In this article, Sunil Kumar Shaw, pursuing Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata discusses Funding options to raise capital for your business.
Introduction
Money is the lifeline of any business but how and when a company requires funding depends basically on:
- The type
- Nature, and
- The objective of the business.
As the business of the company grows, the promoters/ founders require more capital to achieve company’s growth objectives such as:
- Expansion of capacity
- Increase in the marketing budget
- R&D budget
- New product development budget, etc.
A company may raise funds for different purposes as said above depending on the time periods which may differ from short term to long term. The total amount of capital needed by a company also rests on the type of company and business volume.
Funding options to raise capital for your business
Preparation for obtaining capital is the key and there are three vital elements to the preparation process, namely:
Business strategy and plan
A well-drafted Business Plan and strategy along with financing projections
is prerequisite and essential for a serious contemplation by any
institutionalized source of capital.
Effective liaising and networking
Effective liaising and networking with:
- Investment bankers
- Commercial Lenders
- Professional advisers, and
- Consultants who can assist and get the Business Proposal into the appropriate hands of the source of funding or financial institutions or banks.
Narrowing down & close follow-up
Often financing firms receive a number of business plans every year.
Therefore finding a way to increase the chance of getting approved for financing by the financial firm. Normally financing firms have certain investment preferences in term of companies for their investment portfolio. These preferences depend on the type of the company, products, and services, rates of return, geographic location, development stage and amount of capital needed.
Process for obtaining Capital
Raising of capital depends on the sources from where funds will be available and type of company.
Sole Proprietor and Partnership firm
The Sole proprietor and partnership have limited avenues for raising capital. They can obtain capital for their business by the following means:
- Investment of own savings
- Raising loans from friends and relatives
- Arranging advances from commercial banks
- Borrowing from finance companies
Private and Public company
The private and Public company can raise capital by a number of ways. To raise long-term and medium-term capital, a company has the following alternatives:
Issue of Shares
Companies may look for to raise capital by diluting ownership/equity (selling a certain amount of stake in the company) primarily in two ways:
- Preferential Shares:
The company can allot shares to a selected group of investors. This way is often used by private equity firms who are looking for investment in their growing businesses.
- Initial Public Offer:
Companies can make an “Offer for Shares” of the company in the arrangement of an IPO i.e. Initial Public Offering. So Company invites investors to become stakeholders in their company in return for capital.
The process involved in IPO
Underwriting
- Underwriting is a process by which companies raise capital through debt or equity. To issue IPO through a proper process to public underwriting are instrumental.
- The very first step in order to issue an IPO is to select and appoint an investment banker like Goldman Sachs, Credit Suisse and Morgan Stanley etc.
- Although in theory, a company may sell its shares on its own but in practice, investment bankers are very helpful and needful.
Various factors are considered by the investment bankers
- Amount of money that company need to raise
- Type of securities to be issued
- Other details and condition in the underwriting agreement
Filing with the SEBI
On behalf of the company, investment bank file a registration statement with SEBI. A registration statement contains information regarding offering and company information like management background, financial statements, where and how money is going to be utilized if any legal problems exist etc. SEBI ask for a cooling off period, in which SEBI investigate and verify the correctness of all material/information which has been furnished/disclosed. After SEBI approval of offering, a date (called effective date) is to be decided when the stock is to be made available to the public.
Role of SEBI
A company advertises its requirement for raising equity capital and the manner by which capital will be utilized. The process is monitored and regulated by Securities and Exchange Board of India (SEBI) and the various stock exchanges where shares of the company will get listed after their sale.
SEBI has laid down terms and conditions for raising capital through IPO route in ICDR Regulations. Small companies can also take IPO route subject to fulfillment of certain conditions.
Red Herring
During the period of cooling off, underwriter places the red herring. It is an initial prospectus which contains all the details/information regarding the company except the offer price and the effective date. The underwriter and company try to hype and build up interest in the public offer. With the red herring, efforts are also put wherein big institutional investors are aimed at (this also called dog and pony show).
As the effective date approaches, the underwriter and the company take a decision on the price of the public issue. Price of the offer depends on the company balance sheet, current market conditions and the success of the promotional activities which took place. At last, the securities are being sold on various stock markets and money is collected via IPO from investors.
How does IPO work in India?
Company files a registration declaration in accordance with regulation laid down by SEBI, the entire list of the declaration is reviewed by SEBI. This is followed by the prelude brochure proposed by the sponsor and then an authorized catalog before the share offering. The value and time of the IPO have determined afterward.
Applying for an IPO in India
When a firm proposes a public issue, it offers forms for submission which need to be filled by the shareholders and Public offers for shares can be bought for a limited time period only. The form should be duly filled and submitted by cash, cheque or demand draft before the closing date and in line with the prescribed guidelines.
