Chapter 13

8/9/2016
Chapter 13 Learning Objectives
• To learn about need and importance of finance for
Copyright © 2012 Dorling Kindersley (India) Pvt. Ltd.

Financing Venture entrepreneurial venture.
• To learn about different financial requirements for starting a
venture, and their relevance.
• To learn about what constitutes working capital requirements
and the relevance of cash cycle in business.
• To know about the difference between debt and equity, and
different types of equity funding.
• To know about different exit options available to investors
and their relevance.
• To understand the difference between seed funding, angel
funding and venture funding.
Contd…
Entrepreneurship: Creating and Leading an Entrepreneurial Organization Author: Arya Kumar Entrepreneurship: Creating and Leading an Entrepreneurial Organization Author: Arya Kumar
Learning Objectives Importance of Financing a Venture
• Fund requirement is a prerequisite for giving a shape to the

• To understand the criteria that angel funder and venture

idea which has been assessed as an opportunity.
funder use to invest.
• Entrepreneur need to develop a knack of raising funds or
• To learn about criteria that banks use to invest in a venture.
inducting a professional to look after these aspects.
• To learn about different fund-based and non fund-based
• What matters most is the appropriate finances in terms of
funding options that bank extends. quantum, timings, and other associated terms and conditions
attached to getting funds for promoting ventures.
• To understand the importance and relevance of lease
financing. • Entrepreneur need to assess well the requirement of funds and
the purpose for which these are required, so as to work on a
• To know and understand the funding opportunities for start- possibility of sourcing the funds from the most appropriate
ups in India. source, from the point of view of its relevance and other
associated terms and conditions.
Financing Difficulties for Start-ups Growth Trajectory of Gazelles

Company C
Cash Flow Start-ups that do not undergo major Company A
• Most difficult phase to raise capital is the financing valley of financial challenges in the beginning
death, particularly as an entrepreneur you may not have and have a relatively better and
smooth growth from the beginning
anything other than the idea and its worth in the eyes of as in case of (Company C)
Company B
funding organizations.
Toughest phase lies in incurring
cash losses in the beginning that
• Generally investors, from angels to venture capitalists and persists far longer than
bankers would like to back a venture that has sure chances of expectations (Company A).
success.
• Start-up must show that it has customers who are willing to Down fall and again a rise
pay upfront or otherwise for buying the product or availing

Time
service from them. Death Valley Once it is able to come out of this phase, it either
grows with certain minor ups and downs or keeps
moving on the path of growth or passes through
similar phase of major downfall (Company B).
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Raising Finance—Pertinent Issues Financial Requirements for Start up

Pertinent Issues
What for How much What type When What is What are
do you money is of money exactly do stored for the exit
need the required? is you need investors options
money? required money? in offering available
by you? you a to
money? investors? Fixed cost
Living expenses of Working capital
requirements
entrepreneurial which are must on requirements to
team by putting in plant and operate the
all austerity business on month
machinery, land
measures and building to month basis
Estimate Fund Requirement for Business
Estimation of Working Capital Start ups – Simple Technique to

Requirement Estimate Fund Requirement by Pollen
and Levine
• Current assets constitute the following:
• Estimate monthly variable cost: Costs that vary with volume of

Stock of raw materials
production such as raw materials, packaging charges, sales
Work-in-progress inventory
commission, other direct cost of production, etc.
Finished goods inventory
Debtors or receivables
• Monthly fixed costs: Expenses that do not vary with volume of
Expenses paid in advance
production such as rent, fees, advertising, water, electricity,
Minimum estimated cash required etc.
insurance, depricia-tion, maintenance of premises, etc.
• The current liabilities constitute the following:
Creditors for purchase of raw materials
• Estimate the price that can be charged for product/service:
Creditors for expenses Estimate the price that customer will be willing to pay in the
Advances received from customers backdrop of competitors, market conditions, industry norms,
Dues payable to the statutory bodies, etc. uniqueness of product/service and any legal stipulations on
• Working capital gap = Current assets – Current liabilities charging price.
• Cash cycle = No. of days inventory outstanding + No. of days Contd…
sales outstanding – Number of days payable outstanding
Start ups – Simple Technique to Start ups – Simple Technique to

