GROUP NO.

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Q 5. VENTURE CAPITAL. ADVANTAGES & DISADVANTAGES TO INDIAN
CORPORATE.
Ans..
VENTURE CAPITAL :
1. Starting and growing a business always require capital. There are a number of alternative
methods to fund growth. These include the owner or proprietor’s own capital, arranging
debt finance, or seeking an equity partner, as is the case with private equity and venture
capital.
2. 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.)
3. 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. 
4. 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.
5. 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.
6. Venture capital typically comes from institutional investors and high net worth individuals,
and is pooled together by dedicated investment firms.
7. Venture capital firms typically comprise small teams with technology backgrounds
(scientists, researchers) or those with business training or deep industry experience.
A Venture Capitalist (also known as a VC) is a person or investment firm that makes
venture investments, and these venture capitalists are expected to bring managerial and
technical expertise as well as capital to their investments. A Venture Capital Fund refers
to a pooled investment vehicle (often an LP or LLC) that primarily invests the  financial
capital of third-party investors in enterprises that are too risky for the standard capital
markets or bank loans.

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ADVANTAGES VENTURE CAPITAL :
1. It injects long term equity finance which provides a solid capital base for future growth.
2. The venture capitalist is a business partner, sharing both the risks and rewards. Venture
capitalists are rewarded by business success and the capital gain.
3. 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.
4. 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 rounds of financing are required.
5. The venture capitalist may be capable of providing additional rounds of funding should it
be required to finance growth.

DISADVANTAGES OF VENTURE CAPITAL :

1. Pricing - Venture capitalists are typically more sophisticated and may drive a harder
bargain.
2. Intrusion - Venture capitalists are more likely to want to influence the strategic direction
of the company. 
3. Control - Venture capitalists are more likely to be interested in taking control of the
company if the management is unable to drive the business.

EXAMPLE : AIR TRANSPORT.

Advantages:
1. High Speed
2. Quick Service
3. No Infrastructure Investment
4. Natural Route

Disadvantages:
1. Risky
2. Very Costly
3. Small Carrying Capacity
4. Huge Investment

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Q 6. IPOS’S AND PROCESS OF BOOK BUILDING.
Ans..
INITIAL PUBLIC OFFERING (IPO) :
1. If a brand new company or a company already in existence, but with no shares listed on
the stock exchange, decides to invite the public to buy its shares, it is called an Initial
Public Offering or an IPO.
2. Since it is the first time the company is approaching the public for money, it is also
referred to as 'going public'.
3. If a company that is already listed (its shares are available for buying and selling on the
stock exchange) is coming out with a fresh lot of shares, it is called the new issue.
4. Here are six terms commonly associated with an IPO that you, as an investor, must be
aware of.
5. An Initial Public Offer (IPO) is the selling of securities to the public in the primary
market. This Initial Public Offering can be made through the fixed price method, book
building method or a combination of both.
6. SEBI guidelines, 1995 defines book building as “a process undertaken by which a
demand for the securities proposed to be issued by a body corporate is elicited and built
up and the price for such securities is assessed for the determination of the quantum of
such securities to be issued by means of a notice, circular, advertisement, document or
information memoranda or offer document.” Book building process is a common practice
used in most developed countries for marketing a public offer of equity shares of a
company. However, book building is a transparent and flexible price discovery method of
initial public offerings (IPOs) in which price of securities is fixed by the issuer company
along with the Book Running Lead Manager (BRLM) on the basis of feedback received
from investors as well as market intermediaries during a certain period.
7. Book building acts as scientific method through which a consensus price of IPOs may be
determined on the basis of feedback received from most informed investors who are
institutional and corporate investors like, UTI, LICI, GICI, FIIs, SFCI etc. The method
helps to make a correct evaluation of a company’s potential and the price of its shares.

BOOK BUILDING AND FIXED PRICE OPTION IN THE IPOs :

A company may raise capital in the primary capital market through initial public offers (IPOs),
rights issues and private placement. IPOs, the largest sources of funds in the primary capital
market, to the company are basically an invitation by a company to the public to subscribe to its
securities offered through prospectus. In fixed price process in IPOs, allotments of shares to all
investors are made on proportionate basis Institutional investors normally are not interested to
participate in fixed price public issues due to uncertainty of allotment and lack of opportunity
cost. On the other, they like to participate largely in book built transactions as in this process the

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costs of public issue and the time taken for the completion of the entire process are much lesser
than the fixed price issues. In Book Building the price is determined on the basis of demand
received or at price above or equal to the floor price whereas in fixed price option the price of
issues is fixed first and then the securities are offered to the investors. In case of Book Building
process book is built by Book Runner Lead Manager (BRLM) to know the everyday demand
whereas in case of fixed price of public issues, the demand is known at the close of the issue.

