Getting Financing for the Business

"Money is always there, but the pockets change." Gertrude Stein

Getting money for the business involves a variety of considerations, both
financial and non-financial.

Finding Smart Money. Small businesses usually need more than just cash:
they need smart money. By smart money we mean financing where the
financier provides not only capital, but support and expertise to the business.
Smart money could be an SBA guaranteed loan that allows one to keep their
ownership interests intact until the business reaches the stage at which they
may want to sell shares of the business.

The problem in locating "smart" money is that the capital market for small
businesses is imperfect and consists of a great variety of under publicized
and poorly organized financing sources. Whether one is trying to locate a
bank that is willing to lend money to a small business or whether one is
looking for a business "angel" who will contribute needed equity capital, the
quest for financing will require the owner to devote the same attention to
obtaining capital as given to decisions involving the business's basic product
or service.

The discussion in this module is designed to help one identify relevant traits
about the business's financing profile and understand the various financing
sources that may be available.

A business's financing profile explains how a position in the business

life cycle influences ones financing options, how one can estimate the
amount of money needed, and how to find money in ones own back
yard by tapping friends, family, and personal assets.

Debt vs. equity shows how the two basic forms of financing differ, and
how one can combine them to their best advantage.

Equity financing explains how a form of business organization can be

used to bankroll the business, and the advantages and disadvantages
of using venture capital, "angels," sales of securities, franchising, and
employee stock ownership plans.

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A Business's Financing Profile
Most entrepreneurs consider their resource pool to consist of whatever
personal assets they are willing to sink into the business, and whatever
money they might be able to get through a local bank loan. Yet, a number of
alternative (or additional) financing options may be available.

To assess whether a business can take advantage of any of these financing

options, one should begin by realistically evaluating the investment profile
and creditworthiness of their enterprise. The basic things to consider are:

The stage of business's development in the financial life cycle of that

type of business (e.g., startup, developing, or mature)

The appeal of business and its operators, in the eyes of investors

The amount of capital needed for business

Whether personal financing can cover most of the needs

Whether insider financing can fill the gap between what it has and
what is needed

Whether bootstrapping can reduce the need for additional funds

Maturity of the Business

Where the business is in its financial life cycle from startup to aging will
often dictate the availability of certain financing alternatives.

Startup businesses typically face the greatest obstacles to obtaining

financing because they lack a performance record and a credit history.

Acquired businesses face fewer obstacles than those being started

from scratch, and might have seller financing as an option.

Growing businesses generally have more financing options because as

a business matures, it establishes creditworthiness and operating
success.

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 Aging businesses tend to be cash-rich because new investment is not
taking place. Owners are often searching for the best way to sell out.

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Startup Small Businesses
Startup businesses often begin with only ideas and enthusiasm. One of the
many issues that every entrepreneur must address in starting a small
business is the financial reality involved in deciding exactly what he or she
wants to do, when it can be done, and how it's going to be done.

New small businesses have trouble securing conventional financing because

they present a tremendous risk to lenders and investors. The result is that
nearly three-quarters of startup businesses are funded through the owner's
own resources, such as personal savings, residential mortgages, or consumer
loans. Family members, friends, and investments by private contacts or
"angels" provide most of the remaining "seed" funds for new small
businesses.

The Cash Crunch

The most common financial problem for startup businesses is a shortage of
short-term cash, and cash flow problems during a potentially long initial
period can be fatal to the business. Any debt financing (loans) that the
business can secure from traditional lenders, e.g., banks, is likely to be
expensive because of the high risks assumed by the financier. Moreover,
unless the business can boast a significant owner investment and
marketable collateral, the availability of conventional debt financing is
almost nonexistent.

This cash crunch puts a tremendous focus upon inventory turnover, and the
need for immediate revenue often becomes a daily crisis that takes priority
over financing for sustained growth or development of new products.
Perseverance and a willingness to investigate all sources of financing from
angels to government loan programs are invaluable at this stage.

Acquired Businesses
In many respects, the financing options available when one purchases an
existing business are similar to the options for raising capital in a growing
business that is already own. Debt and equity vehicles are typically more
available than if it were starting a similar business from scratch. Because the
target business has a credit history, existing assets, an established operating
cycle and business goodwill, lenders and investors can be approached in the

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same manner as if one is seeking to expand a business which is already
owned.

The major distinction between financing for the purchase of an existing

business and financing to raise funds for their own growing business is that
the former offers the opportunity for seller-financing. Entrepreneurs who are
selling their small businesses usually realize that they may need to
participate in the buyer's financing of the business sale, and they may be
willing to negotiate a very favorable debt or equity arrangement.

Potential Advantages to Seller-Assisted

Financing
Get a reasonable interest rate and a less demanding credit review.

The existing assets of the business are often the exclusive collateral for
the financing. In contrast to the common practice of conventional
lenders, additional or personal assets of the buyer are rarely pledged
as additional collateral on a seller-financed loan. Moreover, a seller's
valuation of the business's assets (collateral) tends to be higher than
that of a conventional lender; a low valuation might appear
inconsistent with the asking price for the business.

Personal guarantees are less likely.

A seller may be willing to take a subordinate (secondary) security

interest. The seller may be amenable to taking a subordinate interest
to allow you to obtain conventional financing. The incentive for the
seller is that the more money that can obtain from other sources, the
more money the seller gets upfront. A conventional lender will require
a priority claim on business assets and so the only way one may be
able to qualify for the loan is to subordinate other creditor claims.

The buyer's assumption of the existing debts or liabilities of the

business may be a means of reducing the purchase price. Typically,
much of the down payment or initial cash price of a business sale goes
toward a reduction of existing business debt. However, rather than pay
off existing creditors, those debts may be assumable by the buyer in
exchange for a set-off on the purchase price of the business. The
business creditors essentially become financiers for the acquisition.

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 The use of a gradual buyout may be acceptable to the seller. For
instance, the business name and goodwill, and perhaps some tangible
assets, could be sold upfront; other equipment or property could be
leased by the buyer with an optional or mandatory buyout at a future
time. The seller may be willing to accept an earn out arrangement,
where a portion of the purchase price is depending on the future
success of the business.

Growing or Mature Businesses

A growing or mature business usually has sufficient stability in its operations
so that cash flow problems are not a constant crisis. If the business is
successful, internally generated funds from sales and investments can fund
many of the business's needs.

Typically, growing and mature businesses have more financing options

available to them because of their operating history, established value,
credit history, and availability of inventory and accounts receivable
financing. In addition, the advantages of having established customers and
suppliers, efficient internal operating procedures, more sophisticated
marketing and advertising, realistic long-term business plans, and the
company's emerging goodwill help improve the creditworthiness and
investor appeal of the business.

Financing with Debt

Debt financing becomes increasingly available to a business as its track
record supports creditworthiness. If the business has been profitable, debt
financing is generally the preferred form of raising new capital for existing
businesses.

Financing with Equity

Nonetheless, a growing business may be stifled by inadequate capital for
expansion that stems from the reluctance of an entrepreneur to dilute his or
her ownership through equity financing. Sometimes the decision simply
comes down to whether you want a profitable, growing business in which you
share control or will cash out the interest at a given time, or whether you
own a business that fails because you could not raise sufficient capital for
the business to grow. Growing businesses can consider raising equity capital

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through private transfers of ownership interests, by using venture capital
firms, or by selling ownership interests through formal limited private
offerings or an initial public offering.

Dangers to the financial health of a growing business are often attributable

to the business overextending itself or to poor decision-making. If you rush
expansion or acquisitions, purchase too many expensive fixed assets, or form
unwise associations with other businesses, you may find yourself throwing
good money after bad money. Even very "street-wise" entrepreneurs may be
better served by engaging professionals to assist in legal and business
matters, and by employing experienced management to handle the growing
complexities of the daily operations.

Aging Businesses
Many businesses never reach this stage of the business life cycle because
they either fail at an earlier stage or they remain healthy, growing entities.
An aging business is characterized by a conservative philosophy aimed at
maintaining the business's internal bureaucracy and its market status quo.

Some companies reach the point where innovation and creativity are limited
to tinkering with current products and existing markets. Investment into new
product lines and emerging markets represents a financial risk that a
complacent ownership is unwilling to assume. Aging businesses tend to be
cash-rich because less investment is being undertaken.

The financial concerns for owners of aging businesses often involve selling
the business and retirement planning .

Appeal: Nothing Sells Like Success

Every small business owner is convinced that the enterprise will be
successful and that investors can be persuaded by these convictions.
However, to obtain financing, one will need to provide evidence that the
business will succeed.

Objective and Subjective Evidence

On the most basic level, every potential lender or investor evaluates a
business by looking at how the injection of cash will be used and how the
money will either be repaid or result in a profitable return. Many of these

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questions may be answered by data contained in the business's financial
statements and projections; however, lenders and investors also make more
subjective evaluations of the promoter and the company. These assessments
may affect the financing requests even more than the objective numbers.

Additional evidence of future success for the business can sometimes take
the form of contract commitments from existing or prospective customers,
industry or professional opinions, and market research even if it's informal
testimonials. In a business plan or loan application, make a note of any
advantageous market trends, consumer appeal, management experience,
retention of skilled employees, and availability of any special resources, e.g.,
a valuable patent.

Finding a Good Match

Identifying a lender whose strategic approach or special industry focus
matches the receivers business will also enhance the subjective appeal.

While making a case that the business is a worthy investment, keep in mind
that most lenders and investors are followers, not leaders, and the best
evidence of a good investment will be the promoters prior success in raising
capital.

A financier wants to spread risk as much as possible, and a certain comfort

level may be reached if other investors have a significant vested economic
interest in the business. If the owner can show a strong financial
commitment to the business from additional investors, as well as a
meaningful personal investment by the business owners, the appeal of the
company will correspondingly increase.

Owner/Promoter, Too, are an Asset

Their past business experiences, expertise, and managerial skills likewise
play a crucial factor in determining the appeal of the business. If they can
establish a personal relationship with a particular financier, such as a local
community banker, past successes and business experience are more apt to
be considered in determining the likely future success of the business. Use

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personal resume, as well as letters of reference from community
professionals and business persons, to help project themselves as a
reputable, reliable, and creative business person.

