Lecture 26

Added: 2026-05-07

[00:00:19]Now let's discuss about the external sources. What are the external sources of financing? And in the external sourcing the first is equity financing.

[00:00:34]Let's discuss the primary disadvantage of this equity finding. Otherwise it sounds great but the primary and the high and the heavy impacted disadvantage this concept has is that the firm owners are going to dilute their controls if they go with the equity financing.

[00:00:56]They will definitely get the access to the capital because they they will definitely get the access to the capital but because their investors are going to become the partial owners of the firm in which they have invested. So they will definitely going to offer you certain kind of expertise and assistance which is good actually. You need their expertise, you need their assistant and there is nothing bad in that. But the problem is that you have you that but the problem is that at this point now the entrepreneur is not going to take decisions solely.

[00:01:36]their authority is going to get diluted and in return because this is not a loan uh in which the entrepreneurs and definitely it is not a loan on which the entrepreneur always have to pay the interest whether they are generating the profits or they are just going getting the losses. This is the investment in which the investor will receive a kind of return in the form of dividend only when the company is generating the profits.

[00:02:10]And the other source the investors would get to generate the money is they have an option to sell their share in the open market.

[00:02:21]The most three common forms of equity funding we are going to discuss in the coming slides are business angels, venture capitals and initial public offering which are also known as IPOs.

[00:02:35]Now let's start with B let's start with business angels.

[00:02:41]Business engines are those individuals who are ready and who are investing to and who are ready or who are even investing their personal capital directly in these startups. The term angel was first used in a conjunction with finance to describe wealthy New Yorkers who invested in Broadway plays.

[00:03:05]The prototypical business angel who invests in entrepreneurial startups is about 50 years of age and has high income and wealth, well educated, succeeded as an entrepreneur, succeeded as an entrepreneur and invest in companies that are in the region where he or she lives. This is a very ideal state. These investors generally invest between $10,000 to $5 in a single company and are looking for companies that have the potential to grow around 30 to 40% per year before they acquired or go public.

[00:03:42]Even many well-known firms have received their initial fundings from one or more business angels and when they decide to and when they decide to invest in a specific firm they ask them for the equity because they are looking for the equity.

[00:04:03]Let's take an example of Apple. Apple received its initial investment capital from Mike Mccula uh who used to be an high position executive with Intel. In 1977, Merula invested 91,000 in Apple and personally guaranteed another 2K50,000 US in credit lines because Marcula was not an idiot. He was definitely he was a very very intelligent man and he got the potential in the idea of Steve Jobs. So he decided to invest in it and in 1997 around $91,000 was a actually a big big amount and he decided to invest it and he eventually invested it.

[00:04:53]Do you know that when Apple went public in 1980 just after 3 years his stock in the company was worth more than 150 million US that was his return and this is the reason the angel investors are looking for the potential start ideas of startups because Mercula just because what Mula did he decided to invest just because he found the potential in the idea and just in 3 years just in 3 years after spending $91,000 he got $150 million US it is more than 150 times of his initial investment similarly in 1998 Google received its first investment from Sun Micros systemystems co-founder Andy Bachulition Andy Bachulition who gave Larry Page and Sergy Bin those are quite popular founders of Google a check of1 US after they just showed him a early version of their search engine because Andy decided to invest because he found the potential in the search engine. And can you imagine what happened with the investment of Andy Batush uh Andy Beck uh Andy Beto when Google went public in 2004 just after spending1 lakh US dollars of when Google went public in 2004 the company was valued about $23 billion. So Andy's initial capital was like u1 lakh US dollars which just he invested six year back. Now it turned into shares worth rupees 1.5 billion.

[00:07:04]So this is these people got and this is how the angel investors make money because the only option they have they are not going to get something directly on their returns. They don't want something directly on their investment.

[00:07:19]What they are looking for is a hike or is a jump on their share and then they have take a decision to sell off their share in the market and they may get 150 or even up to 200 300% of profits.

[00:07:36]Many angels are also motivated.

[00:07:40]Many angel investors are not only motivated for the sake of generating money but they also enjoy the process of mentoring a new firm because once they become owners they have a right to make they have a right to get involved in the decision making of the company. Most angels remain purely anonymous and are matched up with entrepreneurs through referrals. they just don't advertise themselves.

