Understanding the Indian Financial Markets

RUNNING HEAD: FINANCING AN INTERNET CAFÉ IN INDIA

Financing an Internet Café in India
Benjamin S. Cheeks
International School of Management, Paris

Author Note
This paper was submitted to fulfill the requirements of Indian Financial
Markets, IFNM 7019. I would like to thank all of the faculty and staff at Amity
University, Noida, for their support and dedication to make the first ISM / Amity
Seminar a success.

Correspondence concerning this article should be addressed to Benjamin S.
Cheeks. Email: bencheeks@hotmail.com

1

FINANCING AN INTERNET CAFÉ IN INDIA
Abstract
India has developed a sophisticated financial system in order to facilitate the
mobilization of savings within the economy. This system is characterized by a strong
legal and regulatory environment and a sophisticated network of financial markets,
financial intermediaries, and financial instruments working together to meet the
funding needs of businesses of all sizes. This paper presents a high-level overview of
this system and then reviews the network through the eyes of a retail start-up to
determine the most suitable sources and instruments for funding.
Keywords: Indian financial system, business financing

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Financing a Internet Café in India
This paper will look at the various funding options for a new business
enterprise in India. For illustrative purposes, a draft business proposal for an internet
café, Social Café, will be used.
The paper is divided into three sections. The first provides an overview of the
Indian financial system; including the types of financial regulators, the financial
markets, the common financial instruments available, and the main intermediaries of
these instruments. The second section will review the funding needs of Social Café.
The final section will review and recommend the most suitable instruments and
sources for funding.
The Indian Financial System
A financial system consists of an interconnecting network of markets,
institutions, and instruments through which the savings in the economy are mobilized
and effectively allocated among the ultimate borrowers and investors. Ensuring this
timely and adequate supply of capital is critical to promote industrial growth and
economic well-being of the country. Levine (2004) suggests that a well-developed
financial system can encourage economic growth through improved information on
firms and managers, intensity with which creditors monitor and exert corporate
governance, better management of risk, pooling of savings, and ease of exchange.
In recognition of this fact, India has created a well-developed financial system.
The International Monetary Fund (2013) stated that “India has made remarkable
progress toward developing a stable financial system. Since liberalization in the early
1990s, the system’s growth and increasing commercial orientation have been

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accompanied by steady improvements in the legal, regulatory, and supervisory
framework”.
India’s financial system consists of financial regulators, financial markets,
financial instruments, and financial intermediaries.
Financial Regulators
There are two primary regulatory bodies in the Indian financial system. These
are the Reserve Bank of India (RBI) and the Securities and Exchange Board of India
(SEBI). The RBI is the supreme monetary authority of the country. It is responsible
for formulating and implementing monetary policy, maintaining price stability and
ensuring adequate flow of capital. The RBI issues currency, serves as the banker to
the government, sets bank rates, reverse repurchase (repo) rates, the statutory liquidity
ratio, and the cash reserve ratio. The SEBI was established under the Securities and
Exchange Board of India Act, 1992. It is governed by the Capital Markets Division of
the Department of Economic Affairs, Ministry of Finance. SEBI has the authority to
regulate capital markets, check trading of securities, investigate malpractice in
securities markets, regulate stockbrokers and sub-brokers, promote investor interests,
and make rules and regulations for the securities market.
Generally speaking, government securities and bonds, instruments issued by
banks and financial institutions are regulated by the RBI while issues of nongovernment securities (i.e. issues of corporations) are regulated by SEBI.
Financial Markets
The Indian financial markets are broadly categorized into the capital market,
the money market, and the foreign exchange (forex) market.

