Debt Versus Equity

The use of debt to finance a new venture involves

a payback of the funds plus a fee (interest for the
use of the money. Equity financing involves the
sale of some of the ownership in the venture.
LEGAL STRUCTURES FOR
ENTREPRENEURIAL VENTURES
• New Zealand, US, Singapore, Australia and Hong Kong are among the
easiest countries in the world to start a business.
• Every country has a regulatory body – composed of legislation and a
regulatory authority – that dictates how businesses are started, operated
and wound up.
 Sole Proprietorships
A sole proprietorship is a business
that is owned and operated by one person. The enterprise
has no existence apart from its owner.
 Advantages
• Ease of formation
• Sole ownership of profits
• Decision making and control vested in one owner
• Flexibility
• Relative freedom from governmental control
• Freedom from corporate business taxes
Disadvantages
• Unlimited liability
• Lack of continuity
• Less available capital
• Relative difficulty obtaining long-term financing
• Relatively limited viewpoint and experience
 Partnerships

• A partnership is an association of two or more persons acting

as co-owners of a business for profit.
• The Uniform Partnership Act is generally followed by most
states as the guide for legal requirements in forming
partnerships.
• The articles of partnership clearly outline the financial and
managerial contributions of the partners and carefully
delineate the roles in the partnership relationship.
 Advantages
• Ease of formation
• Direct rewards
• Growth and performance facilitated
• Flexibility
• Relative freedom from governmental control and regulation
• Possible tax advantage
 Disadvantages
• Unlimited liability of at least one partner
• Lack of continuity
• Relative difficulty obtaining large sums of capital
• Bound by the acts of just one partner
• Difficulty of disposing of partnership interest
 Factors Associated with Partnership Success

Partnership Attributes
•Commitment
•Coordination
•Interdependence
•Trust
Communication Behavior Partnership Success
•Quality •Satisfaction
•Information Sharing •Dyadic Sales
•Participation

Conflict Resolution Techniques

•Joint Problem
Solving •Domination
•Persuasion •Harsh Words
•Smoothing •Arbitration
 Corporations
• A corporation is “an artificial being, invisible, intangible, and existing
only in contemplation of the law”*. As such, a corporation is a
separate legal entity apart from the individuals who own it.

*Supreme Court Justice John Marshall

 Advantages
• Limited liability
• Transfer of ownership
• Unlimited life
• Relative ease of securing capital in large amounts
• Increased ability and expertise
 Disadvantages
• Activity restrictions
• Lack of representation
• Regulation
• Organizing expenses
• Double taxation
Specific Forms of Partnerships and Corporations
 Limited Partnerships
• Permits capital investment without responsibility for management
and without liability for losses beyond the initial investment.
• Limited partnerships are governed by the Uniform Limited
Partnerships Act (ULPA).
 Limited Liability Partnerships

• The limited liability partnership (LLP) is a relatively new form of

partnership that allows professionals the tax benefits of a partnership
while avoiding personal liability for the malpractice of other partners.
 Limited Liability Companies
• The LLC is a hybrid form of business enterprise that
offers the limited liability of a corporation but the tax
advantages of a partnership.
• Perhaps the greatest disadvantage is that LLC statutes
differ from state to state, and thus any firm engaged
in multistate operations may face difficulties.
 Other Corporation Classifications

• Domestic and Foreign Corporations

• Public and Private Corporations
• Nonprofit Corporations
• Professional Corporations
• Close Corporations
Sources Of Funds
Beginning of
Start-up Production ? Going Concern
Company
Size
Personal
IPO
Friends and Family Banks

Angels Government

Venture Capitalist Customers/Suppliers

Amount

13–18
 Debt Versus Equity

The use of debt to finance a new venture involves a payback of the

funds plus a fee (interest for the use of the money.
Equity financing involves the sale of some of the ownership in the
venture.
Debt Financing
• Commercial Banks
• Other Debt-Financing Sources:
• Trade Credit
• Accounts Receivable Financing
• Factoring
• Finance Companies
Source of Finance Throughout the
Evolution of the Entrepreneurial Firm

High
Founder, friends,
and family

Level of Investment Risk

Business Angels

Assumed by Investor
Venture Capitalists

Nonfinancial
corporations

Equity
markets

Commercial banks
Low
Seed Start-Up Early Established
Growth
Stage of Development of the Entrepreneurial Firm
Debt Versus Equity
With no debt and all equity:

No debt
$28,000
14% return 14% return
income on
equals on assets on $200,000
total assets
($28,000÷ $200,000) ($28,000÷ $200,000)
of $200,000
$200,000
equity

Equity: Owners get to keep all of the profits in

return for accepting the risk of lower returns

13–22
Debt Versus Equity (Cont’d)
With $100,000 debt and $100,000 equity:

$100,000 debt
(10% cost)
$28,000
14% return 18% return
income on
equals on assets on $100,000
total assets
($28,000 ÷ $200,000) ($18,000÷ $100,000)
of $200,000
$100,000
equity

Debt is Risky: Lenders have first claim on profits

and must be paid even if there are no profits.

13–23
Business Suppliers and
Asset-Based Lenders
• Trade Credit (Accounts Payable)

• Short-duration financing (30 days)

• Amount of credit available is

dependent on type of firm
and supplier’s willingness
to extend credit

13–25
Business Suppliers and
Asset-Based Lenders (cont’d)
• Equipment Loan and Leases

• Leases
• Free up cash for other purposes
• Leaves lines of credit open
• Provides a hedge against
obsolescence

13–26
Business Suppliers and
Asset-Based Lenders (cont’d)
• Asset-based Loan

• Factoring
• Accounts are sold to factor at a discount to invoice value

• Factor can refuse questionable accounts

• Factor charges fees for servicing accounts and for amount

advanced to firm prior to collection

13–27
Financial Information Required
for a Bank Loan
• Three years of the firm’s historical statements

• The firm’s pro forma financial statements

• Personal financial statements

13–29
Negotiating a Loan
• Terms of Loans
• Interest rate

• Loan maturity date

• Repayment schedule

• Loan covenants

13–30
The Banker’s Perspective
• Bankers’ Concerns!

