Sources of Funds

LESSON TWO

SOURCES OF FUNDS

INSTRUCTIONS
 Read Chapter 28 and 31 of Financial Management text book by I.M. Pandey.
 Complete answers to reinforcement questions at the end of the lesson.
 Check model answers given in lesson 10 of the study pack.
 Reinforcing Comments

CONTENTS
 Equity capital
 Debt finance
 Bills of exchange
 Lease finance
 Overdraft finance
 Plastic money – Debenture finance
 Venture capital

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1. EQUITY FINANCE
For small companies, this is personal savings (contribution of owners to the company). For large
companies equity finance is made of ordinary share capital and reserves; (both revenue and capital
reserves). Equity finance is divided into the following classes:

a) Ordinary share capital – this is raised from the public from the sale of ordinary shares to the
shareholders. This finance is available to limited companies. It is a permanent finance as the
owner/shareholder cannot recall this money except under liquidation. It is thus a base on which
other finances are raised.

Ordinary share capital carries a return that is variable (ordinary dividends). These shares carry
voting rights and can influence the company’s decision making process at the AGM.

These shares carry the highest risk in the company (high securities – documentary claim to) because of:

a) Uncertainty of return
b) Cannot ensure refund
c) Have residual claims – claim last on profits, claim last on assets.

However this investment grows through retention.

Rights of ordinary shareholders
1. Right to vote

a. elect BOD
b. Sales/purchase of assets

2. Influence decisions:

a) Right to residual assets claim

b) Right to amend company’s by-laws
c) Right to appoint another auditor
d) Right to approve merger acquisition
e) Right to approve payment of dividends

Reasons why ordinary share capital is attractive despite being risky

 Shares are used as securities for loans (a compromise of the market price of a share).
 Its value grows.
 They are transferable at capital gain.
 They influence the company’s decisions.
 Carry variable returns – is good under high profit
 Perpetual investment – thus a perpetual return
 Such shares are used as guarantees for credibility.

Advantages of using ordinary share capital in financing.

 They facilitate projects especially long-term projects because they are permanent..
 Its cost is not a legal obligation.
 It lowers gearing level – reduces chances of receivership/liquidation.
 Used with flexibility – without preconditions.

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 Such finances boost the company’s credibility and credit rating.

 Owners contribute valuable ideas to the company’s operations (during AGM by professionals).

b) RETAINED EARNINGS

i) Revenue Reserves
These are undistributed earnings. Such reserves are retained for the following reasons:

 To make up for the fall in profits so as to sustain acceptable risks.

 . To sustain growth through plough backs. They are cheap source of
finance.
 . They are used to boost the company’s credit rating so they enable further finance to be
obtained.
 . It lowers the company’s gearing ratio – reduces chances of receivership/liquidation.

ii) Capital Reserves

1. It is raised by selling shares at a premium. (The difference between the market price (less
floatation costs) and par value is credited to the capital reserve).
2. Through revaluation of the company’s assets. This leads to a fictitious entry which is of the
nature of a capital reserve.
3. By creation of a sinking fund.

c) PREFERENCE SHARE CAPITAL (Quasi-Equity)

It is also called quasi-equity because it combines features of equity and those of debt. It is preference
because it is preferred to ordinary share capital that is:

i) It is paid dividends first – preferred to dividend

ii) It is paid asset proceeds first – preferred to assets.

Unlike ordinary share capital, it has a fixed return. It carries no voting rights. It is an unsecured finance
and it increases the company’s gearing ratio.

2. DEBT FINANCE
Debt finance is a fixed return finance as the cost (interest) is fixed on the par value (face value of debt). It
is ideal to use if there’s a strong equity base. It is raised from external sources to qualifying companies
and is available in limited quantities. It is limited to:

i) Value of security.
ii) Liquidity situation in a given country. It is ideal for companies where gearing allows
them to raise more debt and thus gearing level.

Classification of Debt Finance

Loan finance – this is a common type of debt and is available in different terms usually short term.
Medium term loans vary from 2 - 5 years. Long-term loans vary from 6 years and above

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The terms are relative and depend on the borrower. This finance is used on the basis of Matching
approach i.e. matching the economic life of the project to the term of the loan. It is prudent to use short-
term loans for short-term ventures i.e. if a venture is to last 4 years generating returns, it is prudent to
raise a loan of 4 years maturity period.

