SMALL BUSINESS FINANCE CHAPTER 15 Intermediate Financing

1. Small Business Finance
Ch 15: Intermediate Financing

2. Term Loan
Asset based short term (usually for one to five years) loan
payable in a fixed number of equal installments over
the term of the loan.
Intermediate Financing
term loans are commonly granted to small businesses that need
cash to purchase equipment, a new building for their production
processes, or any other fixed assets to keep their businesses
going. Some businesses borrow the cash they need to operate
on a month-to-month basis.

3. Maturity
borrowers get a lump sum of cash and are required to make payments over a certain
period of maturity time (usually for one to five years)
Principal and Interest Term loans carry a fixed or variable interest rate along with
principal amount and a set maturity date. If the proceeds are used to finance the
purchase of an asset, the useful life of that asset can impact the repayment
schedule
Collateral loan requires collateral and a rigorous approval process to reduce the risk
of default or failure to make payments. Banks generally require some type of
collateral from their borrowers, and this is especially true for small companies. The
collateral may include personal assets such as stock and bonds as well as real
property such as machinery and equipment. Occasionally the firm is required to
secure the loan with real estate
Sweeteners During recent years many lenders have required sweeteners” in addition
to fixed interest payments. The most common sweeteners is the option to
purchase common stock.
A feature of a security that makes it more attractive to potential purchasers.
An extra incentive to encourage investors to buy a bond or preferred stock.
Characteristic Of A Term Loan

4. Restrictive Provisions
• Lenders usually include several restrictive provisions in
term loan agreements.
• The exact nature of each restrictive clause varies among
firms.
• The common restrictive clauses relate to:
– Volume of working capital.
– Long term debt.
– Payments of dividends.
– Changes in key managerial personnel.
– Sale of assets.
– Additional borrowing.
Characteristic of a term loan

5. Principal suppliers of term loans are
banks,
 insurance companies,
 finance companies,
 the small business administration
 various other federal and state agencies.
Sources of term loan
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6. The lending characteristics of the sources are as follows:
1. Length of term loan
First, the length of term loans is shorter for small firms than for large firms. It is
unusual for financial institutions to make term loans to small businesses in excess
of five years whereas many term loans to large businesses are as long as ten years.
2. SBA Loans
Second, nearly all of the loans guaranteed by the SBA are term loans rather than
short- or long-term loans. Again these loans usually range from three to seven
years. the majority of which fall in the three- to five-year category.
3. Collateral Finally, small firms are more often required to collateralize their term
loans than larger firms; however, it should be emphasized that the strongest and
best collateral is cash flow. This fact further emphasizes the importance of cash
management to small businesses.
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7. Advantages for financial Institutions
• Higher Yield it is able to obtain a higher yield from such an
arrangement than it could by holding high-grade bonds.
• Safety it is generally conceded that the lessor is in a relatively safe
position since the types of firms that enter into these agreements
have relatively small amounts of debt outstanding In the event of
insolvency. the lessor is not in SO strong a position as a general
creditor since the lessee can obtain legal relict’ from rental
obligations: however, until insolvency occurs, the lessor is in a very
strong position since the asset involved is of such character that the
lessee cannot operate without it.
• Expiration of Lease in many cases the asset will have a value at the
expiration of the lease. This offers the investor several courses of
action. Repurchase property , sale and lease back
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8. Leasing
• Leasing is a process by which a firm can obtain the use of a certain fixed
assets for which it must pay a series of contractual, periodic, tax
deductible payments.
Term of the lease
• The term of the lease may be fixed, periodic or of indefinite duration.
THE NATURE AND IMPORTANCE OF LEASING
• Leasing as a method of procuring assets is probably the most significant
development that has taken place in the field of finance during the past
three decades. Originally (he emphasis was on real estate leasing, but
during the past several years firms have been able to lease almost any
type fixed asset. Although there are no figures measuring the amount of
leased equipment presently in use, we may safely conclude that lease
financing is one of the major methods of external financing being used by
many industries. Although a firm would probably never lease all its fixed
assets, there is a definite trend toward owning less and leasing more. It is
difficult to say whether the increased importance of leasing is a result of
the financial officers desire to conserve funds or whether it results from
increased effort on the part of the leasing companies.
Leasing