• The Five C’s of Credit

• Character of the borrower
• Capacity of the borrower to repay the loan
• Capital invested in the venture by the borrower
• Conditions of the industry and economy
• Collateral available to secure the loan

13–31
 PH 306.2
ENTREPRENEURSHIP MANAGEMENT

UNIT-03

VENTURE FINANCING

Vinay Krishna
AIMIT, St Aloysius College (Autonomous)
Learnings
• Angel Investors
• Public Offerings
• Private Placements
• Government-Sponsored Programs
and Agencies
• Venture Capital
Equity Financing
Public Offerings
“Going public” is a term used to refer to a corporation’s raising capital
through the sale of securities on the public markets. Here are some of the
advantages to this approach:
• Size of capital amount
• Liquidity
• Value
• Image

(new issues, referred to as initial public

offerings IPOs)
 Entry Norm I (Profitability Route)
• a) Net tangible assets of at least Rs. 3 crore in each of the
preceding three full years of which not more than 50% are held in
monetary assets. However, the limit of 50% on monetary assets
shall not be applicable in case the public offer is made entirely
through offer for sale.
• b) Minimum of Rs. 15 crore as average pre-tax operating profit in
at least three years of the immediately preceding five years.
• c) Net worth of at least Rs. 1 crore in each of the preceding three
full years.
• d) If there has been a change in the company’s name, at least 50%
of the revenue for preceding one year should be from the new
activity denoted by the new name
• e) The issue size should not exceed 5 times the pre-issue net
worth
Public Offerings
Disadvantages of going public:
• Costs
• Disclosure
• Requirements
• Shareholder pressure
 Private placements
• “Private Placement” means any offer of securities (Not Only Shares) or
invitation to subscribe securities to a select group of persons by a
company through issue of a private placement offer letter and which
satisfies the conditions specified in section 42 of the Companies Act of
2013.
• The offer of securities or invitation to subscribe securities, shall be
made to not more than 200 persons in the aggregate in a financial year
(excluding qualified institutional buyers and employees of the company
being offered securities under ESOP). This restriction would be reckoned
individually for each kind of security that is equity share, preference
share or debenture.
Informal Risk Capital –
“Angel” Financing
An angel investor is a person who invests in a new or
small business venture, providing capital for start-up
or expansion. 
Angel investors are typically individuals who have
spare cash available and are looking for a higher rate
of return than would be given by more
traditional investments.
 Angels
• Well to do private
individuals

• Geography and
industry specific

• Invest lower
amount than VC

• Often a good
source of industry
experience

13–40
Types of Angel Investors
• Corporate Angels-Senior managers at Fortune 1000
corporation with big paychecks.
• Entrepreneurial Angels-own and operate already
successful enterprises.
• Enthusiast Angles- Wealthy senior individuals who
want to be involved.
• Micromanagement Angels- Serious investors who
invest money but expect to be part of major decisions.
• Professional Angels- Wealthy professionals like
doctors, lawyers engineers.
The Pros and Cons of Business
Angel Investments

Investment Characteristics
Angels’ Characteristics Seek Smaller Deals
Added Bonuses
Value-adding Leveraging effect
Prefer start-up & early stage
Geographically dispersed Give loan guarantees
Invest in all industry sectors
More permissive investors No high fees
Like high-tech firms

Advantages

Business Angels

Disadvantages

Little Want a say Could turn No national

follow-on in firm out to be reputation
money “devils” to leverage
Venture Capital
Venture capital is a form of private equity
and a type of financing that investors provide
to startup companies and small businesses
that are believed to have long-term growth
potential. 

Venture capital generally comes from well-off

investors, investment banks and any other
financial institutions
VC fills a void
• Gap between innovation and traditional sources of debt

• Risk inherent in startups typically justify interest rates higher

than allowed by law

• VCs must balance high returns for their investors against

sufficient upside potential for entrepreneurs to keep them
motivated

13–44
 Returns on Investment Typically Sought by
Venture Capitalists
Expected Expected
Stage of Annual Return Increase on
Business on Investment Initial Investment
Start-up business 60% 10-15 x investment
(idea stage)
First-stage financing 40%-60% 6-12 x investment
(new business)
Second-stage financing 30%-50% 4-8 x investment
(development stage)
Third-stage financing 25%-40% 3-6 x investment
(expansion stage)
Turnaround situation 50% 8-15 x investment
 Venture Capitalist Screening Criteria

• Venture Capital Firm Requirements

• Nature of the Proposed Business
• Economic Environment of Proposed Industry
• Proposed Business Strategy
• Financial Information on the Proposed Business
• Proposal Characteristics
• Entrepreneur/Team Characteristics
Factors in Venture capitalist evaluation
process
 Venture capitalist in India
•  Sequoia Capital India-Just Dial, Knowlarity, Practo, Akosha
• Helion Venture Partners-Make My Trip, Red Bus, YepMe,
PubMatic, TAXI for Sure, Komli
• Accel Partners- FlipKart, BabyOye, Book My Show, Myntra,
Common Floor
• Nexus Venture Partners-SnapDeal, Komli, Delhivery, Housing
• Intel Capital India-Hungama, SnapDeal 
•  Blume Ventures- Exotel, Printo, Carbon Clean Solutions 
• Inventus Capital Partners-Savaari, Poshmark, Policy Bazaar
•  IDG India Ventures-Yatra.com, Myntra, First Cry, Ozone