Financing a small business the equity side of picture

BUS 202 Financing_EQUITY Spring 2006 Financing a Small Business The Equity side of the picture…... Debt or Equity?• DEBT is borrowed money…it becomes a liability on your balance state

BUS 202 Financing_EQUITY Spring 2006

Financing a Small Business

The Equity side of the

picture…

Debt or Equity?

• DEBT is borrowed

money…it becomes a liability on

your balance statement (long

term loan)

• EQUITY is an “investment”

in your business (silent partner

or venture capital)

Remember the Accounting Equation

Asset = Liabilities - Owners’ Equity

Equity vs Debt Financing

Advantages

Debt Financing

Advantages:

• Relatively Easy &

Quick

• Maintain control &

ownership

• Interest & other costs

tax deductible

• May be able to save

money

Equity Financing

Advantages:

• Brings in more cash

• Share of financial risk

(partners)

• Less pressure &

restrictions

• May be able to borrow more

Equity vs Debt Financing

Disadvantages

Debt Financing

Disadvantages:

• Interest Costs Expensive

• Risk of profits not

covering repayment

• Easy to abuse & overuse

• Must share financial

information

• Lender Restrictions &

Limitations

Equity Financing

Disadvantages:

• Risk of destroying personal relationships

• Give up part of profits

• Give up part of ownership

of business

• Give up some control of business

• Personal sacrifices

• Loss of savings

Debt: A Loan by any other name

Debt Financing is most frequently used when

there are minimal risks and the investment return

is acceptable to the lender

Businesses that rely on debt financing are those

in earlier stages of business development (primary

& secondary levels of business growth)

There are two specific types of debt financing:

1) Conventional Loan Programs

2) Government Guaranteed Loan Programs

Equity Financing

• Most frequently used to fund emerging businesses and to provide “seed”

start-up early stage and expansion financing.

• For businesses in their 2nd and 3rd level

of business development.

• Start-up businesses often have

challenges attracting traditional equity investment.

• Start-ups often use the 3 F’s for equity investment.

Tips for Tapping the Family & Friends

for Funds

 Consider the impact the investment

will have on all parties

 Keep the arrangement strictly

business

 Keep it professional!

 Settle the details upfront

 Create a written document…put the

agreement in writing

 Treat the money as “bridge” financing

 Develop a payment schedule

Equity or “ Risk” Capital

•Equity capital represents the personal investment of the

owner(s)…it is often called RISK capital

•It is called RISK because the investors assume the primary risk

of losing their funds if the business fails.

•In the 1990’s entrepreneurs began to turn more to equity

financing to get their businesses up & running.

•Apart from personal savings, family and friends, equity capital is

normally tough for a start-up to obtain.

The Equity Ladder

1 Start with your personal savings …lenders & investors

EXPECT you to reach into your pockets first!

2 Three out of four start-ups tap their family members for

capital; followed by friends.

3 Entrepreneurs can take on partners to expand the

capital foundation of their business.

4. Angels fill a significant gap in the seed capital market.

5 Venture Capitalists & Capitalist Firms purchase equity

positions in young businesses that have high-growth potential

6 Going Public- Public Stock Sale

What about Grants?

• Are you a for-profit or a non-profit business?

• The SBA has SBIR Grant

(Small Business Innovative Research) i.e bio-tech

• Very limited amount of “seed” grant funds for disabled

re-training or disadvantaged businesses from federal and state agencies often tied to creating jobs.

The Bootstrapping Method

• Start small and reinvest the money in your

business

• Don’t quit your day job

• Start a business you “don’t like” to get the capital you need to start a business you want (would not

recommend)

Other “entrepreneurial” methods to

grow your financing

• Internal Financing (customer pays in advance)

• Factoring

• Consignment & Flooring

(inventory that doesn’t cost you)

• Concession (sub-lease)

• Vendor Credit (time is money)

• Trade for services (bartering)