CHAPTER SEVEN

ORGANIZING AND FINANCING THE NEW VENTURE

• What if you had a big plan but not capital to invest &
implement ?

Financial Requirements
• Funding methods:
 Permanent Capital:- Equity Capital
– Comes from the form of equity investment in shares, or
personal loans.
– Investment in equity is rewarded by dividends from profits.
 Working Capital:- Short-Term Finance
Sources of Finance
» Personal Investment by Owner
» Equity
» Debt
Types and Sources of Financing for Start-up
Businesses

• Financing is needed to start a business and ramp it up to

profitability.
• The financial needs of a business will vary according to the type
and size of the business.
– For example, processing businesses are usually capital
intensive, requiring large amounts of capital. Retail
businesses usually require less capital.
• Debt and equity are the two major sources of financing.
• Government grants to finance certain aspects of a business may
be an option.
 Equity Capital
• Represents the personal investment of the owner(s) in the
business.
• Is called risk capital because investors assume the risk of losing
their money if the business fails.
• Does not have to be repaid with interest like a loan does.
• The ownership stake resulting from an equity investment allows
the investor to share in the company’s profits.
• Companies may establish different classes of stock to control
voting rights among shareholders.
• Preferred stockholders receive a predetermined dividend before
common stockholders receive a dividend.
 Sources of Equity Financing

» Personal savings
» Friends and family members
» Angels
» Partners
» Corporations
» Venture capital companies
» Public stock sale
 Personal Savings
• The first place an entrepreneur should look for money.
• The most common source of equity capital for starting a
business.

Friends and Family Members

• After emptying her own pockets, an entrepreneur should
turn to those most likely to invest in the business –
friends and family members.
 Angels

• Angels - private investors who back emerging

entrepreneurial companies with their own money.
• Angel investors are individuals and businesses that are
interested in helping small businesses survive and grow.
• An excellent source of “patient money” for investors
needing relatively small amounts of capital.
• Angels almost always invest their money locally
 Corporate Venture Capital
• An investor who either provides capital to startup ventures or
supports small companies that wish to expand but do not have
access to public funding.
• Venture capitalists are willing to invest in such companies because
they can earn a massive return on their investments if these
companies are a success.
• Private investors who provide venture capital to promising business
ventures.
• Often they also provide management and industry expertise and
business connections with other firms and venture capitalists.
Going Public
• Initial public offering (IPO) - when a company raises capital by
selling shares of its stock to the public for the first time.
 » Advantages of “Going Public”
• Ability to raise large amounts of capital
• Improved corporate image
• Improved access to future financing
• Attracting and retaining key employees
• Using stock for acquisitions
• Listing on a stock exchange
» Disadvantages of “Going Public”
• Dilution of founder’s ownership
• Loss of control
• Loss of privacy
• Reporting to the SEC
• Filing expenses
• Accountability to shareholders
• Pressure for short-term performance
• Timing
 Debt Financing
• Involves borrowing funds from creditors with the
stipulation of repaying the borrowed funds plus
interest at a specified future time.
• For the creditors the reward for providing the debt
financing is the interest on the amount lent to the
borrower.
• Debt financing may be secured or unsecured.
• Debt financing may be short term or long term in their
repayment schedules.
• Can be just as difficult to secure as equity financing
 » Sources of Debt Capital
• Commercial banks
• Asset-based lenders
• Trade credit
• Equipment suppliers
• Commercial finance companies
• Saving and loan associations
• Insurance companies
• Credit unions
• Bonds
 CHAPTER 8
MANAGING GROWTRH AND TRANSITION

The growth of a business firm is similar to that of a human being who

passes through the stages of infancy, childhood, adulthood, and old
age.
An enterprise may be considered growing when there is a permanent
increase in its sales turnover, assets, and volume of output.
 Preparing For the Launch of the Venture
The process of launching a new venture can be divided into three key
stages as:
 Discovery;
 Evaluation; and
 Implementation
• These can be further sub-divided into seven steps as shown below:
DISCOVERY
Step 1. Discovering your entrepreneurial potential
• to know more about your personal resources and
attributes through some self-evaluation.
Step 2. Identifying a problem and potential solution
• a new venture has to solve a problem and meet a
genuine need.
EVALUATION
• Evaluate if the idea in the first stage is worthy
Step 3. Evaluating the idea as a business opportunity
• find out information about the market need.
Step 4. Investigating and gathering the resources
• How will the product/service get to market?
• How will it make money?
• What resources are required?
EXPLOITATION (making it more useful) -IMPLEMENTATION
Step 5. Forming the enterprise to create value
• set up a business entity and protect any intellectual
property.
• Get ready to launch the venture in a way that minimizes
risk and maximizes returns
Step 6. Implementing the entrepreneurial
strategy
• activate the marketing, operating, and financial
plans.
Step 7. Planning the future – look ahead and
visualize where you want to go
 Rapid Growth and Management Controls
• Usually, rapid growth is seen as a positive sign of success.
• Problems of rapid growth include
– It can cover up weak management, poor planning, or waste
resources.
– It dilutes effective leadership
– It causes the venture to stray from its goals and objectives
– It leads to communication barriers between departments and
individuals.
– Training and employee development are given little attention
– It can lead to stress and burnout.
– Delegation is avoided and control is maintained by only the
founders, creating bottlenecks in management decision
making.
– Quality control is not maintained.
 Managing Early Growth of the New Venture

