Financing of Entrepreneurial Venture

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Concept of Financial Planning
 Financial planning, also called capital plan involves taking
important decisions so that funds are continuously available
to the company and are used efficiently. It gives a total
picture of the future financial activities of the company. It
involves:
 Determination of financial objectives
 Estimation of capital requirements
 Determination of the kinds of securities to be issued to raise
capital
 Formulation of financial policies
Need for Financial Planning
1. Ensure availability of required funds: Funds are required for
different purposes such as for purchase of long term assets,
meet day-to-day expenses, etc. and also helps to locate source.
2. Fixing the most appropriate capital structure: Mainly equity or
debt
3. Helps in investing finance in right projects: Suggests how the
funds are to be allocated for various purposes by comparing
various investment proposals.
4. Helps in operational activities: Ensures smooth flow of finance
and smooth operation of production and distribution.
5. Base for financial control: Compares the actual revenue with
estimated revenue and actual cost with estimated cost.
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6. Helps in proper utilization of finance
7. Helps in avoiding business shocks and surprises
8. Link between investment and financing decisions: Helps in
deciding debt/equity ratio and by deciding where to invest
the fund.
9. Helps in coordination: helps in coordinating various
business functions like production, sales function, etc.
10. Links present with future: Relates present financial
requirement with future requirement by anticipating the
sales and growth plans of the company.
Preparing to Raise Financing
Step 1: Determine how much money the company needs
This is done on the basis of projected cash flow statement
and capital expenditures. This is important because the company
wants to avoid deficit or excess fund, and to impress the potential
investors showing certainty about the money required.
Step 2: Determine the most appropriate type of financing
Equity (Involves exchanging partial ownership of a firm in
the form of share/stock) or Debt (Getting loan)
Step 3: Developing a strategy for attracting potential investors
It involves three steps:
 Preparing an elevator speech
 Identifying and contacting the best prospects
 Be prepared to provide the investor a completed business plan
Sources of Financing: Equity Financing
 Equity financing is obtaining funds for the business in
exchange of ownership. The equity investors get return on
their investment in the form of dividend and by selling their
shares.
 It is advantageous because: the money received from the
equity investors should not be paid back. There is no
obligation of interest payment. It is of lower risk form
because investors unlike creditors, can not fore the business
bankruptcy. It is collateral free long term investment.
 Its disadvantage is the reduced ownership stake and control.
Sources of Equity Financing
 Angel Investors: Angel investors are those persons who
invest their personal capital directly in start-up business in
exchange for an equity ownership. They are the people with
high wealth and incomes, educated, and have succeeded as
entrepreneurs. They normally invest small amount in the
business with a high growth potentiality. The source of
finding angel investors are:
 Friends and family
 Individual angel investors
 Angel investor networks
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 Venture Capital: It is the money that is invested by venture
capital firm in businesses with a high growth potentiality. It is
different to angel investors as the venture capitalists invest in
the later part of the business whereas angels invest in start-
ups.
 Venture capital firms collect money from high net worth
individuals, pension plan, university endowments, foreign
investors and other sources.
 Difference between Angel Investment
and Venture Capital
Bases of Difference Angel Investment Venture Capital
1. Number of investors Angel investment is made Venture investment is made
by an individual investor. by a company or group of
investors.
2. Stage of investment Angel investors invest in Venture capitalist invest in
the early stage of business the later stage of business.
3. Volume of investment They normally invest in They normally invest in big
small amount. amount.
4. Rapidity of investment Investment decisions are Investment decisions are
decision quick. lengthy.
5. Motivation To help less experienced To make money.
business.
6. Nature Invest their own money. Invest others’ money.
 .Initial Public Offering: It is the first sale of stock by a
company to the public. A company goes public if evidenced
that it is viable and has a good future.
 Its advantages are:
 It is way of raising capital for present as well as future
 It raises a company’s public profile making it easier to attract
investors, customers, and suppliers
 It provides a mechanism for the stockholders to cash out their
investment
 A company creates another form of currency that can be used
for company growth.