Estimating the Money Needed

"A billion here, a billion there, pretty soon it adds up to real money."
Senator Everett Dirksen
Whether the capital is for startup costs, short-term operating costs, or long-
term strategic development, one must accurately estimate the amount of
money that is needed. Preparing a realistic projection of the necessary
funding will not only force to consider the wide variety of costs associated
with the plans, but also help convince a lender or investor that the owner
understands the business and the relevant market realities.

The financier would want to know the amount of money that is needed from
the beginning to the maturity of the project, details on how the money will
be used, and most importantly, how the money will either be repaid or result
in a profit. All of this information should be included in the business plan and
confirmed in the financial projections.

Anchoring Estimates to Reality

The capital projections should appear more realistic by referring to the sales
and expense information characteristic of the industry and business that is
published in sources such as Dun & Bradstreet's "Dun's Business Scope or
such other publications.

The Promoter or owner should be aware that the reasons behind the capital
needs may raise some lender concerns about the management and future
success of the company. If, for instance, the business is growing and a need
for additional working capital may be a result of managerial shortcomings
that are causing slow sales, high inventory, slow collections, or unmet short-
term debt. In situations where additional funds are necessary because
unanticipated sales volume is creating greater needs for inventory or
collection of accounts receivable, management may need to show that the
business can expect continued success.

If cost of a startup business is estimated then, additional

considerations apply.

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 Whether the financing is for a new or existing business, a well-thought-
out business plan is essential.

Estimating the Cost of a Startup

Because the costs of a startup business are often underestimated, new
entrepreneurs should consider completing, at a minimum, a few basic
financial statements even before an attempt is made to estimate how much
money will be needed.

In addition to a personal financial statement, try preparing the following

estimates for initial setup and projected monthly costs.

Initial setup costs. Prepare an itemized estimate of how much it will cost to
get the business set up. These will all be pre-opening expenses.

Include in the estimate:

purchase/lease and installation of

Professional costs
equipment and fixtures
(accounting, legal, etc.)
utility expenses
licenses and fees
advertising
employee expenses
initial inventory costs
startup supplies
real estate expenses
insurance
(or office rental)

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For manufacturing concerns, there may be additional costs related to raw
materials, storage, and shipping.

Projected monthly expenses. Prepare an itemized statement identifying

both personal living costs and the anticipated monthly costs of operating the
business. Include:

living costs lease or mortgage costs

employee wages insurance & taxes

utilities transportation and delivery costs

advertising any professional costs and any

other
supplies, inventory, raw expenses relating to running the
materials business

Planning to Succeed
In order to successfully obtain a mortgage, real estate must have three
legendary ingredients: location, location, and location. But it also helps if the
building looks inviting, has an interesting history, and is surrounded by a few
elegant trees.

And so it goes with successfully obtaining a business loan: in this case,

though, the three key ingredients are planning, planning, and planning and
it also helps if the plan includes some interesting history and a few attractive
non-financial facts to round out the package.

Every small business owner is convinced that the enterprise will be

successful and that investors can be persuaded by these convictions.
However, to obtain financing, one will need to provide objective as well as
subjective evidence that the business will succeed and this evidence
should take the form of a business plan.

Personal Financing
"Save a little money each month and at the end of the year you'll be
surprised at how little you have." Ernest Haskins

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Most small startup business is initially funded by the personal assets of the
entrepreneur. Some funding for the small business is likely to come from the
direct contributions of personal savings or assets to the business (e.g., an
early retirement incentive payout). Additional personal funds are often
contributed after the entrepreneur borrows money through a personal
(consumer) loan and then contributes that money as an equity investment
into the business.

Home as Collateral
There is a great variety of personal assets that can be used as collateral to
obtain cash from a lender, but perhaps the most common source is a
residence. This asset can be used to obtain a first or second mortgage, to
refinance an existing mortgage, or to secure a home equity loan or line of
credit. The major disadvantage to using the house as collateral is that default
on the loan can mean forfeiture of the home.

Nearly all commercial banks and residential lending institutions will have
options available for home-backed financing. The period and computation of
the rate of interest, upfront points, closing costs, administrative costs and
burdens, the length of loan, loan conditions, and default terms all affect the
real cost of a loan. Whether or not the local lender will sell the mortgage to
another creditor may also be a consideration.

For second mortgages or lines of credit, the owner should anticipate that
lenders will allow a maximum total mortgage debt, including preexisting
mortgages, of approximately 70 to 80 percent of the current market value
of the residence at best. Gone are the days financing up to 100% of the
home's current market value. Interest rates are low now but unlikely to
remain so. The risk of losing the home if the business fails make these loans
a last-ditch choice for most budding entrepreneurs.

Also, be aware that second, or even third, mortgages will typically have
higher interest rates than first mortgages because the lender is subordinate
to a prior mortgagor. (In other words, if there is a default on the loans, the
first-mortgage lender will be paid off first, and the second-mortgage lender
may not be paid at all.) In instances where the interest costs would not be
significantly increased, it is better to refinancing the existing mortgage for an
increased loan amount rather than taking a second or third mortgage.

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Other Collateral
Other than the residence, other commonly used collateral for secured
consumer loans include other real estate, life insurance policies, any existing
machinery or other business equipment, stock, and pension plans.

For instance, one can usually borrow the cash surrender value of an ordinary
life insurance policy. You are not obligated to repay the loan principal, only to
pay interest on the loan. The rate of interest charged depends upon when
the policy was purchased; rates on older policies might be very favorable. Of
course, borrowing against own policy means the eventual death benefit of
the policy will be diminished by the amount of the loan, plus the loss of
interest.

There are also other assets in the personal portfolio that permits the owner
to borrow from them or that can be used as collateral in a conventional loan.
For example, if one have an employee retirement plan, it may be able to
borrow against those savings up to a certain percentage of the total plan
value. Marketable securities can also be pledged to a bank as collateral for a
loan.

Insider Financing
"The richer your friends, the more they will cost you." Elisabeth Marbury.
After considering the personal resources, the next place most entrepreneurs
look for additional financing is to "insiders" like family, friends, or business
associates. Borrowing from insiders is attractive because it's private, often
informal, usually unsecured, and often includes favorable terms, and
because legal default proceedings are seldom invoked. In addition, this kind
of financing can often be incorporated into a family's estate plan to assist in
minimizing estate and income tax liabilities.

However, financing from family and friends is often a double-edged sword.

Counterbalancing the convenience and low cost of insider financing are the
misunderstandings, personal conflicts, and other problems that can arise
from a lack of business formality or economic success. These dangers can
seriously damage both the business and the long-term personal relationship
between the parties. The following suggestions and cautionary notes should
be kept in mind while financing from insiders:

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Insider Financing via Equity
If an insider wants to become an owner of the business in exchange for
financing, documentation of the arrangement is again important, but the
paperwork will vary according to the type of ownership interest is being
transferred.

For example, if the business is incorporated, a sale of stock ownership can be

relatively simple. Attention should be given to ensuring that the value of the
capital contribution fairly represents the value of the ownership and control
interest being sold; otherwise gift tax and director liability issues may arise.
In addition, the issues discussed in equity financing concerning business
control and ownership issues (e.g., rights of shareholders, elections of
directors, cumulative voting, preferential rights, minority oppression, stock
transfer restrictions, and buyout arrangements etc.) may need to be
readdressed in the corporation's by-laws.

If the business is not incorporated, equity financing should include a drafting

or redrafting of the partnership, limited partnership, limited liability operating
agreement, or joint venture arrangement. The rights, liabilities, and
responsibilities of the new participants should be defined clearly to avoid
later confusion, disagreements, or unanticipated liabilities.

Bootstrapping: Internal Sources of Funds

Bootstrapping is a buzzword that basically means generating needed funds
by deftly managing the cash inflows and outflows. Improving cash flow
should be a daily task, like housekeeping.

Monitoring, forecasting, and analyzing cash flow is essential to liquidity and

profitability, even for the Fortune 500 crowd. A basic list of areas of
concentration would include:

Collection of accounts receivable Can credit terms or collection

procedures be improved? How about billing cycles and/or cash discount
incentives?

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 Inventory management Is there really a need for all that
inventory? It ties up cash, takes up expensive space, ups insurance
costs, and often "shrinks" so if not absolutely needed for immediate
shipping or manufacturing purposes, keep it lean and mean.

Accounts payable cycle Vendors make good financiers. If they

offer 30 days to pay, take 30 days and think about asking for 45. Set
up a system to take advantage of early payment discounts too.

Expense control Make every rupee count. Does the company van
need to be washed at the fancy place down the block or can it be done
at a place which is simple and cheaper? Thrift applies to fixed assets,
too. Will a used computer, purchased off-lease, do the job or there is a
need to buy that an expensive, leading edge PC?

A little frugality and sensible use of available resources will pay big dividends
in the long run. The old cliche "watch the pennies and the dollars will take
care of themselves" is the bootstrapper's fight song.

Quick Pick Chart for Financing Sources

The "quick pick" chart of suggested financing options is loosely arranged
according to the general age of a business and whether the financing is for
long-term or short-term needs. However, keep in mind that our arrangement
of financing options merely reflects how each option is often used, not how
the option is always used. Most of these types of financing may be used,
under certain circumstances and in certain businesses, throughout the life
cycle of a business.

Startup Business
Primary Sources
Long-term financing Short-term financing

Personal financing Personal financing

Insider (family/friends) Insider financing

financing

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 Angels Credit cards

Equity financing Credit unions

Leasing Trade credit

Credit unions Banks

Secondary Sources
Long-term financing Short-term financing

Business alliances Consumer finance companies

Venture capital Commercial finance companies

SBICs State and local public financing

State and local public

financing

Franchising

Asset-based financing

Growing/Mature Business
Primary Sources
Long-term financing Short-term financing

Debt financing Debt financing

Equity financing Asset-based financing

Bank lending (secured Bank lending (lines of credit, short-

and unsecured) term commercial loans)

Leasing Trade credit

Business alliances Factoring

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 Venture capital (and SBIC) Commercial finance companies

Limited private offerings

Secondary Sources
Long-term financing Short-term financing

Initial public offerings State and local public financing

Franchising Working Capital Loan

Angels

Insurance companies

Commercial finance
companies

ESOPs

The task is to present the most attractive overall portrait of a particular

business by emphasizing its strong points and explaining its weaker traits.
One business may have an extremely valuable asset, e.g., a technology
patent, but no track record; another business may have sizable initial equity
investment but lack short-term cash. With small businesses, the risk to
investors and creditors is so high that each financial trait is exaggerated, and
any shortcomings must be balanced by a compensating advantage. One
needs to be flexible in considering how the strengths and weaknesses of the
business can be presented so that it can have access to as many different
sources of financing as possible.

