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Fund Raising Options for your business

1. Introduction

All commercial organisation need finance to commence, continue well as expand its

operations. The finance is the lifeline of any business. The financing needs and the mode

of financing of entities vary depending upon their size, nature of operations and

structure of business organisation. An entity may raise funds for different purposes

depending on the time periods ranging from very short to fairly long duration. The total

amount of financial needs of a company depends on the nature and size of the business.

The scope of raising funds depends on the sources from which funds may be available.

There must be continuous flow of funds in and out of business. Sound plans, efficient

production and marketing are all dependent on smooth flow of finance. Hence, a

financial plan needs to be prepared, which indicates the requirements of finance,

sources for raising the finance and the application of funds. Financial planning for

starting a business begins with estimating the total amount of capital required by the

firm for the various need of the business.

Therefore, the financial plans of an enterprise should be formulated by taking into

consideration the following factors :-

The financial objectives of the entity

Nature and size of the business

The image and credit-worthiness of the enterprise

Growth and expansion plans

Capital market trends

Government regulations

The business forms of sole proprietor and partnership have limited opportunities for

raising funds. They can finance their business by the following means :-

Investment of own savings

Raising loans from friends and relatives

Arranging advances from commercial banks

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Borrowing from finance companies

However, Companies can Raise Finance by a Number of Methods. To Raise Long-Term

and Medium-Term Capital, they have the following options:-

2. Modes of Corporate Financing

2.1 Issue of Shares

It is the most important method. The liability of shareholders is limited to the face value

of shares, and they are also easily transferable. A private company cannot invite the

general public to subscribe for its share capital and its shares are also not freely

transferable. But for public limited companies there are no such restrictions. There are

two types of shares :-

Equity shares :- the rate of dividend on these shares depends on the profits

available and the discretion of directors. Hence, there is no fixed burden on the

company. Each share carries one vote.

Preference shares :- dividend is payable on these shares at a fixed rate and is

payable only if there are profits. Hence, there is no compulsory burden on the

company's finances. Such shares do not give voting rights.

The company planning to raise funds by issuing shares should be aware of the

regulations under Companies Act and SEBI’s regulations regarding issue of shares.

Moreover, company’s article and memorandum of association should permit such issue

and if not, should be adequately modified.

2.2 Venture Capital Funding

Venture capital is a means of equity financing for rapidly-growing private

companies. Finance may be required for the start-up, development/expansion or

purchase of a company. Venture Capital firms invest funds on a professional basis,

often focusing on a limited sector of specialization (eg. IT, infrastructure, health/life

sciences, clean technology, etc.)

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The goal of venture capital is to build companies so that the shares become liquid

(through IPO or acquisition) and provide a rate of return to the investors (in the

form of cash or shares) that is consistent with the level of risk taken.

With venture capital financing, the venture capitalist acquires an agreed proportion

of the equity of the company in return for the funding. Equity finance offers the

significant advantage of having no interest charges. It is "patient" capital that seeks

a return through long-term capital gain rather than immediate and regular interest

payments, as in the case of debt financing. Given the nature of equity financing,

venture capital investors are therefore exposed to the risk of the company failing. As

a result the venture capitalist must look to invest in companies which have the

ability to grow very successfully and provide higher than average returns to

compensate for the risk.

When venture capitalists invest in a business they typically require a seat on the

company's board of directors. They tend to take a minority share in the company

and usually do not take day-to-day control. Rather, professional venture capitalists

act as mentors and aim to provide support and advice on a range of management,

sales and technical issues to assist the company to develop its full potential.

Venture capital has a number of advantages over other forms of finance, such

as:

It injects long term equity finance which provides a solid capital base for

future growth.

The venture capitalist is a business partner, sharing both the risks and

rewards. Venture capitalists are rewarded by business success and the

capital gain.

The venture capitalist is able to provide practical advice and assistance to the

company based on past experience with other companies which were in

similar situations.

The venture capitalist also has a network of contacts in many areas that can

add value to the company, such as in recruiting key personnel, providing

contacts in international markets, introductions to strategic partners, and if

needed co-investments with other venture capital firms when additional

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rounds of financing are required.

The venture capitalist may be capable of providing additional rounds of

funding should it be required to finance growth.

