## Procurement of Funds

### Three Key Considerations for Every Funding Source

Factor	Description
Cost	How much does it cost to use this source?
Risk	What repayment obligations or failure chances exist?
Control	Does it dilute ownership or management control?

Goal: Keep funding cost low while managing risk and maintaining necessary control.

### Equity vs. Debt Trade-off

Situation	Problem
Too much Debt	High financial risk — must repay regardless of profit
Too much Equity	High cost (dividends) + dilution of owner control

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## Sources of Funds

### 1. Equity Shares

Advantage: No repayment required — low financial risk for the firm
Disadvantage: Shareholders expect high dividends; dividends are paid from after-tax profits (not tax-deductible); may dilute control

### 2. Debentures (Debt)

Advantage: Cheaper than equity — interest is tax-deductible
Disadvantage: Must be repaid per agreed terms; interest payable even if the firm makes a loss

### 3. Bank Loans

Short-term: Working capital needs
Long-term: Buying machinery, buildings
Also supports daily operations (deposits, payments)

### 4. International Sources

FDI (Foreign Direct Investment): Directly buying shares/assets of a company (strategic stake)
FII (Foreign Institutional Investors): Buying through capital markets (portfolio investment)
ADRs & GDRs: Special international share issues for raising capital abroad
Procurement mechanisms must be adapted to foreign investor requirements

### 5. Angel Financing

A wealthy individual provides equity capital to startups in exchange for an ownership stake
Typical investment: 25–60% equity
Used when: Company is too small for venture capital AND doesn't qualify for bank loans
Famous examples: Early investors in Google, Sun Microsystems

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## Effective Utilisation of Funds

> All funds have a cost (interest, dividends). If they don't generate returns higher than their cost, running the business becomes meaningless.

The Finance Manager must ensure funds are never kept idle.

### Two Key Areas of Utilisation:

1. Fixed Assets — Invest in plant and machinery for optimum production without harming financial solvency; requires capital budgeting knowledge to evaluate long-term returns

2. Working Capital — Maintain optimal level; avoid excess funds blocked in inventory, receivables, or idle cash

Worked example

### Example 1

A company needs ₹50 lakh for expansion. Option A: Issue equity shares — no repayment obligation but costlier (dividends are not tax-deductible). Option B: Bank loan — cheaper on an after-tax basis but creates a mandatory repayment obligation. The correct choice depends on the firm's existing debt levels, profitability, and risk capacity.

### Example 2

An angel investor agrees to fund a tech startup with ₹20 lakh in exchange for 40% equity. The startup had no track record for a bank loan and was too small for venture capital. This is a classic angel financing scenario — the investor becomes a part-owner, not a lender.

### Example 3

A firm issues debentures at 10% interest rate. Its tax rate is 30%. Effective after-tax cost = 10% × (1 – 0.30) = 7%. This is cheaper than issuing equity where dividends (say 12%) are fully paid from after-tax profits.

⚠️ Common exam mistakes

Saying equity is always better than debt — equity is actually more expensive (higher cost of capital) even though it doesn't require repayment.
Confusing FDI and FII — FDI involves directly buying into a company (strategic stake), while FII involves buying through capital markets (portfolio investment). They are different in nature and impact.
Thinking angel investors give loans — they provide equity, meaning they become part-owners, not lenders.
Ignoring that interest on debt is tax-deductible — this is why debentures/loans are cheaper than equity on an after-tax basis.

Reference:

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Procurement of Funds — Sources, Considerations, and Effective Utilisation

Worked example

⚠️ Common exam mistakes