Raising Finance for an Established Business


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This revision presentation for business students provides an overview of the finance-raising options for an established business. It covers concepts such as share issues, sale and leaseback, trade credit and venture capital.

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Raising Finance for an Established Business

  1. 1. Raising Finance
  2. 2. Why businesses need finance Finance is needed for… Business Set-up
  3. 3. Factors affecting the type and amount of finance required (1) <ul><li>Purpose - what is finance required for? </li></ul><ul><ul><li>E.g. is it to finance long-term assets like a new factory) or a short-term increase in stocks? </li></ul></ul><ul><li>Cost </li></ul><ul><ul><li>Loan finance incurs interest costs </li></ul></ul><ul><ul><li>Share capital also has a cost – the dividends (returns) required by shareholders </li></ul></ul>
  4. 4. Factors affecting the type and amount of finance required (2) <ul><li>Flexibility </li></ul><ul><ul><li>What repayments might be required (and when) </li></ul></ul><ul><li>Ownership structure </li></ul><ul><ul><li>E.g. limited companies normally find it easier to raise finance than sole traders </li></ul></ul><ul><li>Period required </li></ul><ul><ul><li>Short-term v medium-term v long-term </li></ul></ul>
  5. 5. A key distinction – equity v debt
  6. 6. Many businesses combine both equity and debt in their finance structure Example of a finance structure including both equity and debt
  7. 7. Some key ways to raise finance in a larger business Internal External Retained profits Issue shares Bank overdraft Bank loan Sale of assets Sale & leaseback Reduced working capital Debentures
  8. 8. Retained profits The most important and significant source of finance for an established, profitable business
  9. 9. Retained profits – main advantages <ul><li>Cheap (though not free) </li></ul><ul><ul><li>The “cost of capital” of retained profits is the opportunity cost for shareholders of leaving profits in the business </li></ul></ul><ul><li>Very flexible </li></ul><ul><ul><li>Management control how they are reinvested </li></ul></ul><ul><ul><li>Shareholders control the proportion retained </li></ul></ul><ul><li>Do not dilute the ownership of the company </li></ul>
  10. 10. Disadvantages of retained profits <ul><li>Danger of hoarding cash </li></ul><ul><li>Shareholders may prefer dividends if the business is not earning a sufficient return on investment </li></ul><ul><li>High profits and cash flows would suggest the business could afford debt (higher gearing) </li></ul>
  11. 11. Sale of assets <ul><li>Selling spare or surplus assets is a way to achieve a short-term boost to cash flow </li></ul><ul><li>Good examples: spare land, surplus equipment </li></ul><ul><li>Note – not all businesses have spare assets </li></ul>
  12. 12. Sale of assets - example
  13. 13. Sale and Leaseback <ul><li>Specialist method of raising cash </li></ul><ul><li>Involves selling fixed assets and then leasing them back from new owner </li></ul><ul><li>Tends to involve business properties (e.g. Hotels, supermarkets, offices – popular when property market was booming </li></ul><ul><li>Note: can only be done once! </li></ul>
  14. 14. Sale & leaseback example
  15. 15. Working capital as a source of finance <ul><li>Reducing working capital </li></ul><ul><ul><li>A one-off benefit from lower working capital </li></ul></ul><ul><ul><li>The question – can it be sustained? </li></ul></ul><ul><li>Finance often wasted in excess stocks and trade debtors </li></ul><ul><li>Look for very low stock turnover ratio or high debtor days </li></ul>
  16. 16. Raising finance from suppliers <ul><li>Suppliers provide goods and services in advance of payment = trade creditors </li></ul><ul><li>As a business expands, the amount owed to suppliers at any one time also grows </li></ul><ul><li>If a business has a strong relationship with its suppliers, then it may be able to obtain better (i.e. longer) payment terms </li></ul>
  17. 17. Bank overdrafts <ul><li>Short-term finance, widely used by businesses of all sizes </li></ul><ul><li>An overdraft is really a loan facility – the bank lets the business “owe it money” when the bank balance goes below zero, in return for charging a high rate of interest </li></ul><ul><li>A flexible source of finance, in the sense that it is only used when needed </li></ul><ul><li>Bank overdrafts are excellent for helping a business handle seasonal fluctuations in cash flow or when the business runs into short-term cash flow problems (e.g. a major customer fails to pay on time). </li></ul>
  18. 18. Bank loans <ul><li>Long-term finance </li></ul><ul><ul><li>Loan provided over fixed period </li></ul></ul><ul><ul><li>Rate of interest either fixed or variable </li></ul></ul><ul><ul><li>Timing and amount of repayments are set </li></ul></ul><ul><ul><li>Start-up provide some security for the loan </li></ul></ul><ul><li>Good for financing investment in fixed assets </li></ul><ul><li>Generally at a lower rate of interest that a bank overdraft </li></ul><ul><li>However, they don’t provide much flexibility </li></ul>
  19. 19. Overdraft or bank loan? Bank overdraft Bank loan Bank Overdraft Bank Loan Advantages Relatively easy to arrange Greater certainty of funding, provided terms of loan complied with Flexible – use as cash flow requires Lower interest rate than a bank overdraft Interest – only paid on the amount borrowed under the facility Appropriate method of financing fixed assets Not secured on assets of business Disadvantages Can be withdrawn at short notice Requires security (collateral) Interest charge varies with changes in interest rate Interest paid on full amount outstanding Higher interest rate than a bank loan Harder to arrange
  20. 20. Debentures A debenture is a form of bond or long-term loan which is issued by the company, usually with a fixed rate of interest
  21. 21. Debentures – key features <ul><li>Long-term: often 10-20 years </li></ul><ul><li>Issued by the company (not a bank) </li></ul><ul><li>Fixed rate of interest </li></ul><ul><li>Usually secured against the assets of the company (provides some protection for debenture holders) </li></ul><ul><li>Can be traded </li></ul>
  22. 22. Issuing shares Company issues new shares 1 Shareholders buy the new shares 2 Company has: More cash More shareholders 3
  23. 23. Methods of issuing shares for a plc Flotation Share issued on Stock Exchange for the first time Opportunity for existing shareholders to realise profits on their investment Costly + time-consuming process Aims to raise at least £25-50million + of new capital Rights issue Fresh issue of new shares to existing shareholders Shareholders have the “right” to subscribe for the new shares, usually at a significant discount to the existing share price
  24. 24. Share issues – benefits and drawbacks Benefits Drawbacks Able to raise substantial funds if the business has good prospects Can be costly and time-consuming (particularly flotations) Broader base of shareholders Existing shareholders’ holdings may be diluted Equity rather than debt = lower risk finance structure Equity has a cost of capital that is higher than debt
  25. 25. Who are venture capitalists? <ul><li>Specialist investors in private companies </li></ul><ul><li>Often back management buy-outs (MBOs) </li></ul><ul><li>They manage investment funds designed to achieve high rates of returns </li></ul><ul><li>Tend to focus on larger investments (>£1m) than business angels </li></ul><ul><li>Will seek a large share of the share capital (equity) + representation on the Board </li></ul><ul><li>Look to sell (&quot;exit&quot;) their investment in the medium-term (e.g. 5-7 years) </li></ul>
  26. 26. Venture capital + / - Advantages Disadvantages Can raise substantial amounts Venture capitalist requires a high rate of return Business benefits from specialist investor support Investment often supported by a high level of bank debt in business Brings better discipline to business management & strategy Not a long-term investment – venture capitalist will aim to sell within 5-7 years Helps original business owners realise their investment Loss of control – venture capitalist may take a majority share in company
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