 1980s – microfinance. The role of microfinance institutions (MFIs) in recent years has become well known in terms of helping low-income individuals to start small-scale microenterprises and to alleviate themselves from poverty. Microfinance drew particular attention in 2006 when Muhammad Yunus was awarded the Nobel Peace Prize for his work with the Grameen Bank, and in December 2012 there were more than 3,700 MFIs (Microcredit Summit, 2014) which had assets of $70 billion in 2011 (Microrate, 2011), and reached more than 203 million clients (Microcredit Summit, 2014). The literature is fairly well-developed in terms of microfinance governance and