Unit 4: Institutional setup for term finance and working capital finance
Institutional Setup for Term Finance and Working Capital Finance
Companies need two types of finance:
A. Term Finance
- Long-term funds (more than 1 year)
- Used for fixed assets: plant, machinery, land, buildings, modernization.
B. Working Capital Finance
- Short-term funds (up to 1 year)
- Used to meet day-to-day operational needs: inventory, wages, bills, utilities.
Different institutions provide these according to their mandate.
Term-Lending Institutions (Development Finance Institutions - DFIs)
These institutions provide long-term loans, project finance, modernisation loans, and technical support.
Examples in India:
1. IFCI (Industrial Finance Corporation of India)
- Oldest DFI (est. 1948)
- Provides medium and long-term credit for industrial projects.
2. IDBI (Industrial Development Bank of India)
- Initially a DFI (1964), now also a commercial bank.
- Provides industrial finance, project appraisal, and infrastructure finance.
3. ICICI (Industrial Credit and Investment Corporation of India)
- Established 1955; now ICICI Bank.
- Provides project finance, modernization, and industrial loans.
4. SIDBI (Small Industries Development Bank of India)
- Established for Micro, Small & Medium Enterprises (MSMEs).
- Provides long-term finance, refinancing to banks, and cluster financing.
5. Exim Bank (Export-Import Bank of India)
- Provides term loans to exporters and importers.
- Supports export promotion, overseas investment financing.
6. NABARD
-
Provides finance for rural development, agriculture, co-operatives.
Role of DFIs
- Promote industrial growth
- Finance infrastructure
- Provide long-term loans
- Support technology upgradation
- Assist in project development and advisory services
Commercial Banks
Commercial Banks provide both:
- Working Capital Finance (primary role)
- Term Finance (to some extent)
Functions Related to Finance
- Cash Credit / Overdraft
- Short-term Loans
- Trade Finance (Bills discounting, LC)
- Term Loans for 3–7 years
- Bank Guarantees
- Project Appraisal
Banks follow RBI guidelines on credit, asset classification, and interest rates.
NBFCs (Non-Banking Financial Companies)
NBFCs provide financial services without having a banking license.
Types
- Asset Finance Companies (AFC)
- Loan Companies
- Infrastructure Finance Companies
- Investment Companies
- Microfinance NBFCs
Services Provided
- Medium and long-term loans
- Equipment leasing
- Hire-purchase financing
- Housing finance
- Vehicle finance
- Personal loans / SME loans
NBFCs play an important role in credit expansion, especially where banks are less accessible.
Commercial Banking
Commercial banks are financial institutions offering banking and credit facilities.
Main Functions
- Accepting Deposits
- Providing Loans and Advances
- Facilitating Payments (RTGS, NEFT, UPI)
- Credit Creation
- Trade Financing
Role in Economy
- Promote savings
- Provide liquidity
- Support industries and agriculture
- Encourage entrepreneurship
Working Capital
Working Capital = Current Assets – Current Liabilities
It is the money needed for day-to-day operations.
Types
- Gross Working Capital → Investment in total current assets
- Net Working Capital → Current Assets – Current Liabilities
- Permanent Working Capital → Minimum level required always
- Temporary Working Capital → Additional during peak seasons
Sources of Working Capital Finance
- Cash Credit
- Overdraft
- Trade Credit
- Commercial Paper
- Factoring
- Bank Loans
- Advances from customers
Determinants
- Business cycle
- Inventory level
- Credit policy
- Production process duration
- Sales level
Venture Capital
Venture Capital (VC) is financing provided to high-risk, innovative, early-stage startups with long-term growth potential.
Key Features
- High risk
- High return expectation
- Equity participation
- Active involvement in management
- Provided in stages
Stages of Venture Capital Finance
| Stage | Description |
|---|---|
| 1. Seed Capital | Idea-stage loan to develop prototype |
| 2. Start-up Finance | For product development & initial marketing |
| 3. Early-stage / First-stage Finance | For manufacturing, hiring, expansion |
| 4. Expansion / Growth Stage Finance | Scaling up operations, large investments |
| 5. Bridge / Mezzanine Financing | Before IPO or acquisition |
Venture Capital Funds (VCFs)
These are professionally managed investment funds that invest in startups.
Sources of Funds
- High-net-worth individuals (HNIs)
- Pension funds
- Corporates
- Banks
- Financial institutions
Types of Venture Capital Funds
- Public Venture Capital Funds Example: IFCI Venture Capital Funds, SIDBI Venture Capital
- Private Venture Capital Funds Example: Sequoia Capital, Tiger Global, Accel Partners
- Corporate Venture Capital Example: Google Ventures, Intel Capital
- Foreign Venture Capital Funds Global VC firms investing in Indian startups
Functions
- Fund high-potential innovators
- Evaluate and mentor entrepreneurs
- Provide managerial and technical support
- Facilitate scaling and international expansion
Exit Strategies
- IPO (Initial Public Offering)
- Trade Sale (merger/acquisition)
- Buyback by promoters
- Sale to another investor (secondary sale)
Summary Table
| Topic | Key Points |
|---|---|
| Term-Lending Institutions | Provide long-term loans for industrial projects (IDBI, IFCI, ICICI, SIDBI). |
| Commercial Banks | Provide working capital, short-term and term loans. |
| NBFCs | Provide specialized finance: leasing, hire purchase, SME loans. |
| Working Capital | Funds for daily operations; includes cash credit, overdraft, bill discounting. |
| Venture Capital | High-risk capital for startups; provided in stages. |
| Venture Capital Funds | Managed funds investing in high-growth startups; have different exit routes. |
Stages in Venture Capital Financing
Venture capital financing takes place in multiple stages depending on the maturity of the startup.
