Chapter 6: Financing the Small Business

Informal Risk-Capital Market (Angels)

- Virtually invisible group of wealthy investors, often called "business angels", who are looking for equity-type investments opportunities in a wide variety of entrepreneurial ventures. -Typically investing anywhere from $10,000 to $500,000 - Provide the funds needed in all stages of financing, but particularly in start-up

Disadvantages of Equity Financing

- dilutes ownership and independence - disagreements - compromises - legal costs

1. The applicant's management ability

- how much the applicant knows about the business - how much care was taken in preparing the proposal

Crowd-Funding (Equity)

- new and emerging trend in equity investment for business is crowd-funding - occurs when an entrepreneur solicits small donations from the public to fund the start-up or growth of their company or social enterprise - kickstarter, indiegogo

Advantages of Equity Financing

- no obligations for dividends or interest - investor expertise - equity expands borrowing power - equity spreads risk of failure

3. Applicants Background and creditworthiness

- personal information - present debt and past lending history - amount of equity the applicant has invested - will the applicant bank with the lender - Lender Relations

CONCEPT CHECKS

1. What problems are often the result of lack of management competence and experience ? 2. What are some of the operating costs involved in determining the start up capital needed ? 3. Why is it important to determine the owner's net worth? 4. What are the sources of equity financing for the small business ? 5. What are the advantages and disadvantages of equity financing ? 6. What are the advantages and disadvantages of debt financing ? 7. What are the major sources of debt financing ? 8. What are the potential advantages and disadvantages of borrowing through government lenders ? 9. What criteria do lenders use in making the loan decision ? 10. What can the entrepreneur do if he/she is unsuccessful in obtaining financing ?

Debt Financing

funds raised through various forms of borrowing that must be repaid with interest

start-up costs

the expenses a new business must pay before it can begin to produce and sell goods

Bootstrap Financing (Equity)

Using any possible method for conserving cash

Government (Equity)

Programs have been developed in recent years that permit government funding and incentives for venture-capital firms or allow for direct equity investment by government in the business

Owner's net worth

combined investments of the owner and the accumulation of profit or losses for the business since it began.

Small Business Financing

The entrepreneur often require financing not only to start the business but also to provide capital to fund ongoing operations - Usually, its because the business is growing Sometimes, the business is in trouble

Disadvantages of Debt Financing

- Interest must be paid on borrowed money - Increased paperwork requirements and lender monitoring -Total risk on part of the owner

2. The Proposal

- Level of working capital - Current Ratio - Quick Ratio - Debt-to-equity ratio - Collateral

Corporate Investors (Equity)

- Many companies are interested in investing in a small business in the hope that the value of their investment will increase over time - Often they then sell their ownership interest back to the original owners

Advantages of Debt Financing

- Obtain higher ROI by using leverage debt - Interest costs are tax deductible; dividends from equity are not - No loss of ownership control and greater flexibility with debt financing - Easier to obtain than equity capital

Sources of Debt Financing

- Private Lenders (Shareholder loans) - Corporate Lenders - Regular Private Lending Institutions (Chartered banks, trust companies, credit unions, finance companies) - Government Lenders - Canadian Small Business Finance Program

Reasons for financing of ongoing operations

-New Products and Services -Acquisition / Joint Venture -Expansion -Capital expenditures -Working capital needs

Other management problems affecting financing

-underestimating financial requirements -lack of knowledge of sources of equity and debt capital -lack of skills in presenting a proposal for financing -failure to plan in advance for needs -poor financial control of operations

Criteria Used in the Loan Decision

1. The applicant's management ability 2. The Proposal 3. Applicant's background and creditworthiness.

Angel Organizations (Equity)

A new trend that has emerged in angel investing over the last decade is the formation of angel clubs or associations Angels use these clubs to network with other angels, share investment opportunities, and pool money to invest in start-up ventures

ongoing operating costs

Cost of running the business

Equity (Ownership) Financing

Offering part of the company in exchange for money. Mostly done if lender offers a magnitude of expertise (Dragon's Den/Shark Tank) -Private investors - Corporate Investors - Government - Informal Risk (Angels) - Crowd-funding - Family and Friends - Personal Funds

Determining Terms of Financing

Types. - short term(demand), medium term, long term Sources. - banks, private sources, factors, confirming houses; term lenders, leasing companies, foreign banks; trust companies.