MODULE 4

FINANCING A NEW VENTURE

INDRODUCTION
One of the primary goals of starting a business is to make money. However, it takes an
undeniable amount of capital in order to properly launch and sustain a business. This amount
of money for a given venture has to do with the unique goals and needs of the entrepreneur. It
is crucial for a new business to develop resources and additional means to obtain further
capital because without proper financing, a new enterprise may find it extremely difficult to
compete with an already established competition. In addition, the lack of funding may also
lead to a company closing or even worse, bankruptcy. It is important to consider the pros and
cons of different financial sources that are available in order to make an effective educated
decision to fund a start-up.

VENTURE CAPITAL FINANCING

Venture capital financing is a type of financing by venture capital: the type of private equity
capital is provided as seed funding to early-stage, high-potential, growth companies and more
often after the seed funding round as growth funding round (also referred as series A round)
in the interest of generating a return through an eventual realization event such as an IPO or
trade sale of the company.
To start a new startup company or to bring a new product to the market, the venture needs to
attract funding. There are several categories of financing possibilities. Smaller ventures
sometimes rely on family funding, loans from friends, personal bank loans or crowd funding.
More ambitious projects that need more substantial funding may turn to angel investors private investors who use their own capital to finance a ventures need, or Venture Capital
(VC) companies that specialize in financing new ventures. VC firms may also provide
expertise the venture is lacking, such as legal or marketing knowledge.
There are five common stages of venture capital financing.
1. The Seed stage.
2. The Start-up stage
3. The Second stage
4. The Third stage
5. The Bridge/Pre-public stage

THE SEED STAGE

This is where the seed funding takes place. It is considered as the setup stage where a person
or a venture approaches an angel investor or an investor in a VC firm for funding for their
idea/product. During this stage, the person or venture has to convince the investor why the
idea/product is worthwhile. The investor will investigate into the technical and the economic
feasibility (Feasibility Study) of the idea. In some cases, there is some sort of prototype of the
idea/product that is not fully developed or tested.
If the idea is not feasible at this stage, and the investor does not see any potential in the
idea/product, the investor will not consider financing the idea. However if the idea/product is
not directly feasible, but part of the idea is worth for more investigation, the investor may
invest some time and money in it for further investigation.
START UP STAGE
If the idea/product/process is qualified for further investigation and/or investment, the process
will go to the second stage; this is also called the start-up stage. At this point many exciting
things happen. A business plan is presented by the attendant of the venture to the VC firm. A
management team is being formed to run the venture. If the company has a board of directors,
a person from the VC firms will take seats at the board of directors.
To prove that the assumptions of the investors are correct about the investment, the VC firm
wants to see result of market research to see whether the market size is big enough, if there
are enough consumers to buy their product. They also want to create a realistic forecast of the
investment needed to push the venture into the next stage. If at this stage, the VC firm is not
satisfied about the progress or result from market research, the VC firm may stop their
funding and the venture will have to search for another investor(s). When the cause relies on
handling of the management in charge, they will recommend replacing (parts of) the
management team.
THE SECOND STAGE
At this stage, we presume that the idea has been transformed into a product and is being
produced and sold. This is the first encounter with the rest of the market, the competitors. The
venture is trying to squeeze between the rest and it tries to get some market share from the
competitors. This is one of the main goals at this stage. Another important point is the cost.
The venture is trying to minimize their losses in order to reach the break-even.
The management team has to handle very decisively. The VC firm monitors the management
capability of the team. This consists of how the management team manages the development
process of the product and how they react to competition.
THE THIRD STAGE
This stage is seen as the expansion/maturity phase of the previous stage. The venture tries to
expand the market share they gained in the previous stage. This can be done by selling more

amount of the product and having a good marketing campaign. Also, the venture will have to
see whether it is possible to cut down their production cost or restructure the internal process.
This can become more visible by doing a SWOT analysis. It is used to figure out the strength,
weakness, opportunity and the threat the venture is facing and how to deal with it.
THE BRIDGE STAGE
In general this stage is the last stage of the venture capital financing process. The main goal
of this stage is to achieve an exit vehicle for the investors and for the venture to go public. At
this stage the venture achieves a certain amount of the market share. This gives the venture
some opportunities; for example:
1. Merger with other companies
2. Keeping away new competitors from approaching the market
3. Eliminate competitors