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The capital market is primarily involved in long-term funding. It has two
segments, the primary or new issue market and secondary or stock market. The
primary or new market deals with securities offered to investors for the first time.
The issuer sells the securities in this market to raise funds. The secondary or stock
market supports the buying and selling of previously issued securities. The secondary
market enables holders of security to adjust their holdings in response to charges in
their evaluation of the stock or to meet cash flow needs.
The money market is involved in short-term funding. It is the organized
exchange where participants can lend and borrow money for a period of one year or
less. Key submarkets within the money market are markets for commercial paper,
call money, and treasury bills.
The forex market assists with the exchange of foreign currency. As the forex
market is not a traditional market for business financing, it is beyond the scope of this
paper.
Financial Instruments
Kahn (2006) describes three broad categories of financial instruments: direct,
indirect, and derivatives. Direct instruments are those issued by non-financial
economic units such as corporations. Key types of direct instruments are equity
shares (both common and preferred), debentures such as bonds, and innovative debt
instruments such as convertible bonds and warrants. Indirect instruments are those
issued by financial economic units. Key types of indirect instruments include mutual
fund units, insurance policies, and bank deposits. The final category of financial
instruments is derivatives. Derivatives are products whose value is derived by that of
another asset. The key types of derivatives are forwards, futures, and options.

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Financial Intermediaries
The primary roles of financial intermediaries are to bring together buyers and
sellers of securities, and where necessary to repackage these securities to make them
more attractive. An example of the latter would be repackaging securities into smaller
units for individual investors. The key financial intermediaries in India are banks,
financial institutions, mutual funds and insurance funds, and non-banking financial
companies (NBFCs).
Banks. The primary providers of credit in India are the banks. The banking
sector in India is comprised of commercial banks and cooperative banks. The
commercial banks include 19 Nationalized Banks, the State Bank of India (SBI) and
its six associate banks, the Regional Rural Banks (RRBs), Foreign Banks, and other
Indian private sector banks. The cooperative banks are comprised of the State
Cooperative Banks and the Urban Cooperative Banks.
Financial institutions. Financial institutions were originated to drive public
economic development. At the time of their formation, the capital markets were
relatively underdeveloped. This sector has undergone changes in recent years when
two major financial institutions, ICICI and IDBI, converted into banks. Financial
institutions are broadly categorized into All-India financial institutions, State-Level
financial institutions, and Specialized Financial Institutions. Key All-India
institutions are Industrial Finance Corporation of India Ltd (IFCI Ltd), Small
Industries Development Bank of India (SIDBI), and Industrial Investment Bank of
India Ltd (IIBI). Generally speaking, All-India institutions invest in long and medium
term projects, while State-Level institutions invest in medium and small scale
projects. The list of specialized financial institutions in India includes: Export-Import

6

Bank Of India, Export Credit Guarantee Corporation of India Ltd, Board for Industrial
& Financial Reconstruction, and National Housing Bank.
Mutual funds and insurance organizations. Mutual funds and insurance
organizations invest in a wide-cross section of securities and sell units to investors.
This allows investors to diversify their holdings without having to buy individual
securities. The primary difference between the two is that investments with insurance
organizations also serve as life insurance policies. Also, insurance organizations are
regulated by the Insurance Regulatory and Development Authority (IRDA).
NBFC. The Reserve Bank of India (2013) states that a NBFC is a company
whose “principal business is lending, investments in various types of shares / stocks /
bonds / debentures / securities, leasing, hire-purchase, insurance business, chit
business, and its principal business is receiving deposits under any scheme or
arrangement in one lump sum or in installments.” There are three key categories of
heterogeneous NBFCs. These are Asset Finance Companies (AFC), Investment
Companies (IC), Loan Companies (LC). A separate category of NBFCs call the
residuary non-banking companies (RNBCs). These include Infrastructure Finance
Companies (IFC), Stock Exchanges, and Venture Capital-Private Equity Funds.
Funding Needs of the Internet Café
The following business plan has been created for Social Café (Bplans.com,
2013). Social Café is the answer to ever increasing internet demand and the growing
coffee-drinking culture in India. It will provide a unique social environment for
young people in New Delhi to socialize with their friends, be entertained, and access
the internet at affordable prices.

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Based upon the business plan, Social Café requires US$62,290 in initial
funding for start-up expenses. These expenses include such items as site preparation
and legal fees. In addition to start-up expenses, Social Café requires an addition
US$23,000 to purchase or lease equipment, furniture, and fixtures. An additional
US$3,000 is required for initial inventory and supplies. This brings the total start-up
funding requirements to US$88,290.
Table 1: Start-up funding required for Social Café in US$.