HOW IS BOOK BUILT IN INDIA :

The main parties who are directly associated with book building process are the issuer company,
the Book Runner Lead Manager (BRLM) and the syndicate members (Fig-1.1). The Book
Runner Lead Manager (i.e. merchant banker) and the syndicate members who are the
intermediaries are both eligible to act as underwriters.

The steps which are usually followed in the book building process can be summarized below:
1. The issuer company proposing an IPO appoints a lead merchant banker as a BRLM.
2. Initially, the issuer company consults with the BRLM in drawing up a draft prospectus
(i.e. offer document) which does not mention the price of the issues, but includes other
details about the size of the issue, past history of the company, and a price band. The
securities available to the public are separately identified as “net offer to the public”.
3. The draft prospectus is filed with SEBI which gives it a legal standing.
4. A definite period is fixed as the bid period and BRLM conducts awareness campaigns
like advertisement, road shows etc.
5. The BRLM appoints a syndicate member, a SEBI registered intermediary to underwrite
the issues to the extent of “net offer to the public”.
6. The BRLM is entitled to remuneration for conducting the Book Building process.
7. The copy of the draft prospectus may be circulated by the BRLM to the institutional
investors as well as to the syndicate members.
8. The syndicate members create demand and ask each investor for the number of shares
and the offer price.
9. The BRLM receives the feedback about the investor’s bids through syndicate members.
10. The prospective investors may revise their bids at any time during the bid period.
11. The BRLM on receipts of the feedback from the syndicate members about the bid price
and the quantity of shares applied has to build up an order book showing the demand for
the shares of the company at various prices. The syndicate members must also maintain a
record book for orders received from institutional investors for subscribing to the issue
out of the placement portion.
12. On receipts of the above information, the BRLM and the issuer company determine the
issue price. This is known as the market-clearing price.
13. The BRLM then closes the book in consultation with the issuer company and determine
the issue size of (a) placement portion and (b) public offer portion.
14. Once the final price is determined, the allocation of securities should be made by the
BRLM based on prior commitment, investor’s quality, price aggression, earliness of bids
etc. The bid of an institutional bidder, even if he has paid full amount may be rejected
without being assigned any reason as the Book Building portion of institutional investors
is left entirely at the discretion of the issuer company and the BRLM. (15) The Final

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 prospectus is filed with the registrar of companies within 2 days of determination of
issue price and receipts of acknowledgement card from SEBI.
15. Two different accounts for collection of application money, one for the private
placement portion and the other for the public subscription should be opened by the
issuer company.
16. The placement portion is closed a day before the opening of the public issue through
fixed price method. The BRLM is required to have the application forms along with the
application money from the institutional buyers and the underwriters to the private
placement portion.
17. The allotment for the private placement portion shall be made on the 2nd day from the
closure of the issue and the private placement portion is ready to be listed.
18. The allotment and listing of issues under the public portion (i.e. fixed price portion) must
be as per the existing statutory requirements.
19. Finally, the SEBI has the right to inspect such records and books which are maintained
by the BRLM and other intermediaries involved in the Book Building process.

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 Q 7. SOURCES OF VARIOUS FINANCING TO THE CORPORATES AND THEIR
ADVANTAGES & DISADVANTAGES.
Ans..
Equity and debt represent the two broad sources of finance for a business firm. Equity consists of
equity capital, retained earnings, and preference capital. Debt consists of term loans, debentures,
and short-term borrowings.

SOURCES OF FINANCE :

1. Equity Capital:
Equity capital represents ownership capital, as equity shareholders collectively own the
company. They enjoy the rewards and bear the risks of ownership. However, their liability,
unlike the liability of the owner in a proprietary firm and the partners in a partnership concern, is
limited to their capital contribution.