Throughout this module, encouragement is given to finding lenders or

investors who will take the time and effort to consider the unique
characteristics of small business and who may eventually view that business
as a one-of-a-kind opportunity.

Financing Basics: Debt vs. Equity

A brief overview of the basic types of financing may be helpful to
understanding which options might be most attractive and realistically
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available to a particular business. Typically, financing is categorized into two
fundamental types: debt financing and equity financing.

Debt financing means borrowing money that is to be repaid over a period of

time, usually with interest. Debt financing can be either short-term (full
repayment due in less than one year) or long-term (repayment due over
more than one year). The lender does not gain an ownership interest in the
business and the obligations are limited to repaying the loan. In smaller
businesses, personal guarantees are likely to be required on most debt
instruments; commercial debt financing thereby becomes synonymous with
personal debt financing.

Equity financing describes an exchange of money for a share of business

ownership. This form of financing allows to obtain funds without incurring
debt; in other words, without having to repay a specific amount of money at
any particular time. The major disadvantage to equity financing is the
dilution of ownership interests and the possible loss of control that may
accompany a sharing of ownership with additional investors.

Debt and equity financing provide different opportunities for raising funds,
and a commercially acceptable ratio between debt and equity financing
should be maintained. From the lender's perspective, the debt-to-equity ratio
measures the amount of available assets or "cushion" available for
repayment of a debt in the case of default. Excessive debt financing may
impair the credit rating and the ability to raise more money in the future. If
there is too much debt, then the business may be considered overextended
and risky and an unsafe investment. In addition, one may be unable to
weather unanticipated business downturns, credit shortages, or an interest
rate increase if the loan's interest rate floats.

Conversely, too much equity financing can indicate that one is not making
the most productive use of the capital; the capital is not being used
advantageously as leverage for obtaining cash. Too little equity may suggest
the owners are not committed to their own business.

Lenders will consider the debt-to-equity ratio in assessing whether the

company is being operated in a sensible, creditworthy manner. Generally
speaking, a local community bank will consider an acceptable debt-to-equity
ratio to be between 2:1 and 1:1. For startup businesses in particular, the
owners need to guard against cash flow shortages that can force the

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business to take on excess debt, thereby impairing the business's ability to
subsequently obtain needed capital for growth.

Equity Financing
"It is time I stepped aside for a less experienced and less able man."
Professor Scott Elledge, on retiring from Cornell University
Equity financing requires selling of an ownership interest in the business in
exchange for capital. The most basic hurdle to equity financing is finding
investors who are willing to buy into the business; however, the amount of
equity financing that you undertake may depend more upon the willingness
to share management control than upon the investor appeal of the business.
By selling equity interests in the business, one sacrifices some of the
autonomy and management rights.

The effect of selling a large percentage of the ownership interest in the

business may mean that own investment will be short-term, unless one
retains a majority interest in the business and control over future sale of the
business. Of course, many small business operators are not necessarily
interested in maintaining their business indefinitely, and the personal
motives for pursuing a small business will determine the value that is placed
upon business ownership. Sometimes the bottom line is whether one would
rather operate a successful business for several years and then sell the
interests for a fair profit, or be repeatedly frustrated in attempts at financing
a business that cannot achieve its potential because of insufficient capital.

Here are the most common small business options for equity financing:

Forms of business organization the organizational form influences

how willing others will be to invest in the business

Business Combinations cooperative arrangements with other

businesses for sharing costs

Venture Capital money and expertise for hot businesses

SBICs the government's venture capital businesses

Angels private investors who want to make money and also help
small businesses

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 Initial Public Offerings going public can mean big gains, but it's not
for everyone

Alternatives to going public limited private offerings of ownership

interests

Franchising a shortcut to getting started, but don't expect to run the

whole show

ESOPs employee stock ownership plans that allow employees to own

a piece of the business; can boost production and provide leverage for
additional financing

Forms of Business Organization

The specific types of equity financing available are, to some extent,
determined by the organizational form of the small business. While the
choice of business form or "entity" for the small business involves a wide
spectrum of other important issues such as the degree of personal risk
involved in the type of business, tax considerations, and the need to attract
good business managers the following discussion highlights some of the
financing considerations associated with different forms of business entities.

Sole proprietorships are the simplest businesses to form, but equity

financing is limited to the owner's assets.

General partnerships require at least two owners, so equity financing

possibilities are greater than in proprietorships.

Limited partnerships can provide limited liability to some of the

owners, if they're not active participants in the business.

Corporations provide the most flexible possibilities for investors.

Limited liability companies/limited liability partnerships are business

entities that combine favorable tax treatment with limited legal liability
for the owners.

Which form is best for you? No formula exists for making the
determination of which entity is best for your business.

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 Business combinations are a way of leveraging the business's assets
through contractual arrangements with other companies.

Financing Sole Proprietorships

A sole proprietorship is a single-owner business and the simplest form of
business entity. However, a sole proprietorship is also the most restrictive
form of organization for equity financing because the equity investment is
limited to whatever personal funds one is willing to put into the business.
Those funds may be already available in the personal financial portfolio
from simple savings accounts at banks to ownership of commercial real
estate or a need to borrow more money and contribute those funds as an
equity investment in the business. Debt financing for startup sole
proprietorships is also typically limited by the amount of personal assets that
the entrepreneur has available to pledge as security for a loan.

Advantages of Sole Proprietorships

Exclusive control: Owner retains sole control over the management and
development of the business.

Cheap and easy to form and maintain: Almost no formalities are

required to create a sole proprietorship (unless certain licenses are
necessary for that type of business) and the administrative costs are
minimal.

Simple (and often favorable) tax treatment : All income and expenses
of the business are included on the personal tax return. In addition,
because startup businesses often operate at a loss during an initial
period, the losses can be deducted on the personal tax return to offset
income earned from other sources.

Disadvantages of Sole Proprietorships

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 Personal liability: The business is not a separate legal entity and all
business debts and liabilities are the personal obligations. Sole
Proprietor is personally responsible for the business's contracts, taxes,
and the misconduct of employees or co-owners who create legal
liabilities while acting within their employment. Although personal
liability is a risk for sole proprietors, several considerations should be
kept in mind. First, insurance may be available to minimize the effects
of personal exposure for some of these liabilities. In addition, personal
liability for business contracts is common in any form of small business
the situation is not necessarily worse for sole proprietors. To
minimize the risks associated with small businesses, customers,
landlords, suppliers, and others will often require that the owner
assume personal responsibility (sign a personal guarantee) for the
business's contract, regardless of the form of the business enterprise.

Limited financing options: The financing profile of a sole proprietorship

is limited to the credit profile of the individual entrepreneur. If the sole
proprietor is unwilling, or unable, to sell off any ownership interests in
the business, then he is the sole source of available equity financing.
He may also have a difficult time obtaining debt financing, except to
the extent he can pledge personal assets on a secured loan .

23
Financing General Partnerships
A general partnership is an association of two or more parties to operate a
business for profit. The partners raise equity funds through their own capital
contributions, by adding a new partner, or by restructuring the relative
ownership interests of the existing partners to reflect new contributions.
Debt financing for general partnerships is similar to financing for sole
proprietorships, because the individual creditworthiness of the owners
largely determines the business's creditworthiness.

Advantages of a Partnership include:

Inexpensive and simple to form and maintain: Partnerships can be
relatively cheap and easy to form and maintain. All partnerships should
adopt a written partnership agreement, but there is no legal
requirement for a contract. No statutory formalities are required nor
are there any fees.

Favorable tax treatment: Partners are taxed as individuals, and the

partnership itself is not taxed. Each individual partner shares the
income and deductions of the business according to the agreed-upon
allocation of partnership interests. Because new small businesses
frequently experience temporary losses, the pass-through tax
treatment of a partnership can often benefit a partner by allowing the
partner to immediately apply any losses from the business to offset
income from other sources.

Sharing of expertise and risk: Partnerships are often formed to take

advantage of the different skills and expertise of different persons. In
addition, the partners also agree to share the financial and legal risks
of the business, thereby spreading the cost of possible losses.

Disadvantages of a Partnership include:

Personal liability: A general partner has unlimited personal liability for
business liabilities. Each partner bears personal financial liability for
the contract and tort debts of the business.

24
 Limited transferability of ownership: Most partnership arrangements
restrict a partner's rights to withdraw from the partnership or to
transfer the ownership interests.

Limited financing options: Obtaining financing, especially long-term

financing, is often difficult for smaller partnerships. New equity
financing is generally limited to increased contributions from existing
partners in exchange for a greater ownership percentage, or by adding
a new partner, which ordinarily requires the unanimous approval of all
existing partners. Debt financing is easier than in a sole proprietorship,
but may still be difficult because the business's credit is no better than
the credit of each individual partner.

Financing Limited Partnerships (LLPs)

A limited partnership is a partnership wherein the partners are not assumed
personally for the business liability. Their liability is limited to the total
amount of capital that is contributed by each of them towards the business.
The LLPs can be formed by registering the partnership deed with the
Registrar of Companies (ROC) and thus a partnership firm can enjoy all the
benefits of the partnership firm but with a limited liability of all the partners.

Financing Corporations
A corporation is a separate legal entity that can be created only by
registering it with the Registrar of Companies (ROC).

For many small businesses, incorporation provides the easiest method for
raising capital from multiple investors, particularly those investors who are
not necessarily interested in actively participating in the business. In some
instances, it may be easier to persuade 15 people to invest $5,000 than to
convince one person to contribute $125,000, and a corporation permits this
kind of widespread ownership.

Active and Passive Investors

Several alternative types of corporations may be available for small
businesses, including S corporations , close corporations, and C
corporations . Each of these types of corporations have different
requirements but they all permit equity financing through the sale of stock in
exchange for a capital contribution of money or property. Stock comes in a

25
variety of different types and, depending upon the negotiating strength and
the interests of the investors, a small business can limit the extent of
ownership control being sold by limiting the number of shares for sale and/or
the rights associated with each class of stock. Nonvoting shares, preferred
shares, redeemable shares, and a variety of hybrid shares are possible.