Alternative sources of finance

One of the most important issues facing all businesses, whether a business in the start-up
phase or well-established, is the obtaining of appropriate levels of financing. Whether it is
needed for investing in land, buildings or equipment, hiring new employees, investing in
inventory or moving into new markets, obtaining sufficient financing to accomplish these
goals is a dilemma nearly all business owners face
The large variety of financing sources makes raising funds for different ventures
easier. However, every specific source of financing is associated with certain obligations that
entrepreneurs must understand before raising capital. The more educated entrepreneurs are,
the more likely they are going to succeed in raising startup capital.

The following are the major sources of funding for entrepreneurs:

1. Personal finances
2. Friends and family
3. Angel Investors
4. Debt financing
5. Equity financing
6. Customer financing

7. Governmentsponsored programs

Personal Finances

People start companies at different points in their lives. Some entrepreneurs start companies
during the early stages of their career. A majority of entrepreneurs start companies at later
stages in their lives and these entrepreneurs often have personal assets that they could use to
finance their ideas. It is important for entrepreneurs to invest their personal savings in their
business ideas as it indicates that the entrepreneur is confident about his or her own idea,
thereby encouraging other investors to look at the idea more seriously. After all, who would
want to invest in a company wherein the founder does not want to bet on the idea?
Additionally, entrepreneurs who do not put their personal savings into the venture can find it
hard to raise money from friends and family. Entrepreneurs should think thoroughly before
investing their personal finances. If the business idea is not feasible, the entrepreneur loses
everything.

Friends and Family

Friends and family are important sources for financing startups since they would like to see
the entrepreneur succeed. Such loans can be obtained quickly as this type of financing is
based more on personal relationships than on financial analysis. However, friends and
relatives who provide business loans sometime feel that they have the right to offer
suggestions concerning the management of the business. Their suggestions might be
orthogonal to the entrepreneurs strategy and might create fissures in the relationships. It is
important to minimize the chance of damaging important personal relationships. Therefore,
entrepreneurs should plan on repaying such loans as soon as possible even if the business
idea fails, thereby ensuring that relationships are maintained.

Angel Investors

A large number of individuals invest in a variety of entrepreneurial ventures. They are

affluent people such as successful entrepreneurs, lawyers, physicians, etc. who have moderate
to significant business experience. This type of financing is called as informal capital because
these individuals do not make such investments in established market places. Such investors
are called business angels. They represent the oldest and the largest segment of the U.S.
venture capital industry. On average, a typical angel investor invests more than $200,000 a

year. Angels frequently put their mind share in a companys strategy and assist entrepreneurs
in taking their companies forward. Although angel investment is easier to acquire than some
of the more formal types of financing, angels can sometimes be very demanding.
Entrepreneurs should therefore define their relationships with the angels before finalizing the
terms of the agreement. It is imperative to emphasize that any angel investor would be
skeptical to fund a company, wherein the founders do want not invest their personal savings.

Debt Financing

Entrepreneurs can also raise capital from banks through the debt financing route. Although
some angels provide debt capital, commercial banks are the primary providers of debt capital
to small companies. Bankers tend to make business loans through lines of credit, term loans
and mortgages. A line of credit loan is the largest amount of money that the borrower can
obtain from the bank at any one time. An entrepreneur must work with a bank in advance to
obtain a line of credit before the company needs the money because if banks do not know the
specifics of their investment, they will refuse credit. Attempts to obtain line-of-credit loan
instantaneously are generally ineffective. In addition to the line-of-credit load, banks issue
five to ten year term loans that are generally used to finance equipment. Since the economic
benefits of investing in equipment extend beyond a single year, banks are generally open to
lending money to buy equipment that generate revenues, which match the interest to be
received from such a loan. Finally, entrepreneurs can also obtain a mortgage to provide
funding. Mortgages are loans for which certain items of inventory or other properties serve as
collateral. Debt financing has its own set of advantages and disadvantages. Although debt
financing increases the potential for higher rates of return on investment (ROI) and allows
entrepreneurs to retain much of the board control, it also puts entrepreneurs at greater risk.
Irrespective of the startups outcome, banks make sure that they will get their investment
back along with interests. To accomplish this, banks structure their agreements accordingly.

