Introduction
Finance is among the most important requirements to establish and grow a business. It is usually required to successfully run the operations of a business (Hilferding et al., 2019). As shown in the case scenario, DALMA IT Software Consultancy and Solutions requires about £250,000 to support its growth. There are several financing options that the business can choose from to provide the funds. The available financing options for the company are venture capital, private equity, debt financing, and debenture financing. Each of these financial options has its share of advantages and disadvantages. However, the most appropriate financing option for the organization is venture capital. This type of financing that investors offer companies that are believed to have long-term growth potential. Therefore, venture capital is exceptional because it brings with it expertise and funds for the operation.
A Case Study Summary About DALMA
DALMA is a business that is committed to growth and development. Since 2015, the company has continuously experienced a growth rate of 120%. Currently, the business is about to close a contract valued at about £1,000,000 from a recognized business in the financial service industry. While rapid growth attracts venture capital and private equity, the business felt the strain on cash flow. The company estimated a one-year working capital requirement of about £250,000 to fund this expansion. Contract finance would have been scalable and straightforward given their client credit quality, growing contract book, and three-year contract safety. However, the directors were price-conscious and did not want to borrow more than necessary. As a result, the company wants to source funds to finance its operations.
Financing Options
Venture Capital
Venture capital is a type of financing that gives money to small, new businesses that have the potential for growth in exchange for a share of the company. In other words, it is the money that an outside investor gives to help start, grow, or solve a business problem (Rosa, Sukoharsono and Saraswati, 2019). The main goal of a venture capitalist is to create value through investing in early-stage and or start-up companies with high growth capabilities. In this case, the funding into the business is done in exchange for an equity stake rather than a loan. Therefore, venture capital allows people who have not run a business before and do not have a lot of money to get the money they need to start a business and get advice from experts.
The advantages of venture capital are business know-how, adequate funding, and connections. Apart from funding, venture capital can offer businesses a valuable source of guidance and consultation (Rosa, Sukoharsono and Saraswati, 2019). This can assist with various business decisions, including financial and human resource management. In addition, a venture capitalist can offer active support in the growth of an organization. The potential benefits are faster growth and greater success. Finally, venture capitalists are well connected in the business community. A company can benefit from this connection and improve its performance.
The disadvantages of venture capital are reduction of founder ownership stake, it is challenging to obtain and the requirement for formal reporting structure. When an organization obtains funds from this option, they are likely to dilute their equity to issue new shares to their investor (Rosa, Sukoharsono and Saraswati, 2019). When a business gets venture capital, they are required to establish a board of directors and a formalized internal structure. This gives venture capitalists comfort due to increased levels of reporting. The other disadvantage is the possibility of delay because venture capitalists receive a proposal from several firms.
Private Equity
Private equity provides growth capital for long-term investments in high-growth, profit-generating businesses. It is a distinct type of private financing in which funds and investors invest directly in businesses (Zhao and Wan, 2019). Private investors assist companies in improving their financial performance through operational efficiencies and improvements. In addition, they seek to grow revenue via investments in new services and product lines and market expansion. Private equity is a business model that combines operational, financial, and strategic expertise. Assistance and support in areas other than financial include facilitating access to known advertising and marketing channels.
Private equity has a lot of benefits for businesses and start-ups. Businesses prefer it because it allows them to get money quickly instead of getting high-interest bank loans or going public on the stock market (Zhao and Wan, 2019). In addition, it is not just ideas and small businesses that venture capital funds. Getting private equity financing can help companies that are not on the stock market try new ways to grow away from the public radar. There is a lot less time for senior managers to turn a company around or try out new ways to cut costs or make money if they are under pressure from quarterly earnings.
Despite the benefits, private equity has its own set of problems. First, it can be hard to sell private equity because they lack the capacity to connect buyers and sellers (Zhao and Wan, 2019). Second, the cost of shares for an organization in private equity is established by negotiations between an organization and investors, not by the market. The third challenge is that the rights of private equity shareholders are decided through negotiations rather than through a set of rules that usually apply to their counterparts in the public market.
Debt Financing
Debt financing is where an organization raises money by selling debt tools to investors. It is usually taken in the form of bank loans, bonds, bills and many more (Pham and Nguyen, 2020). An organization can attain several benefits through this financing. The primary purpose of deciding to finance via debt rather than equity is to preserve company ownership. The company retails all ownership and control of their business. The other benefit is that an organization can leverage a small capital to create growth. Another advantage of debt financing is that interest payments are tax-deductible, lowering a company’s tax liability.
There are several disadvantages that a business should consider before choosing a debt financing option. The primary disadvantage of this financing is that lenders require interest, which means that the amount paid will exceed the amount borrowed (Pham and Nguyen, 2020). In addition, debt payments must be made regardless of business revenue, which can be especially risky for smaller or newer businesses that have yet to establish a stable cash flow. The other disadvantage is that banks usually require collateral for extended financing in the form of business assets. If an organization lacks the required collateral, the lender will request personal guarantees.
