M5 L2 Financing Sources


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M5 L2 Financing Sources

  1. 1. Sources Available for Financing a Small Business
  2. 2. Types of Sources Used to Finance a Small Business <ul><li>Equity sources : Money or capital contributed by owners; capital sources that trade cash for some portion of ownership or equity in a business. </li></ul><ul><ul><li>Equity is sometimes called risk capital because the investor puts his/her money at risk. </li></ul></ul><ul><ul><li>Since the investor acquires ownership in the business, no repayment of money with interest is required. </li></ul></ul><ul><li>Debt sources :  Sources of funding that require the money borrowed to be paid back with interest. </li></ul>
  3. 3. Equity sources <ul><li>Personal savings </li></ul><ul><li>Friends and relatives </li></ul><ul><li>Partners </li></ul><ul><li>Private investors </li></ul><ul><li>Venture capitalists </li></ul><ul><li>State-sponsored venture capital funds </li></ul>
  4. 4. Equity sources <ul><li>Personal Savings </li></ul><ul><li>Advantages  </li></ul><ul><ul><li>Owner keeps all the profits. </li></ul></ul><ul><ul><li>Owner's risk of loss provides motivation to succeed . </li></ul></ul><ul><li>Disadvantages </li></ul><ul><ul><li>Creates chance of loss </li></ul></ul><ul><ul><li>Causes personal sacrifice </li></ul></ul><ul><ul><li>Causes loss of return from use of savings </li></ul></ul><ul><ul><li>Carries unlimited liability </li></ul></ul>
  5. 5. Equity sources <ul><li>Partnership With People or With Other Companies Having Compatible Goods </li></ul><ul><li>Advantages  </li></ul><ul><ul><li>Brings in more cash </li></ul></ul><ul><ul><li>Shares financial risks and responsibilities </li></ul></ul><ul><ul><li>Increases borrowing power </li></ul></ul><ul><li>Disadvantages </li></ul><ul><ul><li>Requires giving up a portion of profits </li></ul></ul><ul><ul><li>Results in the loss of some control and ownership  </li></ul></ul>
  6. 6. Equity sources <ul><li>Family and friends - Sometimes called &quot;love money&quot; </li></ul><ul><li>Advantages  </li></ul><ul><ul><li>Provides quick and easy source of funds </li></ul></ul><ul><ul><li>Allows less formal arrangements </li></ul></ul><ul><ul><li>Imposes fewer restrictions </li></ul></ul><ul><li>Disadvantages </li></ul><ul><ul><li>Creates chance of loss </li></ul></ul><ul><ul><li>Causes possible loss of return from use of savings </li></ul></ul><ul><ul><li>Carries unlimited liability </li></ul></ul>
  7. 7. Equity sources <ul><li>Private investors - also called Angels :   Wealthy individuals functioning as non-professional investors who are willing to invest in local businesses for financial or emotional reasons and who sometimes prefer to remain anonymous. </li></ul><ul><li>Advantages  </li></ul><ul><ul><li>Invest in region in which they live </li></ul></ul><ul><ul><li>Will finance startup businesses </li></ul></ul><ul><li>Disadvantages </li></ul><ul><ul><li>Not easy to locate </li></ul></ul><ul><ul><li>Must be chosen carefully and may not always be a reliable source </li></ul></ul>
  8. 8. Equity sources <ul><li>Venture capitalists :  Individuals or firms that invest money professionally to make money, expect a large capital gain, and look for high growth potential (30-50% return on investment). </li></ul><ul><li>Advantages  </li></ul><ul><ul><li>Provide large amounts of money </li></ul></ul><ul><ul><li>Allow owner to maintain control and operation of the business </li></ul></ul><ul><ul><li>Provide for additional assistance, when available </li></ul></ul><ul><li>Disadvantages </li></ul><ul><ul><li>Most businesses do not qualify. </li></ul></ul><ul><ul><li>Entrepreneur must give up part ownership. </li></ul></ul><ul><ul><li>Small businesses may have trouble attracting venture capitalists. </li></ul></ul>
  9. 9. Equity sources <ul><li>State-Sponsored Venture Capital Funds :   Funds provided to entrepreneurs by the state in an effort to encourage economic development and creation of jobs. </li></ul><ul><li>Advantages  </li></ul><ul><ul><li>Create jobs </li></ul></ul><ul><ul><li>Do not focus solely on profits </li></ul></ul><ul><li>Disadvantages </li></ul><ul><ul><li>None noted </li></ul></ul>
  10. 10. Money or capital that is borrowed and must be paid back with interest. <ul><li>Banks </li></ul><ul><li>Trade credit through venders </li></ul><ul><li>Finance companies </li></ul><ul><li>Credit unions </li></ul><ul><li>Government agencies </li></ul>Debt sources
