MGT 3361 Ch 9

Unsecured loans

A short term loan for which collateral is not required. Most short term loans are unsecured loans, meaning that the bank does not require any collateral as long as the entrepreneur has a good credit standing. These loans are often self liquidating, which means the loan will be repaid directly with the revenues generated from the original purpose of the loan. Types of short term loans include lines of credit, demand notes, and floor planning.

Commercial banks

Commercial banks are the back bone of the credit market, offering the widest assortment of loans to credit worth the small businesses. Bank loans generally fall into two major categories: - short term loans, for purchasing inventory overcoming cash flow problems, and meeting monthly expenditures - Long term loans, for purchasing land, machinery, and buildings, or renovating facilities Most short term loans are unsecured loans meaning that the bank does not require any collateral as long as the entrepreneur has a good credit standing.

Floor Planning

A type of business loan generally made for big ticket items. The business hold the item in inventory and Pace interest, but it is actually owned by the lender until the item is sold. Floor planning is a special type of loan muse particularly for financing high priced inventory items, such as new automobiles, trucks, recreational vehicles, and boats. A business borrowing money for this purpose is allowed to display the inventory on its premises, but the inventory is actually owed by the bank. When the business sells one of the items, it will use the proceeds of the sale to repay the principle of the loan. The business is generally required to pay interest monthly on each item of inventory purchased with the loan proceeds.

short term assets

Assets that will be converted into cash within one year. Typically short term assets include cash and inventory but may also include prepaid expenses, such as rent or insurance paid in advance, and a working capital, cash reserve. Because many business are not profitable in the first year or so of operating, having a cash reserve with which to pay bills can help you avoid becoming insolvent.

Public offerings

Public offering involves the sale of stock to general public. These cells always are governed by security and exchange commission regulations.

Small business investment companies

Small business investment companies SBICs venture capital firm's license by the SBA to invest in small businesses. SBIC were authorized by Congress in 1958 to provide equity financing to qualified Enterprises.

Advantages of Equity Financing

- Less risky: you don't have to pay it back - long-term view: investors tend to look longer-term and not expect their investment back immediately - growth potential: your profits can go back into the business, rather than paying debt - cash flow: you'll keep more cash in fist for building your business

What if a lender says no

- Thank the lender for the time spent reviewing your package. Do not show resentment. - ask what specific information, or lack, counted against you. Talk about the points sided, but don't argue. If you can make the changes suggestion, ask when you can reapply. - ask the lender for specific, personal recommendations. Straight out ask for any personal advice the lender may have. - give the bank a reason to make the loan. Make sure you know exactly what you are asking for and the reason behind the request. - understand that business loans are generally turn down for one one more reasons: A poor credit score, lack of collateral, uncertainty of cash flow, and a poorly written business plan. - Ask whether the bank can rework your application so that it meets the lending criteria.

Disadvantages of equity financing

- total cost: giving up a percentage of ownership may cost more than you would pay for a loan - Less control: Giving up ownership means you will have to give up some control including asking investors for decision approval - Irreconcilable difference: if you and your investors do not agree there will come a point when one of you will have to be bought out of the business - Time and effort: finding the right investors is not easy and their relationship has to be maintained

Angels

A lender, usually a successful entrepreneur, who loans money to help new businesses. An Angel is a wealthy, experienced individual who has a desire to assist start up for emerging businesses, frequently and companies in their own communities. Often they provide funding for start ups that will allow the business to grow to the point where a VC will then pick up the funding. Most angels are self-made entrepreneurs who wants to help sustain the system that allowed them to become successful. Usually there are knowledgeable about the market and technology areas in which they invest. There are more than 250,000 such investors in the United States. A typical Angel investment ranges from $20,000-$50,000, although nearly 1/4 car for more than $50,000. And Angel can't add much more than money to a business. His business know-how and contracts can prove far more valuable to the success of the business then the capital invested. Several types of angel investors exist, corporate angels, entrepreneur angels, enthusiastic angels, professional angels, and micromanagement angels. When approaching angel investors some experience and an in-depth knowledge of your business are essential. Finding an angel investor is not easy the best way for an entrepreneur to locate one are to maintain business contacts with tax attorneys, bankers, and accountants in the closest metropolitan area and to ask for an introduction. Networking can be key.

