Corporate ventures can be financed through internal or external sources. Internally, retained earnings and reserves can provide funds. Externally, companies can obtain debt through short, intermediate, or long-term loans. They can also sell preferred or common stock. The optimal financing strategy depends on the company's cost of capital and current debt levels compared to its industry peers. Large institutional investors are a major source of external corporate financing.

1. Financing the Corporate Venture

2. How to finance?
• Prior to WWI, companies were owned and operated by the
founders.
• Funds for various expenditures (replacement of worn-out
equipment, modest plant expansions) from the company
earnings.
• After WWII, internal funds not sufficient to meet company
needs.
– Mergers
– Acquisitions
– Joint ventures
– Alliances
• External sources the only option for large-scale projects.

3. Business Plans
• A business plan must be developed before any
funds are sought for a new product or venture.
• Business Plans minimally consist of the following
information along with a projected timetable:
– Perceived goals and objectives of the company
– Market data
• Projected share of the market
• Market Prices
• Market Growth
• Market the company serves
• Competition, both domestic and global
• Project and/or product life

4. Business Plans
– Capital requirements
• Fixed capital investment
• Working capital
• Other capital requirements
– Operating expenses
• Manufacturing expenses
• Sales expenses
• General overhead expenses
– Profitability
• Profit after taxes
• Cash flow
• Payout period
• Rate of return
• Returns on equity and assets
• Economic value added

5. Business Plans
– Projected risk
• Effect of changes in revenue
• Effect of changes in direct and indirect expenses
• Effect of cost of capital
• Effect of potential changes in market competition
– Project life:
• Estimated life cycle of the product or venture
• The business plan is then submitted to the
sources of capital funding, e.g., investment
banks, insurance companies.

6. Sources of Funds
• The funding available for corporate ventures may be obtained from
internal or external sources.
• Internal financing is “owned” capital – could be loaned or invested
in other ventures to receive a given return.
• Internal funds may be retained earnings or reserves.
• Retained earnings of a company are the difference between the
after-tax earnings and the dividends paid to stockholders.
• Usually not all after-tax earnings are distributed as dividends.
• The part retained by company is used for R&D expenditures or for
capital projects.
• Reserves are to provide for depreciation, depletion and
obsolescence.
• Inflation cuts severely into reserves.

7. Sources of Funds
• Three sources of external financing:
– Debt
– Preferred stock
– Common stock
• A new venture with modest capital
requirements could be funded by common
stock.
• In contrast, a well-established business area
may be financed by debt.

8. Debt
• Debt may be classified as:
– Current debt: maturing up to 1 year
– Intermediate debt: maturing between 1 and 10 years
– Long-term debt: maturing beyond 10 years
• Current debt: Suppose a company wants to take a loan it
will pay off in 90-120 days.
– It can obtain a commercial loan from a bank.
– It can borrow from the open market using a negotiable note
called commercial paper.
– Open-market paper or banker’s acceptance: The company could
sign a 90-day draft on its own bank paid to the order of the
vendor; the company will pay a commission to its own bank to
accept in writing the draft.

9. Debt
• Intermediate debt:
– This form of debt is retired in 1-10 years
– Three types:
• Deferred payment contract: borrower signs a note that
specifies a series of payments to be made over a period of
time.
• Revolving credit: the lender agrees to loan a company an
amount of money for a specified time period. A commission
or fee is paid on the unused portion of the total credit.
• Term loans: divided into installments that are due at
specified maturity dates. Monthly, quarterly, semiannual or
annual payments.

10. Debt
• Long-term debt:
– Bonds are special kinds of promissory notes.
– Four types of bonds in the market:
• Mortgage bonds – backed by specific pledged assets that may be
claimed particularly if the company goes out of business.
• Debenture bonds – only a general claim on the assets of a
company. Not secured by specific assets but by the future earning
power of the company.
• Income bonds –interest is paid not on loan taken but on earnings
in that period; used to recapitalize after bankruptcy and the
company has uncertain earning power.
• Convertible bonds – hybrids that can be converted to stock. Bonds
are safe investments in periods of low inflation or deflation. Stocks
reflect the inflationary trend and retain purchasing power.

11. Stockholders’ Equity
• This is the total equity interest that stockholders have
in a corporation.
• Two broad classes:
– Preferred stock
• These stockholders receive their dividends before common
stockholders.
• These stockholders recover funds before common stockholders in
case of company liquidation.
• Have no vote in company affairs.
– Common stock
• Common stockholders are at greatest risk because they are the
last to receive dividends for use of their money.
• Have a voice in company affairs at the company annual meetings.

12. Debt versus Equity Financing
• The question is a complex one and depends on other issues:
– State of the economy
– Company’s cost of capital, i.e. cost of borrowing from all sources.
– Current level of indebtedness
• If a company has a large proportion of its debt in bonds, it may not
be able to cover the interest on bonds.
• A high debt/equity ratio is a weakness.
• Many capital-intensive industries like chemicals, petroleum, steel
etc have ratios of 2 or 3 to 1.
• They may have to liquidate some of their assets to survive.
• On the other hand, if ratio is 1 to 1, chance of a takeover.
• A company must have a debt/equity ratio similar to successful
companies in the same line of business.

13. In Conclusion
• The largest holders of corporate securities are
“institutional” investors.
• These include
– Insurance companies
– Educational organizations
– Philanthropic organizations
– Religious organizations
– Pension funds
• They may purchase securities in a “private”
placement or in the open market as initial public
offerings (IPO).