Other prospective shareholders, such as venture capitalists and investment

"angels," may demand a more active role in exchange for their capital
contribution. As a condition of investing, they may even require a public sale
of the business within a certain time period in order to ensure a quick return
on their investment.

Advantages and Disadvantages

Advantages of corporations include ease of transfer, limited personal
liability for the investors, and a great deal of flexibility in structuring
ownership and control over the business.

Disadvantages of corporations include the expense and administrative

burden of maintaining the formalities of corporate structure, double
taxation of profits while operating, and double taxation of capital gains
upon dissolution.

Which Form Is Best?

Although we discuss the main advantages and disadvantages of different
organizational forms, no formula exists for making the determination of
which entity is best for the business, and this module's focus on how to
obtain financing for the business does not fully address important
considerations relating to taxes, personnel, marketing and business
strategies, and a variety of other factors that influence the choice of entity.

However, certain general principles can be identified to help guide the

selection of an organizational form for the small business. For example, many
startup businesses follow a progression of organizational forms, evolving
from a sole proprietorship into some form of corporate entity as the
business's financing needs and options become more complicated. The sole
proprietorship is popular for startups because it requires virtually no
formalities and no cost to create and maintain, and tax treatment is
favorable and simple.

26
On the other hand, if the business will have employees (creating potential
personal tort liability for owners), poses relatively high risks, and/or needs to
attract equity financing, the business may benefit from beginning as a
corporation. Among the more specific principles to consider are:

Use of equity financing. The degree to which there is a need to sell

ownership interests to raise money for the business will influence the choice
of organizational forms. A sole proprietorship obviously precludes equity
financing from anyone other than himself. Likewise, a general partnership
may have problems raising equity capital because adding a new partner
requires the unanimous consent of all existing partners. In addition, having
numerous partners in a general partnership can create cumbersome
management decision-making. LLPs are similar to partnerships in this
constraint.

Of course, most small businesses do not begin with a large number of

owners (e.g., more than ten); consequently, one can usually convert a more
simple organizational form, such as a partnership, into a corporation if and
when the need for greater equity financing arises.

Risk management. If the business has employees, or if several owners will

participate actively in the business, the potential personal liability from the
conduct of these persons can influence the choice of organizational form. A
high-risk business, such as construction contracting, may favor an entity that
limits the personal liability of the owners, such as a corporation or limited
liability partnership. In contrast, a sole proprietor and a partner in a general
partnership have unlimited personal liability for the conduct of associates
and employees.

Taxation. Startup businesses typically experience an initial period of tax

losses. A sole proprietorship, a general or limited partnership will usually
allow to "pass-through" a greater amount of these losses to the individual tax
return.

Image. To some investors, a more formal organizational entity may add to

the intangible appeal of the business. A corporate name may create an
image of credibility and business sophistication for some investors.

Control. Any entity that has more than one owner involves compromising
the exclusive control over the business. The willingness to dilute the

27
ownership control, and the need to obtain outside equity financing, will
govern this factor.

Transferability and Marketability. All organizational forms, other than

sole proprietorships & Corporations, usually have restrictions on the transfer
of ownership interests. Although these restrictions allow the owners a greater
degree of ownership control, the constraints are also likely to limit the
marketability and liquidity of the equity interests.

Business Combinations
Mergers, joint ventures, consolidations, acquisitions, strategic alliances,
associations, and other combinations of business entities can also be
employed to raise new funds for the business. The business climate of the
'90s has encouraged the use of joint ventures and alliances between
businesses as a means of reducing costs and ownership dilution. Most of
these arrangements are contractual, but no standard contract terms exist for
all industries. The advantages of these joint ventures and alliances is that
the business can finance certain services or production functions by sharing
expertise, assets, expenses, and risk without necessarily incurring cash debt
or trading equity.

Strategic alliances. For small businesses, strategic alliances often consist

of simple "bartering" with customers, suppliers, and even competitors. For
example, if one owns a manufacturing business, he might be able to get a
better price for component parts if he proposes using a label on the final
product that includes the supplier's trademark. Alliances for research and
development efforts are also quite common as a means of minimizing these
long-term costs. In certain high-tech industries, the cooperation of other
businesses is essential, not only from the standpoint of financing, but also for
marketing, licensing, and distribution.

Added value. When considering strategic partners, most small businesses

will benefit from partners that add value, not just money. For instance, a
business association with a well-recognized industry name can generate
immediate credibility and also assist in advertising and marketing for the
company. The networking ability plays a major role in locating and
investigating strategic partnering opportunities.

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Venture Capital
Venture capital ("VC") firms supply funding from private sources for investing
in select companies that have a high, rapid growth potential and a need for
large amounts of capital. VC firms speculate on certain high-risk businesses
producing a very high rate of return in a very short time. The firms typically
invest for periods of three to seven years and expect at least a 20 percent to
40 percent annual return on their investment.

Venture capital financing may not be available, nor a good choice of

financing, for many small businesses. Usually, venture capital firms favor
existing businesses that have a minimal operating history of several years;
financing of startups is limited to situations where the high risk is tempered
by special circumstances, such as a company with extremely experienced
management and a very marketable product or service. The target
companies often have revenues in excess of two million dollars and a
preexisting capital investment of at least one million.

VCs research target companies and markets more vigorously than

conventional lenders, although the ultimate investment decision is often
influenced by the market speculations of the particular venture capitalists.
Due to the amount of money that venture capital firms spend in examining
and researching businesses before they invest, they will usually want to
invest at least a quarter of a million dollars to justify their costs.

High cost. The price of financing through venture capital firms is high.
Although the investing company will not typically get involved in the ongoing
management of the company, it will usually want at least one seat on the
target company's board of directors and involvement, for better or worse, in
the major decisions affecting the direction of the company. The ownership
interest of the VC firm is usually a straight equity interest or an ownership
option in the target company through either a convertible debt (where the
debt holder has the option to convert the loan instrument into stock of the
borrower) or a debt with warrants to a straight equity investment (where the
warrant holder has the right to buy shares of common stock at a fixed price
within a specified time period). An arrangement that eventually calls for an
initial public offering is also possible. Despite the high costs of financing
through venture capital companies, they do offer tremendous potential for
obtaining a very large amount of equity financing and they usually provide
qualified business advice in addition to capital.

29
Private Investors/Business Angels
A less-formal source for external equity financing is through private
investors, called "angels," who are seeking new business investments for a
variety of economic and personal reasons. Angels can be a very good source
of money if you are looking for outside investors but you are not interested
in, or not a likely target for, a venture capital firm. Although angels tend to
be less demanding in their financing terms than venture capital firms, you
should still exercise great caution in ensuring that the "angel" financier
doesn't turn out to be a devil in disguise.

What do angels look like? Frequently they are other small business
owners, or former owners, in the community.

Angel networks can put you in touch with potential investors around
the country.

What Do Angels Look Like?

No standard "angel" profile exists, but these investors are often individuals or
groups of either local professionals or businesspersons who are interested in
assisting new businesses that will enhance the immediate community. They
are not typically interested in controlling the business, although they usually
want an advisory role. In addition, they may make financing contingent upon
the business's adherence to certain goals or practices.

Most entrepreneurs already recognize that potential "angel" investors for

their business might be just about anywhere. Networking within the
community and the business circles can often provide a good starting point.
Potential financing contacts can arise through the business associates,
affiliations with relevant trade associations, inquiries through the local
banker, accountant or attorney, local chambers of commerce, and through
other small business entrepreneurs.

The terms of angel financing depend entirely on what is negotiated with a

particular investor, but almost any type of debt or equity financing is a
possibility.

Some angels may offer loans at very low interest rates simply to help a new
business or the community; others may expect specific rates of return on an
equity investment. Some deals involve a debt instrument that allows the

30
investor an option to convert the debt into an equity investment at either a
specified time or if certain conditions are met. The investor can thereby
protect himself or herself by retaining a debt claim if the business does not
do well or can profit by converting the interest into equity ownership if the
business succeeds.

Most commonly, however, angels will want an equity interest in the business
and some guaranteed "exit" provisions, such as a mandatory buyout, a "put"
option requiring the business to repurchase the stock at the investor's
option, or a public offering of stock . In a five-year period, angels might
expect a return on investment of three to five times their initial investment,
while a venture capital firm might want a return of five to 10 times its
original investment.

Angel Networks
In addition to the own efforts at finding interested investors in the
community, one can take advantage of a growing cottage industry of "angel
network" firms that will match up prospective investors with small
businesses.

Angel network firms solicit background information from entrepreneurs and

investors who subscribe to their service. The network firms make their
money by charging a subscription fee to each entrepreneur and investor for
inclusion in their match-making database. The entrepreneur will be asked to
prepare a business profile identifying traits such as the relevant industry, the
business's age, geographic location, size of investment needed, and any
conditions or factors that the entrepreneur requires. The investors prepare a
similar profile of the kind of company they are looking to invest in and the
type of investment they are willing to make. The network firms typically
screen these submissions and then send a limited list to compatible
investors.

Whether or not the investor elects to contact the business, and the terms of
any investment relationship, is left to the parties to determine. For investors,
the most important factor typically is the relevant work experience of the
entrepreneur. They want to know if this person has a track record that may
allow him or her to pull off the difficult task of making a big success out of a
small business. Startup businesses have been funded through these
networks, but many angels prefer that you have at least a minimal operating

31
history before they'll be willing to risk their personal funds in a small
business.

Private Equity
Private equity, in finance, is an asset class consisting of equity securities in
operating companies that are not publicly traded on a stock exchange.

A private equity investment will generally be made by a private equity firm,

a venture capital firm or an angel investor. Each of these categories of
investor has its own set of goals, preferences and investment strategies;
each however providing working capital to a target company to nurture
expansion, new product development, or restructuring of the companys
operations, management, or ownership.