Installment loans

A loan me to a business for the purchase of fixed assets such as equipment and real estate. These loans are to be repaid in periodic payments that include accrued interest and part of the outstanding principal balance.

Unsecured term loans

A loan me to an established business that has demonstrated a strong overall credit profile. Eligible businesses must show excellent credit worthiness and have an extremely high probability of repayment. These loans are usually made for very specific terms and may come with restrictions on the use of the loan proceeds.

Secured loan

A loan that requires collateral as security for the lender.

Balloon notes

A loan that requires the borrower to make small monthly payments, and usually enough to cover the interest, with the balance of the loan due at maturity. This allows you more flexibility with your cash flow over the life of the loan. If you are unable to make the final balloon payment, a bank may refinance the loan for a longer period of time, allowing you to continue making monthly payments.

Fixed Rate Loan

A loan who's interest rate remains constant. A fixed rate loan retains the same interest rate for the entire length of time for which the funds are borrowed. A fixed rate loan typically has a higher interest rate than the initial rate on a variable rate loan.

Variable rate loan

A loan whose interest rate changes over the life of the loan. With a variable rate loan, the interest rate may fluctuate over time. The variable rate is tied to a benchmark such as the prime rate or federal funds rate. Every year normally on an anniversary of the original long date, the variable interest rate is adjusted according to changes in the benchmark. A variable loan represents much more of a gamble than a fixed rate loan when borrowing for a long period of time. A start up business May want to consider a variable rate loan to help offset it's lower cash flow's in the first year of operation.

Certified development company

A nonprofit organization sponsored either by private interests or by state or local governments. The 504 loan program provide small businesses with funding for fixed assets when conventional loans are not possible. These funds are distributed through a certified development company, which is a nonprofit organization sponsored either by private interest or by state or local governments. In a typical arrangement, a private lender will provide 50% of the total value of the loan, the borrower 10% and the certified development company the remaining 40% of the necessary funds. The maturity for 504 financing is 10 years for equipment purchases and 20 years for real estate.

demand note

A short term loan that must be repaid, both principal and interest, in a lump sum at maturity. With this type of loan the bank reserves the right to demand repayment of the loan at any time. The only reason a bank is likely to demand repayment sooner is if the business appears to be struggling and is potentially unable to repay the loan in full at the end of the specific time.

Long-term assets

Assets that will not be converted into cash within one year. The most common long-term assets are buildings and equipment, but these assets may also include land, leasehold improvements, Patons, and a host of either items. Each of these assets must be in the business before the enterprise earns its first dollar of sales. This means you must carefully evaluate your situation to determine exactly what has to be in place for the business to operate efficiently.aa

loan security

Assurance to a lender that a loan will be repaid. If the entrepreneur signature on a loan is not considered sufficient security by a lender, the lender will require another signature to guarantee the loan. Other individuals who signatures appear on the loan are known as endorsers. Endorsers are liable for the notes they sign. There are two types of endorsers comakers and guarantors. Comakers: create a joint liability with the borrower. The lender can collect from either the maker, original borrower or the comaker. Guarantors: Insured the repayment of a note by signing a guarantee commitment. Both private and government leaders often require guarantees from officers of corporations to ensure continuity of effective management.

Commercial finance companies

Commercial finance companies extend short and intermediate term credit to firms that cannot easily obtain credit elsewhere. Because these companies are willing to take a bigger risk than commercial banks, their interest rates are often considerable higher. Among the most common types of loans provided by commercial finance companies are: - Floorplanning - leasing - factoring accounts receivable

sources of equity financing

Lenders will expect entrepreneurs to provide their own funds, equity funds, at least 25% and probably much higher before approving a loan. The higher the risk assume by the lender, the more of your own money you must put into the business. The most common source of equity financing our personal funds, family and friends, partners, venture capital firm's, small business investment companies, angels, and various forms of stock offerings.

