Financing Entrepreneurial Ventures PDF

FINANCING ENTREPRENEURIAL VENTURES INTRODUCTION Starting a new venture requires funding for different activities. New ventures need financing for different purposes like licensing, professional fees, purchasing machinery and equipments, advertising and promotional expenses, working capital financi...

FINANCING ENTREPRENEURIAL VENTURES INTRODUCTION Starting a new venture requires funding for different activities. New ventures need financing for different purposes like licensing, professional fees, purchasing machinery and equipments, advertising and promotional expenses, working capital financing and other reasons. When new ventures start off, they do not generate enough income to be able to pay for the up-front costs. Without sufficient funding, many brilliant ideas have met stumbling blocks and come to a sad end despite holding great potential. Therefore, this session is very important to understand as it shed some light on start-up costs, and alternative funding sources available to finance new ventures. OBJECTIVES 1. To explain the concept of Financing new venture 2. To explain the sources of financing ventures 3. To make you understand the internal sources of financing 4. To make you understand external sources of financing 5. To analyze the appropriate sources of financing for entrepreneurs. REQUIREMENTS OF ENTEPRENERIAL FINANCE Entrepreneurial financing refers to the different sources of funding available for entrepreneurial or early-stage ventures. Entrepreneurs need finance for different purposes of operations which includes purchasing machines and equipments, buying office space or land, furniture, fixures, licencing fees and permits,  maintaining inventory, professional fees, advertising expenses, working capital, for meeting unanticipated expenses and so on. The estimation of this expenses is very important task for an entrepreneur. (No need to put this figure in slide) Sources of Financing Lets focus upon the sources of financing for starting new entrepreneurial venture. The entrepreneur can bring money through two types of sources. Internal sources of sources as well as external sources of finance. LET’S TRY TO UNDERSTAND IN DETAIL. Internal Sources of Funding - Internal sources of funding means the funding within the entrepreneurial capacity. If The entrepreneur brings finance from within his or her own sources rather than borrowed from outside, it is referred as internal sources of financing. It includes : 1. Founder, Family and Friends 2. Bootstrapping 3. Business alliances 1 -Founder, Family and Friends Entrepreneur can start business by bringing money from personal savings, as well as funds received from family and friends. The longer the entrepreneur is able to survive on personal funds and hard work that is his sweat equity and internally generated funds the lower the cost of external risk capital the more sovereignty the entrepreneur has. Thus, if any entrepreneur has funds of his or her own, than it is better for the enterprise. 2- Bootstrapping Friends, this is the second important internal source of financing. In this highlycreative acquisition, use of resources is done without raising capital from traditional sources or borrowing money from a bank. This prevents the entrepreneur from using different forms of financing and it leads to greater awareness of financial risk as well as other forms of potential risks. There is a high reliability on: internally generated retained earnings, credit cards, home mortgages, and customer advances. Safer side of bootstrapping are waiting as long as possible to seek capital financing permits, getting financing at better terms and retaining more ownership share, greater authority and overall control, the entrepreneur spends time and resources on growing the firm, rather than courting investors, and the entrepreneurs avoids problems associated with raising too much money. One of the limitation of bootstrapping are that it may not generate enough money to grow the firm at the desired rate, the firm competing poorly against its financially endowed competitors, there is limited potential grasp on sales, market share, and overall competitive position, and it offers only limited support for high-growth prospects. 3- Business Alliances Business alliances comprises of forming cooperative agreements with another firm to generate revenues and mitigate costs. Reasons for forming a business alliance are: market infiltrations, accelerate time to market, utilize sales and marketing channels, geographic extension, access to customer lists, build product credibility, inadequate resources to go alone, customer requests, product development, economies of scale, teaming up against competing, gain business experience, joint bidding on projects, and other. Thus alliance partners are found by active search based on industry knowledge, professional associations, industry networks and contacts, attorneys, trade shows, accountants, bankers, friends, investment forums, and other. Effective business alliances can be very beneficial to a startup or early stage firm with inadequate resources to do it alone,but these alliances do not always make sense once the firm has grown, is healthy, and reaches autonomy. External Sources of Funding There are many sources of funding available for entrepreneurial ventures. These alternatives can be generally grouped into two major sources of finance which are debt financing and equity financing. Debt Financing - Debt financing refers to the financing through debt from the public. The company raises money through public on a specified rate of interest with a fixed maturity. For ex. Company want to raise Rs. 50,00,000 at 10 percent interest rate , it will have to announce the amount, the interest rate and the number of years in which the company would like to return the amount. So on the very first day when the company issues debenture or bonds company declares like 10% Debetures for Rs. 50,00,000 for 5 years. Which means that company want to raise 50,00,.000 in total from general public for 5 years and will pay 10 percent interest upto 5 years to the public. Thus,  Debt financing is financing that must be paid back with interest.  