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  1. 1. Entrepreneurship Chapter 10 Financing Strategy: Debt, Equity or Both?
  2. 2. Financing <ul><li>Ways to obtain capital for a small business : </li></ul><ul><li>Put more of your money into the business </li></ul><ul><li>Exchange a share of the business for money …allow “buy-ins” (equity) </li></ul><ul><li>Borrow the money from others (debt) </li></ul><ul><li>Obtain gifts & grants from others </li></ul>
  3. 3. Gifts & Grants <ul><li>Gifts </li></ul><ul><ul><li>Cash, free use of facilities & equipment, unpaid labor from friends & family, & forgiveness of debts </li></ul></ul><ul><ul><li>Tax abatements & tax credits </li></ul></ul><ul><li>Grants </li></ul><ul><ul><li>Primarily for research & commercialization </li></ul></ul><ul><ul><li>Difficult to get for low-tech, start-ups </li></ul></ul><ul><li>+ Do not require repayment, loss of ownership, or financing costs </li></ul><ul><li>- Gifts/grants often have restrictions…come with “strings attached” </li></ul><ul><li>DON’T STAKE YOUR BUSINESS ONLY ON GIFTS & GRANTS </li></ul>
  4. 4. Ways to Secure Growth Funding <ul><li>Finance with equity </li></ul><ul><ul><li>Incorporated firms can sell stock </li></ul></ul><ul><ul><li>Take on a partner and have them put $$$ into the firm </li></ul></ul><ul><li>Finance with debt </li></ul><ul><ul><li>Borrow the money. Is the business “credit worthy?” </li></ul></ul><ul><li>Government sources of funding </li></ul><ul><ul><li>Grants, guaranteed loans, etc. </li></ul></ul><ul><li>Customers and suppliers </li></ul><ul><ul><li>Using special terms and float </li></ul></ul><ul><li>Finance with earnings (future) </li></ul><ul><ul><li>Is the firm profitable? Does the firm have positive cash flow? </li></ul></ul>
  5. 5. Finance Sources <ul><li>Financing with Equity Sources </li></ul><ul><li>Getting an ownership stake </li></ul><ul><li>No guaranteed returns </li></ul><ul><li>No protection against losses </li></ul><ul><li>Appreciation in value through… </li></ul><ul><ul><li>growth in earnings and growth in assets </li></ul></ul><ul><ul><li>Takes time arrange </li></ul></ul>
  6. 6. Stocks <ul><li>Shares of stock represent a percentage ownership in a corporation. </li></ul><ul><li>Public corporations sell stock to the general public to raise capital. </li></ul><ul><li>Prices of stocks reflect investors’ opinions about business performance & value. </li></ul><ul><li>Traded on stock exchanges. </li></ul>
  7. 7. Other “Equity” Financing Options <ul><li>Venture Capitalists : </li></ul><ul><li>Private investors seeking equity … want to have influence on decisions </li></ul><ul><li>Won’t invest in company with less than $25 million in sales over 5 years </li></ul><ul><li>Want return of 6 times investment over 5 years (45% ROI/yr) </li></ul><ul><li>Want a business with 30-50% growth/yr and 20% pre-tax profit margins </li></ul><ul><li>Typically invest sizable amounts in businesses </li></ul><ul><li>Angel Financing : </li></ul><ul><li>Private investors seeking equity … Net worth > $1 Million </li></ul><ul><li>Want return of 10 times investment over 5 years (60% ROI/yr) </li></ul><ul><li>Typically invest $100,000–$500,000 </li></ul><ul><li>Bootstrap Financing : </li></ul><ul><li>Hire as few employees as possible </li></ul><ul><li>Lease rather than buy equipment </li></ul><ul><li>Use vendor financing…get suppliers to extend your credit terms </li></ul><ul><li>Use personal savings, second mortgages, loans from friends & relatives </li></ul><ul><li>Work from home, borrow office space, or use business incubators </li></ul><ul><li>Put profits back into business </li></ul>
