Summary

Capital Structure and Taxation

Capital is needed for any startup. Raising the right amount of capital from the right sources is a crucial
element in ensuring the success of a startup. It is also important for the founders to find the right balance
between their own funds, equity they raise and the debt they raise from banks or financial institutions.
Moreover, a basic understanding of tax liabilities emerging from the business operations is necessary for
smooth operations of the business.

Debt v/s Equity

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Debt and Equity are two major sources of raising finance. In relation to entrepreneurship, there are
several sources for equity funds, which include own funds, funds from venture capitalists and funds
from angel investors. Equity capital has the following features:

It is permanent in nature

There is no obligation for payment of dividend

It involves allotting part of management control

It involves no tax benefits

It leads to dilution of ownership

Debt refers to funds taken as loan from individuals and financial institutions during the starting phase
of the venture. Family, friends and banks are typical sources for such financing. Debt instruments have
the following features:

It is cheaper than equity

It allows tax saving on interest

It does not involve dilution of control

It has to be serviced regularly with interest payments

The event of default leads to bankruptcy and loss of assets

Financial Leverage and Capital Planning

Finding the right balance between equity and debt components in a ventures capital structure becomes
important in order to minimize the cost of raising funds. The choice and proportion between equity and
debt is basis the individual scenario in the business and is a factor of several elements. For instance, when
you have unstable earnings and are low on cash, and are already loaded with debt, the use of equity is
Summary Capital Structure and Taxation Debt v/s Equity Financial Leverage and Capital Planning
recommended. However, in the case of a business with liquid assets and unwillingness to dilute control,
debt is recommended.
In short, proper capital planning is needed in order to assess the right amount and source of raising capital.
Following are some of the sources that an entrepreneur can look at for raising funds:

Bootstrapping

Angel Investors

Incubator

Venture Capitalist /PE Funds

Financial Institutions and Banks

Government

Measuring Performances

An entrepreneur must equip himself/herself to analyse the financial statements of the business, in order
to extract useful conclusions. This is a critical activity from time to time and should not be ignored. A
technique called ratio analysis is often employed for this purpose, and involves the use of the following
categories of ratios:
Liquidity Ratios: Liquidity Ratios help organizations measure the short-term liquidity of their business.
These are:
Current Ratio
Acid Test Ratio
Leverage Ratios: Leverage Ratios help evaluate the extent of use of debt component in capital. These
are:
Debt-Equity Ratio
Interest Coverage Ratio
Turnover Ratio: Turnover Ratios measure how efficiently assets have been used in the firm. These are:
Inventory Turnover Ratio
Receivables Turnover Ratios
Profitability Ratios: Profitability Ratios reflect the final result of business operations. These are:
Gross Profit Ratio
Net Profit Ratio
Return on Equity

Taxation
Taxation is an important aspect that many entrepreneurs ignore or do not have the expertise for. There
Measuring Performances Taxation are two major categories of taxes, which are:
1. Direct Tax
Income Tax: To be paid on the companys net profits over a period of time.
TDS: A mechanism by which the government collects income tax payable by a person, at the source of
generation of income.
2. Indirect Tax
Sales Tax or VAT: Applicable and to be paid on a transaction or sale.
Service Tax: Applicable when there is a service provided for a consideration.

Financing and Management of Working Capital

You should be able to:

At the end of this session, you should be able to:

Understand the importance, benefits and disadvantages of two major sources of finance, i.e.
debt and equity

Understand how to raise balanced capital from best available sources

Have a sense of the taxation aspects involved in funding your business