Advantages of Equity Capital:

1. There is no compulsion to pay dividends. If the firm has insufficiency of cash it can skip
equity dividends without suffering any legal consequences.
2. Equity capital has no maturity date and hence the firm has no obligation to redeem.
3. Since equity capital provides a cushion to lenders, it enhances the creditworthiness of the
company.
4. Presently, dividends are tax-exempt in the hands of investors. The company paying
equity dividend, however, is required to pay a dividend distribution tax of 15%.

Disadvantages of Equity Capital

1. Sale of equity shares to the outsiders dilutes the control of existing owners.
2. The cost of equity capital is high. The rate of return required by equity shareholders is
generally higher than the rate of return required by other investors.
3. Equity dividends are paid out of profit after tax, whereas interest payments are tax-
deductible expenses. This makes the relative cost of equity more.
4. The cost of issuing equity shares is generally higher than the cost of issuing other types of
securities. Underwriting commission, brokerage costs, and other issue expenses are high
for equity issues.

2. Retained Earnings:
Retained earnings are that portion of equity earnings (profit after tax less preference
dividends) which are ploughed back in the firm. Retained earnings are also referred to as internal
equity. Companies normally retain 30% to 80% of profit after tax for financing growth.

Advantages of Retained Earnings:

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 1. Retained earnings are readily available internally also they do not require involvement of
outsiders (shareholders or lenders).
2. The use of retained earnings as opposed to new shares or debentures avoids issue costs.
3. The use of retained earnings avoids the possibility of a change in control resulting from
an issue of new shares.

Disadvantages of Retained Earnings:

1. The amount that can be raised by way of retained earnings may be limited and the
quantum tends to be highly variable.
2. The opportunity cost of retained earnings is quite high.

3. Preference Capital:
Preference shares have a fixed percentage dividend before any dividend is paid to the
ordinary shareholders. As with ordinary shares a preference dividend can only be paid if
sufficient distributable profits are available, although with 'cumulative' preference shares the
right to an unpaid dividend is carried forward to later years. The arrears of dividend on
cumulative preference shares must be paid before any dividend is paid to the ordinary
shareholders.

Advantages of Preference Capital:

1. There is no legal obligation to pay preference dividend.
2. Since they do not carry voting rights, preference shares avoid diluting the control of
existing shareholders while an issue of equity shares would not.
3. The issue of preference shares does not restrict the company's borrowing power, at least
in the sense that preference share capital is not secured against assets in the business.
4. The non-payment of dividend does not give the preference shareholders the right to
appoint a receiver, a right which is normally given to debenture holders.
5. Preference capital is generally regarded as part of net worth and hence, it enhances the
creditworthiness of the firm.
Disadvantages of Preference Capital:
1. Dividend payments on preference shares are not tax deductible in the way that interest
payments on debt are.
2. Though there is no legal obligation to pay preference dividends, skipping them can
adversely affect the image of the firm in the capital market.
3. Preference shareholders have a prior claim on the assets and earnings of the firm as
compared to equity shareholders.

4. Term Loans:
Term loans, also referred to as term finance; represent a source of debt finance which is
generally repayable in less than 10 years. They are employed to finance acquisition of fixed
assets and working capital margin. Term loan differs from short-term bank loans which are
employed to finance short-term working capital need and tend to be self-liquidating over a period
of time, usually less than one year.

Advantages of Term Loan:

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 1. Interest on term loan is a tax-deductible expense.
2. It does not result in dilution of control because banks and financial institutions (debt
holders) are not entitled to vote.
3. Banks and financial institutions do not partake in the value created by the company as
payments to them are limited to interest and principal.
4. The maturity of a term loan can be tailored to synchronize with the period for which the
firm needs funds.
5. It is generally easier for management to communicate their proprietary information about
the firm’s prospects to private lenders than to public capital markets. In case of a term
loan a firms deal with one or few institutional investors.

Disadvantages of Term Loan:

1. Term loan entails fixed interest and principal repayment obligation. Failure to meet these
commitments can cause a great deal of financial embarrassment and even lead to
bankruptcy.
2. It increases financial leverage.
3. It imposes restrictions that limit the borrowing firm’s financial and operating flexibility.

5. Debentures:
Debentures are legally defined as the written acknowledgement of a debt incurred by a
company, normally containing provisions about the payment of interest and the eventual
repayment of capital. Debenture holders are the creditors of company. Debentures often provide
more flexibility than term loans as they offer greater variety of choices with respect to maturity,
interest rate, security, repayment, etc.

