Chapter 6 6 Organizing and Financing the New Venture 6.

1 Entrepreneurial Team and Business Formation:

An entrepreneurial team consists of two persons who have an interest, both financial and otherwise in and commitment to the venture success and Whose work interdependent in the pursuit of common goals and venture success, Who are accountable to the entrepreneurial team and for the venture; Who are considered to be at the executive level with executive responsibility in the early phases of the venture, including founding and pre-start up; and Who are seen as a social entity by themselves and by others?

Entrepreneurs must juggle countless tasks and competing priorities well before they open shop, including the creation of a legal structure. Business formation is a necessary early step of starting a business. The entrepreneurial team can form by members of the same family or by people successively involved by the entrepreneur in the new businesses. Individual entrepreneurs do not always drive the new venture creation process. Entrepreneurial teams are responsible for many (or perhaps most) of the major start-ups today. Venture capitalists rarely consider a business proposal based on the talents of a single individual but rather, the skills and experience of the entrepreneurial team. However, despite the importance of new venture teams, very few entrepreneurs consider this part of the business as essential. Entrepreneurial teams performance depends upon Venture performance is dependent on the entrepreneurial teams effectiveness. Venture performance depends on the founding environment, not necessarily an industry, and on the match between the environment, stable or turbulent, and heterogeneity/homogeneity of the entrepreneurial team. Shifting power (e.g. to make decision within the entrepreneurial team based on the situation and/or task at hand) positively influences both entrepreneurial team effectiveness and venture performance. Politics within the entrepreneurial team, nosed on destructive motivations, will reduce entrepreneurial team effectiveness and venture performance.

 Rich communication, both in quality and quantity will enhance the entrepreneurial team effectiveness and in turn, venture performance. An entrepreneurial team that is composed of people with a balance of demographic and cognitive heterogeneity and homogeneity that match the ventures development stage and its environment will achieve superior venture performance. Entrepreneurial teams that have members with heterogeneous and complementary industry experiences and educational backgrounds and have (developed) effective communication within the team will be more effective and will enhance venture performance. Entrepreneurs set up new companies with the aim of raising external finance; this allows them to enlarge the activities controlled while minimizing the amount of personal capital invested to do so. Moreover, they can take advantage of the benefits of control. for this reason, minority shareholders are not expected to play a significant role in the management of the new companies (they are pure financiers) we know from empirical evidence, however, that this motive applies to only a few of the largest groups, when minority stakes in listed companies are owned by dispersed shareholders. In the case of non-listed companies memories minority shareholders are commonly involved in the control of the company; otherwise the agency cost of external equity is too high. The start up new business is a time consuming job one that needs almost complete dedication, especially in the initial phases. The enlargement of the entrepreneurial team is mainly aimed at removing the limits in the time available for the entrepreneur to pursue new business opportunities. The time allocation problem cannot per se explain why habitual entrepreneurs are more likely to involve other people in new venture start-up 6.2 Sources of Financing: 6.2.1 Asset Management Asset management refers to the professional management of investments such as stocks and bonds, along with real estate. Typically, asset management is only practiced by the very wealthy, as the services of a professional firm can demand considerable sums of money, and successful asset management usually requires a large and diverse portfolio. Asset management, broadly defined, refers to any system whereby things that are of value to an entity or group are monitored and maintained. Many investors call it private banning or wealth management. Asset management includes many different aspects and relative fields among them are asset and stock selection, monitoring of investments etc. asset management is a great industry today that has a global meaning. Typically, the investor meets with an asset management team before

surrendering control of the assets to discuss goals and investment styles. In general, the team works with the investor to set realistic goals to grow the investors wealth and measure the performance of the team. The investor also usually expresses directions as to what type of investment style he would prefer the team to engage in. once funds are surrendered to an asset management team, the has a great deal of leeway with them. This flexibility allows team members to make rapid investing decisions without constantly consulting the holder of the funds, who remains confident that the overall return on the investments will remain high. By putting funds under management, the investor has access to hundreds oilers of combined investing experience. Along with special services that only an investment bank can offer. This results in a higher return on the assets than could be achieved conventionally. 6.2.2 Equity Financing: Equity capital is money given for a share of ownership of the company. Equity can be provided by individual investors, venture capital companies, joint venture partners and contributions of founders of the company. The acquisition of funds by issuing shares of common or preferred stock. Firms usually use equity financing when they are unable to raise sufficient funds through retaining or when they have to raise additional equity capital to offset debt. Equity financing is the process of obtaining funds for the company in exchange of ownership. Equity providers are more interested in the growth potential of the company. It does not require collateral security and offers some form of ownership position in the business venture. Since the objectives of investors are different from those of the lenders, the factors they evaluate in determining whether to invest are different from lending sources. Growth potential is based on the quality of management of the company, product brand strength, barriers of entry to competitors and size of market for the products. The investors share the profit and bear losses on pro rata basis. Advantages and disadvantages of equity finance Equity finance can sometimes be more appropriate than other sources of finance, e.g. bank loans but it can place different demands on you and your business. The main advantages of equity finance are: The funding is committed to your business and your intended projects. Investors only realise their investment if the business is doing well, e.g. through stock market flotation or a sale to new investors. The right business angels and venture capitalists can bring valuable skills, contacts and experience to your business. They can assist with

and key decision making In common with you, investors have a vested interest in the business success, i.e. its growth, profitability and increase in value. Investors are often prepared to provide follow-up funding as the business grows.