Its disadvantages are:
 It is time taking and needs huge money to prepare hence
limitation for limited fund company
 Going public is an expensive and time consuming process
 Going public demands increased regulatory requirement
Debt Financing
 Debt financing is obtaining borrowed funds for the business.
It involves getting loan or issuing debenture or bond. For a
new venture, issuing debenture or bond is not possible.
 There are two types of loan:
 In the single purpose loan, specific amount of loan is taken and
repaid in a fixed amount of time with interest.
 In the line of credit, a borrowing cap is fixed and the borrower
can use the credit on their requirements. It requires periodic
interest payment.
Advantages of Debt Financing
 It does not dilute the owner’s ownership interest in the
company. This is because the lender does not have a claim to
equity in the business.
 A lender has no direct claim on future profits of the business.
 Generally, the principal and interest obligations are known
amounts and can be forecasted and planned for.
 Interest on the debt can be deducted on the company’s tax
return. It lowers the actual cost of the loan.
 Raising debt capital is less complicated on ground of legal
compliances.
Disadvantages
 Unlike equity, debt must be repaid at a certain point of time.
It may be difficult for the start-up venture.
 Interest is a fixed cost which raises the financial obligation of
the company. It affects the company liquidity.
 Debt financing may restrict company’s activities, preventing
management from pursuing alternative financing options.
 It makes the debt-equity ratio higher, making the company
risky in the eyes of lenders and investors.
Sources of Debt Financing
 Commercial Banks: Commercial banks are the main source
of debt financing. However, they are reluctant to invest in
start-up firms. There are two reasons behind this. First is the
banks are risk averse and start-up firms have a high degree of
risks. Second, small firms are not attractive in lending
compared to large firms. However, banks have also started to
engage with start-up firms. They mostly consider cash flow
strength of the start-ups than the collateral and balance sheet
position.
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 Private Sources: Many entrepreneurs begin their business by
borrowing money from friends and relatives. Such lenders
provide flexible terms of repayment than banks or other
lenders. They are also comfortable to invest in start-ups as
well. However, they may try to involve in the management of
the business.
 Micro Credit: Micro credit is offered to small entrepreneurs.
It involves relatively small amount. Loan is provided in group
guarantee basis. It is normally offered to deprived rural
people. The main focus is rural women. Different
governmental as well as non-governmental micro credit
institutions are involved in this.
 Differences between Equity Capital and
Debt Capital
Bases of Difference Debt capital Equity capital
1. Meaning It is the loan taken by It is the funds raised by
the company from the company by issuing
another party shares
2. Nature It is an obligation of the It is the ownership of
company the company
3. Term It is raised for It is raised for a long
comparatively short term and permanent in
term nature
4. Status of holders The providers of debt The providers of equity
capital are lenders capital are proprietors
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Bases of difference Debt capital Equity capital
5. Risk The risk of the lenders The risk of the
is comparatively low proprietor is high
6. Return The lenders enjoy The proprietors enjoy
return in the form of return in the form of
interest dividend
7. Nature of return The lenders get fixed The return of the
and regular return proprietors is variable
and irregular
8. Collateral It may demand certain It does not demand any
form of collateral form of collateral
Sources of Short-term Loans for Ventures
 Bank Overdraft: A bank overdraft is the facility extended by a bank
to companies to withdraw funds from their account in excess of
the balance. This facility is provided by the bank against a certain
fee. Interest is charged on the excess amount that is withdrawn for
the length of the time.
 Trade Credit: It is another common form of debt financing. If the
supplier allows a small business to delay payment on the products
or services it purchases, it is termed as trade credit.
 Public Deposits: It is the deposits invited by companies from the
public for working capital needs. A company wishing to invite
public deposits makes an advertisement in the newspapers. The
public can fill up the prescribed form and deposit their money. The
company in return issues a deposit receipt as an acknowledgement
of debt. Rate of interest depends on period of deposit.
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 Advances from Customer: It is the money collected by the
company prior to providing a product or service.
 Accrual Accounts: Accrual accounts are the expenses which
have been incurred but not yet paid. The most important
items of accruals are wages and salaries, interest, and taxes.
 Bank Loans: Loans that are given by the bank for less than
one year are considered as short term finance.