Joseph Fabiilli is explaining about the Nature of a Firm and Its Financing Sources. Joseph Fabiilli is a funding consultant for future-thinking entrepreneurs and agencies. Joseph helps people secure funding for their environmental projects and programs.

1. Joseph Fabiilli
The Nature of a Firm and
Its Financing Sources

2. Looking Ahead
After studying this chapter, you should be able to:
1. Describe how the nature of a firm affects its financing
sources.
2. Evaluate the choice between debt financing and equity
financing.
3. Describe various sources of financing available to small
firms.

3. The Nature of a Firm and
Its Financing Sources
• Factors That Determine Financing
–Firm’s economic potential
Growth prospects and long-term profitability
–Maturity of the company
Life-cycle position in business
–Nature of its assets
Tangible or intangible
–Owners’ preferences for debt or equity
Tradeoffs required for debt and equity

4. Debt or Equity Financing?
• Potential Profitability
–Borrowing increases potential for higher rates of
return on owners’ equity; exposes firm to more
financial risk.
• Financial Risk
–Investing more owner equity limits potential return
on equity; lowers financial risk for firm.
• Voting
–Increasing equity through borrowing requires
owners to share control with external investors.

5. Equity
financing
Debt
financing
HIGH
LOW
LOW HIGH
Equity
Financing
Debt
Financing
Potential
Profitability
Financial Risk/Control
Tradeoffs Among Potential Profitability,
Financial Risk, and Voting

6. $28,000
income on
total assets
of $200,000
14% return
on assets
($28,000÷ $200,000)
14% return
on $200,000
($28,000÷$200,000)
No debt
equals
$200,000
equity
With no debt and all equity:
Debt Versus Equity at the Levine Company
Equity: Owners get to keep all of the profits in
return for accepting the risk of lower returns

7. $28,000
income on
total assets
of $200,000
14% return
on assets
($28,000 ÷ $200,000)
18% return
on $100,000
($18,000÷$100,000)
$100,000 debt
(10% cost)
equals
$100,000
equity
With $100,000 debt and $100,000 equity:
Debt Versus Equity at the Levine Company
Debt is Risky: Lenders have first claim on profits
and must be paid even if there are no profits.

8. Sources of Financing
0 10 20 30 40 50 60 70 80
Personal Savings
Family Members
Partners
Personal Charge Cards
Friends
Bank Loans
Private Investors
Mortgaged Property
Venture Capital
Other
Percentage of Entrepreneurs
Using Source of Financing
Sources of Financing

9. DebtEquity
Personal Savings
Other Individual Investors
Business Suppliers
Asset-Based Lenders
Commercial Banks
Government-Sponsored Programs
Community-Based Financial Institutions
Large Corporations
Venture Capital Firms
Sale of Stock
Friends and Relatives
Sources of Funds

10. Business Suppliers and
Asset-Based Lenders
• Trade Credit (Accounts Payable)
–Financing provided by a supplier of inventory to a
company, which sets up an account payable for
the amount.
Short-duration financing (30 days)
Amount of credit available is
dependent on type of firm
and supplier’s willingness
to extend credit

11. Business Suppliers and
Asset-Based Lenders (cont’d)
• Equipment Loan and Leases
–Installment loan (mortgage on equipment) from
the seller of machinery purchased by a business.
–Equipment leased from a supplier:
Frees up cash for other purposes
Leaves lines of credit open
Provides a hedge against
obsolescence

12. Business Suppliers and
Asset-Based Lenders (cont’d)
• Asset-based Loan
–A line of credit secured by working-capital assets
• Factoring
–Obtaining cash by selling accounts receivable to
another firm.
Accounts are sold to factor at a discount to invoice value
Factor can refuse questionable accounts
Factor charges fees for servicing accounts and for
amount advanced to firm prior to collection

13. Business Suppliers and
Asset-Based Lenders (cont’d)
• Commercial Banks
–Line of credit
Maximum amount that bank will permit firm to borrow.
–Revolving credit agreement
Maximum amount bank is
committed to lend a firm
on an ongoing basis.

14. Business Suppliers and
Asset-Based Lenders (cont’d)
• Commercial Banks (cont’d)
–Term loans
Loans for 5 to 10 years to finance equipment
–Chattel mortgage
Loan collateralized by inventory or
moveable property
–Real estate mortgage
Long-term loan with real property
held as collateral

15. The Banker’s Perspective
• Bankers’ Concerns
–How much the bank will earn on the loan?
–What is the likelihood that the lender will be able
to repay the loan?
• The Five C’s of Credit
–Character of the borrower
–Capacity of the borrower to repay the loan
–Capital invested in the venture by the borrower
–Conditions of the industry and economy
–Collateral available to secure the loan

16. Questions Lenders Ask
• Lender’s Questions
–What are the strengths and qualities of the
management team?
–How has the firm performed financially?
–How much money is needed?
–What is the venture going to do with the money?
–When is the money needed?
–When and how will the money be paid back?
–Does the borrower have qualified support people,
such as a good public accountant and attorney?

17. Financial Information Required
for a Bank Loan
• Three years of the firm’s historical statements
–Balance sheets, income statements, and
statements of cash flow
• The firm’s pro forma financial statements
–The timing and amounts of the debt repayment
included as part of the forecasts
• Personal financial statements
–The borrower’s personal net worth (assets –
debts) and estimated annual income

18. Negotiating a Loan
• Terms of Loans
–Interest rate
Fixed or floating rates
–Loan maturity date
–Repayment schedule
Equal monthly or annual payments
Decreasing monthly or annual payments
–Loan covenants
Bank-imposed restrictions on a borrower that enhance
the chances of timely repayment
Filing financial statements, restricting salaries and
personal loans, requiring personal loan guarantees

19. Government-Sponsored Programs
and Agencies
• Small Business Administration (SBA) loans
–Guaranty loan
SBA guarantees repayment of loan to lender
–Direct loan
SBA loans money directly to small firm/borrower
• Small business investment centers (SBICs)
• Small Business Innovative Research (SBIR)
• State and Local Government Assistance

20. Other Sources of Financing
• Venture Capital Firms
–An investor or investment group that commits
money to new business ventures
• Community-based financial institutions
–Lenders that provide financing to small
businesses in low-income communities for the
purpose of encouraging economic development
• Large corporations
–Financing and technical assistance to critical
suppliers and technology developers

21. Other Sources of Financing (cont’d)
• Stock Sales
–Private placement
The sale of a firm’s capital stock to selected individuals
–Initial public offering (IPO)
The issuance of stock that is to be traded in public
financial markets
Places firm under SEC securities regulations

22. Thank You