  8. 8. Equity Financing: Pros and Cons <ul><li>Pros : </li></ul><ul><li>If business doesn’t make profit, investor don’t get paid </li></ul><ul><li>Equity investor can’t force bankruptcy to recoup investment </li></ul><ul><li>Equity investors want business success; will share contacts & advice </li></ul><ul><li>Cons : </li></ul><ul><li>Entrepreneur can lose control of business to equity investors…stock holdings become diluted </li></ul><ul><li>Equity investors take more risk, want higher returns and influence over how the company is run </li></ul><ul><li>Entrepreneur must share profits with equity investors </li></ul>
  9. 9. Debt Financing: Pros and Cons <ul><li>Pros : </li></ul><ul><li>Lender has no say in operation of business </li></ul><ul><li>Loan payments are predictable </li></ul><ul><li>Lenders do not share business’s profits </li></ul><ul><li>Cons : </li></ul><ul><li>If loan payments are not made, lender can force business into bankruptcy </li></ul><ul><li>If business is not incorporated & defaults, lender can take house & other possessions of owner </li></ul><ul><li>Loan payments increase fixed costs, lower profit </li></ul><ul><li>Payments reduce available cash in the company </li></ul><ul><li>Compliance with the contract is expected…no skips </li></ul>
  10. 10. Finance Sources <ul><li>Financing with Debt </li></ul><ul><li>Commercial Banks & Finance Companies </li></ul><ul><li>Personal Loans </li></ul><ul><li>Leases </li></ul><ul><li>Convertible Debt </li></ul><ul><li>Bonds </li></ul>Getty Images
  11. 11. Debt Financing <ul><li>Available in many forms </li></ul><ul><ul><li>Commercial loans </li></ul></ul><ul><ul><ul><li>REAL ESTATE - up to 20 years </li></ul></ul></ul><ul><ul><ul><li>EQUIPMENT - up to 7 years </li></ul></ul></ul><ul><ul><ul><li>WORKING CAPITAL - less than 1 year </li></ul></ul></ul><ul><ul><ul><li>ACCOUNTS RECEIVABLE FACTORING - 30 to 90 dys </li></ul></ul></ul><ul><ul><li>Personal loans </li></ul></ul><ul><ul><ul><li>CREDIT CARDS </li></ul></ul></ul><ul><ul><ul><li>HOME EQUITY LOANS </li></ul></ul></ul><ul><ul><ul><li>PAY DAY LOAN </li></ul></ul></ul><ul><ul><li>Leases </li></ul></ul><ul><ul><ul><li>VEHICLE LEASE - 2 to 3 years with option to purchase at the end </li></ul></ul></ul><ul><ul><ul><li>EQUIPMENT LEASES - why buy what you can rent? </li></ul></ul></ul>
  12. 12. Finance Sources <ul><li>Commercial Banks </li></ul><ul><li>Are highly regulated </li></ul><ul><li>Look at the five “C’s”: character, capacity, capital, collateral, conditions </li></ul><ul><li>Favor ventures that can give hard assets as collateral </li></ul><ul><li>Are difficult to get financing from </li></ul>
  13. 13. The 5 “Cs” of Credit <ul><li>Collateral </li></ul><ul><ul><li>Property and assets to pledge </li></ul></ul><ul><li>Character </li></ul><ul><ul><li>What is your credit history? </li></ul></ul><ul><li>Capacity </li></ul><ul><ul><li>Sufficient cash flow to make the monthly payments? </li></ul></ul><ul><li>Capital </li></ul><ul><ul><li>How much investment (“skin”) do the owners have in this business? </li></ul></ul><ul><li>Conditions </li></ul><ul><ul><li>Industry and economic climate </li></ul></ul><ul><ul><li>ARE YOU WILLING TO SIGN A PERSONAL GUARANTEE TO GET THE LOAN? </li></ul></ul>
  14. 14. Finance Sources <ul><li>Commercial finance companies or asset based lenders: </li></ul><ul><li>Are less rigid compared to regular banks </li></ul><ul><li>Often charge a higher rate of interest </li></ul><ul><li>Consider the quality of the assets of the business </li></ul>