Conditions under Which Loans Are Ideal

a) When the company’s gearing level is low (the level of outstanding loans is low.
b) The company’s future cash flows (inflows and their stability) must be assured. The company
must be able to repay the principal and the interest.
c) Economic conditions prevailing. The company must have a long-term forecast of the prevailing
economic condition. Boom conditions are ideal for debt.
d) When the company’s market share guarantees stable sales.
e) When the company’s anticipated future expansion programs, justify such borrowing.

Requirements for Raising Loan

a) History of the company and its subsidiaries.
b) Names, ages, and qualifications of the company’s directors.
c) The names of major shareholders – 51% plus i.e. owner who must give consent.
d) Nature of the products and product lines.
e) Publicity of the product.
f) Nature of the loan – either secured, floating or unsecured.
g) Cash flow forecast.

Reasons Why Commercial Banks Prefer To Lend Short Term Loans

a) Long-term forecasts are not only difficult but also vague as uncertainties tend to jeopardise
planning e.g. political and economic factors.
b) Commercial banks are limited by the Central Bank of Kenya in their long term lending due to
liquidity considerations.
c) Short-term loans are profitable. This is because interest is high as in overdrafts.
d) Long term finance loses value with time due to inflation.
e) Cost of finance – in the long term, the cost of finance may increase and yet they cannot pass such
a cost to borrowers since the interest rate is fixed.
f) Commercial banks do credit analysis that is limited to short term situations.

g) Usually security market favours short term loans because there are very few long term securities
and as such commercial banks prefer to lend short term due to security problems.

Advantages of Using Debt Finance

 Interest on debt is a tax allowable expense and as such it is reduced by the tax allowance.

Example
Interest = 10% tax rate = 30%
The effective cost of debt (interest) = Interest rate(1 – T)
= 10%(1-0.30)
= 7%

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 The cost of debt is fixed regardless of profits made and as such under conditions of high profits the
cost of debt will be lower.
 It does not call for a lot of formalities to raise and as such its ideal for urgent ventures
 It is usually self-sustaining in that the asset acquired is used to pay for its cost i.e. leaving the
company with the value of the asset.
 In case of long-term debt, amount of loan declines with time and repayments reduce its burden to
the borrower.
 Debt finance does not influence the company’s decision since lenders don’t participate at the AGM.

Disadvantages
 It is a conditional finance i.e. it is not invested without the approval of lender.
 Debt finance, if used in excess may interrupt the companies decision making process when gearing
level is high, creditors will demand a say in the company i.e. and demand representation in the BOD.
 It is dangerous to use in a recession as such a condition may force the company into receivership
through lack of funds to service the loan.
 It calls for securities which are highly negotiable or marketable thus limiting its availability.
 It is only available for specific ventures and for a short term, which reduces its investment in strategic
ventures.
 The use of debt finance may lower the value of a share if used excessively. It increases financial risk
and required rate of return by shareholders thus reduce the value of shares.

Differences between Debt Finance and Ordinary Share Capital (Equity Finance)

Ordinary share capital Debt

a) It is a permanent finance a) It is refundable (redeemable)
b) Return paid when available b) It is fixed return capital
c) Dividends are not tax allowable c) Interest on debt is a tax allowable expense
d) Unsecured finance d) Secured finance
e) Carry voting rights e) No voting right
f) Reduces gearing ratio f) Increases gearing ratio
g) No legal obligation to pay g) A legal obligation to pay
h) Has a residue claim h) Carries a superior claim
i) Owners’ money i) Creditors finance.

Similarities between Preference and Equity Finance

a) Both may be permanent if preference share capital is irredeemable (convertible).

b) Both are naked or unsecured finances.
c) Both are traded at the stock exchange
d) Both are raised by public limited companies only
e) Both carry residue claims after debt.
f) Both dividends are not a legal obligations for the company to pay.

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Differences between Preference and Equity Finance

Ordinary share capital Preference share capital
a) Has a residue claim both on assets and a) Has a superior claim
b) profit b) No voting rights
c) Carries voting rights c) Increases the gearing ratio
d) Reduces the gearing ratio d) Fixed dividends hence no growth
e) Variable dividends hence grow over time e) Usually redeemable
f) Permanent finance f) Not easily transferable
Easily transferable.

Similarities between Debt and Preference Share Capital

a) Both have fixed returns.
b) Both will increase the company’s gearing ratio.
c) Both are usually redeemable.
d) Both do not have voting rights.
e) Both may force the company into receivership
f) Both have superior claims over and above owners.
g) Both are external finances.
h) There is no growth with time.