Bloomberg Business Week has called private equity a rebranding of

leveraged buyout firms after the 1980's. Among the most common
investment strategies in private equity are: leveraged buyouts, growth
capital, distressed investments and mezzanine capital. In a typical leveraged
buyout transaction, a private equity firm buys majority control of an existing
or mature firm. This is distinct from a venture capital or growth capital
investment, in which the investors (typically venture capital firms or angel
investors) invest in young or emerging companies, and rarely obtain majority
control.

Private equity is also often grouped into a broader category called private
capital, generally used to describe capital supporting any long-term, illiquid
investment strategy.

The strategies private equity firms may use are as follows, leveraged buyout
being the most important.

Leveraged buyout
Leveraged buyout, LBO or Buyout refers to a strategy of making equity
investments as part of a transaction in which a company, business unit or
business assets is acquired from the current shareholders typically with the
use of financial leverage. The companies involved in these transactions are
typically mature and generate operating cash flows.

32
Leveraged buyouts involve a financial sponsor agreeing to an acquisition
without itself committing all the capital required for the acquisition. To do
this, the financial sponsor will raise acquisition debt which ultimately looks to
the cash flows of the acquisition target to make interest and principal
payments. Acquisition debt in an LBO is often non-recourse to the financial
sponsor and has no claim on other investment managed by the financial
sponsor. Therefore, an LBO transaction's financial structure is particularly
attractive to a fund's limited partners, allowing them the benefits of leverage
but greatly limiting the degree of recourse of that leverage. This kind of
financing structure leverage benefits an LBO's financial sponsor in two ways:
(1) the investor itself only needs to provide a fraction of the capital for the
acquisition, and (2) the returns to the investor will be enhanced (as long as
the return on assets exceeds the cost of the debt).

As a percentage of the purchase price for a leverage buyout target, the

amount of debt used to finance a transaction varies according the financial
condition and history of the acquisition target, market conditions, the
willingness of lenders to extend credit (both to the LBO's financial sponsors
and the company to be acquired) as well as the interest costs and the ability
of the company to cover those costs. Historically the debt portion of a LBO
will range from 60%90% of the purchase price, although during certain
periods the debt ratio can be higher or lower than the historical averages.

33
Diagram of the basic structure of a generic leveraged buyout transaction

Mezzanine capital
Mezzanine capital refers to subordinated debt or preferred equity securities
that often represent the most junior portion of a company's capital structure
that is senior to the company's common equity. This form of financing is
often used by private equity investors to reduce the amount of equity capital
required to finance a leveraged buyout or major expansion. Mezzanine
capital, which is often used by smaller companies that are unable to access
the high yield market, allows such companies to borrow additional capital
beyond the levels that traditional lenders are willing to provide through bank
loans. In compensation for the increased risk, mezzanine debt holders
require a higher return for their investment than secured or other more
senior lenders. Mezzanine securities are often structured with a current
income coupon.

Distressed and Special Situations

Distressed or Special Situations are a broad category referring to
investments in equity or debt securities of financially stressed companies.
The "distressed" category encompasses two broad sub-strategies including:

"Distressed-to-Control" or "Loan-to-Own" strategies where the investor

acquires debt securities in the hopes of emerging from a corporate
restructuring in control of the company's equity;

"Special Situations" or "Turnaround" strategies where an investor will

provide debt and equity investments, often "rescue financing" to
companies undergoing operational or financial challenges.

In addition to these private equity strategies, hedge funds employ a variety

of distressed investment strategies including the active trading of loans and
bonds issued by distressed companies.

34
Other strategies
Other strategies that can be considered private equity or a close adjacent
market include:

Real Estate: in the context of private equity this will typically refer to
the riskier end of the investment spectrum including "value added"
and opportunity funds where the investments often more closely
resemble leveraged buyouts than traditional real estate investments.
Certain investors in private equity consider real estate to be a separate
asset class.

Infrastructure: investments in various public works (e.g., bridges,

tunnels, toll roads, airports, public transportation and other public
works) that are made typically as part of a privatization initiative on
the part of a government entity.

Energy and Power: investments in a wide variety of companies (rather

than assets) engaged in the production and sale of energy, including
fuel extraction, manufacturing, refining and distribution (Energy) or
companies engaged in the production or transmission of electrical
power (Power).

Merchant banking: negotiated private equity investment by financial

institutions in the unregistered securities of either privately or publicly
held companies.

Fund of Funds: investments made in a fund whose primary activity is

investing in other private equity funds. The fund of funds model is used
by investors looking for:

Diversification but have insufficient capital to diversify their

portfolio by themselves

Access to top performing funds that are otherwise

oversubscribed

Experience in a particular fund type or strategy before investing

directly in funds in that niche

Exposure to difficult-to-reach and/or emerging markets

35
 Superior fund selection by high-talent fund of fund
managers/teams

Initial Public Offerings

One may have read about how some small company became an overnight
success story by deciding to "go public" through an initial public offering
(IPO) of its stock. Going public simply means that a company that was
previously owned by a limited number of private investors has elected, for
the first time, to sell ownership shares of the business to the general public.

Reasons to Go Public. The public sale of ownership interests can generate

funds for working capital, repayment of debt, diversification, acquisitions,
marketing, and other uses. In addition, a successful public offering increases
the visibility and appeal of the company, thereby escalating the demand and
value for shares of the company. Investors can benefit from an IPO not only
because of the potential increase in market value for their stock, but also
because publicly-held stock is more liquid and can be readily sold if the
business appears to falter or if the investor needs quick cash. The availability
of a public market for shares will also help determine the taxable values of
the shares and assist in estate transfers.

The use of IPOs had increased in popularity before the market meltdown of
2008, but despite the IPO hype, most small companies are not going to "go
public;" IPOs largely remain a financing option limited to rapidly growing,
successful businesses that generate over a million dollars in net annual
income.

The use of IPOs is limited primarily because: (1) there is a very high
cost and much complexity in complying with SEBI, Companies Act & Stock
Exchanges rules and regulations governing the sale of business securities;

(2) Offering the business's ownership for public sale does little good unless
the company has sufficient investor awareness and appeal to make the IPO
worthwhile; and

(3) Management must be ready to handle the administrative and legal

demands of widespread public ownership. Of course, an IPO also means a
dilution of the existing shareholders" interests and the possibilities of
takeovers or adjustments in management control are present.

36
Securities laws are complicated. The sale of "securities" to the public is
regulated by SEBI in its Disclosure for Investor Protection Guidelines and the
listing agreement of the stock exchanges that have two primary objectives:
(1) to require businesses to disclose material information about the company
to investors, and (2) to prohibit misrepresentation and fraud in the sale of
securities.

Possible exemptions from securities laws. Many small businesses can

sell stock to insiders or to a small group of investors without being subject to
securities laws; in effect, they can take advantage of alternatives to going
public. However, it's not always clear where the exemptions end, so one
should always consult a knowledgeable attorney before selling any stock in
the company. The process of soliciting money from the public through the
issuance and sale of securities requires a working knowledge of the state and
federal registration statements concerning the securities to be sold, complex
disclosure documents about the company with detailed information for
potential investors, and financial statements. Employing professionals
(attorney, accountant, and sometimes a stock underwriter) to assist in the
process is a practical necessity.

GUIDELINES RELATING TO INITIAL PUBLIC

OFFERS IN INDIA
The principle Indian regulations pertaining to listing of securities are the SEBI
(Disclosure and Investor Protection) Guidelines, 2000 (DIP Guidelines).
These guidelines are applicable to all public issues by listed and unlisted
companies, all offers for sale and rights issues by listed companies, except
rights issues where the average value of the shares offered does not exceed
Rs. 5,000,000 (Rupees five million). (Clause 1.4 of the DIP Guidelines)
Criteria for Initial Public Offers (IPOs)
In order to make an IPO, an unlisted company must satisfy the following
conditions:

37
 1. it must have a pre-issue net worth of not less than Rs. 10,000,000 (Rupees
ten million) in three (3) out of the preceding five (5) years, with a minimum
net worth to be met during the two (2) immediately preceding years;
2. it must have a track record of distributing dividends for at least three (3) out
of the immediately preceding five (5) years; and
3. the issue size, i.e., the offer through the offer document, the firm allotment
and the promoters contribution through the offer document, should not
exceed five times the pre-issue net worth as per the last available audited
account, either at the time of filing the draft offer document with the
Securities and Exchange Board of India (SEBI) or at the time of opening of
the issue. (Clause 2.2.1 of the DIP Guidelines)

If the above conditions are not satisfied, then the IPO can be made only
through a book-building process, provided that sixty percent (60%) of the
issue size must be allotted to Qualified Institutional Buyers (QIBs). (Clause
2.2.2 of the DIP Guidelines)
QIBs, inter alia, includes public financial institutions, scheduled commercial
banks, mutual funds, venture capital funds registered with the SEBI (VCFs),
foreign venture capital investors registered with the SEBI (FVCIs), etc.
Net worth means the average of the value of the paid up equity capital
and free reserves (excluding reserves created out of revaluation), minus the
average value of the accumulated losses and deferred expenditure not
written off (including miscellaneous expenses not written off). (Clause
1.2.1(xixa) of the DIP Guidelines)
For the purpose of calculating the track record of distributing dividends,
profits emanating only from the information technology (IT) business or
activities of the company will be considered in the following cases:
1. for companies in the IT sector or proposing to raise money for projects in the
IT sector; and
2. for companies whose name suggests that they are engaged in IT activities or
business, i.e., names containing the words software, hardware, info, infotech,
com, informatics, technology, computer, information, etc.

IT comprises of the following activities:

1. production of computer software;
2. IT services;
3. manufacturing of IT hardware, products, and components;
4. computer education and training, maintenance, and consultancy; and
5. e-commerce or internet related activities.

38
Promoters Contribution
In an IPO, the promoters must contribute at least twenty percent (20%) of
the post issue capital.
The term promoter includes:
1. person(s) in overall control of the company;
2. person(s) who are instrumental in the formulation of a plan or program
pursuant to which the securities are offered to the public; and
3. persons named in the prospectus as promoters.

Any person acting as a director or officer of the issuer company merely in a

professional capacity is not included in the definition of promoter.