Start-up Funding
Start-up Expenses to Fund

$62,290

Start-up Assets (Equipment, Furniture, and Fixtures)

$23,000

Start-up Assets (Inventory and Supplies)

$3,000

Total Funding Required

$88,290

In order to determine the working capital requirements, it is initially assumed
that the start-up funding would be borrowed from a bank at 12.5% interest over seven
years and working capital advanced at 14.75%. Using these assumptions, working
capital requirements peak at slightly over US$10,000 in month three and slowly
reduce until month eight, at which time the business is self financing.
Table 2: Pro forma cash flow analysis for Social Café.
Pro Forma Cash Flow
Month 1 Month 2
Subtotal Cash Received
$7,600 $10,730
Subtotal Cash Spent
$8,574 $15,156
Net Cash Flow
-$974 -$4,426
Net Working Capital Requirements
-$974 -$5,400

Month 3 Month 4 Month 5 Month 6 Month 7 Month 8 Month 9 Month 10 Month 11 Month 12
$12,425 $20,812 $21,611 $24,454 $23,277 $24,135 $25,023 $25,959 $26,920 $27,922
$17,435 $17,522 $22,424 $20,963 $22,177 $22,484 $23,025 $23,591 $26,180 $26,520
-$5,010 $3,290
-$813 $3,491 $1,100 $1,651 $1,998
$2,368
$740
$1,402
-$10,410 -$7,120 -$7,933 -$4,442 -$3,342 -$1,691
$307
$2,675
$3,415
$4,817

Now that Social Café has created its initial business plan, it must determine
the best sources and instruments of financing.
Selecting the Most Suitable Instruments and Intermediaries
There are two primary avenues for raising capital. These are equity financing
and debt financing. With equity financing, the investor has an ownership stake in the

business and therefore a claim on the future earnings of the firm. With debt financing,
the investor does not gain an ownership stake in the business, but will be repaid the
principal and interest at the agreed upon intervals. There are advantages and
disadvantages of each. With equity financing, the money does not have to be repaid,
so the risk falls more heavily on the investor. However, the more shareholders a
company has, the more claims on the earnings as well as involvement in key decisions
of the organization. With debt financing, companies must comply with repayment
schedules. This increases the amount of profit required to break-even. For this
example, we will assume that the owner of Social Café is open to equity financing to
some degree, but wants to retain a majority ownership stake in the business.
Equity Financing
Within the Indian financial system, there are three main intermediaries for
equity financing. The most basic is the personal savings-friends and family, the
second is venture capital-private equity funds (VC/PE), and the final is stock
exchanges.
Personal savings-friends and family. Personal savings, friends, and family
are key sources of funding for most start-up businesses. Many of the most successful
businesses in India today are family owned and managed. Some advantages of
funding from this source is the hopeful sharing of profits with friends and family as
well as having investors that are truly interested in your success. It is generally
timelier and involves less bureaucracy than dealing with professional investors. The
key disadvantages are family squabbles and meddling from family members. These
can be overcome by clarifying roles and responsibilities in the beginning. Another
key consideration is that funding from personal savings will be a prerequisite from

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future investors. Many require the owner provide at least 10% of the initial funding.
VC/PE. For a business of this size, the second key source of equity financing
is venture capital-private equity funds (VC/PE). Primarily due to the presence of
high-information technology skills, India has a robust VC/PE industry. According to
Venture Intelligence (2011), India had the fourth largest VC/PE penetration as a
percentage of GDP behind only Israel, the United States, and the United Kingdom.
Venture Intelligence (2012) divides the VC/PE community in India into five
categories based upon the level of investment and the timing of the investment. These
are Incubators, Angel Networks, Seed Level Funds, Early Stage Funds, Growth Stage
Funds, and SME Focused. Based upon the funding requirements of Social Café, the
Angel Networks would be the category of VC/PE to focus. Angel Investors tend to be
high net-worth individuals or groups of the same that invest in early stages of
businesses for an equity stake. In additional to the generic advantages and
disadvantages are equity investments by VC/PE funds, there are advantages and
disadvantages specific to this type of funding. The key advantage when accepting
capital from VC/PE funds is that they tend to invest in industries where they have
experience. This creates great opportunities for mentoring and network building. A
key disadvantage is the VC/PE fund often look to take a large equity position and
push for active involvement in decision making. Before reaching out to the VC/PE
community, the entrepreneur must first consider the likelihood of this type of
investment. Venture Intelligence (2011) reports that only 3% of VC/PE investments
in 2011 were in the food and beverage industries. VC/PE firms tend towards
industries with high-growth potential and low capital requirements. For 2011, the
bulk of the venture funds flowed towards IT, ecommerce, Mobile VAS, education,

