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The Corporate Chaiwala

October 26, 2011

The Corporate Chaiwala

Through Soma’s business expansion, the difference between a limited company, private limited company and public limited company is explained

Mr. Darphatia sat down with Soma and explained that he would value Soma’s business at 5 times the revenue that he makes, as well as help him expand his brand across Gujrat or even across the country. Soma was doing a business of about Rs. 10,000 per day, and with an exception of a Sunday and a few public holidays, his stalls would be open for business.
Arrangements were made by Mr. Darphatia, to convert Soma’s business into a private limited company, making Soma, his parents and Gopi Kaka its token shareholders. He valued the business and advised Soma to open a bank account and handed him the money for the 10% stake he had purchased.

Soma understanding what an equity stake is.

Through the year following the venture, Soma’s business acquired a corporate structure. Soma gradually started understanding board meetings and other corporate matters. The local media began covering his business with regular articles on the ‘corporate chaiwala’. Soma also gave an interview, where he claimed that his tea was very good for health and much better than the normal tea with white sugar. He refused to divulge the magic formula for his tea, though.
Soma further introduced some South Indian fast food dishes to one of his restaurants’ menu, to test the customers’ response. The new menu soon gained popularity, after which it was introduced to all his restaurants as well.

Limited Company

  • A limited company is a type of company, with liability limited to the capital invested. In other words, the shareholders’ personal assets are protected in the event of bankruptcy, but they might lose the capital they have invested.
  • A limited company can be private or public. A private limited company’s shares are not available to the general public, but those of a public limited company are easily available.
To be continued…

An Uncertain Venture

October 25, 2011

An Uncertain Venture

Today’s story introduces terms like Venture Capital, Venture Capitalist and Venture Capital Fund

Soma set up a sugar cane crushing unit on Gopi Kaka’s advice, and began selling sugarcane juice along with tea. Eventually, Soma’s magic formula worked, and the taste of the tea that was earlier found to be ‘odd’ and ‘different’ suddenly became addictive; people started liking it more and more, and over the period of time, his tea and sugar cane stand became very popular, so much that they used to have long queues of people waiting for a drink.. Soma got people from his village, his relatives and friends to set up more stalls across Ahmedabad. The business was expanding!
One of Soma’s valued customers, Mr. Darphatia, was the Chairman of the Gujrat Small Industries Venture Fund. Mr. Darphatia was very impressed by Soma’s chai and his entrepreneurial spirit. He proposed to allow his venture fund invest some money in Soma’s business, in return of which, he would take a 10% equity stake in Soma’s business. Though Soma didn’t fully understand the proposal, he knew one thing for sure, that he wanted to be the sole proprietor of his business and that getting a partner would mean sharing profits, which he alone had enjoyed till now. He straight away rejected the proposal.

A chance to expand his business all over Gujarat!

Mr. Darphatia, however, was persistent and after several lengthy discussions over the topic, Soma realised that Mr. Darphatia’s goodwill and blessings could prove helpful to him in more ways than one. Many of his stalls and premises were without proper legal documentation and Mr. Darphatia was very well connected with the State Government. Somewhat reluctantly and without a clear understanding of the purpose, he agreed to accept the proposal. Mr. Darphatia asked Soma what the evaluation of his business was, or at what price he would like to hand the 10% to him. Soma did not understand this either…


Venture Capital

  • Venture Capital is the capital typically provided by investors for financing of new, growing or struggling businesses.
  • Venture capital investments generally are high risk investments but offer the potential for above average returns.
  • A venture capitalist (VC) is a person who makes such investments.
  • A venture capital fund is a pooled investment vehicle (often a partnership) that primarily invests in those companies that they feel have huge growth potential and are too risky for the standard capital markets or bank loans.
Next: The Corporate Chaiwala

The Telegram

October 24, 2011

The Telegram

Through this story, you are introduced to Preference and Debenture Capitals, along with other related terms

A few months later, while Soma was struggling to keep up with his expanding business, he got a telegram asking him to visit his village immediately. He got worried and started conjuring up various reasons for the invite; was someone ill? did his father want his money and the interest since the crops had failed? He rushed home by the earliest bus available. His mind was still cooking up worst case scenarios.
Instead of the long faces he was expecting, Soma was pleasantly surprised to be greeted by hugs from his extremely happy looking parents. After a good meal and some sweets, he was told that they had arranged his marriage to Gomti. Gomti and Soma’s families knew each other well, since they belonged to the same village, comprising a closely knit community. The girl’s father was a rich farmer with huge ancestral properties, while her brothers were doing good businesses in the city.
On meeting her parents, he discussed at length with them and his would-be father-in-law, why his magic tea formula wasn’t working any more. His  would-be father-in-law quickly understood the problem and offered Soma Rs.1000 to expand his business.

Soma's Rs 1000 to extend his business

The money was not to be treated as debt or partnership, he clarified; If Soma makes profits, he should pay his father-in-law 12% p.a. In case of no profits, the payment could be deferred, however, he should repay cumulatively @ 12%p.a. on the amount given by his father-in-law, whenever his profits are adequate.
His future mother-in-law, who joined in the conversation, offered him Rs.1000 as a debt, with 10% interest, however, with an option of offering her a partnership at next Diwali, based on the profits.
Soma, rather than jumping to the opportunity, asked for some time to think on whether he can take such a big loan and if he can take the responsibility of returning and servicing the money.


