Entrepreneurship and small business management chapter 15

Entrepreneurship and Small Business Management Chapter 15 Financing Strategy: Debt, Equity, or Both?... What Is Financing? The act of providing or raising funds capital for a purpose

Entrepreneurship and Small

Business Management

Chapter 15

Financing Strategy:

Debt, Equity, or Both?

Ch 15 Performance Objectives

 Explore your financing preferences.

 Identify the types of business financing.

 Compare the pros and cons of debt and

equity financing.

 Identify sources of capital for your

business.

 Understand stocks and bonds as

investment alternatives.

What Is Financing?

 The act of providing or raising funds

(capital) for a purpose

 Ways to start or expand a business:

 Use personal savings

 Use company profits (finance with earnings)

 Obtain gifts and grants

 Borrow money (finance with debt)

 Exchange a share of the business for money

(finance with equity)

 Repayment not required but may come

with conditions or “strings attached”

 Examples:

 Cash

 Free use of facilities and equipment

 Unpaid labor by friends and family

 Forgiveness or deferral of debts

 Tax abatements—legal reductions in taxes

 Tax credits—direct reductions of taxes

 No repayment, but may have specific

requirements

 Primarily provided for research and

commercialization efforts

 Difficult for start-up or low-technology companies to obtain

Forms of Debt Financing

 Commercial loans—business loans

typically provided by a bank

 Real estate—up to 20 yrs.

 Equipment and improvements—up to 7 yrs.

 Working capital—1 year or less

 Asset based—depends on type of asset

pledged Accounts receivable factoring—often 30 days

Forms of Debt Financing

(continued)

 Personal loans—taken out on personal

credit and used for the business

 Credit cards—”revolving” terms

 Home equity loans—variable terms; some

are lines of credit

 Title loans—short-term fixed repayment

 Payday loans—short-term fixed repayment

Forms of Debt Financing

(continued)

 Leases—debts incurred for the rights

to use specific property

 Vehicle leases

 Equipment leases

 Bonds—long-term debt used to raise

large sums of money

Debt Financing: Pros and Cons

Advantages

 Lenders have no say in

business management.

 Payments are predictable.

 Payments can be set up

to coincide with seasonal

sales.

 Lenders have no share in

business profits.

Disadvantages

 Lenders can force bankruptcy.

 Lenders can take owner’s home and possessions.

 Payments increase fixed costs, lowering profits.

 Repayment reduces available cash.

 Lenders expect financial reporting and compliance.

Equity Financing: Pros and Cons

Advantages

 If no profit is made,

investors are not paid.

 There are no required

regular payments of

principal or interest.

 Investors cannot force

bankruptcy.

 Investors may provide

valuable advice and

Disadvantages

 Giving up too much ownership may lead to loss of business control.

 Investors may interfere with the business.

 Investors may want to influence business

management and receive higher rate of return.

Bankers Operate on the

Five Cs of Credit

 Collateral—property or assets that lender

can take if loan is not repaid

 Character—measured by your ability to

borrow and your credit history

 Capacity—sufficient business cash flow

 Capital—personal resources invested

 Conditions—industrial/economic “climate”

Community Development

Financial Institutions (CDFIs)

 Lenders that share a vision of expanding

economic opportunity and improving quality

of life for low-income communities

 Four sectors:

 Community development banks (CDBs)

 Community development credit unions (CDCUs)

 Community development loan funds (CDLFs)

 Community development venture capital funds

Venture Capitalists

 Investors or investment companies

seeking equity

 Expect 6 times their money back over 5

years, or a 45% rate of return

 Desire candidates likely to generate at

least $50 million in sales within 5 years

 Sometimes seek a majority interest

 Wealthy, private individual investors

 Usual investment is between $100,000 and

$500,000

 Typically seek a return of 10 times the

investment at the end of 5 years

 Best strategy: recruit one angel who finds

others

Other Financing Options

 Insurance companies provide loans based

on the surrender value of a policy.

 Vendor financing is achieved by extending

the “float” time between receiving bills and

paying bills.

 Federally supported investment companies

provide loans to minorities, rural

enterprises, and small businesses in

low-income geographic areas.

Other Financing Options

(continued)

 U.S Department of Agriculture—provides

assistance to rural/agricultural businesses

 Youth financing—grants, scholarships, and

other awards for entrepreneurs who are 25

years old and younger

 Bootstrap financing—creative ways of

“stretching” existing capital resources

Three Categories of Investment

 Stocks—shares of companies (equity)

 Bonds—loans (debt) to companies or

government entities

 Cash—investments easily liquidated

(turned into cash) within 24 hours, such

as savings accounts and treasury bills

High Risk = High Reward Low Risk = Low Reward

 Shares of stock represent a percentage

of ownership in a corporation.

 Public corporations sell stock to the

general public to raise capital.

 Stock prices reflect investors’ opinions

about business performance and value.

 Investors make money by selling stock

at a price higher than the one they paid.

 A re interest-bearing certificates that

corporations and governments issue to raise capital

 Have a lower risk and lower return

expected than stocks

 Are a form of debt financing with a specific rate of return to investors

 Pay a yearly interest rate semi-annually to

bondholders until “maturity” when they are redeemable at face value