Question

Suggest a way to fund the business. Recommend how to attract equity investors. Please provide reference

Answer 1

Some important points to be considered on the subject of funding new business is given below:

1) Attracting equity investors requires providing proof for performance with regard to growth projections. Hence, only companies that can provide tangible proof with regard to their past performance that supports projected growth of the companies only can attract equity investors. Hence, it is difficult for any new business to raise equity finance. This is why companies start as private limited or parternship form with owner's equity capital and bank finance. Once they grow and can showcase their past performance and capabilities to grow their business, they can enter into primary market for initial public offering. In fact, even if investors are willing the regulatory boards like SEC will not allow any company to float equity without meeting its stringent eligibility criteria which includes percentage of equity owned by the promoters etc.

2) The next alternative for equity financing for new start-ups is to approach venture capital funds. These companies have their primary business objective of funding new startups which have promising business idea in order to make higher returns but uable to float equity offerings in primary market. Typically, you have to prove your business proposition with these funds and convince them about the likely value of your firm after 5, 10 or 20 years. These funds will infuse equity capital and will seek sufficient management control to ensure that you are utilising the funds the way you projected and efficiently approaching the projected financial goals. Once tangible results are obtained over the next 5-10 years, the VC will help you float an IPO in the primary market through which the VCs will exit with possibly tremendous returns, provided your business proposition had been proved successful. However, as the success rate of new businesses are very less, VCs will make up any loss (failure of the business and closure) with profit in some other company in their venture fund portfolio. This way an avenue for risky new business is available through venture capital funds and private equity funds.

(3) Another possible option is to approach government financial institutions. In developing countries, governments have established "development financial institutions" and other similar government bodies like "entrepreneurship development organizatioins" in order to provide support for entreprenurs with innovative business ideas and who lack financial support..This is especially true for small and medium size companies. You can submit your busienss proposal to these organizations and seek seed capital. Commercial banks of these countries are also expected to support SMEs in priority sectors and they might have goal with regard to financing to be done for such start-ups.

(4) As mentioned in the first point, If you decide to first start your business as partnership or private limited company, you can raise funds from informal sources like family and friends subject to legal laws governing pvt limited companies (max number of shareholders). In all the above cases, you should also explore getting bank finance that allows having an optimal capital structure of a mix of debt and equity.

References: You can find the information provided above in any standard corporate finance text book like Brealey and Myers. If you are interested in funding new businesses, you can refer to standard text books on entrepreneurship financing and text books on venture capital funds for knowing more about start-up financing.

Example:

1. Principles of Corporate Finance - Brealey and Myers

2. Entrepreneurial Finance (Fifth Edition) by Leach and Melicher

3. Venture capital and the finance of innovation by andrew metrick and ayako yasuda

The above books are used as standard text books in reputed university curriculums.