CHAPTER SIX

ORGANIZING AND FINANCING THE NEW VENTURE

6.2. Sources of financing
Finance is needed throughout a company’s life. The type and amount of finance required for a
business depends on many factors: type of business, success of firm and state of the company.
Debt Financing
The process of borrowing money from the moneylender at a predetermined interest, which has to be
paid within the predetermined time, is called debt financing.
Usually, the debt must be secured against the assets of the company and very commonly must also be
secured against the assets of the owner of the company, also called a personal guarantee or collateral
security, be kept with him (which is usually a fixed asset like land, building, etc.) to ensure that incase
of the entrepreneur’s incapacity to repay the debt (incase he become insolvent) he can sell the
collateral security to realize the money. There can be additional fees, sometimes referred to as points,
for using or being able to borrow the money.
Short-term debt (less than a year) is usually used to provide working to finance inventory, accounts
receivable or the operations of the business.
The long-term debt (more than a year) are used to purchase assets such as land and building.
Merits of debt financing
o Allows the owner to retain large portion of ownership
o Management and control, and greater return on equity
o Preferable when the interest rate is low
Equity Financing
Equity capital is money given for a share of ownership of the company. Equity can be provided by
individual inventors, sometimes known as angles, venture capital companies, joint venture partners
and capital contribution of the founders of the company.
Equity financing- is the process of obtaining funds for the company in exchange of ownership.
Merits of equity financing
o Equity providers are more interested in the growth potential of the company.
o It does not require collateral security
o Offers some form of ownership position in the business venture.

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Capital structure
The composition of borrowed capital i.e. the debt and the ownership capital i.e. the equity in overall
capital of an enterprise is called ‘capital structure’. The ratio of debt to equity is capital structure.
Capital structure means permanent financing of the enterprise represented primarily by long-term
sources of funds i.e. debt and equity. Thus it excludes funds raised from short-term sources.
An optimum capital structure bears the following features:
o It should involve the minimum cost and the maximum yields.
o The adopted capital structure should be flexible enough to fulfill the future requirements of the
capital as and when needed.
o The use of debts should be within the replaying capacity of the enterprise. In fact, failure to
recognize this important aspect is the common cause of financial strain among small enterprise.
o The capital structure should ensure proper control over the affairs of the enterprise.
The venture capital
Venture capital is money provided by professional who invest alongside the management in young,
rapid growing companies that have the potential to develop into significant economic contributors.
Venture capitalists generally:
o Finance new and rapidly growing companies
o Purchase equity securities
o Assist in the development of new products or services
o Add value to the company through active participation.
o Take higher risks with the exception of higher rewards;
o Have a long-term orientation.