Sourcing Funds from Venture Capitalists, Creditors, Bonds and Equities - Essay Example

Sourcing Funds from Venture Capitalists, Creditors, Bonds & Equities ID 19714 Order No. 288074 [Name] [University Name] [Course Name] [Supervisor] [Any other details] 09 April 2009 Table of Contents: Introduction: In this short essay, the author presents the rationale of sourcing funds by the finance managers. The sources of funds prevalent in Croatia and the preferred mode by Finance Managers are discussed and some discussion points presented in this context. Do finance managers source funds to maximize shareholder wealth Funds are raised by corporations through various means - Venture Capitalists, Banks & Financial Institutions, Mutual Funds, Publicly traded Equities, Private & Public Bonds, etc. Fund raising is one of the primary duties of finance managers. But why are funds raised They are raised to build capital & contingency funds, to fund the operational expenses or overcome corporate losses. Funding may improve the capitalization of the firms at the face value but doesn't mean that they have increased the share holder value. Funds are collected with some business objectives to realize the benefits of current innovations in the form of product launch, market campaigns, investments in profit making financial instruments, funding running projects with assured returns (like government projects bagged against tenders, infrastructure projects, conflict-free projects that have realized large payments prior to funding), etc. and invest the equities thus built (as an outcome of profits realized from projects) into diversifications, expansions, new Plant & Machinery purchase, new business initiatives, etc. This means that the primary objective of funding should be to invest in profit making ventures that can increase the valuation of the assets of the company and hence result in profits for the investors & in the process improve of share holder value. Faure-Grimaud and Gromb (2004. pp986-987) presented that block of funds raised by a corporation is controlled by insiders for the purpose of improving asset valuation of the corporation by allocating corporate resources or acquiring new resources. In the process of increasing firm's asset valuation, the shareholders increase their own wealth as well but this should be viewed more as an incentive of the shareholder's tangible value-increasing actions and not as the fundamental objective of fund raising. Amihud and Garbade et al. (1999. pp453) argued that after a company has taken the debt, a conflict of interest arises between creditors, managers and shareholders. Managers are forced by share holders to maximize their wealth and in this process may end up maximizing risk taking activities. Example, shareholders may be tempted to invest the debt (rather than equity) in high risk projects that may maximize equity at the cost of debt at the cost of overall devaluation of the company. These conflicts call for effective corporate governance which requires lot of contribution by finance managers. They have to manage the compromise between creditors and shareholders by keeping the former satisfied with the investment portfolio while controlling the wish list of the shareholders. Sources of Funds available in Europe (including Croatia) Bottazzi and Rin et al. (2002. 239-244) reported the source of long term funding in Europe (Croatia included) as the Venture Capitalist funding from Institutional Investors (includes endowments & pension funds), corporations, financial institutions (includes primarily banks, insurance companies and fund raisers from capital markets), Government and individuals. Unlike US, Europe has shown dismal maturity when it comes to venture capitalism as compared to US. This is understood from the fact that the funding contribution in US is largely by Institutional Investors (shows the maturity of US markets) but in Europe is largely from banks that control a major part of the mutual fund industry. There are many bank funded companies in Europe (having operations in Croatia as well) that are listed on various stock exchanges under federation of European Securities Exchanges and also on the London Stock Exchange & New York Stock Exchange. However, there is a significant advantage in European Venture Capitalist market - the banks have funded a much larger number of startup companies in Europe than US. This is primarily because the model of venture capitalism in Europe has largely been of Captive Mode against the Independent Mode preferred in US as reported by Bottazzi and Rin et al. (2002. 