Differences between Preference Share Capital and Debt

DEBT PREFERENCE SHARE CAPITAL
a) Interest is tax allowable a) Dividends are not tax allowable
b) Interest is a legal obligation b) Dividends are not a legal obligation
c) Debt finance is always secured c) Preference is not secured finance
d) Debt finance is a pre-conditional d) Is not conditional finance
e) Has a superior claim e) Has a residue claim (after debt)

Why It May Be Difficult For Small Companies To Raise Debt Finance In Kenya (Say Jua Kali
Companies)
 Lack of security
 Ignorance of finances available
 Most of them are risky businesses as there are no feasibility studies done (chances of failure have
been put to 80%).
 Their size being small tends to make them UNKNOWN i.e. they are not a significant competitor
to the big companies.
 Cost of finance may be high – their market share may not allow them to secure debt.
 Small loans are expensive to extend by bank i.e. administration costs are very high.
 Lack of business principles that are sound and difficult in evaluating their performance.

Solutions to the Above Problems

 There should be diversification of securities e.g. to accept guarantees.
 Education of such businessmen on sound business principles.
 The government should set up a special fund to assist the jua kali businessmen.
 Encourage formation of co-operative societies.

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 To request bankers to follow up the use of these loans.

3. Bills of Exchange
Bills of Exchange are a source of finance in particular in the export trade. A Bill of Exchange is an
unconditional order in writing addressed by one person to another requiring the person to whom it is
addressed to pay to him as his order a specific sum of money. The commonest types of bills of exchange
used in financing are accommodation bills of exchange. For a bill to be a legal document; it must be

a) Drawn by the drawer.

b) Bear a stamp duty
c) Acceptable by the drawee
e) Mature in time.

It is used to raise finance through:

i) Discounting it.
ii) Negotiating
iii) Giving it out as security.

Advantages of Using a Bill as a Source of Finance

 They are a faster means of raising finance (if drawer is credible).
 Is highly negotiable/liquid investment
 Does not require security
 Does not affect the gearing level of the company
 It is unconditional and can be invested flexibly
 It is useful as a source of finance to finance working capital
 It is used without diluting capital.

4 Lease Finance
Leasing is a contract between one party called lessor (owner of asset) and another called lessee where the
lessee is given the right to use the asset (without legal ownership) and undertakes to pay the lessor
periodic lease rental charges due to generation of economic benefits from use of the assets. Leases can be
short term (operating leases) in which case the lessor incurs the operating and maintenance costs of the
assets or long term (finance leases) in which the lessee maintains and insure the assets.

Lease finance is ideal under the following conditions:

a) When the asset depreciates faster.

b) When the asset is subject to obsolescence
c) When the available asset cannot meet the contemplated expansion program
d) When the asset’s cost is prohibiting
e) If the asset is required seasonally
f) If the asset can generate returns to pay off lease charges in the short run.

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Advantage of Leasing an Asset

 It does not tie up the company’s funds in an asset.
 The arrangement may ensure lessor bears the maintenance costs reducing the companies
operating costs.
 The company has the option to purchase assets at the expiry of the lease period at which time it
will know the viability of the asset.
 The company (lessee) will enjoy the lease charges as allowable expenses thus reducing taxable
income and tax liability.
 Lease finance enables the lessee to use the asset to create financial surpluses which may then be
used to buy assets.
 It is usually a long-term arrangement which enables the company to plan returns expected and
operations which may be carried out.

Disadvantage of Leasing an Asset

 It is a pre-conditional finance (as on the use of asset)
 In the long term the lease charges may out-weigh the cost of buying own asset.
 It is available for a selected asset and this limits flexibility.
 It is useful for financing fixed assets and not working capital
 Lease finance may not be renewed leading to loss of business.
 Lease financing lowers the company’s credit rating (i.e. the asset in the balance
sheet is shown as leased asset).

Reasons Why Lease Finance Is Not Well Developed In Kenya

 Lease charges are usually prohibitive i.e. the cost of finance is excessive.
 It may not be known to businessmen.
 Uncertainty as to returns from such assets i.e. the returns from such assets leased may not
encourage the growth of lease finance.
 There is an imperfect market as a number of companies lease assets on basis of credibility of the
lessee.
 Lack of flexibility i.e. a number of assets which are ideal for leasing are unavailable.
 Kenya’s financial markets are underdeveloped and this has affected the development of lease
finance.
 After lease service is poor and this leads to loss of revenue.

