Assignment 226

Chapter Seven

How to Obtain the Right

Financing for Your Business

Copyright © 2018 by McGraw-Hill Education. All rights reserved.

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Learning Objectives

Explain the importance of proper financing for a small business.

Tell how to estimate financial needs, and explain some principles to follow in obtaining financing.

Explain why equity and debt financing are used, and describe the role each plays in the capital structure of a small firm.

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Learning Objectives (cont.)

Distinguish the types of equity and debt securities.

Describe some sources of equity financing.

Describe some sources of debt financing.

Explain what a lender looks for in a borrower.

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Estimating Financial Needs

Determine seed money needed to start up.

Determine which costs are onetime costs.

Determine ongoing costs.

Separate your costs into fixed or variable with sales.

Do you need to renovate the facility?

Identify which costs are essential or optional.

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Principles to Follow

Fixed assets

Those that are of a relatively permanent nature and are necessary for the functioning of the business.

Should be financed with equity funds, or partially with debt funds.

Working capital

Current assets, less current liabilities, that a firm uses to produce goods and services, and to finance the extension of credit to customers.

These assets include cash, accounts receivable, and inventories.

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Using Cash Budgets

Cash budgets

Project working capital needs by estimating what out-of-pocket expenses will be incurred and when revenues from
these sales are to be
collected.

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Reasons for Using Equity
and Debt Financing

Equity

An owner’s share of the assets of a company.

In a corporation, it is represented by shares of c common or preferred stock.

Stock

Represents ownership in a corporation.

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Reasons for Using Equity
and Debt Financing

Common stockholders

The owners of a corporation with claim to a share of its profits and the right to vote on certain corporate decisions.

Preferred stockholders

Owners with a superior claim to a share of the firm’s profits, but they often have no voting rights.

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Debt Financing

Debt financing

Comes from lenders who will be repaid at a specified interest rate within a specified time span.

Are legally enforceable claims against the business.

Entails substantial risk for the firm (or the entrepreneur) if the debt is guaranteed by personal wealth.

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Reasons for Using Debt Financing

The cost of interest paid on debt capital is usually lower that the cost of financial difficulty.

An entrepreneur may be able to raise more capital with debt funding than from equity sources alone.

Debt payments are fixed costs, any remaining profits belong solely to the owners.

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Role of Debt Financing

Financial leverage

Using fixed-charge financing, usually debt, to fund a business’s operations.

Lease

A contract that permits use of someone else’s property for a specified time period.

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Equity Securities

Common stock

Representing the owners’ interest, usually consists of many identical shares, each of which gives the holder one vote in all corporate elections.

Preferred stock

Has a fixed par value and a fixed dividend payment, expressed as a percentage of par value.

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Equity Securities

Small Company Offering Registration (SCOR)

The sale of common stock to the public through a regulated board such as Nasdaq or AMEX without the hassle of an initial public offering.

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Debt Securities

Short-term securities

Mature in one year or less.

Intermediate-term securities

Mature in one to five years.

Long-term securities

Mature after five years or longer.

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Debt Securities

Bonds

Form of debt security with a standard denomination, method of interest payment, and method of principal repayment.

Asset-based financing

Accepts as collateral the assets of a firm in exchange for the loan.

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Debt Securities

Mortgage loan

Long-term debt that is secured by real property.

Chattel mortgage loan

Debt backed by some physical asset other than land, such as machinery, equipment, or inventory.

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Small Business Investment Companies (SBICs)

Small business investment companies (SBICs)

Private firms licensed and regulated by the SBA to make “venture” investments in small firms.

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Venture Capitalists

Venture capital (VC) firms

Make investments based on projected future income and generally require a substantial return as either equity or profit.

Venture capital funding exceeded $72 Billion in 2015.

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Angel Capitalists

Angel capitalists or Business Angels

Wealthy local businesspeople and other investors who may be external sources of equity funding.

A diverse group of high income individuals who will invest part of their assets in high-risk, high-return entrepreneurial ventures

In 2015, the number of angel investors was approximately 145,135 individuals.

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Business Incubators

Managing in-house and revolving loan funds.

Networking it to locate and connect venture capitalists.

Connections with angel investors.

Assisting with loan applications.

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Other Sources

Employee stock ownership plans (ESOPs)

Allow small businesses to reap tax advantages and cash flow advantages by selling stock shares to workers.

Barter

Consists of two or more companies exchanging items of roughly equal value.

Barterers must report the value of their transactions to the IRS on IRS pub. 525.

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Sources of Debt Financing

Trade credit

Extended by vendors on purchases of inventory, equipment, and/or supplies.

Consignment selling

Payments to suppliers are made only when the products are sold, rather than when they are received in stock.

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Sources of Debt Financing

Line of credit: Extended by bank permitting a business to borrow up to a set amount without red tape.

Credit cards

Insurance companies

Seller Financing: Refers to the elimination of a third party when financing. This includes a promissory note with interest rate, repayment schedule, and default consequences.

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Eligibility for SBA-Guaranteed Business Loans by Industry Type

Table 7.2

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SBA Specialized Programs

Special government contracts to be awarded to small, disadvantaged business subcontractors.

SBA Low Documentation (LowDoc) Loan Program.

CAPLine Revolving Line of Credit initiative.

Women’s Prequalification Loan Program.

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What Lenders Look For

Can you live within your income?

Given your expected revenues and expenses, will you be able to repay the loan?

How much collateral can you put up to insure the lender against your inability to pay?

Are there problems with your track record? What will you do different in the future?

Do you have a new business plan?

Are you going to buy new equipment or technology?

Is there a new marketing plan?

Your income, stability and credit record.

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How to Improve the Entrepreneur-Investor Relationship

Figure 7.3