Issue of Debentures
Companies often raise loans by issuing debentures. The rate of interest to be paid on debentures is fixed at the time of issuance and can be recovered by a charge on assets/property of the company, which provide the necessary security for payment. The company is held liable to pay the interest even if the company does not make a profit. Debentures are commonly issued to meet long-term requirements of business and it does not carry any voting right.
Obtaining a loan from banks (called Debt Capital)
Banks or financial institution are free to finance, technically feasible, and bankable projects undertaken by both private sector and public sector subject to fulfillment of the certain conditions as prescribed by Reserve bank of India.
Loans from the bank and financial institutions
Long term and short term loans may be obtained by companies from banks (PSU banks or private banks) and financial institutions such as:
- Industrial Credit
- Investment Corporation of India
- Industrial Finance Corporation of India
- State level other Industrial Development Corporations, etc.
These financial institutions can grant loans for a period up to maximum 25 years in accordance with RBI guideline.
Loans sanctioned must be covered by securities by way of mortgage of property of the company or shares, gold, etc. Loan from a bank is sanctioned based on various factors which involve the process of submission of the business plan and the valuation details of the company, project report and future growth prospect, balance sheet etc.
Loans from commercial banks
Capital required for renovation of plant and modernization of equipment and assets may be borrowed from commercial banks. Medium term loans can be secured from commercial banks against the security of assets or properties of the company. This kind of loan does not require any legal formality barring mortgaging of assets and properties.
Public Deposits
Companies can often raise funds by inviting their employees, shareholders or the general public and solicit them to deposit their savings with the company. The Companies Act allows this kind of deposits to be received for a time period maximum 3 years at a given time. By this process, public deposits can be secured by companies to fulfill their medium-term financial requirements.
Short-Term Capital
To raise short-term capital, companies may follow the methods and processes as given below:
Trade Credit
Companies can purchase Raw materials, spare parts, components on credit from different vendor or suppliers. In general Vendor or suppliers give credit for a time period of three to six months which provides a company short-term finance. This type of finance is available depends upon the volume of business.
Factoring
An amount which is due to a company from distributor or customer due to credit sale normally remains outstanding till the dues are received from the debtors. The book of debts may be allocated to a bank and in lieu of cash can be realized in advance from the bank. Therefore the responsibility of collecting the debtors is transferred to the bank provided a payment of specified charges as a commission to bank. This process of raising capital is known as factoring. The bank charge to be paid for the purpose of collecting is considered as the cost of raising funds.
Discounting bills of exchange
When the goods are sold on credit, bills of exchange are generally drawn for acceptance by the buyers of goods. In lieu of keeping the bills hold till the date of maturity, companies may discount it with commercial banks on payment of certain charges. The amount of discount is deducted from the value of bills at the time of discounting. The rate of discount charge is prescribed by the Reserve Bank of India (RBI) from time to time.
Bank overdraft and cash credit
This method is also very common and being adopted by many companies for fulfilling their short-term financial needs. Cash credit means a kind of arrangement whereby a commercial bank permits company to draw money as advances from time to time but within a certain limit. However, this kind of facility or arrangement is granted against the security of promissory notes bearing a second signature or security of goods in warehouse or stock or other financial instruments such as Government bonds etc.
Overdraft is a temporary facility provided by the bank in which it allows the company to overdraw from its current deposit account but within a specified limit. The overdraft facility is granted by the bank against the securities and the rate of interest is levied on cash credit and overdraft is relatively higher than the rate of interest on bank deposits.
Conclusion
As a responsible business owner or company should question themselves the amount of financial assistance they really require in order to meet business object.
Preparing a proper business plan for fundraising is essential to gain the confidence of the Banks. So it is prudent from the beginning with good corporate governance and tries to exercise fiscal discipline.
Debt capital would increase the liability of the company and mandate it to pay regular interest on the amount borrowed. On the other hand, raising equity capital would increase the number of stakeholder in the company thereby reducing or diluting the stake of each owner.
In order to achieve the delicate balance among the debt, equity and the requirement of the company, management should understand the process of obtaining capital financing.
References
[1] Master Circular- Loans and Advances – Statutory and Other Restrictions; dated 1st July 2015
https://rbi.org.in/scripts/BS_ViewMasCirculardetails.aspx?id=9902
[2] Section 56, 72, of the Companies Act, 2013 with Rule 18 and 19 of the Companies (Share Capital and Debentures) Rules, 2014.
[3] Bierman, Harold. The Capital Structure Decision. Springer, 2002.
[4] Downes, John, and Jordan Elliot Goodman. Finance & Investment Handbook. Barron’s Educational Series, 2003.
[5] IPO Meaning, Process, Recent IPOs, Factors considered. EduPristine dated 23rd July 2015;
https://www.edupristine.com/blog/initial-public-offer
[6] Methods of Raising Capital
https://archive.india.gov.in/business/starting_business/methods_raisingcapital.php .
[7]Funding Options To Raise Startup Capital For Your Business; https://www.profitbooks.net/funding-options-to-raise-startup-capital-for-your-business/