Long restrictions (covenants)

Long restrictions spell out what the borrower cannot do negative covenants, or what they must do positive covenants. These restrictions are built into each loan argument and are generally negotiable, as long as you are aware of them. Typically negative covenants preclued the borrower from acquiring any additional debt without prior approval from the original lender. Common and positive covenants required that the borrower maintain some minimum level of working capital until the loan is repaid, carry some type of insurance while the loan is in effect, or provide periodic financial statements to the lender.

Partners

Requiring one or more partners is another way to secure equity capital. Approximately 10% of US businesses are partnerships. Many partnerships are formed to take advantage of diverse skills and attributes that can be contributed to the new business. Partners may play an active role in the ventures operation or may choose to be silent, providing funds only in exchange for an equity position.

Funding for small businesses

Some entrepreneurs are well-versed in determining their need for capital and knowing where to find it, the failure of mini businesses can be traced to under capitalization, not having the funds available to get started and carry you through until your business starts to produce a positive cash flow. The ability to be a proactive manager of the financial aspect of a business is the paramount importance when the economy takes a downturn.

Initial Public Offering (IPO)

The first sale of stock of a business made available to public investors. The first time a company offers it stock to the general public is called an initial public offering IPO. To be a viable candidate for an IPO, a company must be in good financial help and be able to attract an underwriter, typically a stock brokerage firm or investment banker, to help sell the stock offering. In addition the market conditions must be favorable for selling equity securities. There were three main reasons companies choose public offerings: 1. When marketing conditions are favorable, more funds can be raised in public offering then through other venture capital methods, without imposing the replacement burdens of death. 2. Having an establishment public price for the company stock enhances it's image. 3. The owners wealth can be magnified greater when owner held shares are subsequentially sold in the market. One critical caution about public stock offering is that they require companies to make financial disclosures to the public. If the company feels to live up to its self-reported expectations, shareholders can sue the company, charging that the company with held or misrepresented important information.

Maturity

The length of time in which a loan must be repaid. The maturity of a long refers to the length of time for which a borrower obtains the use of the funds. - A short term loan must be repaid within one year, - intermediate term loan must be re-paid within 1 to 10 years, - and a long-term loan must be repaid within 10 to more years. Example: A short term loan to purchase inventory that you expect to sell within one year. Once you sell the inventory, you repay the loan. Example: for the purchase of a building, which facility will be served the business for decades, a long-term loan is preferable. The maturity of the loan should essentially match the borrows use of the loan proceeds. The longer the maturity, The higher the rate of interest. But gives you more time to repay the loan, resulting in smaller payments and reduced constraints on your current cash flow. Along with a shorter maturity will usually have a lower rate of interest but must be repaid quickly, affecting cash flow more dramatically.

Factoring

The practice of raising funds for a business through the sale of accounts receivable. Another important type of loan available for commercial finance companies is accounts receivable factoring. Under this arrangement, a small business either sells it's accounts receivable to a finance company out right or uses the receivables as collateral for a loan. The purchase price of the receivables, or the amount of the loan, is discounted from the face value of what the business is owed to allow the potential losses, in the form of unpaid accounts, and for the fact that the finance company will not receive for repayment of the loan until something in the future.

trade credit (accounts payable)

The purchase of goods from suppliers that do not demand payment immediately. The last major source of debt financing covered here is the use of Trade credit, or accounts payable. Accounts payable are the amounts owed by a business to the creditors that have supply goods or services to the business. Start ups may find it difficult to obtain everything on credit card right away, many manufacturers and wholesalers will ship good at least 30 days before payment is required. This 30 day grace period is essential a loan to the small business. Because no interest is charged for the first 30 days, the loan is free. For this reason you should take advantage of as much trade credit as possible.

equity financing

The sale of common stock or the use of retained earnings to provide long-term financing. Equity financing does not have to be repaid. There are no payments to constrain the cash flow of the business and there is no interest to be paid on the funds. Providers of equity capital wind up owning a portion of the business and are generally interested in 1. Getting dividends 2. Benefiting from the increased value of the business, and their investment in it 3. Having a voice in the management of the business

Loan application process

To determine credit worthiness, a lending institution will collect relevant information from financial statements supplied by the applicant and by external sources, such as local or regional credit associations, credit interchange bureaus, and the applicants bank. This procedure is known as credit scoring. Personal credit scores range from 350 to 850. Business credit scores range from 0 to 100. Most lenders hesitate to make loans to start up businesses, unless either a wealthy friend or a relative will cosign the loan, or unless loan proceeds will be used to purchase assets that could be repossessed in easily re-sold in case of default.