Preference Capital

  • When several investors contribute to the capital of the business with the condition that every year they will get a fixed rate of return, subject to the company earning profits, then this capital is termed as Preference Capital.
  • Preferential shareholders, as the name suggests, enjoy a preferential right over equity shareholders with regards to:
  1. Receipt of dividend which is fixed
  2. Receipt of residual funds after liquidation, i.e. in the event of the company closing down, the preference shareholders will first receive their capital.

Debenture Capital

  • A Debenture is a contract where the company will pay the lender the initial amount (principal) and interest (rate of interest predefined at the beginning) after a pre-defined period of time (maturity date).
  • Debentures can be convertible or non-convertible.
  1. Convertible Debentures can be converted into equity after a specified period of time. These debentures may or may not carry interest till the date of conversion.
  2. Non-convertible Debentures cannot be converted into equity shares and will be redeemed at the end of the maturity.

Next: Venture Capital

Soma ki Chai

October 21, 2011
In this post you can understand the different types of capitals and learn how the debt equity ratio is calculated.

He wasn’t one of the brightest kids in school; in fact, he couldn’t clear his third grade even after three attempts. His father was a sugar cane farmer with reasonable means. His mother could prepare delicious tea, a skill Soma, her youngest child, picked up like a fish to water. ‘Soma ki chai’ soon became famous in his village. His parents, following the advise of his uncle, Gopi Kaka, decided to send Soma to Ahmedabad to let him set up his own business under Gopi Kaka’s supervision.

Soma ki Chai

His Mother helped by giving him a thousand rupees

His Mother helped by giving him a thousand rupees

His mother handed him Rs.1000 from her savings and told him that she had saved the money for him and it need not be returned.

His Father loaned him Rs 1000

His Father loaned him Rs 1000

His father also gave him Rs.1000, however, he said, “You will have to return the money after a year, with five per cent interest. In case you fail to pay me back, you will have to come back to the village and help me with the farm.” With Rs. 2000 safely tucked in a little bag that also carried his clothes and some snacks made lovingly by his anxious mother, Soma set off his journey, uncertain of his destination.

Dr. Solanki removed his glasses and wiped his tears. “What a long journey it has been, a journey called life,” he thought.

After a bumpy three-and-half hour journey, Soma had reached Ahmedabad. Roaming around on his first day, he came to the banks of the River Sabarmati.

Gopi kaka served Mumbai chat outside the Gujrat University campus, where he extended his table to provide Soma a 4×4 sq.ft. space to prepare tea. With some initial purchases under Gopi Kaka’s guidance, Soma commenced his business. The response for his tea, on the very first day, was positive; the students found his tea much tastier than the tea offered inside the campus.

Soma put in a lot of hard word in the following three months, and as the business grew, he hired a few boys to help him out. The hard work paid off; the business picked up and started gaining popularity. On Gopi Kaka’s advice, Soma made a small donation to the local municipal authorities, in return to which, they turned a blind eye to his stall and allowed him to extend his counter so that he could now place two more stoves, thereby doubling his capacity.

Lesson I

Types of capital

  • When you start a business, you need money that is capital. This can be your own money – ‘Equity‘ or borrowed money – ‘Debt‘.
  • If a business is started by more than one person in partnership, then can contribute and share profits and losses in agreed ratio, typically the ratio in which they have contributed capital.
  • While on debt, you have to pay interest, there is no such obligation for equity money.
  • Owners, when they make profits, can take part of it out of the business as their share of profits that is ‘dividend’.
  • Debt can be secured by mortgage or pledge of movable or immovable property such as house, land, machinery, shares, fixed deposit receipt etc. If the lender has not taken any security, it is called unsecured debt.

Debt Equity Ratio

The more the debt, higher the risk, as there is obligation to repay initial amount borrowed as well as interest. Analysts typically calculate Debt Equity ratio, which is debt divided by equity, to understand the financial risk in the business.

Somnath’s Story

October 20, 2011

On the Banks of Sabarmati

Through Somnath’s rags to riches story, IIFL explains the various terms in Equity in an easy and simplified manner

On the banks of the Sabarmati

Dr. Somnath Solanki stepped out of his Mercedes, instructed his chauffeur and security guard not to follow him, and the guard immediately removed his cellphone, leading to a series of phone calls. “Let the old man be on his own,” Vice Chairman, Mr. K.S. “Be out of his sight, but don’t let him be out of yours. Tomorrow is very important” he added. The guard couldn’t understand what this meant, but he didn’t need to. He simply followed the instructions given.

Dr. Solanki sat on the bank of the river. He could feel the cool breeze, see the banyan trees across the river and hear the birds chirping. He had been at the same place, 50 years ago. Nothing had changed – not the river, the breeze, the trees the birds; yet how everything had changed. Tomorrow is going to be a very important day in his life, very hectic as well, he thought. His company was planing the largest ever overseas acquisition and was going to announce quarterly results that were going to surprise the street. He also made plans to reveal the successor for the Soma Group of Industries, laying to rest months of speculation.

His mind drifted 50 years back in time, when he was lovingly called Soma in a little village near Ahmedabad…