Good Practice

Venture Capital and Financial Institutions

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Many incubated enterprises will need to raise capital to support growth at some stage in their development. This article discusses a variety of forms of finance potentially available, to help incubators provide the best advice to their clients.

Objectives

This Guideline discusses the role that venture capital and financial institutions can play in enterprise development.

At some time most companies come face-to-face with a situation in which they must expand at a rate that is greater than their financing capacity can support. This is a crucial stage in which the company must expand to move to a new level or face the threat of a degenerative process of sluggish growth that will eventually lead to its demise. The discovery that a company’s available capital will soon be insufficient to support the pace of growth is a consequence of the fact that, sooner or later, the majority of new companies are forced to seek a source of long-term financing to sustain their growth.

Based on these factors, it is fundamental that the businessperson involved seeks out the knowledge that is required to be able to understand and control the systems of capitalization available on the market, with the objective of increasing the success of the company’s growth process.

The major objective of accessing capital is to strengthen the company’s short and medium-term financial position, making it possible to implement new investment plans focused either on the development of new products or the expansion of the company’s market position.

The processes of business capitalization presuppose the existence of investment or business plans involving development of new product lines. Before seeking new capital, it is essential that the company clearly defines and documents the use to which these funds will be put.

Key Issues

Forms of Capitalization

Generally, two sources of capital are available to companies: their own capital and third party capital.

The forms of capitalization depend basically on the origin of the capital. Capitalization through the use of the company’s own capital is normally quite simple and depends on the existence of capital reserves set aside by the company, the resources available to the partners to increase the capital of the company, or resources that are made available by informal sources to the individual person (for example, family resources). The resources normally enter through the company’s cash account or through capital increases that are registered in contract form (in the case of limited liability companies).

Capitalization based on third party capital requires that the company prepare a detailed report of its intentions (plans).

Capital inflows can take the following forms:

Loan capital
Conventional financing lines
Operated by commercial banks, these lines are based on loan contracts that require collateral and guaranties. These are usually short-term options and their typically higher costs can make projects unfeasible.
Subsidized/special financing lines
Made available by the government and operated by official financing agencies and commercial banks. The conditions are better than in conventional operations, principally in terms of interest and maturity terms. However, many of these also require collateral.
Incentive programs for skill training and development
Resources made available by the government and operated by the ministries. These are nonrefundable resources and must be reflected in projects developed by the companies.
Capital investment
Capitalization through new partners
In the case of limited liability companies, entry of a new partner is affected through alterations to the company’s articles of incorporation. There are no preset earnings defined for this capital and the new partner receives a quota of the existing capital of the company.

In the case of corporations, there are forms of capitalization that make it possible for companies to obtain capital without resorting to new partners. There is specific legislation for corporations that make it possible for them to issue securities on the financial market in order to obtain needed resources. Depending on the form and the market on which they are issued, these securities can bear specific denominations and series. In the case of small businesses and incubated companies, the mostly commonly used securities are debentures.