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and health care. Therefore, while VC/PE investments offer a great potential, it is an
unlikely source of funding for an internet café. Therefore, it is advisable for the
entrepreneur to focus on more accessible sources of funding.
Stock exchanges. The final source of equity funds are the stock exchanges.
India currently has 25 stock exchanges with the key exchanges being the Bombay
Stock Exchange (now just BSE) and the National Stock Exchange (NSE). According
to the World Confederation of Exchanges (2013), as of January 2013, the BSE listed
more than 5,195 companies (number one in the world) with a total market
capitalization of US$1.32 trillion. The same report showed the NSE had 1,664
listings with US$1.29 trillion of market capitalization. Many of India’s major
companies are listed on both exchanges.
Trading on both exchanges are done by computer. There are no market
makers or specialists floor traders. Currently orders must be placed on each exchange
by a broker, but many of these brokers provide trading facilities to their customers.
The two main indices are the Sensex and the S&P CNX Nifty. The Sensex includes
30 firms listed on BSE. The Nifty includes 50 shares listed on the NSE.
These two exchanges are not appropriate for Social Café for two primary
reasons. First, they cater to companies much larger than Social Café and equity
funding through these types of exchanges tend to occur once a business has
established themselves as private companies and are looking for funds to expand.
Most of the stock exchanges in India require at least a three-year track record before
listing. The stock exchange that offers the most promise for a company such as Social
Café would be the OTC Exchange of India (OTCEI). According to their website, the
OTCEI (2013) “was set up to aid enterprising promoters in raising finance for new

11

projects in a cost effective manner and to provide investors with a transparent &
efficient mode of trading”. However, despite this encouraging mission, it is not
recommended that Social Café attempt an offering on the OTCEI. For a company
without a track record, investors on the OTCEI would have similar hesitations as
would the VC/PE community in investing. Also, the costs associated with listing
could easily exceed the initial funding requirements. Once again, the entrepreneur’s
time would be better spent looking for alternative sources of funding.
To conclude the section of equity financing, there are many advantages that
equity financing can provide to a business. However, with the exception of friends
and family, early stage equity investment is difficult to come by unless your business
is a high-growth business with small capital investment. This is not just true in India,
but around the world. Nonetheless, the Indian financial system offers extensive
intermediary and instruments for those companies that fit the right profile.
Debt Financing
Other than equity financing, the other alternative is debt financing. The
primary instruments of debt financing in India are loans. However, the Indian
financial system ensures a full range of debt financing vehicles. In addition to loans,
some of the more common debt financing instruments are bonds, commercial paper
(CP), and leases.
Commercial paper. Commercial paper can be eliminated immediately as a
source of funding for Social Café. The Reserve Bank of India (2011) defines
commercial paper as an unsecured money-market instrument issued in the form of a
promissory note. In India, commercial paper can be issued by corporates and AllIndia Financial Institutions. They are a great alternative to working capital loans to