[00:08:09]Whosoever want to get in contact with them, they have to approach the existing entrepreneur. So this this is a kind of a networking through which you can reach these people to find a business engine investor and entrepreneur should discreetly work a network of acquaintances to see if anyone can make an appropriate introduction. One advantage which college students have in finding business angels is that many angels judge college or university sponsored business plan or business model competitions. So they just get in touch with the students.

[00:08:46]An example of angel group is an arbor angels. It is located in Ann Arbor in Michigan. The group invest in early stage technology companies in southeast Michigan.

[00:09:00]Now we need to understand how the angel investors group. Now the next thing you need to understand is how these angel investors group operate. So they operate in two stages. First is their screening processes and second is individual investment decision. In screening process when a startup apply for funding a small committee formed by these people first review their applications. This is the preliminary sorting round in which the committee decide which idea or which startup look promising enough to present their business ideas to the larger group of angel investors.

[00:09:39]This step actually saves time and ensure that only serious and highquality opportunities reach the entire group.

[00:09:47]And once they your idea or your proposal get passed with the screening process you get the opportunity to present your idea before the angel investors. In the second part, the angel investors or the group of them as a whole does not in invest ask you to give the presentation and they take the in and the next round the angel group ask you to give a presentation and they u take a decision on it and they take a decision on it.

[00:10:21]But one thing you need to remember that they are not going to it is not but one thing you need to remember that it is not like that they are just going to pull their investment all together and then take a collective decision. It is just about their individual decisions because they are going to give you money individually.

[00:10:43]Each member decides individually whether they are going to invest in a particular startup or not and then they take a decision how much they are going to invest and they give the money.

[00:10:55]Sometimes it also happen that they form a team and they some of them decide to invest together just for kind of uh sharing the risk or pooling the expertise. The next is venture capital.

[00:11:10]Venture capital is actually a money that is invested by venture capital firms in startups and small businesses with exceptional growth potential. In angel investors, the people were investing individually. But in venture capital, this is actually a money which is being invested by the entire venture capital firm. It's an organization or kind of partnership of money managers who raise money in funds to invest in startups and growing firms.

[00:11:40]A very a distinct difference between angel investors and venture capital firms is that the angels tend to invest earlier in the life of the company where venture capitals don't invest at that point.

[00:11:54]They entered into a later stage.

[00:11:57]The majority of venture capital money goes to follow on funding for businesses that were originally founded by angel investors. Sometimes government program or by other means. It is like they don't have to they don't they don't want to invest money at the initial stages. They always prefer to invest the money at some time later because they just want to ensure the credibility in a better or much stronger way.

[00:12:30]The funds or pool of money are raised from high net worth individuals uh perhaps from the pension plan, endowments, foreign investors and all. The investors who invest in venture capital funds are called limited partners.

[00:12:46]The venture capitalist who manage the funds are called general partners. So these are two different terms who invest they are who invest the money are called limited partners and who manage it are called general partners.

[00:13:02]The venture capital the venture capitalists who manage the fund receive an annual management fee in addition to 20 25% of the profits earned by the fund because they are the person who they are responsible to take a decision for the investment. And this percentage of profit or we can call it a commission these general partners are getting or these venture capitalists are getting is called carry.

[00:13:32]So, so if a venture capital firm raised 100 million fund and suppose it grew to 500 million then how much these managers would get and how much carry would be given. So let's calculate it.

[00:13:53]Five $500 would be the outcome.

[00:14:01]Then initi then you need to deduct $100 which was the initial investment. So the remaining amount is $400.

[00:14:09]Then calculate 20% of $400 that would be $80 million.

[00:14:22]So this is actually the carry. This is the 20% of the amount the they have generated for just managing the funds.

[00:14:36]We can take the example of foundry group who invest in information technology startups. Similarly, BEV Capital invest exclusively in consumer oriented business such as 1800 diapers and Red Fin because of the venture capital industry's lucrative nature and because in the past venture capitalists have funded highprofile success such as Google, Dropbox, Twitter, uh the industry receives a great deal of attention.

[00:15:09]Venture capitalist fund a relatively small number of entrepreneurial ventures.

[00:15:16]But one thing I we need to understand and one thing and I feel that one thing should be very clear to you at this stage is like venture capitalist fund are is like venture capitalist fund only are relatively small number of entrepreneurial ventures compared to what is being financed by the business engines.

[00:15:39]And this is particularly notable given that the large number of firms seeking funding.