It is stated as a liability in a company’s balance sheet.  Debt have specific dates by which it must be repaid  Interest must be paid regardless of operating results  Creditors can have prior claims on assets  Creditors are not owners and can not impose control on the management   Debt financing is the suitable form for the company which is not interested to give the ownership rights in the hands of many. The public will be creditors in this case and upon the maturity they will get the invested principal amount back. The only thing that the company has to keep in mind that irrespective of company having profit or loss, owner need to  manager for interest payable each year. If requires , it has to borrow through loan also. Thus debt financing is advised for the firms and entrepreneurs who feel that there would be regular income in their company. The sectors which is having regular operating cycle and that too shorter operating cycle for ex. Dairy business, FMCG, Pharmaceuticals etc. having regular operating cycle should go for debt financing.  Debt financing can be taken in different forms which includes : o Bank loans o Government and debt financing o Finance companies o Others Lets try to understand each in detail. Bank Loans- The commercial banking system is always relied upon as a source of credit for small businesses. Short-term loan such as commercial loans and line of credit, and longer term loans such as instalment loans are examples of bank loans. When giving out loans, banks tend to rely upon provisions for instance, whether there is a market for the business, the value of the collateral, the credit record of the applicant, the ability of the business to repay the loan, the knowledge and capability of the business owner or manager, and of course the macro factors such as the general economic situation of the country. Government Financing Programmes The government has a variety of financing programmes for small businesses. The range of financial assistance rendered aims to help SMEs improve their workforce, develop products or technology, promote their product or services and restructure their debts. Finance CompaniesOwner may raise finance through finance companies. Commercial finance companies are an alternative source of debt financing when loan applications of new ventures are rejected by commercial banks. Finance companies are primarily interested in financing high risk business ventures and tend to charge higher interest rates as compared to commercial banks. Other Sources of Debt Financing There are several other options for debt financing which are not very popular. However, they may also be considered in times of need. For example, there are asset based lenders who are willing to provide loans to entrepreneurs with a condition that idle assets such as inventory or accounts receivables to be pledged as collaterals. Trade credit is another option with which entrepreneurs can extend their credit in the form of delayed payment. Entrepreneurs can also turn to insurance companies, stock brokerage houses, or credit unions for loans. Now lets understand Equity financing Equity financing is obtained through investment made by investors in exchange for ownership. Unlike debt financing, it does not have to be paid back with interest. Instead, investors receive dividends based on the company’s performance. Equity capital is also referred to as risk capital because the investors bear the risk of losing their investment if the business fails.. Lets say company wants to raise funds of Rs. 40,00,000 through equity. Company would need to give advertise, bring awareness to the general public, raise the money through appointing underwriters (if needed), do share allotment and allocation as per requirements and go for raising capital. The inverstors once they invest the amount in any number. They become the owner of the company upto the extent of their investments.  The equity share holders have right to participate in the decision making of the company. Here when they issue the equity, the company raises equity for life time and it is assumed that the business is never ending process thus there is no maturity date offered while raising the equity, in case the investor want to get out of the company investment he or she can simply sell the shares and the transfer of shares will be done in the name of any other person.  In this form of financing, you have to pay divided to the shareholders. This dividend payments depends upon firms performance. If the company has profit, company will declare the dividend. If the company suffers from losses, company may not declare it for any year or years.   