Venture capital firm

Venture capital firms are groups of individuals or companies that invest a significant amount of dollars in new or expanding firms. Venture-capital's as they are called will make loans, but at higher interest rates, say 20%, usually expect a higher rate of return 30 to 50%, and expect to have a sizable ownership position in your business as their return on investment. VC firms typically invest in companies they expect to sell within a few years. To be considered worthy of investment a company needs to show rapid, steady sales growth: new technology, a sound management team, and potential for being acquired by a large company in your or initial public offering. Of the more than 600 venture capital firm is operating in the United States, approximately 500 our private independent firms, about 65 or major corporations, and the rest are affiliated with banks. Obtaining capital from them is not easy. The average some invested by venture-capital firms is between $1.5 million and $2 million per business, with an overall range between $23,000 to more than $50 million. An excellent business plan is essential when approaching a venture capital firm, and a referral from a credible source, such as a banker or attorney known to the venture capital firm, may also be necessary. It takes an average of 6 to 8 months to receive a potential investment decision. Less than 10% of the plans submitted to venture capital firms are ultimately funded. Venture capital firm is really invest in retail operations. They tend to focus on high technology industries, growth industries, and essential services.

What lenders look for

When an entrepreneur decides to seek external financing, they must be able to prove credit worthiness to potential providers the funds. C's of Credit, where each "C"represents a critical qualifying element: 1. Capacity - Capacity refers to the applicants ability to repay the loan. 2. Capital - Capital is the function of the applicants personal financial strengths. The net worth of a business, the value of its assets minus the value of its liabilities, determines its capital. The bank wants to know what you own outside of the business that might be an alternate repayment source. 3. Collateral- assets owned by the applicant that can be pledged as security for the repayment of the loan constitute collateral. The value of the car lateral is not based on the assets market value, but rather is discounted to take into account the value that would be received if the asset had to be liquidated, which is frequently significantly less than the market value. 4. Character - The applicants character is considered important in that it indicates his apparent willingness to repay the loan. Character is judge primary on the basis of the applicants past repayment patterns, but lenders may consider other factors, such as material status, home ownership, and military service when attribute in character to an application. 5. Conditions- The general economic climate at the time of the loan application may affect the applicants ability to repay the loan. Lenders are usually more reluctant to extend credit in times of economic recession or business down turns.

Federal loan programs

Government lending program is exist to stimulate economic activity. The underlying rational for making these loans is that the borrowers will become profitable and create jobs, which in turn means more tax dollars in there coffers I've government agencies providing the funds for the loans. The most active government lender is the small business administration a federal agency. SBA loan programs include the seven a loan guarantee program, the microloan, The small business investment company program, and the 504 loan program Period

Leasing

Leasing is a contract arrangement whereby a finance company purchases the durable goods needed by a small business and rinse them to the small business for a specific time. The rent payment includes some amount of interest. Due to current tax laws, this activity is very lucrative for finance companies and often allows entrepreneurs to have the use of state of the art equipment at a fraction of the cost.

leverage

The ability to finance an investment through borrowed funds, increasing both the potential for return and the level of risk. Using debt to finance a business creates leverage, which is money you can borrow against the money you already have. The goal in using leverage is to put in a little money and get back a lot of money. Leverage can enable you to greatly increase the potential returns expected as you invest your equity in the business. Increased leverage also increases risk.