[00:15:47]An advantage to obtaining this funding is what venture capitalists are extremely well-connected in the business world. And along with this money, they can offer a kind of assistant which is something we should call beyond funding.

[00:16:03]Firms that qualify typically obtain their money in stages that correspond to their own stage of development.

[00:16:11]Once a venture capitalist make an investment in a firm, subsequent investment are made around and as referred to as follow on funding.

[00:16:22]Let's have a look at the different stages or we call the rounds of venture capital funding. First is seed funding.

[00:16:29]Seed funding are the investment made very early in ventures life just for the prototype or the feasible development analysis.

[00:16:39]Prototype or the feasibility analysis.

[00:16:42]Then next is startup funding. It is when investment made in firms which are not making any commercial sales but they have developed their product and market research and but but they have developed their product and completed the market research. They have they they are claiming that their management is in place and they have a proper business model. They just need funds to start their uh operations.

[00:17:15]The third is first stage funding. First stage funding when the company just started its commercial activities and they just want to increase or enhance their sales. While second stage funding is about when they want to expand or when they want to uh scale up their capacities.

[00:17:38]The uh second last one is MES9 funding.

[00:17:41]MS9 is something which comes after the second stage funding. It is basically in the second stage I said that they when they want to scale up their operations and want to want when they want to enhance their capacity to produce more because they are predicting more demand in the market. So MSN financing is about when they have used this second stage financing and they are about to launch an IPO. So this is the last option they have and they want to explore it. If they don't want to go directly with the IPOs and if they get the fin mez9 funding or mez9 financing it's perfectly all right otherwise they are they will otherwise they will launch an IPO buyout funding it is the funding which is provided to help one company to acquire another there another term which we really need there is another term which we really need to understand at this point is corporate venture capital.

[00:18:44]Along with this traditional venture capital, there is also corporate venture capital.

[00:18:50]This type of capital is similar to traditional capital which is accept that the money comes which expect which accept that the money comes from corporations that invest in startups related to their areas of interest.

[00:19:07]Corporate venture capital firms provide an estimated 10.5% of the venture capital invested in all venture groups. It is we can say in simple words we can say that it is different from the traditional venture capital is that in in one way that in corporate venture capital businesses are pooling their money and they are keen to invest not individuals like in traditional venture capital firms.

[00:19:39]Example of corporate venture capital firms include Intel Capital, Google Ventures and Time Warner Investments.

[00:19:46]But there is a myth. We need to remove this myth before going further. The myth is about the capacity. The myth is the myth is about the strength of the support you are got getting through the venture capital.

[00:20:07]Because the firm receive venture capital funding doesn't mean that it is a sure shot game. doesn't mean that they are going to get success in anyhow. In fact, venture funded firms are under extreme pressure to perform because they have to meet the investors expectations.

[00:20:28]Let's take the example of a company known as Drawquist. It was a startup that got funding from venture capitalist.

[00:20:36]However, despite this financial backing, the company ultimately failed in the market because nobody can guarantee a short shot success. Its story is discussed in a special edition titled what went wrong which examined the reasons of failures of businesses. The feature include a personal statement from the founder Chris Pool in which he shared his emotional experience and reflections about what's like to feel after receiving venture capital investment.

[00:21:07]His comments offer a rare and honest view of the pressure, responsibility and disappointment that entrepreneurs can feel when their investors money is lost due to the business failure. due to the business failure.

[00:21:25]Now the another option is initial public offerings.

[00:21:30]Initial public offerings I just we just discussed about this me uh we just discussed about this MES9 financing. So if their uh requirements are not being filled by the MS9 financing ultimately they will go to the initial public offerings. Initial public offerings are also known as IPOs is another source of equity funding to about to sell stock to the public by staging an IPOs.

[00:21:58]IPO is the first sale of a stock by a firm to the public. Before that firm was just moving with the venture capitals and angel investors.

[00:22:09]Any later public issuance of share is referred to as secondary market offerings because after this first issue or first sale these equity will start revolving or rotating into the general market. When a company goes public it stock is typically traded on one of the major stock exchanges.

[00:22:30]Most entrepreneurial firms that go public, they trade on a stock exchanges which is weighted heavily toward technology, biotech and small company stocks. An IPO is a significant milestone for a company. It means that company is capable enough to get the money from the open market.

[00:22:52]Typically, a firm is not able to go public until it has demonstrated that it is viable and has a bright future.

