LMPP14eCh11.ppt

PowerPoint Presentation by Charlie Cook
The University of West Alabama
Longenecker • Moore • Petty • Palich
© 2008 Cengage Learning.
All rights reserved.
CHAPTER 11
A Firm’s Sources
of Financing
Developing the New Venture Business Plan
Part 3

© 2008 Cengage Learning. All rights reserved. 11–2
Looking AHEAD
1. Describe how the nature of a firm affects its financing
sources.
2. Evaluate the choice between debt financing and
equity financing.
3. Identify the typical sources of financing used at the
outset of a new venture.
4. Discuss the basic process for acquiring and
structuring a bank loan.
5. Explain how business relationships can be used to
finance a small firm.
After you have read this chapter, you should be able to:

Looking AHEAD (cont’d)
6. Describe the two types of private equity investors that
offer financing to small firms.
7. Distinguish among the different government loan
programs available to small companies.
8. Explain when large companies and public stock
offerings can be sources of financing.
After you have read this chapter, you should be able to:

The Nature of a Firm and
Its Financing Sources
Firm’s
economic
potential
Owner
preferences
for debt or
equity
Company
size and
maturity
Factors That Determine
Financing
Types of
assets

Debt or Equity Financing?
Tradeoffs
Between Debt
and Equity
Potential
Profitability
Voting
Control
Financial
Risk

Tradeoffs Between Debt and Equity
11-1

Debt or Equity Financing? (cont’d)
• Return on Assets
Rate of return earned on a firm’s total assets invested,
computed as operating income ÷ total assets
• Return on Equity
Rate of return earned on the owner’s equity
investment, computed as net income ÷ owner’s equity
investment

Debt Versus Equity at the Levine Company
11-2

Sources of Funds
11-3

Startup Financing for Inc. 500 Companies in 2003
11-4
Source: Mike Hofman, “The Big Picture,” Inc., Vol. 25, No. 12 (October 2003), p. 87.
Copyright 2003 by Mansuelo Ventures LLC. Reproduced with permission of Mansuelo
Ventures LLC in the format Textbook via Copyright Clearance Center.

Debt or Equity Financing?
Sources Close
to Home
Personal
Savings
Credit
Cards
Family and
Friends

Sources of Personal Capital for Small Firms
11-5
Source: Republished with permission of Dow Jones Inc. from Staff, “Entrepreneurship Monitor 2002,”
Wall Street Journal, August 26, 2003, p. B8; permission conveyed through Copyright Clearance Center, Inc.

Bank Financing
Types of
Loans
Line of Credit
Revolving Credit
Agreement
Mortgages
Chattel
Real Estate
Term
Loans

Understanding a 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

Questions Lenders Ask
• Lender’s Questions
1. Do the purpose and amount of the loan make sense, both
for the bank and for the borrower?
2. Does the borrower have strong character and reasonable
ability?
3. Does the loan have a certain primary source of repayment?
4. Does the loan have a certain secondary source of
repayment?
5. Can the loan be priced profitably to the customer and to the
bank, and are this loan and the relationship good for both
the customer and the bank?
6. Can the loan be properly structured and documented?

The Banker’s Concerns
How much
money is
needed?
What is the venture
going to do with the
money?
When and
how will the
money be
paid back?
When will
the money
be
needed?

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

Negotiating a Loan: Interest Rate
• Prime Rate
Interest rate charged by a commercial bank on loans
to its most creditworthy customers
• LIBOR (London InterBank Offered Rate)
Interest rate charged by London banks on loans to
other London banks
• Fixed Interest Rates
Interest rate remains the same for the term of the loan
• Floating Interest Rates
Interest rate varies with the changes in the prime rate

Negotiating a Loan: Term of the Loan
• Loan Maturity Date
Maturity date matched to use of funds
• Repayment Schedule
Equal monthly or annual payments
Decreasing monthly or annual payments
• Loan Covenants
Bank-imposed restrictions on a borrower
to encourage timely repayment
Financial statements
Loan use restrictions and salary limits
Equity requirements
Personal guarantees by borrower

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

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

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 sold to factor at discount to invoice value.
Factor can refuse questionable accounts.
Factor charges fees for servicing accounts and for
amount advanced to firm prior to collection.

Private Equity Investors
• Informal Venture Capital
Funds provided by wealthy private individuals
(business angels) to high-risk ventures
• Formal Venture Capitalists
Individuals who form limited partnerships for the
purpose of raising venture capital from large
institutional investors
The firm’s expected profits in future years
The venture capitalist’s required rate of return.

The Government
• Small Business Administration (SBA) loans
 The 7 (a) Guaranty Loan Program
SBA guarantees repayment of loan to lender
 The Certified Development Company (CDC) 504
Loan Program
 The 7(m) Microloan Program
 Small Business Investment Companies (SBICs)
 Small Business Innovative Research (SBIR)

The Government (cont’d)
• State and Local Government Assistance
 Loan guarantees help lower down payment.
 Focus on enhancing specific industries or facilitating
certain community goals.
• Community-Based Financial Institutions
 Lenders that provide financing to small businesses in
low-income communities for the purpose of
encouraging economic development.

Where Else to Look
• Large Corporations
Financing and technical assistance to critical suppliers
and technology developers
• 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

Key TERMS
• return on assets
• return on equity
• line of credit
• revolving credit agreement
• term loan
• chattel mortgage
• real estate mortgage
• prime rate
• LIBOR (London InterBank
Offered Rate)
• balloon payment
• loan covenants
• limited liability
• accounts payable (trade credit)
• equipment loan
• asset-based loan
• factoring
• business angels
• informal venture capital
• formal venture capitalists
• 7(a) Loan Guaranty Program
• Certified Development Company
• (CDC) 504 Loan Program
• 7(m) Microloan Program
• small business investment companies
(SBICs)
• Small Business Innovative Research
(SBIR) Program
• community-based financial institution
• private placement
• initial public offering (IPO)

LMPP14eCh11.ppt

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