In India, the venture capital funds (VCFs) can be categorised into the following

groups:-

Those promoted by the Central Government controlled development finance

institutions, for example:-

ICICI Venture Funds Ltd.

IFCI Venture Capital Funds Limited (IVCF)

SIDBI Venture Capital Limited (SVCL)

Those promoted by State Government controlled development finance

institutions, for example:-

Gujarat Venture Finance Limited (GVFL)

Kerala Venture Capital Fund Pvt Ltd.

Punjab Infotech Venture Fund

Hyderabad Information Technology Venture Enterprises Limited

(HITVEL)

Those promoted by public banks, for example:-

Canbank Venture Capital Fund

SBI Capital Markets Limited

Those promoted by private sector companies, for example:-

IL&FS Trust Company Limited

Infinity Venture India Fund

Those established as an overseas venture capital fund, for example:-

Walden International Investment Group

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SEAF India Investment & Growth Fund

BTS India Private Equity Fund Limited

Governing Regulations: Securities and Exchange Board of India (Venture Capital

Funds) Regulations 1996 and Securities and Exchange Board of India (Foreign

Venture Capital Investors) Regulations 2000 lays down the overall regulatory

framework for the registration and operations of venture capital funds in India.

Besides, there are many other regulations that directly or indirectly regulate

venture capital funding in India. Some of these are:

2.3 Private Equity Funding

Private equity fund is a pooled investment vehicle used for making investments in

various equity securities (and to a lesser extent debt) according to one of the

investment strategies associated with private equity. Private equity funds are typically

limited partnerships with a fixed term of 10 years (often with annual extensions). At

inception, institutional investors make an unfunded commitment to the limited

partnership, which is then drawn over the term of the fund. A private equity fund is

raised and managed by investment professionals of a specific private equity firm (the

general partner and investment advisor). Typically, a single private equity firm will

manage a series of distinct private equity funds and will attempt to raise a new fund

every 3 to 5 years as the previous fund is fully invested.

There are no legal and regulatory differences between venture capital and private

equity and therefore, the regulatory framework for venture capital as discussed above

are applicable tro private equity as well.

2.4 Issue of Debentures

Companies generally have powers to borrow and raise loans by issuing debentures. The

rate of interest payable on debentures is fixed at the time of issue and are recovered by

a charge on the property or assets of the company, which provide the necessary security

for payment. The company is liable to pay interest even if there are no profits.

Debentures are mostly issued to finance the long-term requirements of business and do

not carry any voting rights.

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2.5 Loans from Financial Institutions

Long-term and medium-term loans can be secured by companies from financial

institutions like the Industrial Finance Corporation of India, Industrial Credit and

Investment Corporation of India (ICICI) , State level Industrial Development

Corporations, etc. These financial institutions grant loans for a maximum period of 25

years against approved schemes or projects. Loans agreed to be sanctioned must be

covered by securities by way of mortgage of the company's property or assignment of

stocks, shares, gold, etc.

2.6 Loans from Commercial Banks

Medium-term loans can be raised by companies from commercial banks against the

security of properties and assets. Funds required for modernisation and renovation of

assets can be borrowed from banks. This method of financing does not require any legal

formality except that of creating a mortgage on the assets.

2.7 Public Deposits

Companies often raise funds by inviting their shareholders, employees and the general

public to deposit their savings with the company. The Companies Act permits such

deposits to be received for a period up to 3 years at a time. Public deposits can be raised

by companies to meet their medium-term as well as short-term financial needs. The

increasing popularity of public deposits is due to :-

The rate of interest the companies have to pay on them is lower than the interest

on bank loans.

These are an easier method of mobilising funds than banks, especially during

periods of credit squeeze.

They are unsecured.

Unlike commercial banks, the company does not need to satisfy credit-

worthiness for securing loans.

2.8 Reinvestment of Profits

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Profitable companies do not generally distribute the whole amount of profits as

dividend but, transfer certain proportion to reserves. This may be regarded as

reinvestment of profits or ploughing back of profits. As these retained profits actually

belong to the shareholders of the company, these are treated as a part of ownership

capital. Retention of profits is a sort of self financing of business. The reserves built up

over the years by ploughing back of profits may be utilised by the company for the

following purposes :-

Expansion of the undertaking

Replacement of obsolete assets and modernisation.