A promoter group includes:

1. the promoter;
2. an immediate relative of the promoter; and
3. in case the promoter is a company:
a) a subsidiary or holding company of that company;
b) any company in which the promoter holds ten percent (10%) or more of
the equity capital or which holds ten percent (10%) or more of the equity
capital of the promoter;
c) any company in which a group of individuals, companies or combinations
thereof holds twenty percent (20%) or more of the equity capital and also
holds twenty percent (20%) or more of the equity capital of the issuer
company; and
4. in case the promoter is an individual:
a) any company in which the promoter, an immediate relative of the
promoter or a firm in which the promoter or his immediate relative is a
member, holds ten percent (10%) or more of the share capital;
b) any company in which a company specified in (a) above, holds ten percent
(10%) or more, of the share capital; and
c) any firm in which the aggregate share of the promoter and his immediate
relatives is equal to or more than ten percent (10%) of the total; and
5. all persons whose shareholding is aggregated for the purpose of disclosing
in the prospectus as the shareholding of the promoter group.
Financial institutions, scheduled banks, foreign institutional investors and
mutual funds are not deemed to be a promoter or a promoter group merely
because they hold ten percent (10%) or more of the equity of the issuer
company. However, such entities will be treated as promoters or a promoter
group with respect to the subsidiaries or companies promoted by them or for
the mutual funds sponsored by them.

39
The following will not be eligible to be considered for computation of the
promoters contribution:
1. equity acquired by promoters of a company during the three (3) years
preceding the filing of the offer document with the SEBI, if it:
a) is acquired for consideration other than cash and revaluation of assets or
capitalization of intangible assets is involved in such transactions; or
b) Results from a bonus issue, out of revaluation of reserves, or reserves
without accrual of cash resources (Clause 4.6.1 of the DIP Guidelines);
2. securities that have been issued to the promoters, during the preceding
year, at a lower price than at which they are being offered to the public,
except if the promoters bring in the difference between the offer price and
the issue price for the shares and all the requirements under the Companies
Act, 1956 are fulfilled, i.e., passing of revised resolutions by shareholders or
Board filing of the revised return of allotment with the ROC, etc. (Clause
4.6.2 of the DIP Guidelines); and
3. securities for which a specific written consent has not been obtained from
the shareholders for inclusion of their shares in the minimum promoters
contribution subject to lock-in. (Clause 4.6.7 of the DIP Guidelines) The
ineligible shares mentioned in 1 and 2 above, acquired pursuant to a scheme
of merger or amalgamation approved by a High Court, will be eligible to
compute the promoters contribution. (Clause 4.6.4 of the DIP Guidelines) A
minimum contribution of Rs. 25,000 (Rupees twenty-five thousand) per
application from each individual and Rs. 100,000 (Rupees hundred thousand)
from firms and companies will be eligible for consideration to calculate the
minimum promoters contribution. (Clause 4.6.5 of the DIP Guidelines) The
promoters must bring in the full amount of contribution at least one (1) day
before the issue opening date, to be kept in an escrow account with a
scheduled commercial bank, which will be released to the company along
with the public issue proceeds. If the promoters contribution has been
brought before the public issue and has already been deployed by the
company, the company must give a cash flow statement in the offer
document, disclosing how the promoters contribution was used. If the
minimum promoters contribution exceeds Rs. 10,000,000 (Rupees ten
million), the promoters must bring in Rs. 10,000,000 (Rupees ten million)
before the opening of the issue and the remaining amount on a pro rata
basis before the calls are made on the public. (Clause 4.9.1 of the DIP
Guidelines)
The companys Board must pass a resolution allotting the shares or
convertible instruments to the promoters against the amount received. A
copy of the resolution and a certificate from a chartered accountant

40
indicating receipt of the promoters contribution must be filed with the SEBI.
A list of the names and addresses of friends, relatives and associates who
have contributed to the promoters quota and their subscription amount
must also be attached to the chartered accountants certificate. (Clause
4.9.2 r/w Clause 4.9.3 r/w Clause 4.9.4 of the DIP Guidelines) The promoters
contribution will not be required in case of companies where there is no
identifiable promoter or promoter group.

Lock-in Requirements
The DIP Guidelines specify the minimum lock-in period and lay down the
other requirements relating to the lock-in period. The minimum promoters
contribution, i.e., twenty percent (20%) of the post-issue capital, is required
to be locked-in for a period of three (3) years, starting from the date of
allotment in the proposed issue and ending three (3) years from the date of
commencement of commercial production or the date of allotment in the
public issue, whichever is later. (Clause 4.11.1 r/w Clause 4.11.2 of the DIP
Guidelines) Promoters contribution in excess of the required minimum
percentage must be locked in for a period of one (1) year. The securities
forming part of the promoters contribution and issued last to the promoters
must be locked-in first, except in the case of financial institutions appearing
as promoters. (Clause 4.12.1 r/w Clause 4.13.1 of the DIP Guidelines) The
entire pre-issue capital, other than the promoters contribution, must be
locked in for a period of one (1) year from the date of commencement of
commercial production or the date of allotment in the public issue, whichever
is later. This provision is not applicable to the pre-issue share capital:
1. held by VCFs and FVCIs, which must be locked-in according to the SEBI
(VCF) Regulations, 1999 and the SEBI (FVCI) Regulations, 2000; and
2. held for a period of at least one (1) year at the time of filing of the draft
offer document with the SEBI and being offered to the public through an offer
for sale, i.e., an offer by existing shareholders of a company to the public.
(Clause 4.14.1 r/w Clause 4.14.2 of the DIP Guidelines) Locked-in securities
forming part of the promoters contribution may be pledged only with banks
or financial institutions as collateral for loans, if the pledge of shares is one of
the terms of the loan. (Clause 4.15.1 of the DIP Guidelines) Further, the
transfer of securities, inter se, amongst promoters is also subject to the lock-
in applicable to transferees for the remaining lock-in period. (Clause 4.16.1 of
the DIP Guidelines) The face of the security certificate of locked-in securities
must contain the inscription non-transferable and specify the period for
which it is not transferable. (Clause 4.17.1 of the DIP Guidelines)

41
Prospectus Requirements
The offer document must contain true and sufficient information to enable
the investor to make an informed decision while investing in the offered
securities (Clause 6.1 of the DIP Guidelines) The prospectus must, inter alia,
provide information relating to risk factors, project costs, means of financing,
appraisal, issue schedule, details of the managerial personnel, capital
structure of the company, terms of the issue, financial information of
company and group companies, basis for issue price and details of the
products, machinery and technology.
The SEBI the power to pass directions as mentioned below, for any violation
of the DIP Guidelines, including misstatement in the prospectus. In addition,
under the Companies Act, 1956, every person who authorizes the issue of a
prospectus that contains any untrue statement is liable to be punished with
imprisonment of up to two years or with a fine of up to Rs. 50,000 (US $
1040). (Section 62 of the Companies Act, 1956)

Powers of the SEBI

In the event of any violation of the DIP Guidelines, the SEBI can take
measures to protect the interest of investors and the securities market and
pass the following orders:
1. direct the persons concerned to refund the money collected under the issue
to the investors with or without interest;
2. prohibit the persons concerned from accessing the capital market for a
particular period;
3. direct the stock exchange not to list or permit trading in the securities;
4. direct the stock exchange to forfeit the security deposit of the issuing
company; and
5. any other direction that the SEBI deems fit. (Clause 17.1 of the DIP
Guidelines)

Before issuing any of the above directions, the SEBI may give the person
concerned a reasonable opportunity to show cause against the direction. The
Board may also initiate action against intermediaries who fail to exercise due
diligence or to comply with any obligation under the DIP Guidelines. (Clause
17.2 of the DIP Guidelines)

Conclusion

42
The DIP Guidelines provide detailed regulations that must be complied with
in all public issues by listed and unlisted companies. These guidelines set out
the criteria for IPOs, including, the minimum percentage of promoters
contributions, the lock in periods and the prospectus requirements. The SEBI
has the discretion to pass directions and take other actions against persons
who did not comply with the DIP Guidelines. The DIP Guidelines, therefore,
help in achieving greater transparency in the capital market and in
protecting the interest of the investors.

Foreign Currency Convertible Bonds (FCCBs)

Foreign Currency Convertible Bonds commonly referred to as FCCB's are a
special category of bonds. FCCB's are issued in currencies different from the
issuing company's domestic currency. Corporates issue FCCB's to raise
money in foreign currencies. These bonds retain all features of a convertible
bond making them very attractive to both the investors and the issuers.

These bonds assume great importance for multi-nationals and in the current
business scenario of globalization where companies are constantly dealing in
foreign currencies.

FCCB's are quasi-debt instruments and tradable on the stock exchange.

Investors are hedge-fund arbitrators or foreign nationals.

FCCB's appear on the liabilities side of the issuing company's balance-sheet

Under IFRS provisions, a company must mark-to-market the amount of its

outstanding bonds

The relevant provisions for FCCB accounting are International Accounting

Standards: IAS 39, IAS 32 and IFRS 7

FCCB are issued by a company which can be redeemed either at maturity or

at a price assured by the issuer. In case the company fails to reach the
assured price bond issuer to get it redeemed. The price and the yield on the
bond moves on the opposite direction. The higher the yield lower is the price.

Financing Through Franchising

"Franchising" is the transfer of the right to sell a trademarked product or
service through a system prescribed by a "franchisor," who owns the
trademark. Franchising has been one of the fastest growing areas of new

43
business development during the last 15 years. While traditional franchise
businesses such as gasoline stations, auto dealers, and soft drink bottlers
continue to grow, the most rapidly expanding industries for franchises are
service businesses involving recreation and leisure activity and business
services.

Franchise arrangements are usually either:

Product and trade name franchises, or

Business format franchises.

The former involves product distribution arrangements within a specified

geographic territory. For example, a gas station can be a product and trade
name franchise. A business format franchise includes not only a product and
trade name, but also operating procedures such as facility design,
accounting and bookkeeping procedures, employee relations, quality
assurance standards, and the overall image and appearance of the business.
For instance, restaurants and convenience stores are often business format
franchises.

For the franchisee, franchising is a way to reduce the risks of a new

business by buying into an established product or concept.

For the franchisor, franchising is a way to expand the business more

quickly, by sharing some of the costs, risks, and rewards with
franchisees.

For the Franchisee

A primary advantage of franchising is that one can reduce the risks
associated with a new business by buying into an existing business that has
established goodwill and a marketable reputation. While purchasing a
franchise may often be a more expensive way to start a business, franchises
can also provide a "blueprint" for business operations that's especially

44
valuable if there is lack of experience in the type of business that is being
started.