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secure short-term cash flow needs. CP can be issued with maturities between seven
days and one year and can be denominated in Rs. 5 lakh or multiples there of. Social
Café could not issue CP for several reasons, but most notably it does not meet the
minimum credit rating of A-2 and does not have an audited net worth of Rs. 4 crore.
Corporate bonds. In India, the term corporate bond and debenture are used
interchangeably. As per Security and Exchange Board of India (2009) a corporate
bond is a “debt instruments issued by a corporation, the holder of which receives
interest from the corporation periodically for a fixed period of time and gets back the
principal along with the interest due at the end of the maturity period.” In India,
public and private companies can issue corporate bonds. However, a company
incorporated outside India cannot issue corporate bonds in India.
Corporate-bond funding in India makes up a very small percentage of
corporate funding needs in India. An article in the Financial Times Chilkoti (2013),
reports that in 2010-11, corporate bonds made up 4% of funding needs whereas in
China it made up 17%. One problem holding back the corporate bond market is the
lack of liquidity. In India corporate bonds are sold over-the-counter (OTC) rather
than through an organized market. Therefore, due to the limitations of the bond
market, this type of debt financing would not be appropriate for Social Café.
Leases. There are a variety of NBFCs that specialize in the leasing of
equipment or financing of such an activity. A lease is defined as a contract between
two parties for the hire of an asset where the lessor retains ownership of the asset
while the lessee has possession and use of the asset and pays specified rentals over a
period of time. The most common type of leases are short-term and long-term leases.
Short-term leases are usually two to three years for assets such as computers that have

13

high depreciation. Long-term leases are for assets with lower depreciation such as
machinery, cars, and furniture. Leases offer a number of advantages over loans. For
example, many leasing companies will finance 100% of the capital required for the
equipment; including administrative fees. Social Café should consider lease financing
as a funding option; especially for its computers as well as its furniture and fixtures.
Based upon the initial business plan, this amount was estimated at US$23,000 in
furniture and fixtures.
Loans. The primary source of loans in India are banks. However, loans can be
obtained from financial institutions and an NBFC such as loan companies. Many
banks and financial institutions have created loan schemes designed to meet the
funding needs of businesses. In addition, there are many loans in India backed by
government funding and schemes. Many of these schemes were designed specifically
with the small to medium-size business in mind. The advantages of these loan
schemes are that they can provide loans to businesses without previous credit and/or
provide interest-rate subsidies. For companies such as Social Café, the Credit
Guarantee fund Trust for Micro and Small Enterprises (CGTMSE) is the trust behind
the Credit Guarantee Scheme (CSG). The objective of this scheme is to make
available bank credit without collateral or third party guarantees. There are currently
131 banks that are eligible to extend loans backed by the CSG.
Summary and Recommendation
Based upon the review of funding sources and types, Social Café should look
to personal savings-friends and family for initial equity investment. For debt
financing, Social Café should consider financing their computers with short-term
leases and its equipment, furniture, and fixtures with a leasing company. Naturally,

14

this recommendation is dependent upon a lease versus buy comparison. For the
additional financing needs for start-up expenses and working capital, Social Café
should look at loan packages from banks and financial institutions; particularly those
loans backed by one of the government schemes, such as the CSG, designed to
support small to medium-size businesses.
Limitations of Analysis
This paper analysed the formal financial system in India. India has an
extensive informal network consisting of money lenders, funding clubs, chit funds,
and landlords. Due to the fragmentation of this market, it was considered beyond the
scope of this paper.
Also, this paper focused on more traditional sources of funding.
Intermediaries in India also support derivatives and other innovative instruments.
However these instruments are thinly traded and not appropriate for Social Café and
therefore considered out of scope.
Conclusion
Ensuring a timely and adequate supply of capital is critical to promote
industrial growth and economic well-being of the country. To this end, India has
developed a sophisticated network of financial markets, intermediaries, and
instruments, supported by a strong legal and regulatory environment. This paper has
presented a high-level overview of this system. It then reviewed this system through
the eyes of Social Café to determine the most suitable sources and instruments for
funding. The recommendation was for Social Café to tap into personal savingsfriends and family of the owner for initial equity funding. This is the most common
source of seed capital for a new enterprise and is usually a prerequisite for subsequent

15

funding. To fund the remaining shortfall, Social Café should investigate lease
financing for its computers, equipment, furniture, and fixtures from one of India’s
NFBC leasing companies. For the funding of the remaining expenses and working
capital, Social Café should pursue a SME Loan Pack, especially one supported by
government schemes, from one of India’s many banks or financial institutions.

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