Financial Contracting for New Venture: Investments in a new venture usually involve financial contracts between the entrepreneur and external investors. These external investors include venture capitalists, angel financiers, banks, private financing companies, and credits unions among others. Notably, financial contracts can have positive and negative effects on the new venture. For instance, an angel financier can add a clause on the financial contract that will not permit the entrepreneur to borrow more funds without permission from the lender. While this is likely to occur when the lending institution has a mortgage or lean on the venture's property, the clause is usually added to lessen foreclosure risk. As an individual seeking to venture in a clothing business for the Mixed Martial Arts customers to provide shirts, hoodies/fleeces, and hats, it is important to choose the most appropriate type of financial contracting with the external investor. This process of selecting the most suitable type of contracts will include evaluating financing alternatives for the new business to avoid being controlled by lending institutions. This paper basically seeks to determine the type of financial contracting for the new venture that might be agreed upon between the entrepreneur and prospective investor.

Need for Financial Contracting for the New Venture:

Generally, many businesses are developed without generating significant amounts of outside capital from outside investors (Maeder, n.d.). These businesses are started with minimal infusions of cash from the entrepreneurs and sometimes amplified by support from wealthy individuals or relatives. Through these sources of capital, the entrepreneurs avoid attempts and intensity of raising capital from lending institutions or outside institutional investors. Most of these small businesses end up small and their entrepreneurs are happy to maintain control of the family and seek for modest growth.

The main goal of the new venture of a clothing business for Mixed Martial Arts is to achieve tremendous growth and productivity and eventually grow into a big venture. As a result, this venture requires generating more capital to promote its growth and profitability across all operations. Generating small capital for this venture will not be appropriate because it will put the enterprise in a weak position and will demonstrate lack of ability to project the future. Following the recognition of the necessity for the enterprise to develop and grow rapidly, the venture will require large amounts of capital from outside investors, especially institutional investors through financial contracting.

Financial Contracting with Outside Investors:

As previously mentioned, the new venture of a clothing business for Mixed Martial Arts customers requires financial contracting with outside investors in order to raise large amounts of capital that are needed to start-up the business. After identifying the need to develop and grow rapidly and need to generate large amounts of external capital, there are a wide range of options for the entrepreneur with each option being suitable to a different stage of growth. The choice of the type of financial contracting to be considered for the new venture requires evaluation of financial alternatives to avoid being controlled by the lending institutions. It will also involve examining what the possibilities are and agree about the certainty of likelihood of each outcome between the entrepreneur and prospective investor.

Similar to starting a fashion business, starting up the new venture requires consideration of some major steps before financial contracting with outside investors. These steps include conducting extensive research, determining the location of the enterprise, knowledge of customers and neighborhood, determining the budget, and preparation of appropriate documents for the business (Anderson, 2013). Conducting each of these steps is crucial because of the role it plays in determining investor confidence in the business. Outside investors, particularly institutional investors make their investment decisions after evaluating the extent with which the entrepreneur has carried out each of these steps. This is primarily because these steps play a significant role in determining the success and profitability of the business and returns on investments for the outside investors.

There are four major types of financial contracts that could be considered for the new venture of a clothing business for Mixed Martial Arts customers. These types of financial contracts are classified into two major categories i.e. debt-type contracts and equity-type contracts. The debt-type contracts include standard debt and debt with reorganization while equity-type contracts are voting equity and preferred equity contracts (de Bettignies, 2008, p.157). Standard debt contract is appropriate when investor control and entrepreneur control are the only two viable control right allocations. This contract is implemented as long as the investor's cost of capital...

On the contrary, debt with reorganization is a debt contract that allows the entrepreneur to retain full control if he/she makes repayment before the expected date and converts to joint control. Under this contract, default is followed by reorganization with the entrepreneur and investor sharing control instead of liquidation.
Voting equity is a type of contract that assigns joint control unconditionally based on focusing on control rights instead of cash flow rights. Generally, joint control generates a flow of payoffs to the investor similar to payoffs that are normally obtained in an equity contract. Preferred equity contract is a type of equity-contract where joint control is assigned conditionally on a pre-determined debt payment at a particular date and eventual investor control in case of default (de Bettignies, 2008, p.157).

The type of financial contracting I would consider for the new venture of a clothing business for Mixed Martial Arts customers is debt with reorganization contract. This type of financial contracting involves an agreement that permits altering of terms for servicing an existing debt, normally on more favorable terms for the debtor i.e. entrepreneur (Shepherd, 2005). In most cases, debt reorganization contracts usually include relief for the debtor from the initial terms and conditions of the obligations of the debt between two parties. This relief is brought by various factors such as liquidity issues, sustainability issues, and restructuring of the industry where the debtor operates.

Debt with reorganization seems to be the most appropriate type of financial contracting for this new venture since it will enable the business and entrepreneur to avoid being controlled by the lending institution. The contract will include clauses that provide the entrepreneur with some relief and altering of terms for servicing the debt based on original terms. However, the relief clauses will stipulate the type of conditions that could lead to the relief such as liquidity, sustainability, and restructuring issues. The inclusion of these specific conditions for eligibility of relief will help protect the investor and ensure that the entrepreneur undertakes appropriate measures to promote the success of the business.

The liquidity issues that may contribute to alliterations of the terms of servicing the debt include cases where the business or entrepreneur does not have adequate cash to meet looming debt service payments due to lack of profitability from the venture. The sustainability issues are situations where the entrepreneur is unlikely to meet debt obligations in the short or medium term. On the other hand, restructuring issues may involve situations where the clothing industry experiences a restructuring and contribute to changes in the terms and conditions of the contract between the entrepreneur and investor.

In addition to these clauses, financial contracting for this new venture should include vesting and non-compete clauses, which would make it more costly for the entrepreneur to leave the venture or business. One of these clauses include permitting entrepreneur's share to vest over time, which implies that the business can buy back or receive any unvested shares in the event that the entrepreneur leaves the venture. Secondly, the contract can include provisions that prohibit the entrepreneur from working for another venture in the same industry for a certain period of time in case he leaves the firm (Kaplan & Stromberg, 2002, p.12). While these clauses seem to provide more control to the outside investor, they help in guiding the actions of the entrepreneur towards promoting the growth and profitability of the new venture.

Lesson Learnt:

This assignment has provided insights on how financial contracting for a new venture functions in a real world between an entrepreneur and a prospective investor. I have learnt that evaluation of financial alternatives is crucial in determining the type of financial contracting for a new venture. The failure to examine the financial alternatives contributes to a situation where the entrepreneur and the business are controlled by the investors or lending institutions. I have also learnt that the contracts should have appropriate clauses that protect both the entrepreneur and investor in order to promote the success and profitability of the venture. The clauses should consider some issues that are likely to affect new ventures such as liquidity, sustainability, and restructuring issues.

Conclusion:

This report provides an overview of financial contracting for new venture based on a study of financial contracting for a clothing business for Mixed Martial Arts customers. It demonstrates why entrepreneurs should evaluate financial alternatives during the financial contracting process. The need to evaluate financial alternatives protects the entrepreneurs from being controlled by the lending institutions or investors and helps…