  11. 11. <ul><li>Analysis of Debt Sources </li></ul><ul><li>Advantages  </li></ul><ul><ul><li>Relatively easy and quick to obtain </li></ul></ul><ul><ul><li>Maintain control and ownership of the business </li></ul></ul><ul><ul><li>Repay at a more advantageous time </li></ul></ul><ul><ul><li>Tax deduction for interest and related costs </li></ul></ul><ul><li>Disadvantages </li></ul><ul><ul><li>Higher interest rates </li></ul></ul><ul><ul><li>Risk of insufficient profit to cover repayment </li></ul></ul><ul><ul><li>Easy to abuse and overuse </li></ul></ul><ul><ul><li>Restrictions and limitations imposed by the lender </li></ul></ul>Debt sources
  12. 12. <ul><ul><li>Most common source of business financing </li></ul></ul><ul><ul><li>A line of credit allows businesses to borrow a stated amount of money at a stated interest rate to use as the business chooses. </li></ul></ul><ul><ul><li>Require that money be paid back on a regular basis according to the repayment plan specified </li></ul></ul><ul><ul><li>Very conservative and not inclined to lend to businesses that are not well established </li></ul></ul><ul><ul><li>Usually require some kind of collateral </li></ul></ul>Sources of Debt Source Financing Banks
  13. 13. <ul><li>Short-term financing </li></ul><ul><li>Credit from within the industry or trade  </li></ul><ul><li>Example:  </li></ul><ul><ul><li>One may purchase goods on 30-90 days of credit, interest-free.  </li></ul></ul><ul><ul><li>The business owner then has the use of the money for at least 30 days.  </li></ul></ul><ul><ul><li>Provided customers pay for goods and services on time, the owner can then pay his/her bills on time. </li></ul></ul>Sources of Debt Source Financing Trade Credit Through Vendors
  14. 14. <ul><li>Take more risks than banks </li></ul><ul><li>Are more expensive than banks </li></ul><ul><li>Will ask for some form of security like the entrepreneur's home, accounts receivable, or business inventories </li></ul>Sources of Debt Source Financing Finance Companies
  15. 15. Credit Unions Cooperatives formed by labor unions or employees for the benefit of the members Sources of Debt Source Financing
  16. 16. <ul><li>Terms of repayment may be quite flexible. </li></ul><ul><li>Interest rate may be low or the loan might be interest free. </li></ul><ul><li>Mixing financial affairs with family relationships or friendships can sometimes cause problems. </li></ul>Sources of Debt Source Financing Personal Loan From a Family Member or Close Friend
  17. 17. <ul><li>Uses a commercial bank to process and release the money and guarantees up to 90% of the loan if the business fails </li></ul><ul><li>Also lends public funds to veterans and handicapped persons who qualify </li></ul>Sources of Debt Source Financing Government Agencies Small Business Administration (SBA)
  18. 18. Government Agencies Minority Enterprise Small Business Investment Companies (MESBIC's) Sources of Debt Source Financing <ul><li>Established by SBA </li></ul><ul><li>Provide funding to businesses whose ownership is at least 51% minority, female, or disabled </li></ul>
  19. 19. Government Agencies Small Business Investment Companies (SBIC's)Minority Sources of Debt Source Financing <ul><li>Licensed by SBA </li></ul><ul><li>Provide equity and debt financing to young businesses </li></ul><ul><li>Invest about twice as often in startup ventures as do venture capitalists </li></ul><ul><li>Privately owned </li></ul><ul><li>Requirements vary </li></ul>
  20. 20. Government Agencies Department of Housing and Urban Development (HUD):  Provides grants to cities to lend money to private developers to help improve impoverished areas. Sources of Debt Source Financing
  21. 21. Government Agencies The Economic Development Administration (EDA) Sources of Debt Source Financing <ul><li>Division of the U. S. Department of Commerce </li></ul><ul><li>Lends money to businesses that operate in and benefit economically distressed parts of the country </li></ul><ul><li>Similar to SBA, but more restricted </li></ul><ul><li>Most states have economic development agencies and finance authorities that make or guarantee loans to small businesses. </li></ul>
  22. 22. <ul><li>Government Agencies </li></ul><ul><li>Local and municipal governments can be sources. </li></ul><ul><li>Sometimes these agencies make small loans of $10,000 or less </li></ul>Sources of Debt Source Financing