9. Types of Lease
1. Operating Lease
2. Financial Lease
Parties in leasing
A lessor is essentially someone who grants a lease to someone else. As such, a
lessor is the owner of an asset that is leased under an agreement to a lessee
A Lessee is a party who uses the asset under a lease agreement, which can either
be written or verbal. The agreement grants the right to use the asset to the
Lessee; a mutually agreed one-time or monthly payment (rent) to the asset’s
owner for the specified period.
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10. Advantages to the Lessee
Saves Big Capital Investment:
Leasing an asset saves the Lessee from spending a significant amount to purchase the same asset.
Hence, this is a more economical option when the new business has less capital.
100% Financing:
In most lease agreements, no upfront fee is required, like in the case of loan financing of
the asset, where a certain amount of down payment is required. Only the monthly
lease rental payments are to be made.
No Risk of Obsolescence:
If the asset becomes obsolete due to a change in technology or any other reason, there is
any risk for this.
Tax Benefits:
Lease rentals are shown as an expense in the Lessee’s books. Hence, it reduces the overall
income and taxes of these.
Flexibility: The parties to the lease can make or amend the rules of the lease agreement as
per their convenience. For example, during the project’s initial days, the Lessee’s cash
inflow is restricted. So lessor and the Lessee agree to have minimum rent during the
initial months and maximum towards the end of the lease period.
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11. Operating Lease
• In operating lease, the asset is provided to the lessee by
the lessor to use that for specific period of time. At the end
of that period, the asset is returned by the lessee to the
lessor and it remains the property of lessor.
• Normally, the lease term is short compared to the useful
life of the asset or piece of equipment being leased.
For example, an aircraft which has an economic life of 25
years may be leased to an airline for 5 years on an
operating lease.
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12. Operating Lease
At the maturity of an operating lease, the lessee
has several possibilities:
o Return of the equipment.
o Renewal of equipment.
o Restoration of equipment.
o Purchase of equipment at their market value.
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13. Intermediate Financing
Financial Lease
A lease is classified as a finance lease if it transfers the ownership of assets to
the lessee. The example of finance lease may be the car lease in which
lessee makes periodic payments to the lessor and after a specific period of
time say after five years, the possession of car is transferred to the lessee.
A finance lease or capital lease is a lease which meets at least one of the
following criteria:
• The lease term is greater than 75% of the asset's estimated useful life.
• The lease contains a bargain purchase option to buy the equipment less
than fair market value.
• Ownership of the asset is transferred to the lessee at the end of the lease
term.
• The present value of the lease payments exceeds 90% of the total original
cost of the equipment.

14. financial lease contract clause
financial lease contract includes the following:
(I) the term of the lease (during which time the lease is non
cancelable)
(2) periodic rental payments, which include the cost of the
equipment plus a return on the lessor’s investment
(3) cost of maintenance, taxes, insurance, and so on
(4) a renewable clause.

15. Features of Financial Lease
• It is non cancelable.
• The lessor may or may not bear the cost of insurance,
repair, maintenance etc. Usually the lessee has to bear
all cost.
• The lessor transfer ownership of the asset to the lessee
by the end of the lease term.
• The lessee has an option to purchase the asset at a
price which is expected to be sufficiently lower than
the value at the end of the lease period.
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16. Advantages Of Financial Leases
The following advantages of financial leases are currently
acknowledged as being valid:
1. Permit a lessee to obtain the use of property that cannot be
acquired in any other way.
2. Provide facilities that are needed only temporally.
3. Avoid the risk of’ obsolescence.
4. Relieve the user of maintenance. service, and administrative
problems.
5. Provide an additional source of financing.
6. Give the lessee flexibility.

17. Disadvantages Of Financial Leasing
The most frequently mentioned disadvantages of leasing are
(1) High Cost
(2) loss of residual values
(3) the possibility that a premium will be demanded for vital
equipment unless adequate care is taken when the lease is
negotiated
(4) inadequate evaluation due to habitual leasing:
(5) the lack of accumulation of equity. which could have some
adverse effects on future financing
(6) the possibility that control of the facility may be lost at the
end of the lease period.

18. Sources of lease funds
Funds to finance leases are obtained from
several important sources, chiefly the following:
Independent leasing corporation
Banks
Insurance companies
Pension funds
Industrial development agencies
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19. A. Independent leasing companies
independent leasing company is the most important of the sources listed.
there are three types of independent leasing companies:
I. the service leasing company
II. Finance leasing companies
III. the lease broker.
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20. (i) Service leasing companies
 Service leasing companies generally specialize in
automobiles, office equipment and computers. and,
occasionally, industrial equipment.
 The leases of such equipment are often cancelable and run
from two to four years.
 The profit of many service leasing companies depend on the
residual value of the leased equipment.
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21. (ii) Finance leasing companies
 The process is quite simple in that the leasing company will
upon instruction of the customer, purchase the desired
equipment.
 The equipment is usually delivered directly from the
manufacturer to the lessee.
 While the cost of the equipment is usually fully amortized,
some leasing companies issue leases for approximately 10%
of the value of the equipment.
 This permits them to realize a profit from the residual value
of the assets.
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22. (iii) Lease broker
The lease broker acts as a “go- between” for the
supplier of funds and the lessor and deals
primarily with large businesses.
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23. B. Bank
• Financial institutions, such as banks, are the major
sources of funds for both service & finance leasing
companies.
• Banks have increased their participation in leasing
during the past several years. It is believed that they
have become a major supplier of leases.
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24. C. Insurance companies & Pension fund
• Insurance companies & pension funds also
lease equipment.
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25. D. Industrial development agencies
• Industrial development agencies have been
active in leasing entire plants to small and
middle-sized firms.
• This activity is done in order to attract
industries in certain underdeveloped areas.
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