The principal disadvantages of equity finance are Raising equity fianc is demanding, costly and time consuming. Your business may suffer as you devote time to the deal. Potential investors will seek background information on you and your business- they will closely scrutinize past results and forecasts will probe the management team. However, many businesses find this discipline useful regardless of whether or not they actually receive any funding. Depending on the investor, you will lose a certain amount your power to management decisions. You will have to invest management time to provide regular information for the investor to monitor. At first you will have a smaller share in the business- both as a percentage and in absolute monetary terms. However, you reduce share may be come worth a lot more in absolute monetary terms if the investment leads to your business becoming more successful. There can be legal and regulatory issues to comply with when raising finance, e.g. when promoting investments. 6.2.3 Venture capital Some individuals join together to provide finance for a new business that are just starting up. They look for promising business and invest in them, hoping that the business will grow and that they will make a profit. This is similar to issuing shares. Venture capital is the money provided by professionals who invest alongside the management in young rapidly growing companies that have the potential to develop significant economic contributions. Venture capital is an important source for start up companies professionally managed venture capital firms generally are private partnerships or closely held corporations funded by private and public pension funds endowment funds, foundations, corporations, wealthy individuals, foreign investors, and the venture capitalists themselves. Venture capitalists generally Finance new and rapidly growing companies

Purchase equity securities Assist in the development of new product or services Add value to the company through active participation Take higher risks with the expectation of higher rewards Have a long term orientation

ADVANTAGES AND DISADVANTAGES OF VENTURE CAPITAL Venture capital provides the finding that a company needs to expand its business. it also offers a number of value added services. Advantages In addition to being a source of funding, an advantage of venture capital is that a number of value-added services are provided to companies: Mentoring venture capitalists provide companies with ongoing strategic, operational and financial advice. They will typically have nominee directors appointed to the companys board and often become intimately involved with the strategic direction of the company. Alliances- venture capitalists can introduce the company to an extensive network of strategic partners both domestically and internationally and may also identify potential acquisition targets for the business and facilitate the acquisition. Facilitate- venture capitalists are experienced in the process of preparing a company for an initial public offering (IPO) of its shares onto the Australian Stock Exchange (ASX) or overseas stock exchange such as NASDAQ. They can also facilitate a trade sale. Disadvantages Most venture capitalists seek to realise their investment in a company in three to five years. If an entrepreneurs business plan contemplates a longer timetable before providing liquidity, venture capital may not be appropriate. Entrepreneurs should also consider: Pricing venture capitalists are typically more sophisticated and may drive a harder bargain. Intrusion Venture capitalists are more likely to want to influence the strategic direction of the company. Control venture capitalists are more likely to be interested in taking control of the company if the management is unable to drive the business. 6.2.4. Debt Financing:

The process of borrowing money from the money lenders at a predetermined interest, which has to be paid within a predetermined time, is called debt financing. Usually, debt must be secured against the assets of the owner of the company also called a personal guarantee or collateral security,(which is usually a fixed asset like land, building etc) to ensure that in case of the entrepreneurs incapacity to repay the debt. He can sell the collateral security to realize. The short-term debt (less than a year) are used to providing working capital to finance inventory, accounts receivable or the operations of the business. The long-term debts (more than one year) are used to purchase assets such as lands and buildings, machinery etc. debt financing allows the owners to retain larger portion of ownership (and have management and control and greater on equity) and is preferable when the interest rates are low. Advantages and disadvantages of debt financing The primary advantage of debt financing is that it allows the founders to retain ownership and control of the company. In contrast to equity financing, the entrepreneurs are able to make key strategic decisions and also to keep and reinvest more company profits. Another advantage of debt financing is that it provides small business owners with a greater degree of financial freedom than equity financing. Debt obligations are limited to loan repayment period, after which the lender has no further claim on the business, whereas equity investors claim does not end until their stock is sold. Furthermore, a debt that is paid on time can enhance a small businesss credit rating and make it easier to obtain various types of financing in the future. Debt financing is also easy to administer, as it generally lacks the complex reporting requirements that accompany some of equity financing. Generally lacks the complex reporting requirements that accompany some forms of equity financing. Finally, debt financing tends to be less expensive for small businesses over the long term, though more expensive over the short term, than equity financing. The main disadvantage of debt financing is that requires a small business to make regular monthly payments of principal and interest. Very young companies often experience shortages in cash flow that may make such regular payments difficult. Most lenders provide severe penalties for late or missed payments, which may include charging late fees, taking possession of collateral, or calling the loan due early. Failure to make payments on a loan, even temporarily, can adversely affect a small businesss credit rating and its ability to obtain future financing. Another disadvantage associated with debt financing is that availability is often limited to established businesses. Since lenders primarily Seek security for their funds; it can be difficult for unproven businesses to obtain loans. Finally, the amount of money small businesses may be able to obtain via debt financing is likely to be limited, so they may need to use other sources of financing as well.