The conventional wisdom is that franchised businesses have a much greater

likelihood of success than independently started firms. However, some
recent studies have reached an opposite conclusion. It's probably safest to
say that the jury is still out on this one.

Franchising as Finance. Franchising can be a form of capital financing, and

franchisors may offer financing assistance in securing fixed assets and
occasionally even working capital. For example, where real estate and
building costs are high, the franchisor may be able to secure financing
because of its creditworthiness or by use of a real estate limited partnership.
The franchisor would then lease the property to the franchisee. A franchisor
may also sign a guarantee or assume other contingent liability on loans or
leases made directly between a third party and the franchisee. Less direct
methods of financing assistance can take the form of the franchisor's
subordination of certain claims to franchisee lenders or assistance in
preparing loan packages for commercial lenders.

Nonetheless, while franchisors can assist in financing, one should be aware

that startup costs with franchises may run from $25,000 to $500,000 or
more, depending upon the particular franchise and the nature of the
business. Professional service franchises, such as tax preparation, usually are
significantly less expensive than, for instance, hotels or gas stations.

Franchise and other fees. The costs of franchising include a variety of fees
and contributions typically required by the franchisor in exchange for the
assistance and experience of the franchisor.

Usually an initial franchise fee or license fee will be required. The fee may be
a lump sum or may be payable in installments. Interest varies and is often
nonrefundable.

Other fees may be assessed for training costs (tuition, room, board, and
transportation) and on-site startup assistance and promotions, advertising (2
percent to 8 percent of gross sales), periodic royalties (4 percent to 6 percent
of gross sales), or fees. These fees are typically tied to a percentage of sales
and payable weekly or monthly. Royalties usually represent the cost of using
trade names and commercial symbols, as well as any trade secrets, patents,
or other intellectual property rights, and advertising contributions (often

45
payable monthly or weekly, based upon a percentage of sales). If
bookkeeping is centralized, separate accounting and processing fees may be
assessed.

Additional payments for equipment, supplies, property, and beginning

inventory may be required. Note that "initial fees" do not generally include
product inventory or equipment down payments.

For the Franchisor

Some entrepreneurs may begin their business with the intent of franchising
their operations; other businesses may elect to franchise an existing
business because it has been so successful. For franchisors, franchising is a
means of equity financing in which the franchisor "sells off" expansion rights
in the business. In return, the franchisor typically receives an initial franchise
fee, service fees, equipment sale or lease fees, and royalties.

Financing Expansion: The advantage of this form of financing is that the

franchisor passes on much of the cost of expansion to the franchisee,
thereby permitting much faster growth in a wider geographic market. This is
particularly true when the startup costs of a new facility entail high capital
expenditures.

The Downside: Disadvantages of franchising are the unique development

and overhead costs associated with franchising, the heightened legal risks
from vicarious liability for the acts of franchisee operations, increased
regulatory costs, and a dilution of ownership.

Employee Stock Ownership Plans

One may be able to find equity financing within the own company if there are
employees and are willing to share some ownership control with them.

An Employee Stock Ownership Plan (ESOP) is a qualified retirement benefit

plan in which the major investment is securities of the employer's company.
In an ESOP, employees can purchase shares of stock in the company by
paying cash or by agreeing to reductions from salary or benefits. The
employees become part owners of the business and the promoter/owner
have additional funds for other business purposes. In addition, the company
contributes to the ESOP by either making an annual cash contribution to the
plan for the purchase of company securities or by directly contributing stock

46
to the plan. Either way, the company's contribution results in the cash price
of the stock being returned to the company. The company gets a tax
deduction for the ESOP contribution while effectively retaining the cash.

Some ESOPs are also used as leverage for borrowing additional funds for the
business. An ESOP can borrow funds from lenders in order to purchase
additional securities in the employer's business. Alternatively, the employer
can borrow from a lender and re-lend the funds to the ESOP; the ESOP would
then purchase company stock with the cash. In both scenarios, the employer
ends up with the cash price of the stock. ESOPs are sometimes used in this
manner for large stock purchases when funding is necessary to finance
mergers, acquisitions, or buy-outs.

Because an ESOP requires having employees and because implementing an

ESOP can be expensive and time-consuming, this financing tool may not be
sensible for many startup and existing small businesses. Moreover, one
should be aware that plan participants who terminate employment may
demand distribution of stock itself, rather than simply the stock's cash value.
A closely held business may not want former employees to own stock in the
company or to be able to vote as shareholders. In addition, if the trustees of
the ESOP are also the business's owners, they may occasionally face a
conflict of interest between their duties to act in the best interests of the
ESOP and their duties as directors and/or officers of the company. For
example, if a takeover offer was tendered, the ESOP might profit from the
takeover, but company management might oppose the possible change.

ESOPs are, however, commonly used by business owners seeking to retire

from the business. If the small business has grown to the point where you
have a fairly large number of employees, an ESOP can provide an excellent
way to, in effect, sell the business to the employees because the ESOP
provides a ready-made buyer for the stock.

Valuation & Due Diligence

In all the various sources available for the equity financing the most
important thing is the valuation of the business. The real amount of financing
provided by the investor is totally depended upon the valuation of the
company. The percentage of dilution is calculated once the value of the total
business is finalized. There are different valuation approaches which can be
used to value a company. To name a few are Discounted Cash Flow Method,
PE Multiple, EV/EBITDA Multiple, etc. To get to a proper valuation a proper

47
due diligence has to be carried out by the investor. The following are the
aspects should be kept in mind while conducting the due diligence of the
company/business.
Legal Due Diligence
Financial Due Diligence
General Due Diligence

A draft of Due Diligence Checklist is as follows:

Please prepare a folder containing the information requested below.
This checklist is to be placed at the top of the folder and should
indicate against each question either an explanation or the
reference number of the document in the folder that supports the
explanation or both. In case a question is not applicable please
indicate as such. All documents in the folder should be numbered
and the folder should be indexed.
1 General
1. List of companies / firms which are a part of the business group to which
the target company belongs
2. Brief note on the history of the company and of the division being
acquired, including reference to its foundation and expansion
3. Brief note on present business and activities, including list of business
locations, providing details of operations in airports, seaports, cruise ports
4. Any recent reports on the companys activities prepared internally or by
outside consultants (such as analyst reports, information memorandum,
valuation reports etc.)
5. Copies of any literature prepared by the company illustrating its products,
operations, history etc.
6. Listing and copy of all key agreements/licenses with airports, seaport
authorities for carrying on business
7. Any agreements or documents recording arrangements between
shareholders of the company
8. A list of all licenses and registrations held by the company specifying
number, validity period, purpose, granting authority and other relevant
details. Copies of the same may also be enclosed
9. Minutes of meetings of the board of directors, shareholders and audit /
operational committees since incorporation
10. Brief note on the internal control environment in the company
11. Details of bankers, lawyers, consultants and other professional advisers
12. Transactions/agreements with affiliates and related parties especially
with respect to prices, payment terms, etc.
13. All statutory registers and returns filed required to be maintained/filed
under the Companies Act

48
14. Note on planning and control systems prevalent in the organization
including controls over non-financial systems such as Loss Prevention
(including shrinkage management), Material sourcing planning, quality
control, inventory management, sales etc.
15. Details of statutory records maintained under the Companies Act and
other applicable statutes
16. Transaction documents (agreements) for any prior acquisitions done by
the company

2. Financial Statements information for the year ended

1. Audited financial statements of the Company
2. Chart of accounts
3. Accounting policy at present, in particular with respect to income / sales
recognition, exceptional and extraordinary items, acquisition and disposal
of assets, differentiating between capital expenditure & repairs and
maintenance, valuation of fixed assets, capitalisation of interest,
inventory/stock valuation, transfer pricing, preliminary expenses
4. Details of changes in accounting policies since incorporation
5. Closing audit working files prepared by the Company, as appropriate
6. Trail Balance, schedules and groupings supporting the financial
statements for the year ended
7. Audit management letters for the period under review
8. Internal audit reports for the period under review
9. Budgets, comparison with actuals and explanation for variances
10. Cash flow statements for the year ended

3. Management Accounts
1. Copies of monthly management accounts since April 2004 till date
2. Breakdown of above by profit centre / business unit
3. Reconciliation of management accounts to statutory accounts for the year
ended.

Trading Results
4. Customer and Marketing
1. Write up on the pricing policy followed by the company for various
product lines
2. Write up on selling and distribution network (Number of outlets, since,
products available, sea ports, air ports etc), schemes (systems and
procedures followed, etc), factors affecting prices, margins, periods of
peak and low revenue, etc
3. Details on marketing and pricing strategies of the Company especially all
arrangements for long term supply of products from major vendors and
brands.

49
4. Average price realization (monthly) per unit for major product lines
categories of the Company in the last two years
5. Details of sales by key products and their average realizations in last
three years
6. Write up on the club membership scheme of the Company
7. Details of any market survey /research carried out by the target to
understand the market potential, profile of customers and buying patterns
8. Details of the current customer segment in terms of profile, daily walk-ins,
average sales per walk in
9. Details of the current Marketing and sales plan
10. Details of all sales promotions for last 6 months
11. Details of all marketing tie-ups (airlines, hotels etc.)