Equity Financing
As opposed to debt financing, equity financing transfers the risk from the entrepreneur to the
investors, but has its own set of drawbacks. Equity financing is when entrepreneurs can raise
money only through selling common or preferred stock to investors. This implies that an
entrepreneur gives up some of his or her voting rights to investors. Although most angels
offer equity financing, institutional venture capitals make the biggest equity financing
investments. Institutional venture capital firms usually manage large funds - anywhere from
$25 million to $1 billion - and invest in high growth companies. When a VC firm invests in a
company, the firm generally takes a seat in the board of directors. VCs assist the
entrepreneurs in taking the companies forward. The very same VCs do not mind firing
everyone, including the founders and shutting down the company if they determine that it is

economical. In addition, raising venture capital is generally a long shot. Venture capitalists
will not even look into a business plan unless the company meets some of firms criteria
.
Customer financing

At times, large corporations or potential customers finance the entrepreneur through debt or
equity routes. Large corporations provide financial and technical assistance to smaller
businesses because as larger corporations downsize their operations for tactical reasons, it
becomes important that their suppliers, frequently small firms, stay healthy. Examples of
large corporations that have historically invested in smaller firms include giants such as
JCPenny, Ford Motors, Motorola, Micron, and Cisco.

Governmentsponsored programs

Several government programs provide financing to small businesses. The federal government
has a long history of helping new businesses get started, primarily through the following
federal programs:
Small Business Administration (SBA)
Small Business Investment Companies (SBIC)
Small Business innovative Research (SBIR)
Small Business Technology Transfer (STTR)

Recently, Congress has voted to increase the size and scope of the above programs. Apart
from the federally sponsored programs, state and local government are also becoming
increasingly active in financing new businesses. The nature of financing varies, but each
program is generally geared to augment other sources of funding. Although it is possible to
raise money with low interest rates and equity through this route, entrepreneurs must have the
patience to go through the time-consuming government bureaucratic processes.
Although there are a number of financing sources, it is important that entrepreneurs plan their
strategy to raise capital. The decision to use debt or equity financing depends to a large extent
on the type of business, the firms financial strength and the current economic environment,
e.g., whether lenders and investors are optimistic or pessimistic about the immediate future.
The entrepreneur should start pitching his or her idea as soon as the business plan is ready to
meet the investors eyes. The entrepreneur should then determine the best suitable capital

sources for his or her business idea and focus on those sources only. Entrepreneurs should
allow ample time for raising capital, since it generally takes more time than most people
think.
WORKING CAPITAL REQUIREMENT
Working capital (abbreviated WC) is a financial metric which represents operating liquidity
available to a business, organization or other entity, including governmental entity. Along
with fixed assets such as plant and equipment, working capital is considered a part of
operating capital. Net working capital is calculated as current assets minus current liabilities.
It is a derivation of working capital that is commonly used in valuation techniques such as
DCFs (Discounted cash flows). If current assets are less than current liabilities, an entity has
a working capital deficiency, also called a working capital deficit. Decisions relating to
working capital and short term financing are referred to as working capital management.
These involve managing the relationship between a firm's short-term assets and its short-term
liabilities. The goal of working capital management is to ensure that the firm is able to
continue its operations and that it has sufficient cash flow to satisfy both maturing short-term
debt and upcoming operational expenses.
REQUIREMENTS OF WORKING CAPITAL
1. Nature of business
The requirement of working capital of an enterprise depends upon the nature of business. a
trading concern like a garments show-room, a service concern like an electricity undertaking
or a transport corporation have a short operating cycle. their requirement for working capital
is small. a manufacturing concern like cotton textiles or woolen factory will have a long
operating cycle specially if they are selling their goods on credit. hotels and restaurants have
minimum requirement of working capital 10 to 20% whereas trading and construction
industries have highest working capital requirement 80 to 90%.
2. Size of the Enterprise
An enterprise working on a high level of activity has a higher level of working capital
requirement and vice-versa. An increase in production from time to time will tend to increase
the need of working capital.
(iii) Seasonally of Operations:
Those firms which have marked seasonality in their operations have fluctuating working
capital requirements. A firm manufacturing refrigerator will have maximum sales during
summer seasons and minimum sales during winter seasons thus affecting its working capital.
Such firms have a need of higher working capital during summers and lower in winter
season. Firms also experience cyclical fluctuations in the demand of their product and
services. During upward swing in the economy, sales will increase and hence, debtors too.
Under boom, the firms generally do substantial borrowing to increase their productive