Advantages of Debentures:
1. Interest on debentures is a tax-deductible expense, whereas equity and preference
dividend are paid out of profit after tax.
2. Issue of debentures does not result in dilution of control because debenture holders are
not entitled to vote.
3. Cost of issuing debentures is significantly lower than those of equity and preference
capital.
4. The maturity of a debt instrument can be tailored to synchronize with the period for
which the firm needs fund.
5. The burden of servicing debt is generally fixed in nominal terms. Hence, debt provides
protection against high unanticipated inflation.

Disadvantages of Debentures:
1. After the issue of debentures, the firm hardly has any freedom in re-negotiating the terms
of the issue as in case of debenture issue a firm has to deal with numerous investors.
2. Failure in repaying fixed interest and principal obligation can cause financial distress and
it can even lead to bankruptcy.
3. Debt financing increases financial leverage and it imposes restrictions that can impair the
borrowing firm’s operating flexibility.

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Q 8. FINANCIAL PLANNING & FORECASTING, PROJECTIONS FOR P/L A/C AND
BALANCE SHEET.
Ans..
WHAT AND WHY OF FINANCIAL PLANNING :
A long term financial plan represents a blueprint of what a firm proposes to do in the future.
Typically it covers a period of three to ten years – most commonly it spans a period of five years.
Naturally, planning over such an extended time horizon tends to be in fairly aggregative terms.
While there is considerable variation in the scope, degree of formality, and level of sophistication
in financial planning across firms, most corporate financial plans have certain common elements
as follows:

1. Economic Assumptions:
The financial plan is based on certain assumptions about the economic environment ( interest
rate , tax rate, inflation rate, growth rate, exchange rate, and so on).
2. Sales forecast:
The sales forecast is typically the starting point of the financial forecasting exercise. Most
financial variables are related to the sales figure.
3. Pro forma statements:
The heart of a financial plan are the pro forma (forecast) profit and loss account and balance
sheet.
4. Assets requirements:
Firms need to invest in plant and equipment and working capital. The financial plan spells out
the projected capital investments and working capital requirements over time.
5. Financing plan:
Suitable sources of financing have to be thought of for supporting the investment in capital
expenditure and working capital. The financing plan delineates the proposed means of financing.

Companies spend considerable time and resources in financial planning. What are the benefits of
financial planning? Inter alia financial planning:
1. Identifies advance actions to be taken in various areas.
2. Seeks to develop a number of options in various areas that can be exercised under
different conditions.
3. Facilitates a systematic exploration of interaction between investment and financing
decisions.
4. Clarifies the links between present and future decisions.
5. Forecasts what is likely to happen in future and hence helps in avoiding surprises.
6. Ensures that the strategic plan of the firm is financially viable.
7. Provides benchmarks against which future performance may be measured.

SALES FORECAST :

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The sales forecast is typically the starting point of the financial forecasting exercise. Most of the
financial variables are projected in relation to the estimated level of sales. Hence, the accuracy of
the financial forecast depends critically on the accuracy of the sales forecast.
A wide range of sales forecasting techniques and methods are available. They may be divided
into three broad categories:
1. Qualitative Techniques : These techniques rely essentially on the judgment of experts to
translate qualitative information into quantitative estimates.
2. Time Series Projection Methods : These methods generate forecasts on the basis of an
analysis of the past behavior of time series.
3. Casual Models : These techniques seek to develop forecasts based on cause-effect
relationships expressed in an explicit, quantitative manner.
Each technique has its own advantages and limitations. Often, exclusive reliance on a single
technique is somewhat dangerous. Practical wisdom suggests that at least two techniques, which
seem to make sense in the specific circumstances of the firm, may be employed to hammer out
the sales forecast.