Meeting permanent or special working capital requirement.

Redemption of old debts.

2.9 Loan from State Financial Corporation.

State Financial Corporations (SFCs) are state-level financial institutions, operating as

regional development banks playing a crucial role in the development of small and

medium enterprises in the states concerned in tandem with national priorities. There

are 18 SFCs in the country, of which 17 were set up under the SFCs Act 1951. Tamil

Nadu Industrial Investment Corporation Ltd. established in 1949 under the Companies

Act as Madras Industrial Investment Corporation, also functions as a SFC.

SFCs provide financial assistance by way of term loans, direct subscription to

equity/debentures, guarantees, discounting of bills of exchange and seed/ special

capital. The SFCs operate a number of schemes of refinance and equity type assistance

on behalf of IDBI/SIDBI in addition to special schemes for artisans and special target

groups such as SC/ST, women, ex-servicemen, physically handicapped, etc.

2.10 Asset securitisation.

Asset securitisation is a mode of raising finance wherein entity creates an SPV and

transfers assets in it which inturn issues securities which are backed by these assets.

The claim in such cases is on assets, and not on the entity. Hence, it is known as asset-

based funding

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2.11 EXIM Bank

Export-Import Bank of India is the premier export finance institution of the

country, set up in 1982 under the Export-Import Bank of India Act 1981. Exim

Bank offers the following Export Credit facilities, which can be availed of by

Indian companies.

Pre-shipment credit

Exim Bank's Pre-shipment Credit facility, in Indian Rupees and foreign currency,

provides access to finance at the manufacturing stage - enabling exporters to

purchase raw materials and other inputs.

Supplier's Credit

This facility enables Indian exporters to extend term credit to importers

(overseas) of eligible goods at the post-shipment stage

For Project Exporters

Indian project exporters incur Rupee expenditure while executing overseas

project export contracts i.e. costs of mobilisation/acquisition of materials,

personnel and equipment etc. Exim Bank's facility helps them meet these

expenses.

For Exporters of Consultancy and Technological Services

Exim Bank offers a special credit facility to Indian exporters of consultancy and

technology services, so that they can, in turn, extend term credit to overseas

importers.

Guarantee Facilities

Indian companies can avail of these to furnish requisite guarantees to facilitate

execution of export contracts and import transactions.

2.15 International Financing

India presents a vast potential for overseas investment and is actively encouraging the

entrance of foreign players into the market. India has among the most liberal and

transparent policies on FDI among the emerging economies.

Foreign Portfolio Investments

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With respect to Foreign Portfolio Investments, FIIs must register themselves with

India’s Securities Exchange Board of India or SEBI and comply with the exchange

control regulations of the RBI. Thus, India allows Foreign Pension Funds, Mutual Funds,

investment trusts, asset management companies, nominee companies, and

incorporated/institutional portfolio managers or their power of attorney holders to

invest in India as FIIs. FIIs are allowed to invest in securities traded in primary and

secondary capital markets in India under the portfolio investment scheme. These

include shares, debentures, warrants, units of mutual funds, government securities and

derivative instruments

ADRs/GDRs/FCCBs

Another important area of financing is the ADRs/GDRs/ FCCB route for qualifying

Indian companies. Thus, these Indian companies can raise foreign equity through either

of these routes which would form part of the FDI equity caps. This apart, there is the

choice of investing in India through the preference share route. Foreign investment

through convertible preference shares is treated as FDI. These investments can be made

either through the automatic route or the Government approval route.

ECBs

Finally, India also allows External Commercial Borrowings (ECBs), for qualified Indian

companies. Debts raised in foreign currency fall within the definition of ECBs, and are

regulated by India’s Ministry of Finance and the RBI. ECBs can be approved through the

automatic route as well as the approval route. ECBs can be availed by corporates

registered under the Indian Companies Act except for financial intermediaries and must

be availed from an internationally recognized source, export credit agencies, suppliers

of equipment, foreign collaborators and foreign equity holders

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International Financial Institutions :- like World Bank and International Finance

Corporation (IFC) provide long-term funds for the industrial development all over the

world. The World Bank grants loans only to the Governments of member countries or

private enterprises with guarantee of the concerned Government. IFC was set up to

assist the private undertakings without the guarantee of the member countries. It also

provides them risk capital.