capacity. Whereas a decline in the economy results in low level of sales, inventories, debtors
etc. Rather, firms try to reduce their short-term borrowings.
(iv) Production Policy:
A firm having the product of seasonal nature may follow a policy of steady production in
order to dampen the fluctuations in working capital requirements. A manufacturer of
refrigerator will not intensify the production activity during the peak business rather he will
follow a steady production throughout the year. Such a production will help firms utilize its
resources to its fullest extent. Such a policy will mean accumulation of inventories during off
season and their quick disposal during the peak season.
(v) Market Conditions:
When competitive conditions are prevailing in the market, a larger inventory of finished
goods in needed as customers mayn't be inclined to wait. Further, a liberal credit policy may
be offered to the customer by the competitors. Both the conditions demand higher level of
working capital, more investment in finished goods and debtors as well. A higher collection
period will also imply tie-up of larger funds in book debts. Similarly, delayed payments, if
not checked in time, may increase the working capital requirements much to the detrimental
of the entrepreneur.
(vi) Technology and Manufacturing Policy:
The manufacturing cycle comprises of the purchase and use of raw-materials and the
production of finished goods. Longer the manufacturing cycle, larger will be the working
capital requirements. The manufacturing cycle of a computer may range in months whereas
that of a toothpaste may be a few hours. Thus, if there are alternative technologies of
manufacturing a product, the technological process with the shortest manufacturing cycle
should be chosen. Non-manufacturing firms, service enterprises like P & T department, and
financial enterprises like .banks don't have a manufacturing cycle.
(vii) Price Level Changes:
An increase in price level will require a firm to maintain a higher amount of working capital.
Some companies may not be affected by rising prices while others may be badly hit by it.
Rising prices have different effects for different companies.
MANAGEMENT OF WORKING CAPITAL
Guided by the above criteria, management will use a combination of policies and techniques
for the management of working capital. The policies aim at managing the current assets
(generally cash and cash equivalents, inventories and debtors) and the short term financing,
such that cash flows and returns are acceptable.
Cash management.-

Identify the cash balance which allows for the business to meet day to day expenses, but
reduces cash holding costs.
Inventory management:Identify the level of inventory which allows for uninterrupted production but reduces the
investment in raw materials - and minimizes reordering costs - and hence increases cash flow.
Besides this, the lead times in production should be lowered to reduce Work in Process (WIP)
and similarly, the Finished Goods should be kept on as low level as possible to avoid over
production - see Supply chain management; Just In Time (JIT); Economic order quantity
(EOQ); Economic quantity Debtors management. Identify the appropriate credit policy, i.e.
credit terms which will attract customers, such that
any impact on cash flows and the cash conversion cycle will be offset by increased revenue
and hence Return on Capital (or vice versa); see Discounts and allowances.
Short term financing:Identify the appropriate source of financing, given the cash conversion cycle: the inventory
is ideally financed by credit granted by the supplier; however, it may be necessary to utilize a
bank loan (or overdraft), or to "convert debtors to cash" through "factoring".

