M5 L2 Financing Sources
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M5 L2 Financing Sources

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