The Most Appropriate Financing Option
The most suitable financing option for DALMA is venture capital because it meets their needs. A venture capitalist cannot jeopardize a business’ financial position. This financing alternative is not a loan in the traditional sense and thus does not require repayment of the value received. DALMA would only lose equity in the event of a takeover by a venture capitalist. It is, in essence, a transaction that occurs upon receipt of funds. As a result, DALMA stands a better chance of attracting venture capitalists than securing bridge financing. Because a venture capitalist is only interested in becoming a part of a brand, a feasible concept is the only thing that matters.
DALMA is about to enter maturity in its growth cycle. As a result, the organization has a better chance of securing financing because its business model has been validated and has already attained cash flow. However, this does not make financing any easier, as the phase involves various intricate aspects. The possibility of eroding ownership incentives is one factor to consider. Thus, at the same time as venture capital is unquestionably the best financing option because it meets DALMA’s existing fiscal needs, it also has a number of disadvantages, necessitating consideration of other options.
Relationship of Venture Capital to The Development Phases of a Venture
Table 1: Venture Phases and Capital Attributes
Important Considerations to Owners and Financiers
Table 2: Crucial Considerations
Valuation Issues with Venture Capital
Venture capital has a lot of problems with how it is valued. First, because capital ventures tend to focus on new projects, they often do not have enough information (Metrick and Yasuda, 2021). Many companies can help with IT, data engineering, and networks, and DALMA is one of them. These are one-of-a-kind services that do not have a set value in the field. These initiatives are very risky, and it is hard to figure out how much money they will make. As a result, investors and businesses use figures that are not correct. Private equity financing has a lot of the same problems as debt financing because of more regulations and pressure from investors. There are often disagreements and biases even when people follow established industry rules. This is even true for important concepts like fair value.
Venture capital is a private fund that is not subject to the same rules that govern valuations. As a result, it is hard to determine how the company will value its investments, so one cannot get out of the deal (Metrick and Yasuda, 2021). In terms of financial reporting, this is not good news. The problem is linked to another challenge that is significantly similar to it. An organization and an investor would likely have different ideas about what they want to do with the project. For example, a company might pay more attention to the process, but an investor might keep an eye on the return.
Moreover, fund managers and VC investors have different goals when signing a contract. They get paid based on how much money they sign out. To get a bigger pay cut, they take many risks, which could give the wrong impression about the project if a company is interested in a third-party view (Metrick and Yasuda, 2021). People who borrow money to start a business, whether short or long term, make it more valuable. The way this looks may give the wrong impression about how well a company is doing financially, but it could be different for a company that cannot pay back its debts.
Ownership Dilution
Dilution is one of the challenges that affect most financing options in the market. In most of these arrangements, funds are given in exchange for equity in an organization (Harrison and Mason, 2019). However, in venture capital, the amount of funding required affects the degree of ownership. For example, if venture capitalists fund 60% of an organizational value, it is expected that they will own about 60% of the company in terms of equity. This means that the ownership dilution rate depends on how much a company obtains to fund their growth against its value. Therefore, ownership dilution in venture capital cannot reach unreasonable levels.
Conclusion
Venture capital is considered to be the most appropriate mode of financing for the company. DALMA is undergoing rapid development and requires appropriate funding. The current financial requirements are only temporary, as the company is financially sound and has a validated business prototype. In addition, the company is approaching maturity, which is a resource-intensive stage. Venture capital funding is consistent with the characteristics of needs during both the shakeup and maturation phases. To a large extent, this type of financing would be proactive in addressing future funding shortages as the company expands its operations. Although the financing option has several advantage advantages, management should take steps to mitigate the negative effects of venture capital. Among the potential difficulties are the loss of equity and management changes.
References List
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Harrison, R.T. and Mason, C.M. (2019) ‘Venture Capital 20 years on reflections on the evolution of a field,’ Venture Capital, 21(1), pp.1-34. Web.
Hilferding et al. (2019) Finance capital: a study of the latest phase of capitalist development. Routledge.
Metrick, A. and Yasuda, A. (2021) Venture capital and the finance of innovation. John Wiley & Sons.
Pham, H.S.T. and Nguyen, D.T. (2020) ‘Debt financing and firm performance: The moderating role of board independence,’ Journal of General Management, 45(3), pp.141-151. Web.
Rosa, M.C.W., Sukoharsono, E.G. and Saraswati, E. (2019) The role of venture capital on start-up business development in Indonesia. Muhammadiyah University Yogyakarta.
Zhao, D. and Wan, J. (2019) ‘Problems and suggestions for private equity funds. Open Journal of Business and Management, 7(3), pp.1089-1094. Web.