GOVERNMENT AGENCIES ASSISTING IN FINANCING PROJECT

Industrial Development Bank of India (IDBI):was established in July 1964 as an apex financial institution for industrial development in the
country. It caters to the diversified needs of medium and large scale industries in the form of
financial assistance, both direct and indirect. Direct assistance is provided by way of project
loans, underwriting of and direct subscription to industrial securities, soft loans, technical
refund loans, etc. While, indirect assistance is in the form of refinance facilities to industrial
concerns.
Industrial Finance Corporation of India Ltd (IFCI Ltd):was the first development finance institution set up in 1948 under the IFCI Act in order to
pioneer long-term institutional credit to medium and large industries. It aims to provide
financial assistance to industry by way of rupee and foreign currency loans,
underwrites/subscribes the issue of stocks, shares, bonds and debentures of industrial
concerns, etc. It has also diversified its activities in the field of merchant banking, syndication
of loans, formulation of rehabilitation programmes, assignments relating to amalgamations
and mergers, etc.
Small Industries Development Bank of India (SIDBI):-

was set up by the Government of India in April 1990, as a wholly owned subsidiary of IDBI.
It is the principal financial institution for promotion, financing and development of small
scale industries in the economy. It aims to empower the Micro, Small and Medium
Enterprises (MSME) sector with a view to contributing to the process of economic growth,
employment generation and balanced regional development.
Industrial Investment Bank of India Ltd (IIBI):was set up in 1985 under the Industrial reconstruction Bank of India Act, 1984, as the
principal credit and reconstruction agency for sick industrial units. It was converted into IIBI
on March 17, 1997, as a full-fledged development financial institution. It assists industry
mainly in medium and large sector through wide ranging products and services. Besides
project finance, IIBI also provides short duration non-project asset-backed financing in the
form of underwriting/direct subscription, deferred payment guarantees and working
capital/other short-term loans to companies to meet their fund requirements.
State Financial Corporations (SFCs):are the State-level financial institutions which play a crucial role in the development of small
and medium enterprises in the concerned States. They provide financial assistance in the form
of term loans, direct subscription to equity/debentures, guarantees, discounting of bills of
exchange and seed/ special capital, etc. SFCs have been set up with the objective of
catalysing higher investment, generating greater employment and widening the ownership
base of industries. They have also started providing assistance to newer types of business
activities like floriculture, tissue culture, poultry farming, commercial complexes and
services related to engineering, marketing, etc. There are 18 State Financial Corporations
(SFCs) in the country.
State Industrial Development Corporations (SIDCs):have been established under the Companies Act, 1956, as wholly-owned undertakings of
State Governments. They have been set up with the aim of promoting industrial development
in the respective States and providing financial assistance to small entrepreneurs. They are
also involved in setting up of medium and large industrial projects in the joint sector/assisted
sector in collaboration with private entrepreneurs or wholly-owned subsidiaries. They are
undertaking a variety of promotional activities such as preparation of feasibility reports;
conducting industrial potential surveys; entrepreneurship training and development
programmes; as well as developing industrial areas/estates.
National Bank for Agriculture and Rural Development (NABARD):National Bank for Agriculture and Rural Development (NABARD) is an apex development
bank in India having headquarters based in Mumbai (Maharashtra)[3] and other branches are
all over the country. The Committee to Review Arrangements for Institutional Credit for
Agriculture and Rural Development (CRAFICARD), set up by the Reserve Bank of India
(RBI) under the Chairmanship of Shri B. Siva Raman, conceived and recommended the
establishment of the National Bank for Agriculture and Rural Development (NABARD). It

was established on 12 July 1982 by a special act by the parliament and its main focus was to
uplift rural India by increasing the credit flow for elevation of agriculture & rural non-farm
sector and completed its 25 years on 12 July 2007.[4] It has been accredited with "matters
concerning policy, planning and operations in the field of credit for agriculture and other
economic activities in rural areas in India". RBI sold its stake in NABARD to the
Government of India, which now holds 99% stake.
NABARD is the apex institution in the country which looks after the development of the
cottage industry, small industry and village industry, and other rural industries. NABARD
also reaches out to allied economies and supports and promotes integrated development.

Conclusion
Thus country like India financing a new venture is easy, government and lot of government
agencies are providing a lot much financial assistance to new venture. And after
industalisation venture capitalism has grown up in India, and the future of Small business and
venture capitalist has a bright future. But Indian entrepreneurs face a problem of new and
innovating idea. The success of small business needs tremendous and innovative idea.

Submitted by
Shanjo
Shijin
Vishnu
Shefeek