5. Suppliers
1. Purchase policies and procedures
2. List of major suppliers (including related party separately identified) in the
period ended showing nature of purchase, quantity purchased and
amount of purchases
3. Pricing policy for purchases from related companies
4. List of all significant contracts with the suppliers and big brands
5. Details of purchase at forward prices and forward purchase, if any
6. List of any claims / disputes with suppliers giving amounts and
background

6. Revenue and Contribution

1. Product-wise revenue classification for major categories (including
alcohol, tobacco ,confectionary, electronic goods) - both quantitative and
amount-wise
2. Details of sale by retail outlet also categorizing the same into airports, sea
ports, cruise ports etc
3. Historic product-wise contributions earned and gross margin; also
information contribution per store bifurcating between airport and sea
port
4. Details of average sale made per customer in last two years for major
categories
5. Budget / Actual analysis of the profit and loss account and the reasons for
variations
6. Details of sale per square feet of retail space by outlet
7. Comparison of revenue and contribution reflected in the financial
statements with the Management Information System (MIS) and budgets
8. Details of exceptional and extraordinary items
9. Details of other income
10. Details of sales returns, if any

50
7. Purchases and Consumption Costs
1. Material expenditure with the respective supply contracts
2. Details of average purchases made for major category of goods- both
quantitative and amount wise from major suppliers.
3. Details of volume discounts if any received from suppliers
4. Consumption costs for individual products; details of actual consumption
with standard
5. Details of the agreement /contract between the target and the airport
/seaport authorities/SEZ /Private Airport Operator and all payment details
for the last one year
6. Details of all disputes / claims with the airport /seaport authorities with
the amount and background

8. Expenditure
1. Details of any royalties paid to airport, seaport or cruise port authorities,
as relevant; please provide copy of any agreement for the above
2. Personnel cost including perquisites and retirement benefits
3. Details of repairs, rent, carriage and freight, goods handling expenses,
other expenses, etc
4. Details of the inventory write-offs in the last three years
5. Administrative and other expenses
6. Details of the selling and marketing costs
7. Details of financial costs including interest, lease rent and hire charges

Balance sheet
9. Fixed Assets
1. Summary showing principal categories of assets at last year end and most
recent accounting date showing cost, accumulated depreciation, net book
value and depreciation charge for the period
2. Details of capex by outlet, breaking up into different categories of assets
3. Details of charges or lien created against any fixed assets through
guarantees or loan arrangements
4. Details of insurance policies and coverage of fixed assets
5. Details of capital work in progress, if any
6. Contracts for pending capital commitments at last year-end and most
recent date - contracted for and authorized but not contracted
7. Copies of leasehold agreements (lease and sub-leases) and tenancy
rights, title deeds and other agreements giving amounts and terms
involved (renewal options for the lease period)
8. Fixed assets ledger/register and supporting documents for fixed assets
9. Physical verification reports and its periodicity

51
10. Terms and accounting practice for leased / hired assets; details of
financing arrangements and payments thereof and details of future
commitments, if any
11. List of all properties owned or operated that are connected to the
business with details of their book values, usage, title/ lease and rent
details

10. Inventories
1. Details of inventory / stock as on the latest date
2. Quantitative reconciliation of opening stock, purchases, sales and
wastage, etc.
3. Note on the method used for inventory valuation
4. Inventory valuation workings and its basis. Details of overhead and other
costs included in stock values
5. Age wise details of inventory as on latest date.
6. Provisioning policy of inventory and details of provision against inventory
as on latest date
7. Procedure for identification of slow moving and obsolete / unusable
inventories(expired and near expiry stocks)
8. An overview of the Supply chain cycle for the target
9. Details of all forward contracts and open purchase orders

11. Receivables
1. Party-wise break-up of Sundry Debtors balances if any as on the latest
date together with ageing and policy for provisioning for bad debts.

12. Loans and Advances and Other Current Assets

1. Details of Advances recoverable in cash or in kind or value to be received
with supporting documents as on Latest date. Reasons for advancement,
ageing, existence and adequacy of contracts and reasonableness of terms
and conditions of each receivable
2. Details of deposits with Public Bodies and others prepaid expenses with
supporting documents and balance confirmations. Review of the terms of
the deposits, ageing and subsequent clearances thereof
3. Details of Fixed Deposits held for disposal and interest accrued on
investments & deposits
4. Details of provision for doubtful advances, if any
5. Details of amounts due from staff and officers and their subsequent
clearances
6. Details of other receivables on account including reason for advancement,
ageing, existence and adequacy of contracts and reasonableness of terms
and conditions of each receivable

52
7. Nature and details of transactions with related company and accounts
ledger of these receivables
8. List of all bank guarantees and letter of credit open as on date.

13. Cash and bank balances

1. List of bank balances and bank accounts as on Latest date
2. Bank reconciliation statements and confirmations as on latest date
3. Details of the fixed deposit amount providing the date of deposit, interest
rates, etc
4. Note on cash collection, management system and control over cash sales
in different currencies
5. Note on control over credit card sales
6. Note on management of foreign currency fluctuation risk

14. Creditors and Accrued Expenses

1. List of trade creditors at Latest date
2. Ageing details of trade creditors along with supply contracts (including the
terms of payments)and subsequent payments
3. Contracts with the Vendors
4. Creditors balance confirmation certificates and reconciliation statements
as at latest date
5. Details of accruals with supporting documents and subsequent clearances
6. Details of off Balance Sheet Liabilities (such as leases)
7. Details of advances received with aging details, subsequent clearances,
etc
8. Basis of accruals of expenses and other liabilities

15. Amounts due to Related Parties

1. Nature and details of related company dues and account listing of these
dues since the incorporation of the Company

16. Secured and Unsecured Loans

1. Details & terms of working capital loans & other financing from banks &
other parties with their respective repayment schedule. Review of the
outstanding amounts at latest date, current interest rates, period, loan
covenants
2. Bank facility letters for encumbrances on assets
3. Details of any corporate/ personal guarantee extended
4. Confirmation from the Bank on the amount outstanding and interest
accrued thereon

17. Contingencies

53
1. Significant contracts, correspondence with solicitors, tax offices,
shareholders register
2. Details of claims against the Company not acknowledged as debt
3. Details of outstanding bank guarantees and bill discounted
4. Details of capital commitments, non-cancelable operating lease and other
commitments and contingencies
5. Details of litigation disputes against the company, promoters and group
concerns on the company
6. Confirmation from the lawyers about the list of legal issues and current
status of the same

18. Secretarial Records

1. Minutes of Board of Directors and Shareholders meetings
2. Shareholders register
3. Register of Directors and Contracts in which Directors are interested

19. Human Resources

1. Organization structure and reporting relationships as on Latest date
2. Number of employees, grade-wise in each of the outlets and by
department of the company
3. List of directors, officers, senior staff (considered key to the business)
showing position, name, age, length of service, skills, salary benefits, etc
4. HR systems prevalent in the organization, including performance
appraisal systems
5. Staff movement i.e. month-wise number of employees joining and leaving
the organisation in the last two years
6. Details of key employees who have left the Company in the past two
years
7. Is manpower hired from third parties? If so, agreements with these parties
8. Employee Provident Fund registration certificate, sample monthly
remittance challans, annual returns and correspondence with the relevant
authorities
9. Details of accrual of various retirement liabilities viz. leave encashment,
gratuity, etc. as on Latest date. Please also specify how the various
retirement benefit liabilities are funded
10. Details of the incentive programs (employee related) including the
payout details for current year.
11. Details of the split between on-roll and off-roll staff

20. Forecast
1. Details of the forecast for FY 2007 (reflecting actuals YTD) and FY 2008
along with detailed assumption on growth assumed in quantity sales,
prices, product-wise sales and margins, customers , sales and marketing

54
 costs, customer returns, raw material mix-quantity and prices, other
administrative costs, interest cost, etc
2. Details of new licenses expected to be received in future for new outlets
3. Details of new stores to be opened in new future
4. Details of any licenses which are due for re-tendering in next 3 years

TAXES
Direct Taxes:
21. Summary Information
1. Year-wise summary chart for income tax and wealth tax for past seven
years, detailing the following:
a. Current assessment/ litigation status
b. Key disallowances/issues raised by the authorities
c. Amount of demands raised by the authorities and paid by the
Company
d. Level of settlement of dispute (ie CIT(A)/ ITAT/ HC/ SC)
e. Taxable profit/ carried forward loss for the year and set off in future
years
2. Status of brought forward losses/ allowances, if any

22. Information for Review Period

1. Copies of Return, computation of income, transfer pricing report (along
with transfer pricing study) for three preceding years
2. Copies of tax audit report and other annexure for the latest three
assessment years
3. Copies of intimations, assessment orders, submissions made, appellate
orders etc for all open years
4. Details of tax benefits claimed by the Company
5. Year-wise details of amount appearing under the heads provision for tax
and advance tax as at latest date
6. Provisional computation of tax liability for the Financial Year ________,
based on which advance tax installments have been paid by the Company
7. Computation of amount appearing as deferred tax asset/ liability as at
latest date
8. Copies of legal opinions, if any, obtained by the Company
9. Copies of wealth tax returns (along with all annexure) filed by the
Company for three preceding years

Indirect Taxes:
23. Customs
1. Details of bonding created for storage and sale of goods and report on
compliance with obligations therewith

55
2. List of goods which are imported along with tariff classification and rate of
duty
3. Bills of Entry for all imports assessed provisionally
4. Licenses received for operations in all airports and seaports
5. Licenses granted (for import )
6. Licenses granted (under Duty Exemption Scheme)
7. Status on discharge of legal undertaking/ bonds including details about
the goods stored in bonded warehouses
8. Status of show cause notices (SCN) issued; submissions made,
adjudication thereon and appeals

24. Sales Tax / VAT

1. Status of compliance with various sales tax requirements
2. Assessment orders for last 3 assessed years (for CST, local sales tax)
3. Returns filed during the last 3 years
4. Application for any sales tax exemption, along with related documentation

25. Business Operations and Controls

1. Historical trend and last years shrinkage loss
2. High level overview of internal controls over stores operations
3. High level overview of their key business processes i.e. Stores Operations,
4. Details about the key policies i.e. Pricing policy, discount policy, Forex
Hedging policy, delegation of authority, shrinkage management policy,
stores audit process
5. Overview of the target IT systems and key controls over these systems
6. Details of all credit card chargebacks for the current year and details of
current credit card receipts for the last 6 months
7. Details of impact of change in regulators policy i.e. the licensing authority
8. Market share assessment for the target
9. Details of the following operational KPIs
a. Inventory Turnover Rate
b. Bad debt ratio
c. Sales allowance to revenue ratio
d. Selling cost to revenue ratio
e. Sales per sq. ft.
f. Average number of walk ins per day
g. Store Walk ins to the total number of passenger traffic
h. Average sale per walk in

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Conclusion
Thus from the above report we can conclude that there are various methods
of raising finance through the equity route to both the new start up business
as well as a totally established business. We also come to know why there is
a need for equity finance when already a cheaper source of finance is
available i.e. debt.

Also we come to know about the various regulatory issues and the procedure
of raising funds through equity. We can also conclude that valuation & proper
due diligence is very essential while investing through equity in any
business.

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