Thirdly, the shareholders as are owners of the company can not claim over the assets until the debt is paid to creditors.  Importantly unlike the debt financing, here the shareholders have right to vote in the internal matters of the company. Shareholders are owners and thus can influence the firmsmanagement. Thus, if owner has not a problem of giving rights in the hands of many , this form of financing is best suitable as each shareholder is owner there is no burden of debt on the head of the owners. Other forms of financing Beyond equity and debt there are some other forms of financing too. Which includes : 1- Angel Investor These are extra ordinary successful business people who invest their own money. The term "angel" comes from the practice in the early 1900's of wealthy businessmen contributing in Broadway productions. An angel investor or angel is an affluent individual who invests capital into a business start-up, usually in exchange for ownership capital. Angels typically invest in technologies innovation or in business in the areas that are known to them or that are of their interest. They are long haul investors and usually expect to receive a return within 5 to 7 years. The agreement is done between the owner and the angel investors in advance with regards to the ownership and profit-sharing terms. Thus, it is widely known form of financing now a days. 2- Venture Capital These are the financial intermediaries that take the investors capital and invest it directly into portfolio companies. Their main objective is to make a profit by selling the stake and shares in the company in the medium terms. They expect profitability higher than the market to compensate for the ascended risk of investing in young ventures and startups. A venture capital firm invests only in private companies and they take an active role in monitoring and helping the companies in their portfolio management. Their investment is utilized to finance the internal growth of companies and their main goal is to maximize its financial return by exiting investments through sale or IPO. Venture Capital activities are: investing, monitoring, and exiting. The person who is providing venture capital is termed as venture capitalist and this is stage financing form. The risk of financing is very high on the other hand return expected is also very high. 3- Corporate Investors Corporate investors are often seen by small firms as an exit opportunity, rather than a funding source. By acquiring small companies, corporate investors compliment their product or service offerings, and small firms use this new influx of strategic funding to further expand operating areas. An example is Microsoft’s take over to Hotmail for $425 million. Corporate venturing prevents the small firms from allying with the competitors or from competing directly with the corporate sponsor. Many entrepreneurs nowadays are starting ventures with the sole objective of being bought out by a large non-financial organization which in later part can handle every aspect. 4- Banks Long term loans from banks is another source of finance. Even at the time of day to day management firms also take short terms loans from the bank. Normally banks prefer to limit their risk by lending to firms that offer some form of collateral. It is important source of external financing for small firms once they are established. Reasons banks shy-away from early stage firms are: they lack a track record of reliable information on the entrepreneurs, they have too much debt outstanding, they have volatile profit and cash flow measures. Also that banks are at the lowest risk when it comes to capital investment risk. Banks would try to understand the character, capacity, collateral , financial positing, reputation of owner, past track record with bank and business and than only after assessing its performance, bank would give the credit to the owner. The rate of interest is fixed in nature in this form of financing. CONCLUSION Now let me conclude the session, friends we have understood various form of financing the entrepreneurial ventures. An entrepreneur with him brings investment, innovation, employment, development. Financing venture and starting venture is like cultivating a better future for upcoming generations.On the other side Entrepreneurs should financially be able to discriminate between investor types, do not take just the first offer, but rather the most appropriate for the firm. For investors the risk and failure rates associated with start-up firms are extremely high and investors seek commensurable return for which they are sanguine.There are many sources of funding as we have seen in the session. Any source of funding can be selected by an entrepreneur but he need to analyse each source of financing from the perspective of nature of business, requirements of business, earning capacity and operating cycle, time period for which money is required, risk associated with each option, preferences of investors in the market and so on. Thus, for starting venture and raising finance, entrepreneur need to understand and decide source of finance and follow the exercise for raising it because ultimately he has to return that money to the investors on time. Friends , I hope by now you are clear with financing entrepreneurial ventures and would be able to use this fundamentals either as a future business man or entrepreneur or investors. I hope you enjoyed learning from this session. Thank you