• Some of the important guidelines to cultural change during

growth involve the following:
– Communicate all matters to key employees.
– Be a good listener.
– Be willing to delegate responsibility.
– Provide continuous training of key employees.
– Emphasize results to key managers with incentives built in to
encourage them to train and delegate within their roles.
– Maintain a focus by establishing a mission with goals and
using consensus in management decision making.
– Establish a “we” sprit-not a “me” sprit-in meetings and
memoranda to employees.
 Relevance of Record Keeping; include
– Sales
– Inventory
– Expense accounts (Overheads, operational costs, contingencies, etc)
 Recruiting and Hiring New Employees
• It may occur at different organizational level.
• Strategy and procedures may differ depending on the level for which the
individual is being hired.
• The entrepreneur will generally need to establish procedures for hiring
any new employees.
 Motivating and Leading the Team
• The entrepreneur or founder of the new venture will usually be a role
model for other employees.
• A good work ethic, being organized, being prepared for meetings, being
on time, giving praise to employees, and good communication within the
venture- will go a long way toward achieving financial and emotional
success.
 Financial Control
• Some financial skills such as; Cash flows, the income
statement, and the balance sheet are necessary for the
entrepreneur to manage the venture.
 Marketing and Sales Controls
• Some of these key variables might be;
– market share,
– distribution,
– promotion,
– pricing,
– customer satisfaction, and
– sales.
 Need for Growth
• Survival
• Economies of Scale
• Expansion of Market
• Technology
• Prestige and Power
• Self-Sufficiency
Survival:

 Just to retain its present position.

 Growth provides protection or security against periods

of adversity such as recession.

 By diversifying the range of its products and markets,

a firm can meet competition in the market and
minimize its risks.

 Thus, growth is a means of survival in a challenging a

turbulent environment.
• Economies of Scale:

 Large-scale operations provide economies in:

- production,

- marketing,

- finance, and

- management ( expertise).
• A large firm enjoys the advantages of:
– bulk purchase of materials
– strong bargaining power( b/c of volume)
– spreading of overheads, ( VC per unit is constant but
fc per unit declines)
– well organized promotion campaigns,
– cheaper finance (lower interest rate),
– automation,
 These economies result in reduction in per unit cost of
operations and increase in profits
• Expansion of Market:

 Increase in demand for goods and services lead

business firms to expand in size.

 Population explosion and transportation lead to

widening of markets, which in turn resulted in mass
production.
• Technology:

 Business firms also grow in order to reap the

benefits of modern technology.

 Many firms invest in research and development to

develop new products and new techniques.
 Only a large firm can take full advantage of
sophisticated machinery and equipment.

 Rationalization and automation result in more

efficient use of resources and a firm may grow to
obtain them.

 With advancement in science and technology, there

occurs growth in the scale of operations.
• Prestige and Power(High standing):

 Some businesspersons have a lust(desire) for economic and

social power.

 Big business commands power and respect.

 Businesspersons satisfy their craze for power by building

business empires.

 They take pride in the growth of firms established by them.

 Other personal factors such as personal ambition, exceptional

organizing ability, strategic genius, etc also lead to growth of
firms.
• Self-Sufficiency:

 Some firms grow to become independent in terms of

marketing of raw materials or marketing of products.

 They integrate the various stages of industry or

 acquire other firms to gain control over the supply of

materials and marketing of finished products.
 Types of Growth Strategies

• Strategy means a deliberate and well-planned course of

action designed to achieve specific objectives.
• The main strategies for growth are as follows:
1. Expansion
2. Diversification
3. Mergers
4. Sub-contracting
1) Expansion
• Expansion and diversification are forms of internal
growth.
 Expansion may take place in the following forms:
a) Market Penetration
b) Product Development
c) Market Development
• Practical Problems in Expansion

(i) Shortage of funds:

• Many times a small firm has to borrow funds at high rates of

interest.

(ii) Technology:

 Modernization of technology is time consuming and expensive

process.

 It becomes essential to recruit new staff or retain the existing

staff in the use and operation of new technology.
(iii) Marketing Problem:
 Expansion is possible and profitable only when the
increased output can be sold at remunerative prices.

(iv) Risk:

 Expansion involves additional risk.

 Competition is acute and raw materials have to be

imported.