5. Overdraft Finance
This finance is ideal to use as bridging finance in sense that it should be used to solve the company’s
short term liquidity problems in particular those of financing working capital (w.c.). It is usually a
secured finance unless otherwise mentioned. Overdraft finance is an expensive source of finance and the
over-reliance on it is a sign of financial imprudence as it indicates the inability to plan or forecast
financial needs.

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Advantages of Overdraft Finance

 It is useful in financial crisis which an accountant cannot forecast due to abrupt fall in profits thus
liquidity problems.
 In some cases it may be secured on goodwill thus making it flexible finance.
 It does not entail preconditions and is therefore investible in high-risk situations when the firm
would not have finance in normal circumstances.
 It is raised faster and as usual is ideal to invest in urgent ventures e.g. documentary investments
e.g. treasury bonds, shares, treasury bills, housing bonds etc.
 If not used for a long period of time – it does not affect the company’s gearing level and therefore
does not relate to company’s liquidation or receivership.
 Less formalities/procedures involved.

Disadvantages of Overdraft Finance

 It is expensive as the interest rates of overdrafts are much higher than bank rates.
 The use of this finance is an indication of poor financial management principle.
 It may be misused by management because it does not carry pre-conditions
 Being a short-term financial arrangement, it can be recalled at short notice leaving the company in
financial crisis.

6. Plastic Money (Credit Card Finance)

This is finance of a kind whereby a company will make arrangements for the use of the services of a
credit card organisations (through the purchase of credit cards) in return for prompt settlement of bills on
the card and a commission payable on all credit transactions. This is used to finance goods and services
of working capital in nature such as the payment of fuel, spare-

parts, medical and other general provisions and it is rare for it to finance raw materials or capital items.

Reasons behind the Fast Development of This Finance (Plastic Money) In Kenya
a) High incidences of fraud by dishonest employees has been responsible for development of this
finance as it minimises chances of this fraud because it eliminates the use of hard cash in the
execution of transactions.
b) Risk associated with carrying of huge amounts of cash for purchases which cash is open to theft
and misuse has also been responsible for development of this finance.
c) Credit cards have boosted the credibility of holder companies which enables them to obtain trade
credits under conditions which would have otherwise been difficult.
d) Of late, Kenya has experienced emergence of elite, middle and high-income groups’ in particular
professionals who tend to use these cards as a symbol of status in execution of day to day
transactions.
e) These cards have been used by financial institutions and banks to boost their deposit and attract
long term clienteles e.g. Royal Card Finance, Standard Chartered.
f) A number of companies and establishments have acquired such cards as a means of settling their
bills under certain times when their liquidity is low or when in financial crisis.

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Limitations of Credit Cards as a Source of Finance

i) These cards leads to overspending on the part of the holder and as such may disorganise the
organisation’s cash budget and cash planning.
ii) Limited as to the activities they can finance as they are ideal for financing working capital items
and not fixed assets in which case they are not a profitable source of finance.
iii) They are expensive to obtain and maintain because of associated cost such as ledger fees,
registration, insurance, commission expenses, renewal fees etc.
iv) It is a short-term source and is open only to a few establishments in which case a company can
obtain goods and services from those establishments that can accept them.
v) Entail a lot of formalities to obtain e.g. guarantees, presentation of bank statements and even
charging assets that are partially pledged to secure expenses that may be incurred using these
cards.
vi) They may be misused by dishonest employees who may use them to defraud the organisation off
goods and services which may not benefit such organisations.
vii) Credit card organisation may suspend the use of such cards without notice and this will
inconvenience the holder who may not meet his/her ordinary needs obtained through these cards.

7. Debenture Finance
A form of long term debt raised after a company sells debenture certificates to the holder and raises
finance in return. The term debenture has its origin from ‘DEBOE’ which means ‘I owe’ and is thus a
certificate or document that evidences debt of long term nature whereby the person named therein will
have given the issuing company the amount usually less than the total par value of the debenture. These
debentures usually mature between 10 to 15 years but may be endorsed, negotiated, discounted or given
as securities for loans in which case they will have been liquidated before their maturity date. The current
interest rate is payable twice a year and it is a legal obligation.

Classification
i) Secured Debentures
These are those types of debentures which a company will secure usually in two ways, secured with a
fixed charge or with a floating charge.

a) Fixed Charge – a debenture is secured with a fixed charge if it can claim on a specific asset.
b) Floating charge – if it can claim from any or all of the assets which have not been pledged as
securities for any other form of debt.

ii) Naked Debentures

These are not secured by any of the company’s assets and as such they are general creditors.

iii) Redeemable Debentures

These are the type of debentures, which the company can buy back after the minimum redemption period
and before the maximum redemption period (usually 15 years) after which holders can force the company
to receivership to redeem their capital and interest outstanding.

