Foundation of a Idea
Imagine a person called Arjun Reddy with a luminous money making idea , to manufacture highly used hand towel and T-shirt with fragrance of fresh flower, with unique designs, affordable price and the high quality fabric which last for long period of use. He is Arjun Reddy is very sure that the business will be super-hit , and is all enthusiastic to launch the idea into a business. In case every classic entrepreneur he is likely to be hit by the classic problem – where would he get the investment to fund his idea? As Arjun Reddy has no business background he will not be able to attract any serious investor in beginning. Chances are, he would approach his family and friends to pitch the idea and raise some money. He could approach the bank for a loan as well but bank will not show interest in funding new idea.
For an start he used his saving to bank his idea and also convinces 2 of his friends Kabir Singh and Ranvijay Singh to invest in his business. Because these two friends are investing at the pre revenue stage and taking a blind bet on the entrepreneur they would be called the “Angel investors”. Any money from the angels is not a loan, it is actually an investment made by them.
The promoter here Arjun Reddy with his friend the angels raise Rs. 10 million as a capital. This initial money that he gets to kick the business is called ‘Seed Fund’. It is important to note that the seed fund will not deposited in promoter personal bank account but instead deposited in the company’s bank account. Once the seed fund deposited to company’s bank account, the money will be called to be initial share capital of the company.
For the investment which is made as initial capital the promoter along with angles investor will receive share certificated which as proof of their holding percentage and amount they paid
The only asset that the company has at this stage is cash of Rs.10 million , hence the value of the company is also Rs.10 million. This will be called as valuation company’s. Issuing shares is quite simple, the company assumes that each share is worth Rs.100 and because there is Rs. Rs.10 million as share capital, there has to be 0.10 million shares with each share worth Rs.100. So Rs.100 is called the ‘Face value’ (FV) of the share. The face value could be any denomiantion. If the FV is Rs.5, then the number of shares would be 5 million, so on and so forth. The total of 0.10 million shares is called the Authorized shares of the company. These shares have to be allotted amongst the promoter and two angels plus the company has to retain some amount of shares with itself to be issued in the future. So let us assume the promoter retains 50% of the shares and the two angels get 8% each and the company retains 34% of the shares. Since the promoter and two angels own 66% of the shares, this allotted portion is called Issued shares
After 3 yearlong of hard work pays off and the business starts to grow up. At the end of the 3 years of operations, the company starts to break even. The promoter is now no longer a newborn promoter, instead he is more knowledgeable about his own business and of course more confident
Arjun Reddy now wants to expand his business by adding one more manufacturing plant and 7 new retail stores in the city. He chalks out the plan and figures out that the fresh investment needed for his business expansion is Rs. 50 million. He is now in a better situation when compared to where he was 3 years ago. The big difference is the fact that his business is generating revenues. Healthy inflow of revenue validates the business and its offerings. He is now in a situation where he can access reasonably know-how investors for investing in his business. So he meets one such professional investor who agrees to give him 50 million for a 10% stake in his company. The investor who typically invests in such early stage of business is called a Venture Capitalist (VC) and the money that the business gets at this stage is called Series A funding. the balance 24% of shares is still retained within the company and has not been issued.
After the VC’s money coming into the business, a very interesting development has taken place. The VC is valuing the entire business at Rs. 0.5 billion by valuing his 10 % stake in the company at Rs. 50 million. With the initial valuation of Rs.10 million , there is a 50X increase in the company’s valuation. This is was a good business idea made by Arjun Reddy , validated by a hefty revenue stream can do to businesses. It works as a perfect mix for wealth creation business.
Now 2 more years pass by and the company is phenomenally growing in its segment . The company decides to have a retail presence in at least 5 more cities. Backing for their retail presence across 5 cities, the company also plans to increase the production capacity and hire more resources. Whenever a company plans such expenditure to improve the overall business, the expenditure is called ‘Capital Expenditure’ or we call ‘CAPEX’. The management estimates 1 billion towards their Capex requirements. How can the company fund its Capex requirements? There are few options with the company to raise the required funds for their Capex…
1.The company has made some profits over the last few years; a part of the Capex requirement can be funded through the profits. This is also called funding through internal accruals
2.The company can approach another VC and raise another round of VC funding by allotting shares from the authorized capital – this is called Series B funding
3.The company can approach a bank and seek a loan. The bank would be happy to tender this loan as the company has been doing fairly well. The loan is also called ‘Debt’
The company decides to exercise all the three options at its disposal to raise the funds for Capex. It ploughs 0.40 billion from internal accruals, plans a series B - divests 6% equity for a consideration of 0.42 billion from another VC and raise 0.18 billion debt from the banker. So, with 0.42 billion coming in for 6%, the valuation of the company now raise to 7 billion.
Now the company have left with 18% of shares not allotted to shareholders
which are now being valued at 1.26 billion. This is happens to entrepreneurs
with great business ideas, and with a highly skilled management team. Classic real world examples
of such wealth creation stories would be Reliance, TCS , Wipro.
Arjun reddy now aspires to go global as he wants build his brand to be available across all the major international cities; he wants at least 5 retail outlets in each major city across the world. This means, the company needs to invest in market research to understand what people like in other countries, they need to invest in people, and also work towards increasing the manufacturing standards and size. Besides they also need to invest into land space to open there retail outlets across the world. This time around the Capex requirement is huge and the management estimates this at 10 billion. The company has few options to fund the Capex requirement.
1. Fund Capex from profit and reserve and surplus
2.Raise debt from bankers
3. Float a bond
4. File for an Initial Public Offer (IPO).
When a company files for an IPO, they have to offer their shares to the general public. The general public will subscribe to the shares if they want to by paying a certain price. Now, because the company is offering the shares for the first time to the public, it is called the “Initial Public Offer”.
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