 Better managerial skills are required to manage

growth successfully.
Diversification

 Entering new business in terms of either the market

or the technology or both.

 It is a strategy for growth by adding new products or

services to the existing ones.

 Requires a company to acquire new skills, new

techniques and new facilities
 Types of diversification

a) Horizontal integration

b) Vertical integration

c) Concentric and

d) Conglomerate diversification
a) Horizontal Integration

• When a company expands its business into different products

that are similar to current lines.

• E.g. macaroni and pasta

b) Vertical Integration

• new products or services are added which are

complementary to the existing product or service
line.

• New products serve the firm's own needs by either

supplying inputs
• or serve as a customer for its output.
 Backward Integration: It implies moving towards
the production of source of raw materials.
C. Concentric Diversification

• When a firm enters into some business, which is related

with its present business in terms of technology,
marketing or both

• In technology-related concentric diversification, new

product or service is provided with the help of
existing or similar technology.

• In marketing related concentric diversification, the new

product or service is sold through the existing
distribution system.
D. Conglomerate Diversification
• a firm enters into business, which is unrelated to its
existing business both in terms of technology and
marketing.

• Reasons to adopt:

i) To achieve a growth rate higher than what can be

realized through expansion.

ii) To make better use of financial resources with retained

profits exceeding immediate investment needs.
iii) To use potential opportunities for profitable
investment

iv) To achieve distinctive competitive advantage and

greater stability

v) To spread the risk, and

vi) To improve the price earnings ratio and market price of

the company's shares.

• P/E ratio = Market Value per Share

Earnings per Share (EPS)
 External Growth Strategy
i) Joint Ventures

• Created when two or more independent firms together

establish a new enterprise, in which profits and risks are shared

• Contribute to the total equity capital and participate in its

business operations.

• It is a temporary partnership or consortium between two or

more companies for a specified purpose.

• Foreign and local firms can participate in a joint venture.

• Strategic Issues in Joint Ventures:

(i) Objectives of joint venture:

• First of all the basic objectives of joint venture should be spelled

out clearly.

• The interests of two partners may not be identical and

compatible.

(ii) Choice of partner:

 several criteria may be used to select a venture.
• These are financial capacity,
• technical capacity,
• management competency
iii) Pattern of shareholding:

• an explicit provision should also be made for

disinvestment (withdrawal from investment) after
certain period of time

(iv) Management pattern:

• the joint venture should be autonomous.

• The composition of the board of directors may be

decided in the light of choice of partners, shareholding
pattern, etc.
ii) Merger

• A merger means a combination of two or more firms

into one.

• It may occur in two ways:

(a) takeover or acquisition (absorption) of one company by

another, and

(b) amalgamation -creation of new company by complete

consolidation of two or more units
• Types of Mergers

1) Horizontal mergers
• These take place when there is a combination of two or
more firms engaged in the same production or marketing
process.
2) Vertical Mergers:
• It takes place when the combining firms are
complementary to each other either in terms of supply
of inputs or marketing of output.

– For example, a footwear company may take over a leather

tannery.
3) Concentric mergers: When the combining firms are
similar either in terms of technology or marketing
system

4) Conglomerate mergers: It occurs when two

unrelated firms combine together

– E.g. a footwear company combining with a cement

firm.
 Why Mergers?
From the buying firm’s view point

• To gain quick entry into new markets and industries

• To achieve faster rate of growth

• To diversify quickly

• To reduce competition and avoid dependence

• To achieve synergistic advantages

 From the selling firm’s view point

1) To turn around a sick unit

2) To increase the value of the owner’s stock

3) To increase the growth rate

4) To acquire resources for stability of operations

5) To deal with problem of top management succession

6) To reduce tax burden

 Sub – Contracting
• Subcontracting is a type of work contract that seeks
to outsource certain types of work to other
companies.

• Subcontracting is done when the general contractor

does not have the time or skills to perform certain
tasks.

• When a building is being constructed, subcontracting

becomes a major deal.
• To focus on major areas of operation

• It may be in terms of manufacturing or office work

• E.g :
– commercial nominees selling shares of different
companies
 Recruitment agencies

• Sub-contracting has several advantages.

• First, it is the fastest method of increasing output.

• It enables the contractor to use technical and managerial

skills already existing with the sub-contractor.

• It avoids the need of setting up new plants and

equipment, which involves time and expense.
• Second, sub­contracting saves the main contractor from
incurring investment in specialized machinery and
equipment, which may not be required for regular
production.

• Third, sub-contracting may enable the contractor to

buy the components at a cost less than that of
manufacturing.
• Lastly, sub-contracting checks over-expansion of
productive facilities in case of temporary demand.

• However, may be unsuitable in case the contractor

requires the inputs on a large scale and on regular basis.

• It is the case when the contractor can manufacture the

components at a cost less than the price charged by the
sub-­contractor.