Estimate Fund Requirement by Pollen Estimate Fund Requirement by Pollen
and Levine and Levine
• Estimate contribution margin: Contribution margin is the • Estimate working capital requirements: Working capital
difference between sales price and variable cost of production. requirements for the start-up will be the shortfall in cash flow
For example, if price is Rs 10 per unit and variable cost of
till breakeven level and thereafter it would mainly depend on
production is Rs 4 per unit then contribution margin will work
out to be Rs 6 per unit. working capital cycle.
• Estimate the sales that would result in breakeven level. • The total fund requirement will be initial outlay plus the
working capital requirements. It is better to keep an
• Project cash flow: Difference between income and expenses
additional cushion of 15–20% over and above the estimated
each month will give rise to cash flow from the venture. These
need to be estimated by considering customer payment requirements to take care of uncertainties and imponderables.
terms, supplier payment terms, pay back terms for loans, and
requirement of funds for reinvestments in the business.
Contd…
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Types of Funding Requirements Types of Funding—Debt or Equity
• Debt is borrowed money from different sources such as

Long term capital banks, organizations, and individuals that need to be repaid
includes funds for along with interest at regular stipulated intervals.
land, buildings, Financing from long-
equipment, term funding sources
furniture and
fixtures • Benefit of debt financing is that it is limited to the amount
borrowed.
Working capital or
• Debts for short-term that is less than a year are used for
short term funds Financing from working capital while long-term debts are used for purchase
include capital for
cash, inventory, and
short-term funding of plant, machinery, land, building etc. i.e. fixed assets that
accounts receivable sources
are going to give benefit spread over a long period (more
than a year).
Contd…
Types of Funding—Debt or Equity Types of Funding—Debt or Equity
• Timely and regular debt repayment is of utmost importance • No monthly/regular payment requirement to investors.

to the entrepreneur, since in future the lending institutions • Subscriber gets ownership interest in the company.
will judge the loan applications on that basis. • No fixed rate of return/interest.
• Equity investors expect returns from the earnings of the
• Debt financing includes collateralized bonds, debentures,
company in the form of dividends and/or an increase in the
bank loans and lines of credit.
value of the stock of the firm.
• Debt financing usually is tax exempted as interest payments • Equity investors are thereby interested in the long-term
are a part of expenses for the business which are taken care profitability.
of prior to arriving at pretax profits. Therefore it is less • Costly compared to debt as dividends are paid from after tax
expensive than equity financing. profits.
• Equity financing or venture capital results in inducting funds
in business in exchange for equity in form of stock.
Contd…
Types of Equity Stocks Exit Options Available to Investors
• Disposal of business to a large company having synergy with

• Have voting rights

Common Stocks • Dividends subject to making profits may
business.
or may not be declared by Board of
Directors
• Share repurchase at some specified terms by the
entrepreneur.
• Does not carry voting rights.
• Carry fixed dividend being paid before • Public share quotation in stock market and using the platform
Preferred Stocks any dividends can be paid to other to exit.
shareholders
• Plan for franchise business opportunity. It is a successful
strategy for large scale growth potential of a business.
• Convertible preferred stock have an
Convertible option for the holder to convert the • Using merger as a route that provides opportunity to use
Preferred preferred shares into a fixed number of
Stocks/Bonds common shares, usually anytime after a combined resources of two businesses for growth, leading to
predetermined date.
scope for investor to receive increased worth for their
investment.
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Different Stages of Financing Methods of Funding Through