Interest rate

The amount of money paid for the use of borrowed funds. The interest rate of the loan determines the price of the borrowed funds. In most cases it will be based on the current prime rate of interest. In the past the prime rate was defined as the rate of interest banks charge their best customers, those with the lower risk. Interest rates for small business loans are normally the prime rate plus some additional percentage points. For example if the prime rate is 8.5% a bank might offer small business loans at prime +4 or 12.5%. If you miss and interest payment or two you could be considered in default and the entire lawn becomes do. Before you borrow make sure you can make the interest payment on a timely basis.

Disadvantages of debt financing

- Deadlines: money must be paid back by a fixed date - cash flow: too much debt will create cash flow issues which will make repayment difficult - investor potential: too much debt will make you less attractive to investors if you choose to add equity funding later - Collateral: business assets will be held as collateral and you, as a business owner, will have to personally guarantee the business loan

Advantages of debt financing

- Easier to plan budgeting: is easier since principal and interest or known - Appropriate timing: loans can be structured for short, medium, or long term, depending upon what you are funding - tax deductions: Interest paid is tax deductible - flexibility : Since the bank or lending institution does not hold ownership, they have no say in how to run your business

SBA loan

A loan made to a small business through a commercial bank, of which a portion is guaranteed by the small business administration. SBA loan programs include: - 7a loan guarantee program, - micoriloan program - Small business investment company program - The 504 loan program

Line of credit

An agreement that makes a specific amount of short term funding available to business as it is needed. A line of credit is in an agreement between a bank and a business that specifies the amount of unsecured short term funds the bank will make available to a business. The business pays interest only on the amount of funds actually borrowed but may be required to pay a set up for handling fee. For start up business or business is where revenue is erratic, lines of credit can make the difference between business success and failure, as the line of credit can augment cash flow. But be aware that bank financing is not easy to get for small businesses, four out of five small businesses applications are turned down.

Principal

An amount of money borrowed from a lender. The principle of the loan is the original amount of money to be borrowed. Minimizing the size of the long will reduce your leverage and your financial risks. The pro forma balance sheet estimates the amount of funds needed. The amount you need to borrow is the difference between the total of pro forma assets and total owners equity.

Debt funds also known as liabilities

Debt funds also known as liabilities are borrowed from a creditor and of course must be repaid.

Defining required assets

Each business must have its assets in place cash, inventory, Patons, equipment, buildings, whatever it needs to operate before it ever opens its doors.

Choosing a lender or investor

If you decide to pursue debt financing you must have the minimum down payment or other capital requirements necessary to secure the loan. Other important lender selection considerations are: - size: The lender should be small enough to consider the business owner an important customer, but large enough to service the business owners future needs. - Desire: the lender should exhibit a desire to work with start up an emerging businesses, rather than considering them too risky. - approach to problems: the lender should be supportive of all small businesses facing problems offering constructive advice and financing alternatives. - Industry experience: the lender should have experience in the business owners industry especially with start up or emerging ventures. The best guideline may be to seek lenders with which you feel most comfortable.

State and local government lenders

Mini state and local governments lend money to entrepreneurs through various programs. They can sponsor a certified development company to assist small businesses with the acquisition of fixed assets. Loan programs are usually tied to economic development goals, some loans are made contingent on the number of jobs that will be created by the small business. Most state and local government programs have a lower interest rates than conventional loans, often with longer maturities.

Bootstrapping via personal funds

Most new businesses are originally financed with their creators funds. The essence of bootstrapping is stretching resources, both financial and otherwise as far as they will stretch. The first place most entrepreneurs find equity capital is in their personal assets. Cash, savings accounts, and checking accounts are the most obvious sources of equity funds. Additional sources are the sale of stocks, bonds, mutual funds, real estate, or other personal investments.

family and friends

New businesses are often at least partially funded by the family and friends of the entrepreneurs. Family and friends are more willing to risk capital in a venture owned by someone they know then in ventures about which they know little or nothing. Financing a business with capital from family and friends creates a type of risk not found with other funding sources. If the business is not successful and the funds cannot be repaid, relationships with family and friends can become strained. The key is to be sure you have a written contract with an investment letter that clearly outlines who approached him about the funds in question and explains the best specific terms of the funding.