  15. 15. Finance Sources <ul><li>Using Convertible Debt </li></ul><ul><li>Better returns to lenders </li></ul><ul><li>Lenders get returns from day one </li></ul><ul><li>Possibility to get back the loan amount </li></ul><ul><li>Venture gets immediate use of funds </li></ul><ul><li>Conversion relieves the burden of debt </li></ul><ul><li>Planning the timing is possible </li></ul>
  16. 16. Bonds <ul><li>Long-term interest bearing certificates that corporations & governments issue to raise capital. </li></ul><ul><li>Lower risk & return expected than with stocks. </li></ul><ul><li>A form of debt financing with a guaranteed rate of return to investors. </li></ul><ul><li>Trade at premiums or discounts. </li></ul>
  17. 17. Government Finance Sources <ul><li>Government Sources of Funding </li></ul><ul><li>Small Business Investment Company (SBIC) </li></ul><ul><ul><li>Long-term loans or equity capital invested in small growing companies over a longer period of time </li></ul></ul><ul><li>Venture Capital Institutes and Networks </li></ul><ul><ul><li>Found on university campuses…acts as a conduit so entrepreneurs can easily locate interested investors </li></ul></ul><ul><li>Small Business Administration (SBA) </li></ul><ul><ul><li>Counseling, micro-loans, guarantees to debtors </li></ul></ul><ul><li>State-Funded Assistance </li></ul><ul><ul><li>Tax holidays, infrastructure investments, forgiveness programs </li></ul></ul>
  18. 18. Government Finance Sources <ul><li>Small Business Administration (SBA) Loans </li></ul><ul><li>provide aid, counsel, and protection </li></ul><ul><li>Many loan programs: </li></ul><ul><li>Micro loans-up to $35,000 </li></ul><ul><li>LowDoc Loans -- up to $150,000 </li></ul><ul><li>SBA Express loans -- up to $250,000 </li></ul><ul><li>Guarantees given to intermediaries who sanction loan </li></ul>
  19. 19. SBA Financing Options <ul><li>Microenterprise Loans : </li></ul><ul><li>Up to $35,000, often supported by federal government or not-for-profit agencies </li></ul><ul><li>Loan made based on alternative credit criteria & may require training, counseling, &/or a business plan </li></ul><ul><li>May be the only option for debt financing outside of family & friends & personal credit cards for many entrepreneurs </li></ul><ul><li>Often a social impact goal involved for the lender </li></ul>
  20. 20. Government Finance Sources <ul><li>State-Funded Assistance </li></ul><ul><li>States give incentives like… </li></ul><ul><ul><li>Tax holidays </li></ul></ul><ul><ul><li>Tax exemption and relief (Enterprise Zones) </li></ul></ul><ul><ul><li>Equity participation – infrastructure improvements </li></ul></ul><ul><ul><li>Loan programs </li></ul></ul><ul><ul><li>Convertible debt & forgiveness programs </li></ul></ul>
  21. 21. Financing from Customers and Suppliers <ul><li>Customers and Suppliers </li></ul><ul><li>Understand the entrepreneur’s business </li></ul><ul><li>Have a vested interest in your business remaining healthy and cooperative </li></ul><ul><li>Customers may pay early …make down payments on future orders (pay ½ on date of order, and ½ on date of delivery) </li></ul><ul><li>Suppliers may offer special terms favorable to the business (instead of “net 30” on invoices, for you…”net 60 or net 90”) </li></ul>
  22. 22. Financing with Future Earnings <ul><li>Will stable (predictable) profits be generated by the business? </li></ul><ul><li>Will positive cash flows be achieved each year? </li></ul><ul><li>Can we safely withdraw large amounts of cash from the business each year? </li></ul>