2.16 Leasing Companies

Manufacturing companies can secure long-term funds from leasing companies. For this

purpose a lease agreement is made whereby plant, machinery and fixed assets may be

purchased by the leasing company and allowed to be used by the manufacturing

concern for a specified period on payment of an annual rental. At the end of the period

the manufacturing company may have the option of purchasing the asset at a reduced

price. The lease rent includes an element of interest besides expenses and profits of the

leasing company.

2.17 Retained Profits or Reinvestment of Profits

An important source of long-term finance for ongoing profitable companies is the

amount of profit which is accumulated as general reserve from year to year. To the

extent profits are not distributed as dividend to the shareholders, the retained amount

can be reinvested for expansion or diversification of business activities. Retained profit

is an internal source of finance. Hence it does not involve any cost of floatation which

has to be incurred to raise finance from external sources.

3.18 Special Financial Institutions

A large number of financial institutions have been established in India for providing

long-term financial assistance to industrial enterprises. There are many all-India

institutions like Industrial Finance Corporation of India (IFCI); Industrial Credit and

Investment Corporation of India (ICICI); Industrial Development Bank of India(IDBI)

, etc. At the State level, there are State Financial Corporations (SFCs) and State Industrial

Development Corporations (SIDCs). These national and state level institutions are

known as 'Development Banks'. Besides the development banks, there are several other

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institutions called as 'Investment Companies' or 'Investment Trusts' which subscribe to

the shares and debentures offered to the public by companies. These include the Life

Insurance Corporation of India (LIC); General Insurance Corporation of India

(GIC); Unit Trust of India (UTI) , etc

3. Modes of Short-Term Capital Financing

3.1 Trade Credit

Companies buy raw materials, components, stores and spare parts on credit from

different suppliers. Generally suppliers grant credit for a period of 3 to 6 months, and

thus provide short-term finance to the company. Availability of this type of finance is

connected with the volume of business. When the production and sale of goods increase,

there is automatic increase in the volume of purchases, and more of trade credit is

available.

3.2 Factoring

The amounts due to a company from customers, on account of credit sale generally

remains outstanding during the period of credit allowed i.e. till the dues are collected

from the debtors. The book debts may be assigned to a bank and cash realised in

advance from the bank. Thus, the responsibility of collecting the debtors' balance is

taken over by the bank on payment of specified charges by the company. This method of

raising short-term capital is known as factoring. The bank charges payable for the

purpose is treated as the cost of raising funds.

3.3 Discounting Bills of Exchange

This method is widely used by companies for raising short-term finance. When the

goods are sold on credit, bills of exchange are generally drawn for acceptance by the

buyers of goods. Instead of holding the bills till the date of maturity, companies can

discount them with commercial banks on payment of a charge known as bank discount.

The rate of discount to be charged by banks is prescribed by the Reserve Bank of India

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from time to time. The amount of discount is deducted from the value of bills at the time

of discounting. The cost of raising finance by this method is the discount charged by the

bank.

3.4 Bank Overdraft and Cash Credit

It is a common method adopted by companies for meeting short-term financial

requirements. Cash credit refers to an arrangement whereby the commercial bank

allows money to be drawn as advances from time to time within a specified limit. This

facility is granted against the security of goods in stock, or promissory notes bearing a

second signature, or other marketable instruments like Government bonds. Overdraft is

a temporary arrangement with the bank which permits the company to overdraw from

its current deposit account with the bank up to a certain limit. The overdraft facility is

also granted against securities. The rate of interest charged on cash credit and overdraft

is relatively much higher than the rate of interest on bank deposits

Accounts Receivable Financing

Under it, the accounts receivable of a business concern are purchased by a financing

company or money is advanced on security of accounts receivable. The finance

companies usually make advances up to 60 per cent of the value of the accounts

receivable pledged. The debtors of the business concern make payment to it which in

turn forwards to the finance company.

Customer Advance

Manufacturers of goods may insist the customers to make a part of the payment in

advance, particularly in cases of special order or big orders. The customer advance

represents a part of the price of the products that have been ordered by the customer

and which will be delivered at a later date.