Dividence

Payments based on the net profits of the business and made to the providers of equity capital. These payments are made on a quarterly, semi annual, or annual basis. Many small businesses keep net profits in the form of retained earnings to help finance future growth, and dividends are paid only win the business shows profit above the amount necessary to fund projected new development. As a successful business grows and prospers, the owners prosper as well. Because the providers of the equity capital One a piece of the action, the value of their investment increases in direct proportion to the increase in the value of the business.

Insurance companies / Policy loans

Policy loans is a loan made to a business by an insurance company, using the businesses insurance policy as collateral. The collateral for the loan is the cash the business owner has already paid into the policy. The insurance company is lending the business owner his own money. Because the default risk is virtually zero, the rate of interest is often very favorable.

Additional Considerations

Potential investors will want to know more about you and your business than just the five seas. Simply having a good idea will not be enough to convince many investors to risk their capital in your business. You will need to show that you are a competent manager with a track record of prior business success. You should have an informal board of director is made up of people whom you may contact for assistance. Potential members of such a board might include bankers, attorneys, certified public accountant, and successful business owners. A bankers first question is often, how much money can you put in.

Credit card start up funding

The Kauffman foundation states that for every thousand dollars increase in credit card debt, the odds that the small business will fill increases by 2.2%. Do not use them! Credit cards have increased risk because while the personal credit history of the small business owner is used for the approval process, the credit limit is sit higher since it is for business use with no increase collateral required. Credit cards are enticing because most offer extremely low introduction rates, 3.9%, 2.9%, even 0% for a limited time. When those introduction rates in the annual percentage rate charged can jump up as to high as 22% within a matter of months. Funding your small business with credit cards, should only be for short term situations in which you will be able to pay the debt off quickly.

Compounding Interest

The frequency with which interest is compounded can also increase the cost of the loan. Compounding refers to the intervals at which you pay interest. Linders may compound interest annually, semi annually, quarterly, monthly, weekly, daily, or even continuously. The more compounding periods, the higher the effective rate will be. Financial institutions are required to inform borrows of the effective rate of interest on all loans.

Initial capital requirements

The fundamental financial building blocks for a small business owner are recognizing: 1. What assets are required to open the business 2. What will be required to put your business plan in action 3. Which expenses cannot be changed and must be paid, called fixed cost 4. Knowing how these costs will be financed The balance sheet lists the investment decisions of the business owner in the asset column and the financing decisions in the liabilities and owners equity columns. The financing necessary to the choir each acid required for the business must come from either owner provided funds equity or borrowed funds liabilities.

Debt financing

The use of borrowed funds to finance a business. Three important parameters associated with debt financing are : the amount of principles to be borrowed, the loans interest rate, and the loans length of maturity. Together they determine the size and extent of your obligations to the creditor. Until the debt is repaid, the creditor has a legal claim on a portion of the businesses cash flows. Creditors can demand payment and in the most extreme cases, force a business into bankruptcy because of overdue payments.

Guaranteed lungs are generally known as the 7A program

Under this program, private lenders, usually commercial banks, make loans to entrepreneurs that are guaranteed up to 85% of loans up to $150,000 and up to 75% of loans above $150,000 by the SBA. This means the lenders risk exposure is reduced by the amount of the SBA guarantee. The SBA is seven and a maximum loan amount is $2 million with SBA maximum exposure of $1.5 million.

SBA Express Program

a relatively new loan program available through the SBA that simplifies the paperwork that has historically been required. One of the main criticisms of the SBA loan programs has been the amount of paperwork required, especially for relatively small loans. In response to this concern the SBA recently created the SBA express program. Under this program, qualified small businesses can borrow up to $350,000 with the banks on forms and receive a response within 36 hours. Microloan program, which provides very small loans to start up, newly established, or growing small businesses concerns. Under this program the SBA makes funds available to nonprofit community-based lenders, intermediaries, which in turn make loans to eligible barrels in amounts up to a maximum of $35,000. The average lawn size is about $13,000.