Entrepreneurship and small business management chapter 15

Entrepreneurship and
Small Business
Management
Chapter 15
Financing Strategy:
Debt, Equity, or Both?


Ch. 15 Performance
Objectives
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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.

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What Is Financing?
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The act of providing or raising funds
(capital) for a purpose

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Ways to start or expand a business:
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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)

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Gifts
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Repayment not required but may
come with conditions or “strings
attached”
Examples:
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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

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Grants
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No repayment, but may have specific requirements

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Primarily provided for research and commercialization efforts

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

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Forms of Debt Financing
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Commercial loans—business loans typically provided by a bank

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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

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Forms of Debt Financing
(continued)
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Personal loans—taken out on personal credit and used for the business

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Credit cards—”revolving” terms

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Home equity loans—variable terms; some are lines of credit

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Title loans—short-term fixed repayment

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Payday loans—short-term fixed repayment

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Forms of Debt Financing
(continued)
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Leases—debts incurred for the rights to use specific property
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Vehicle leases

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Equipment leases

Bonds—long-term debt used to raise large sums of money

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© 2012 Pearson Education, Upper Saddle River, NJ
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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.
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Disadvantages
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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.

© 2012 Pearson Education, Upper Saddle River, NJ
07458.


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
contacts.
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Disadvantages
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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.
Investors share in profits.

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07458.


Bankers Operate on the
Five Cs of Credit


Collateral—property or assets that lender
can take if loan is not repaid

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Character—measured by your ability to
borrow and your credit history

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Capacity—sufficient business cash flow

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Capital—personal resources invested

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Conditions—industrial/economic “climate”

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Community Development
Financial Institutions (CDFIs)
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Lenders that share a vision of expanding
economic opportunity and improving
quality of life for low-income communities
Four sectors:
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Community
Community
Community
Community
(CDVCs)

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development
development
development

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banks (CDBs)
credit unions (CDCUs)
loan funds (CDLFs)

venture capital funds

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Venture Capitalists


Investors or investment companies
seeking equity

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Expect 6 times their money back
over 5 years, or a 45% rate of return

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Desire candidates likely to generate
at least $50 million in sales within 5
years

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Sometimes seek a majority interest

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Angels
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Wealthy, private individual investors

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Usual investment is between
$100,000 and $500,000

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Typically seek a return of 10 times
the investment at the end of 5 years

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Best strategy: recruit one angel who
finds others

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Other Financing Options
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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.

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© 2012 Pearson Education, Upper Saddle River, NJ
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Other Financing Options
(continued)
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U.S. Department of Agriculture—
provides assistance to
rural/agricultural businesses

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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

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Three Categories of

Investment
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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

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© 2012 Pearson Education, Upper Saddle River, NJ
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Stocks


Shares of stock represent a percentage
of ownership in a corporation.

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Public corporations sell stock to the
general public to raise capital.

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Stock prices reflect investors’ opinions
about business performance and value.

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Investors make money by selling stock
at a price higher than the one they paid.

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© 2012 Pearson Education, Upper Saddle River, NJ
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Bonds:
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Are 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

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© 2012 Pearson Education, Upper Saddle River, NJ
07458.