A. Seed Stage
- Funds provided for research, idea development, prototyping.
- No finished product yet.
- Very high risk.
B. Start-up Stage
- Financing for product development, initial marketing, pilot launch.
- Product exists but revenue is minimal.
C. Early Stage / First Stage
- Funds used for full-scale production, hiring key staff, marketing expansion.
- Company begins generating early revenue.
D. Second Stage / Expansion Stage
-
For growing companies needing capital to increase production capacity, expand into new markets, or improve technology.
E. Third Stage / Growth Stage
-
For large-scale expansion, acquisitions, or entering international markets.
F. Bridge / Mezzanine Stage
- Final stage before IPO.
- Used for working capital needs, strengthening balance sheet.
G. Later Stage Financing / Pre-IPO Stage
- Final round of funding (Series D, E, etc.)
- Goal: maximize valuation before listing or acquisition.
Business Plan
A business plan is a written document that describes the business idea, strategy, market, financials, and future projections.
Purpose of a Business Plan
- Helps entrepreneurs clarify vision
- Required for attracting venture capital
- Acts as a roadmap for growth
- Helps banks and investors assess feasibility
Elements of a Business Plan
A strong VC-ready business plan contains the following components:
| Section | Details |
|---|---|
| 1. Executive Summary | Overview of business idea, objective, USP, funding needs. |
| 2. Business Description | Nature of business, mission, vision, legal structure. |
| 3. Product / Service Description | Features, value proposition, innovation, stage of development. |
| 4. Market Analysis | Industry structure, target customers, demand analysis, market trends. |
| 5. Competitive Analysis | Existing competitors, barriers to entry, SWOT. |
| 6. Marketing & Sales Strategy | Pricing, promotion, distribution, branding, customer acquisition plan. |
| 7. Operations Plan | Location, raw materials, production process, supply chain. |
| 8. Management Team | Founder background, skills, advisory board, organizational structure. |
| 9. Financial Plan | Projected income statement, balance sheet, cash flow, breakeven analysis. |
| 10. Funding Requirements | Amount needed, use of funds, stage-wise allocation. |
| 11. Risk Analysis | Technical, financial, market, regulatory risks with mitigation. |
These elements help investors evaluate potential return and risk.
Process of Venture Capital Financing
Venture capital financing follows a systematic process:
1. Deal Origination
-
VC firms receive proposals from entrepreneurs, incubators, startup events, or referrals.
2. Screening
Basic filtering based on:
- Industry fit
- Stage of business
- Innovation
- Market potential
3. Due Diligence
Detailed analysis of:
- Business model
- Founders' background
- Technology and product
- Legal compliances
- Financial statements
- Market feasibility
4. Negotiation of Terms
Discussion of:
- Amount of investment
- Equity stake
- Valuation
- Rights and obligations
- Exit route
5. Final Approval
-
Investment committee approves deal.
6. Funding
-
Funds released in tranches based on performance milestones.
7. Post-Investment Monitoring
VC participates in:
- Strategic decisions
- Board meetings
- Mentoring
- Hiring senior management
- Market expansion
8. Exit
VC exits through:
- IPO
- Acquisition
- Buyback
- Secondary sale
Methods of Venture Capital Financing
Venture capital can be provided through different instruments:
A. Equity Financing
- VC buys equity shares.
- High-risk, high-return.
- VCs gain ownership and voting rights.
B. Conditional Loans
- No interest charged.
- Royalty is paid after the venture starts making profits.
- Used for tech startups.
C. Convertible Debentures
- Loan that converts into equity at a later stage.
- Reduces risk for the VC.
D. Income Notes
Combination of:
- Interest (fixed)
- Royalty (variable)
E. Participating Debentures
VCs receive:
-
Fixed interest + share in profits.
F. Mezzanine Financing
- Hybrid of debt and equity.
- Used in late stage to prepare for IPO.
G. Direct Equity + Management Support
VC acts like a partner by offering:
- Strategy guidance
- HR and marketing support
- Tech improvements
Future Prospects of Venture Capital Financing
Venture capital is growing rapidly due to:
1. Rising Startup Ecosystem
India has become the 3rd largest startup ecosystem in the world.
More startups → more VC funding.
2. Government Support
Programs like:
- Startup India
- Make in India
- Digital India
- SIDBI Fund of Funds
These encourage VC investments.
3. Technological Innovation
Growth in:
- FinTech
- EdTech
- HealthTech
- AI/ML
- Robotics
- E-commerce
These sectors require high-risk capital.
4. Growing Angel Investor Base
More HNIs and corporate investors entering the VC space.
5. Global Investor Interest
Global firms like SoftBank, Sequoia, Tiger Global, Accel are actively investing in India.
6. Increasing IPO Market
More startups going public (Zomato, Nykaa, Paytm).
Increases confidence in VC returns.
7. Expansion of ESG & Impact Investing
Investments in environment, social, and governance-based startups.
8. Improved Infrastructure
Digital payments, cloud computing, logistics, data centres encourage startup growth.
Summary
| Topic | Key Points |
|---|---|
| Stages | Seed → Startup → Early Stage → Expansion → Growth → Bridge → Pre-IPO |
| Business Plan | Executive summary, market analysis, financial plan, management team |
| Process | Origination → Screening → Due diligence → Negotiation → Funding → Monitoring → Exit |
| Methods | Equity, conditional loan, convertible debenture, mezzanine finance |
| Future | Strong growth, govt support, technological innovation, rising global investments |