[00:23:00]And if it is going to the public and if it is issuing an IPO, it is coming up with an IPO means that public have faith in this idea and in his potential.

[00:23:11]Public has faith in its idea and his potential.

[00:23:18]Sometimes firm decide to go public for several reasons like it's a way to raise equity capital to fund current and future operations.

[00:23:27]Uh secondly, an IPO raises a firm's public profile. It is uh making it easier to attract highquality customers, partners and employees because everyone can say that the company has already issued an IPO and it is doing well in the market. Thirdly, we can say that an IPO is a liquidity event that provides a mechanism for the company's stockholder including its initial investors to cash out their investment because after the uh this public offering and after the IPO the equity will start revolving into the share into the stock exchanges and anyone who owns the equity and is the shareholder is allowed to sell their share in the open market and get cash in return.

[00:24:18]Finally, by going public, a firm creates another form of currency that that a firm creates another form of currency that can be used to grow the company that is his equity and its shares or the transfer of shares in the open market.

[00:24:38]It is not uncommon for one It is also not uncommon for one firm to buy another company by paying for it with stock rather than with cash.

[00:24:50]The stock comes from the stock comes from authorized but not yet issued stock which in essence means that the firm issues new shares of stock to make the purchases.

[00:25:04]uh we can give you the examples of Facebook, Twitter, Alibaba or Candy Crush Saga's manufacturer that is the King Digital Entertainment, King Digital Entertainment, they have gone public in recent years.

[00:25:21]Now the next question is how you can do this activity. Suppose if a one firm wants to is suppose a one firm is not satisfied enough with the fundings they are getting through angel investors and venture capitalist. Now they decided to go with the IPO how they can do it. So they have to follow certain steps in this regard. The first step is initiating a public offering for a firm is to hire an investment banker or uh investment bank. An investment bank is an investment bank is actually an institution that acts as an underwriter or agent for a firm to issue the securities. The investment bank acts as the firm's advocate and advisor and guiding it through the process of going public because a lot of legal compliances are there. They have to fulfill that.

[00:26:18]The most important issue the firm and its investment bank must agree.

[00:26:23]The most important issue at this point is the firm and the investment bank must agree that the amount of capital needed by the firm and the type of stock they are going to issue the prices of the stock when it is going to get public and the cost of the firm to issue these securities. So these things need to be decided properly between the firm and its investment bank. If there are some certain ambiguities left, it is going to be a big trouble for both the parties.

[00:26:56]Then the investment bank files a preliminary prospectus. Prospectus is actually a kind of document or in other in another words we can say it's an advertisement to invite general public to apply for the equity in a specific company. So investment bank initially files uh preliminary perspectives that describe the offering to the general public.

[00:27:22]So uh the securities regulator like say in India, SEC in US they can invest they can investigate the potential offerings.

[00:27:35]Then company executives and underwriters conducts a road show. It is about presenting the business idea to the institutional investors who generate interest and based on the feedback and demand they see in the market or the feedback they get from them. The final IP price per share and the number of shares to be issued are determined. This is determined and then discussed and finally decided with the investment bank. On the IPO day, the company's share are officially listed on an stock exchange. Like in India, the BSE and NSE are there. BSE and NSE are there. In US, NASDAQ and YSE is there. Investors can now buy and sell shares in the open market. The company receives the capital raised from IPO minus underwriting charges and other expenses and other expenses incurred in conducting this IPO.

[00:28:31]After listening, the company must follow ongoing disclosure and compliance requirements, the norms and formalities of the government which need to be fulfilled by the company. The share price now reflects market perceptions and performance because this is the best way if you want to check the performance of a company you may check its share price. If the share prices are continuously increasing that means and it shows that the company is performing really really good in the market and this is one of the uh most established parameters to know the performance of the company.

[00:29:08]Now it's time to wind up this lecture and before winding up this lecture I think we should have a quick look at the summary of this lecture and in this lecture we have learned about the importance of funding in startups different sources of funding in what is internal financing bootstrapping personal savings family and friends.

[00:29:30]Then we started discussing about the equity financing. We discussed about all three very uh different types of equity financing like business angels, venture capitals and IPOs.

[00:29:43]Thank you for your engaged participation today. Now you have started understanding the significance and sources of fundings in startups and in the coming lectures we are just going to discuss the other forms of generating finances for these startups. Thank you all and I look forward to continuing this journey with you next time. Thank you.