Bootstrapping
Seed funding is provided for product
development
Early-stage

financing/Seed Start-up financing is provided to companies
financing for completing product or service development
and initial marketing
Manage
Your Real
Trade Expenses Equipment
Funds to support production activity requiring Customers and Cash Estate
Credit Suppliers
Expansion inventories and sales. Flow
financing Well
Funds for expansion of activity required for

production, marketing, or additional product
Mezzanine
development, new technology or introduction of
financing
new product line.
What is Seed Funding? Different Types of Angel Funders
• Mainly meant for developing a business idea, create the first


product, and test market the new product or service for the • An angel investor is an Corporate
first time. affluent individual who Angels
• Ventures eligible for seed funding are usually in their initial provides capital for a
phase, and have never created a product or service for business start-up, and
commercial sale. usually look forward Entrepren Micro-
eurial management
for an equity stake in Angels Angels
• Seed funding is most commonly provided by government the company. Angel
bodies, angel or other private investors with a basic motive to Funders
create new entrepreneurs.
• While seeking seed funding support, one should make sure
that there is a clear exit plan for the investor in place, after a Professional Enthusiast
Angels Angels
few years.
Where to Look for Angel Funders? What Does Angel Funders Look at?
• Universities: Angel investors tend to hover near university • First incorporate your business
programs because of the high level of new business activity • Have a harmonious and experienced team
they generate through research in developing new • Launch a Web site
technologies. • Defend real intellectual property, if any
• Build a prototype product
• Business incubators: A business incubator is a facility • Be clear about your business model and hit the high notes
designed to assist business ventures to become established • Prepare an investment-grade business plan
and sustainable during their start-up phase. They provide • Finalize your financial model
complete services including seed funding support. • Close at least one customer
• Network ahead of time
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Venture Capital Venture Capitalists
• Venture capital is money provided by professionals who

• Venture capitalist generally:

invest alongside management in young, rapidly growing
companies that have the potential to develop into significant Finance new and rapidly growing companies
economic contributors. Purchase equity securities
Assist in the development of new products or services
• Definition of venture capital is ’’the support by investors of Add value to the company through active participation
entrepreneurial talent with finance and business skills to
Take higher risks with the expectation of higher rewards
exploit market opportunities and thus obtain capital gains”.
Have a long-term orientation
Contd…
Venture Capitalists Key Characteristics of Venture

Capitalists
• Venture capitalists look for following attributes while


Purchase
considering a seed capital project: equity
Project management skills of an entrepreneur
Technical competence on the part of investors Have a Assist in
long-term Product
A very long horizon for investment orientation Venture development
capitalist
Ability of venture capitalist to work with the scientists and characteristics
technologists as opposed to managers
Take higher Add value to
risks for the company
higher through
returns participation
Investment Process Followed by Venture Capital Financing Process

Venture Capitalists
• Early-stage financing
The seed stage: In this stage relatively small amounts of
Stages of Financing capital is used to prove concepts and finance feasibility

studies.
Due Diligence The start-up stage: In this stage funding is done for product
development and initial marketing, but with no commercial
Investment sales yet (basically to get operations started).
Investment Valuation
Process by • Expansion or development financing
Venture Pricing and Structuring The second stage: In this stage working capital is used for
Capitalists the Deal initial growth phase, but no clear profitability or cash flow
yet.
Value Addition and
Monitoring The third stage: In this stage financing is done for major
expansion for company with rapid sales growth, at break
Exit even or positive profit levels but still private company.
The bridge/pre-public stage: In this stage bridge financing is
done so as to prepare the company for public offering.
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Advantages of Venture Capital Funding Advantages of Venture Capital Funding
• Provides long-term funding in a way that acts as a base for • Association of a venture capitalist provides access to other

attracting further equity for growth from other sources. sources of funding for growth.
• Acts as a business partner who shares associated risks and • Acts as instrument in developing strategic partnerships for
rewards from the venture. It mainly gains through enhanced growth of business.
valuation of business arising as a result of business success by
way of capital gains. • Having taken a risk to associate with the venture, venture
capitalist usually provides second round of funding, if badly
• Venture capitalists are a great strength in terms of advice, needed for stabilizing the business.
networking and mentoring to the company based on their past
experience with other companies.
Contd…
Structuring the Deal Structuring the Deal
• The investor tries to ensure the following for himself: • Common consideration for both sides include:

Reasonable reward given the level of risk. Flexibility of structure that will allow room to enable
Sufficient influence on the management of the company additional investments later, incentives for future
through board representation. management and retention of stocks if management leaves.
Minimization of taxes.
Balance sheet attractiveness to suppliers and debt
Ease in achieving future liquidity on the investment.
financiers.
Retention of key employees through adequate equity
• The entrepreneur at the same time seeks:
The creation of the business that he has conceptualized. participation.
Financial rewards for creating the business.
Adequate resources needed to achieve the business goal.
Voting control.
Contd…
Selecting a Venture Capitalist Criteria Used by Bankers for Lending