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iv) Irredeemable Debentures (perpetuities)

These are never bought back in which case they form permanent source of finance for the company.
However, these are rare and are usually sold by company’s with a history of stable ordinary dividend
record.

v) Classification according to convertibility

Convertible debentures – Can be converted into ordinary shares although they can also be converted into
preference shares.

Conversion price = par value of a debenture/No. of shares to be received.

Conversion ratio = Par value of debenture

Par value of ordinary shares

Example
ABC Company Ltd books:

Shs.
10.000, Sh.20 ordinary share capital 200,000
10,000, Shs.10 8% preference share capital 100,000
5,000, Shs.100 12% debentures 500,000
The above debentures are due for conversion:

Required
i) Compute the conversion price
ii) Compute the conversion ratio
iii) Compute new capital structure.

Solution

i) Conversion price = par value of debenture/No. of shares to be received.

No. of shares to be received = 100:20 = 5:1

100
=20
Therefore = 5

100
=5 . 0
ii) Conversion ratio = par value of debenture/par value of share = 20
Receive 5 ordinary shares for every 1 debenture held.

iii) New capital structure

No. of new ordinary shares = 5000 x 5 = 25,000
Shs.
35,000, Shs.20 ordinary shares 700,000
10,000, Shs.10, 8% preference shares 100,000
Total capital 800,000

vi) Non-convertible debentures

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These cannot be converted into ordinary preference shares and they are usually redeemable.

vii) Sub-ordinate debentures

Usually last for as long as 10 years and they are sold by financially strong companies. Such are not
secured and they rank among general creditors in claiming on assets during liquidation. This means that
they are sub-ordinate to senior debt but superior to ordinary and preference share capital.

Reasons behind Unpopularity of Debentures of Kenya’s Financial Market:

i) Their par value is an extremely high value and as such they are unaffordable to purchase by
would be investors.
ii) They are in most cases secured debt and as such constrain the selling company in so far as getting
sufficient securities is difficult.
iii) Most of the would-be sellers have low credit worthiness which is difficult.
iv) Kenya’s capital markets are not developed and as such there is no secondary debenture market
where they can be discounted or endorsed.
v) Debentures finance is not known among the general business community and as such many
would be sellers and buyers are ignorant of its existence.
vi) Being long term finance there are a few buyers who may be willing to stake their savings for a
long period of time.
vii) Such finance calls for a fixed return, which in the long rum will be eroded by inflation.

8. Venture Capital
Venture capital is a form of investment in new small risky enterprises required to get them started by
specialists called venture capitalists. Venture capitalists are therefore investment specialists who raise
pools of capital to fund new ventures which are likely to become public corporations in return for an
ownership interest. They buy part of the stock of the company at a low price in anticipation that when the
company goes public, they would sell the shares at a higher price and therefore make a considerably high
profit.

Venture capitalists also provide managerial skills to the firm. Example of venture capitalists are pension
funds, wealthy individuals, insurance companies, Acacia fund, Rock fella, etc.

Since the goal of venture capitalists is to make quick profits, they will invest only in firms with a potential
for rapid growth.
Venture capitalists, will only invest in a company if there is a reasonable chance that the company will be
successful. Their publicity material states that successful investments have three common characteristics.

a) There is a good basic idea, a product or service which meets real customer needs.
b) There is finance, in the right form to turn the idea into a solid business.
c) There is the commitment and drive of an individual or group and the determination to succeed.

Attributes of venture capital

i) Equity participation – Venture Capital participate through direct purchase of shares or fixed
return securities (debentures and preference shares)
ii) Long term investment – venture capital is an investment attitude that necessitates the venture
capitalists to wait for a long time (5 – 10 years) to make large profits (capital gains).
iii) Participation in Management – Venture capitalists give their Marketing, Planning and
Management Skills to the new firm. This hands – on Management enable them protect their
investment.

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Role of Venture Capital in Economic Development

The types of venture that capitalists might invest will involve:

a) Business start-ups – When a business has been set up by someone who has already put time and
money into getting it started, the group may be willing to provide finance to enable it to get off
the ground. With start-ups, venture capital often prefers to be one of several financial institutions
putting in venture capital.
b) Business development – The group may be willing to provide development capital for a
company which wants to invest in new products or new markets or to make a business
acquisition, and so which so needs a major capital injection.
c) Management buyout – A management buyout is the purchase of all or parts of a business from
its owners by its managers.
d) Helping a company where one of its owners wants to realize all or part of his investment. The
venture capital may be prepared to buy some of the company’s equity.