PRO FORMA PROFIT AND LOSS ACCOUNT :

These are two commonly used methods for preparing the pro forma profit and loss account :
1. The Present Of Sales Method : The percent of sales method for preparing the pro forma
profit and loss account is fairly simple. This method assumes that the future relationship
between various elements of costs to sales will be similar to their historical relationship.
When using this method, a decision has to be taken about which historical cost ratios to
be used: Should these ratios pertain to the previous year, or the average of two or more
previous years ?
In the below P/L A/c historical date are given for two previous years, 2001 and 2002.
For projection purposes, a ratio based on the average of two previous years has been
used. The forecast value of each item is obtained as the product of the estimated sales and
the average percent of sales ratio applicable to that item. For example, the average
percent of sales ratio for cost of goods sold is 65%. Multiplying the estimated sales of
1400 by 65%, the projected value of cost of goods sold has been calculated. Likewise, the
projected values of other items in the income statement have been calculated.
2. The Budgeted Expense Method : The percent of sales method, though simple, it too rigid
and mechanistic. For deriving the pro forma profit and loss account shown in below P/L
A/c we assumed that all elements of costs and expenses bore a strictly proportional
relationship to sales. The budgeted expense method, on the other hand, calls for
estimating the value of each item on the basis of expected developments in the future
period for which the pro forma P/L A/c is being prepared. Obviously, this method
requires greater effort on the part of management because it calls for defining likely
developments.

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 PRO FORMA PROFIT AND LOSS A/C OF SPACEAGE ELECTRONICS FOR 2003 BASE
ON PERCENT OF SALES METHOD.
Historica Dat
    l a  
Average Pro forma profit and loss
% of account of 2003 assuming sales
  2001 2002 sales of 1400
Net sales 1200 1280 100 1400
Cost of goods sold -775 -837 65 910
Gross profit 425 443 35 490
Selling expenses -25 -27 2.1 29.4
General and
administration
expenses -53 -54 4.3 60.2
Depreciation -75 -80 6.3 88.2
Operating Profit 272 282 22.3 312.2
Non-operating
surplus/deficit 30 32 2.5 35
Profit before interest
and tax 302 314 24.8 347.2
Interst on bank
borrowings -60 -65 5 70
Interest on debentures -58 -60 4.8 67.2
Profit before tax 184 189 15 210
Tax -82 -90 6.9 96.6
Profit after tax 102 99 8.1 113.4
Dividends -60 -63    
Retained earnings 42 36    

PRO FORMA BALANCE SHEET :

The projections of various items on the assets side and liabilities side of the balance sheet may be
derived as follows :
1. Employ the % of sales method to project the items on the assets side, except
‘investments’ and ‘miscellaneous expenditure and losses’.
2. Estimate the expected values for ‘investments’ and miscellaneous expenditure and
losses’, using specific information applicable to them.
3. Use the percent of sales method to derive the projected values of current liabilities and
provisions.
4. Obtain the projected value of reserves and surplus by adding the projected retained
earnings to the reserves and surplus figure of the previous period.
5. Set the projected values for equity and preference capital to be tentatively equal to their
previous values.
6. Assume that the projected values for loan funds will be tentatively equal to their previous
levels less repayments or retirements as per terms and conditions applicable to them.

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 7. Compare the total of the assets side with that of the liabilities side and determine the
balancing item (It assets exceed liabilities, the balancing item represents the ‘external
funds required’. If the liabilities exceed assets, the balancing item represents the ‘surplus
available funds’)

PRO FORMA BALANCE SHEET OF SPACEAGE ELECTRONICS FOR DECEMBER 31,

2003.

    Historical data  
Dec Dec Average of % of sales or Projection for Dec. 31 2003 based
  31.2001 31.2002 some other basis on a forecast sales of 1400
Net sales 1200 1280 100 1400
Assets        
Fixed assets (net) 800 850 66.5 931
Investments 30 30 No change 30
Current assets, loans
and advances        
Cash and bank 25 28 2.1 29.4
Receivables 200 212 16.6 232.4
Inventories 375 380 30.4 425.6
Pre-paid expenses 50 55 4.2 58.8
Miscellaneous
expenditure and
losses 20 20 No change 20
Total 1500 1575   1727.2
Liabilities        
Share capital        
Equity 250 250 No change 250
Preference 50 50 No change 50
Pro forma income
Reserves and surplus 250 286 statement 345.6
Secured loans        
Debentures 400 400 No change 400
Bank
borrowings 300 305 24.4 341.6
Unsecured loans        
Bank
borrowings 100 125 9.1 127.4
Current liabilities and
provisions        
Trade
creditors 100 112 8.5 119
Provisions 50 47 3.9 54.6
External funds
requirement     Balancing figure 39
Total 1500 1575   1727.2

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