Decisions
Searching
by line of
business Character
Searching
Searching by Collateral
geographic Competence
by deal size Selecting a
preference and
Venture Criteria for commitment
Capitalist Lending
Decisions by
Searching Banks
by Searching Conditions
leadership by stage of Capacity
status development
Capital
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Classification of Loans Classification of Loans
According to bankers, loans can be classified into the

following: • Working capital finance to units in various sectors in

• Long-term loans the form of fund-based limits: Banks extend cash credit
To fund capital expenditure for setting up new units, limits to meet working capital requirements of the company
expansion and modernization projects, under infrastructure against hypothecation of stock and debtors.
and non-infrastructure sectors.
Usually for a period of 3–10 years. • Working Capital Term Loan (WCTL): At times borrower
Collateralized by a business's assets may fail to immediately induct its margin commitment which
Typically require quarterly or monthly payments derived may necessitate the bank to sanction WCTL which is
from profits or cash flow. expected to be adjusted as soon as possible. At times, when
Usually carry a clause that limits the amount of additional normal cash credit account of the company becomes
financial commitments the business may take on. irregular and it finds it difficult to continue with optimum
Well suited for the established small businesses that can production operations, bank may convert irregular portion of
leverage sound financial statements and substantial down the account into WCTL. Normally working capital term-loan
payments to minimize monthly payments and total loan carries a higher rate of interest.
costs.
Repayment is typically linked to future earning capacity.
Different Type of Financial Assistance Lease Finance

by Banks
• Factoring • Bank guarantee for purchase • Equipment leasing is a process of funding that involves the

• Ad-hoc limits of machinery or goods on lender to buy and own equipment, and then rent it out to a
• Overdraft (OD) credit business at a flat monthly rate for a specified number of
• Bill discounting • Issuance of bank guarantee months. At the end of the lease period, the business may
• Bankers’ acceptance in lieu of security deposit / purchase the equipment for its fair market value or a fixed or
• Line of credit EMD / Performance predetermined amount, continue leasing, lease new
• Packing credit Guarantees equipment or return it.
• Deferred payment guarantee
• Letter of credit (LC)
Advantages of Lease Financing Different Sources of Funding

Source of Funding Range of Funds Best Use Availability
Available
Rs. 5 lakh to 10 lakh Seed stage; Small firms Plenty – depends on the
involving low capital and factors such as real estate
Bootstrapping operational costs—construction owned, creditor goodwill,
• Minimizing initial capital
firms, architecture, designing, etc

consultancies
Growth stage; firms that have a Limited – convincing VC

• Flexibility in availing funding Wide range proven product or service firms involves an effective
Venture Capital Business Plan
Rs 10 lakh to Rs 3 - 4 cr Seed or startup funding; Early Abundant but expensive;
• Better cash flow planning Angel Investors

stage firms with no revenues can be difficult to negotiate
Rs. 2-3 lakh and greater Startup or growth phase; Small Inexpensive and plenty
and established business
Bank Loans
• Provides greater liquidity
Startup phase; companies that Abundant supply; depends
Wide range involve a large number of on a good purchase option
Lease Financing equipment with long economic at the end of the lease
life period in the lease
agreement.
Growth phase; generally Substantial supply;

Rs. 3 lakh upwards involves an established service Product or service to be
Royalty to be provided in the future offered in the future must
Financing be a proven one and must
be of importance to the
investor.
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Funding Opportunities for Start ups in Banks and Financial Institutions

India Funding Ventures
• Department of Scientific and Industrial Research (DSIR)
• National level industrial development banks

• Ministry of Micro Small Medium Enterprises (MoMSME)
• Department of Science and Technology
• Technology Development Board (TDB) • Specialized financial institutions
• SIDBI Venture SME Growth Fund
• Department of Biotechnology
• National Research Development Corporation (NRDC) • Investment institutions
• Department of Information Technology (DIT)
• Risk Capital and Technology Finance Corporation Limited • Other banks offering financial assistance
(RCTC)
• Angel capital to start-ups
• Venture Capital Funding: Technology Development and
Investment Corporation of India (TDICI), GVFL Limited
(formerly Gujarat Venture Finance Limited), etc. At present
there are around 150 active venture capital funds
(government, foreign, corporate) operating in India.