Funding Venture Capital

When a company’s directors look for help from a venture capital institution, they must recognize that:

a) The institution will want an equity stake in the company.

b) It will need convincing that the company can be successful (management buyouts of companies
which already have a record of successful trading have been increasingly favored by venture
capitalists in recent years.
c) It may want to have a representative appointed to the company’s board, to look after its interests.

The directors of the company then contract venture capital organizations, to try to find one or more which
would be willing to offer finance. A venture capital organization will only give funds to a company that
it believes can succeed.

Reasons for Significant Growth in Venture Capital in the Developed Countries

i) Public attitude i.e a favourable attitude by the public at large towards entrepreneurship, success as
well as failure.
ii) Dynamic financial system e.g efficient stock exchange and a competitive banking system.
iii) Government support – e.g taxation system to encourage venture capital e.g tax concessions and
investment allowance taxes.
iv) Establishment of venture capital institutions e.g investors in the industry.
v) Growth in the number of Management buyers (MBO) which have created a demand for equity
finance.

Constraints of Venture Capital in Kenya

1. Lack of rich investors in Kenya, hence inadequate equity capital.

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2. Inefficiencies of stock market – NSE is inefficient and investors cannot sell the shares in future.
Prices do not reflect all the available information in the market.
3. Infrastructural problems – this limits the growth rate of small firms which need raw materials and
unlimited access to the market factors of production.
4. Lack of managerial skills on part of venture capitalists and owners of the firm.

1. Nature of small business in Kenya. There are 3 categories.

a. Large MNC – these are established firms and can raise funds easily.
b. Asian owned small businesses – They are family owned hence do not require interference of
venture capitalists because they are not ready to share profits.
c. African – owned business – need venture capital but have little potential for growth.

6. Focus on low risk ventures e.g confining to low technology, low growth sectors with minimum
investment risks.
7. Conservative approach by the venture capitalists.
8. Delay in project evaluation e.g months or more hence entrepreneurs loose interest in the project.
9. Lack of government support and inefficient financial system.

Summary
In sum, venture capital, by combining risk financing with management and marketing assistance, could
become an effective instrument in fostering developing countries. The experiences of developed
countries and the detailed case study of venture capital however, indicate that the following elements are
needed for the success of venture capital in any country.

 A broad-based (and less family based) entrepreneurial traditional societies and government
encouragement for innovations, creativity and enterprise.
 A less regulated and controlled business and economic environment where attractive customer
opportunities exists or could be created from high-tech and quality products.
 Existence of disinvestments mechanisms, particularly over-the counter stock exchange catering for
the needs of venture capitalists.
 Fiscal incentives which render the equity investment more attractive and develops ‘equity cult’ in
investors.
 A more general, business and entrepreneurship oriented education system where scientists and
engineers have knowledge of accounting, finance and economics and accountants understand
engineering or physical sciences.
 An effective management education and training programme for developing professionally
competent and committed venture capital managers; they should be trained to evaluate and manage
high technology, high risk ventures.
 A vigorous marketing thrust, promotional efforts and development strategy, employing new
concepts such as venture fair clubs, venture networks, business incubators etc. for the growth of
venture capital.
 Linkage between universities/technology institutions, R & D. Organisations, industry, and financial
institutions including venture capital firms.
 Encouragement and funding or R & D by private public sector companies and the government for
ensuring technological competitiveness.

Disadvantages of Venture Capital

 Dilute ownership position of a firm
 Dilute control of a firm

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REINFORCING QUESTIONS
QUESTION ONE
a) What are the practical difficulties of a small scale enterprise wishing to obtain credit to expand
production? (10 marks)

b) Distinguish between internal and external sources of finance for a limited liability company.
(10 marks)

QUESTIONTWO
a) Why do different sources of finance have different costs? (8 marks)

b) What are the advantages of having a farmers’ bank compared with an ordinary commercial bank
in the provision of services to farmers? (12 marks)

QUESTION THREE
a) What is venture capital? (4 marks)

b) Why is the market for venture capital not yet well developed in Kenya or your country?
(16 marks)

QUESTION FOUR
a) Distinguish between debt and equity capital. (10 marks)

b) What are the advantages of leasing an asset compared to borrowing to buy an asset?
(10 marks)

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