239-244). These researchers arrived at the first set of empirical generalizations about venture capitalist markets in Europe. They concluded that the European venture capitalists lack human resources rather than financial resources. Hence, it appears that the venture capitalists in Europe (banks) have focused more on financial benefits although the venture capitalists in US (institutional investors) have focused more on innovations. They further concluded that European venture capitalists have not acquired skills or patents considerably like those of US and also, the European venture capitalists have focused more on increasing firm profitability rather than bringing them to IPO levels. Gompers and Lerner et al. (1998. pp149-150) presented an analysis of the US venture capitalists that choose firms that do not have sufficient tangible assets thus making the investments risky but with high returns. This is one of the reasons why banks do not contribute much to venture capitalist funding in US. In Europe, banks have been the major contributors to venture capitalist funding because they preferred companies with tangible assets and low risk profile. Overall, the funding system in Europe (including Croatia) has been focused on safe investments or equal sharing of residual risks by borrowers & lenders through "mortgages", "captives" or such other safe methodologies. Discussion Points Gompers and Lerner et al. (1998. pp149-150) presented the need for raising venture capitalist funds in USA as lack of tangible assets and possession of high risk business models that repels the banks away. But how do these venture capitalists choose their high risk projects with a confidence that their gains shall be higher Do they possess risk assessment processes that are different (and probably more advanced) compared to those of the banks that are used in loan approval cycles This is the first set of discussion points recommended by the author to be taken up in the class. Amihud and Garbade et al. (1999. pp453) talked about conflicts among creditors, managers and share holders after the debt has been taken by the company. How are these conflicts managed Are they governed by some regulations of corporate governance or are left to the effectiveness of agency theory Are there monitoring & control mechanisms by which the decision making power of the share holders get diluted and transferred to creditors The authors also stated about creditors objecting to the decision of share holders pertaining to investing in high risk ventures or projects, probably for high gains. How do the creditors arrive at such conclusions Do they have access to internal risk databases of the companies or merely rely on market rating agencies This is the second set of discussion points recommended by the author to be taken up in the class. Bottazzi and Rin et al. (2002. 239-244) analyzed that venture capitalists in US take high risk decisions of funding when they are convinced about the innovativeness of startup firms. Hence, they do encourage hiring of talented professionals to take the innovativeness to new heights and build intellectual capitals like patents. But the venture capitalists in Europe (largely banks) focused on ventures that can share the risks with them through physical property mortgages or by becoming captives (or at least very closely monitored companies) and that they focus more on financial revenues than intellectual capitals. Why does this difference exist between the funding systems of US and Europe Does Europe lacks trust in valuation models of intellectual capitals Has Europe not yet learnt the art of earning from intellectual properties like patents How has Europe developed companies like SAP and Siemens whose intellectual properties have taken the world by surprise This is the third set of discussion points recommended by the author to be taken up in the class. Conclusion: The author concluded that funding from external sources is taken by financial managers to invest in profit making ventures such that the creditors enjoy profits. Further investments in new ventures, diversification, new plants/machineries, etc. are carried out using the earned equities and not the debt. The shareholder value increase is the last phenomenon of this process and is more of an incentive for increasing asset valuation rather than the primary objective of finance managers. The author further introduced the funding system of Europe and concluded that it is largely financials based. In the last, the author has presented some discussion questions. Reference List: Amihud, Yakov and Garbade, Kenneth et al. (1999). A New Governance Structure for Corporate Bonds. Stanford Law Review. Vol. 51. No. 3. pp453. Retrieved on 9 April 2009. Available at http://www.jstor.org/stable/1229262 (Liverpool Library). Bottazzi and Rin et al. (2002). Venture Capital in Europe and the Financing of Innovative Companies. Economic Policy. Vol. 17. No. 34. pp239-244. Blackwell Publishing on behalf of Center for Economic Policy Research. Retrieved on 9 April 2009. Available at http://www.jstor.org/stable/1344676 (Liverpool Library). Faure-Grimaud, Antoine and Gromb, Denis. (2004). Public Trading and Private Incentives. The Review of Financial Studies. Vol. 17. No. 4. pp986-987. The Society for Financial Studies. Published by Oxford University Press. Retrieved on 9 April 2009. Available at http://www.jstor.org/stable/3598056 (Liverpool Library). Gompers and Lerner et al. (1998). What drives Venture Capital Fundraising. Brookings papers on Economic Activity. Microeconomics. Vol. 1998. pp149-150. The Brookings Institution. Retrieved on 9 April 2009. Available at http://www.jstor.org/stable/2534802 (Liverpool Library). Read More