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8/9/2016

Chapter 13 Learning Objectives

• To learn about need and importance of finance for

Copyright © 2012 Dorling Kindersley (India) Pvt. Ltd.

Copyright © 2012 Dorling Kindersley (India) Pvt. Ltd.

Learning Objectives Importance of Financing a Venture

• Fund requirement is a prerequisite for giving a shape to the

Copyright © 2012 Dorling Kindersley (India) Pvt. Ltd.

Financing Difficulties for Start-ups Growth Trajectory of Gazelles

Copyright © 2012 Dorling Kindersley (India) Pvt. Ltd.

pay upfront or otherwise for buying the product or availing

Raising Finance—Pertinent Issues Financial Requirements for Start up

Copyright © 2012 Dorling Kindersley (India) Pvt. Ltd.

Copyright © 2012 Dorling Kindersley (India) Pvt. Ltd.

Estimate Fund Requirement for Business

Estimation of Working Capital Start ups – Simple Technique to

Copyright © 2012 Dorling Kindersley (India) Pvt. Ltd.

Start ups – Simple Technique to Start ups – Simple Technique to

Copyright © 2012 Dorling Kindersley (India) Pvt. Ltd.

Types of Funding Requirements Types of Funding—Debt or Equity

• Debt is borrowed money from different sources such as

Copyright © 2012 Dorling Kindersley (India) Pvt. Ltd.

Copyright © 2012 Dorling Kindersley (India) Pvt. Ltd.

Types of Funding—Debt or Equity Types of Funding—Debt or Equity

Copyright © 2012 Dorling Kindersley (India) Pvt. Ltd.

Types of Equity Stocks Exit Options Available to Investors

• Disposal of business to a large company having synergy with

Copyright © 2012 Dorling Kindersley (India) Pvt. Ltd.

• Have voting rights

Different Stages of Financing Methods of Funding Through

Copyright © 2012 Dorling Kindersley (India) Pvt. Ltd.

Copyright © 2012 Dorling Kindersley (India) Pvt. Ltd.

Funds for expansion of activity required for

What is Seed Funding? Different Types of Angel Funders

• Mainly meant for developing a business idea, create the first

Copyright © 2012 Dorling Kindersley (India) Pvt. Ltd.

Copyright © 2012 Dorling Kindersley (India) Pvt. Ltd.

Venture Capital Venture Capitalists

• Venture capital is money provided by professionals who

Copyright © 2012 Dorling Kindersley (India) Pvt. Ltd.

Copyright © 2012 Dorling Kindersley (India) Pvt. Ltd.

Venture Capitalists Key Characteristics of Venture

• Venture capitalists look for following attributes while

Copyright © 2012 Dorling Kindersley (India) Pvt. Ltd.

Investment Process Followed by Venture Capital Financing Process

Copyright © 2012 Dorling Kindersley (India) Pvt. Ltd.

Stages of Financing capital is used to prove concepts and finance feasibility

Advantages of Venture Capital Funding Advantages of Venture Capital Funding

Copyright © 2012 Dorling Kindersley (India) Pvt. Ltd.

Copyright © 2012 Dorling Kindersley (India) Pvt. Ltd.

Structuring the Deal Structuring the Deal

Copyright © 2012 Dorling Kindersley (India) Pvt. Ltd.

Selecting a Venture Capitalist Criteria Used by Bankers for Lending

Copyright © 2012 Dorling Kindersley (India) Pvt. Ltd.

Classification of Loans Classification of Loans

According to bankers, loans can be classified into the

Copyright © 2012 Dorling Kindersley (India) Pvt. Ltd.

Different Type of Financial Assistance Lease Finance

Copyright © 2012 Dorling Kindersley (India) Pvt. Ltd.

Advantages of Lease Financing Different Sources of Funding