Mgmt 164 Final: Raising Capital

Rank the types of capital raising by least costly to most costly

(Least Costly) 1. Your own money 2. Friends and family 3. Banks & Traditional Lenders 4. Private Equity & Venture Capital

What are the 2 benefits of getting a loan from an angel investor, rather than an institutional lending source?

1. Angel investors can be more flexible in their terms than an institution. 2. Angel investors, unlike institutions, make their own rules for lending. *Because of these two things, it is easier to get a loan from an Angel investor than a bank. Also, an Angel investor may be more patient if repayments cannot be made in time.

What are the 4 C's of Credit (i.e., what do investors look for in entrepreneurs & their businesses)

1. Character 2. Capacity 3. Contingency 4. Capital

What are the (6) pros of debt financing

1. Entrepreneur retains complete ownership 2. Cost of capital is low (interest rates are low currently) 3. Loan payments are predictable 4. 5-7 year payback period 5. It can involve value-added lenders 6. It provides tax benefits (when you pay interest to lenders, you get to write it off as an interest expense)

What are the 8 types of debt financing?

1. Friends and Relatives 2. Banks/Commercial Lenders 3. Commercial Finance Companies 4. Government Programs 5. Bonds (issue debt directly to lenders) 6. Factoring 7. Supplier/Purchase Order + Customer Financing 8. Person to Person Lending

4 Key Things to Remember When Raising Capital

1. Never run out of money (positive cash flow) 2. Really understand your business and your product 3. Have a good product 4. Never run out of money

What are the 3 negatives of getting money from friends and family?

1. Not value-added investors 2. Not sophisticated investors 3. Risk of irreparably damaging or losing personal relationships

What are the (4) cons of debt financing

1. Personal guarantees are often required (*at risk of losing personal assets) 2. Lender can force the business into bankruptcy, if they foreclose on the loan 3. Loan amounts may be limited to the value of the company's assets 4. Payments are due regardless of the company's profits

What are the types of equity financing (7)?

1. Personal--personal savings vs. home equity loans 2. Friends and Family 3. Angel Investor 4. Crowdfunding 5. Venture Capital 6. Private Equity 7. Initial Public Offerings

What three things should a business owner do when approaching a lending source (i.e., going to the bank for a loan)?

1. Prepare Financial Statements (Balance Sheet, Income Statement, Personal Financial Statements for those who own 20%+ of the company) 2. Select and list collateral, and estimate its market value (*remember, they are listed on the balance sheet at historical cost) 3. State the amount of the loan, and its purposes

What are the 2 benefits of getting lending from friends and family?

1. Raising money may be easier and faster 2. If repayments cannot be made, these lenders may be more forgiving/patient than institutional lenders (Also, will usually get lower interest rates) *However, the negative aspects of receiving money from friends and family outweigh the positives

What are the 2 negatives of getting a loan from angel investor, rather than an institutional lending source?

1. The cost of debt capital from angel investors is usually higher than that of institutional financing (they want a higher rate of return than a bank) 2. The Angel investors expects to be involved in the entrepreneur's business operations (this could be a negative if the entrepreneur wants to maintain control, but a positive if the Angel investor is value-added)

Factors

Asset based lenders who use a company's A/R as collateral. Often used by companies when they are in a growth phase, and their A/R is turning into cash fast enough for them to purchase more inventory to make their next round of sales

Why do banks like CAP? Why do entrepreneurs like CAP?

Banks like CAP b/c the bank still sets the terms, rates, fees, and collateral for the loan Entrepreneurs like CAP because banks have more flexibility to approve a loan that may not qualify for SBA funding CAP financing is faster and easier than SBA funding

Bonds

Bonds are a special type of debt financing, in that the debt is issued by the company. The company specifies the interest rate and when the company will pay back the principal (maturity date)

Debt Financing

Borrowing money and not giving up ownership. Often comes with strict conditions/covenants, in addition to having pay off interest and principal by specified dates

Capital Access Programs Why do banks like them? Why do entrepreneurs like them?

CAP loan product is a "credit enhancement" that induces banks to consider loan requests that they might otherwise have rejected It is a state or local government sponsored loan program How it works: the bank or the borrower pays 3-7% of the loan amount into the bank's loan-loss reserve account. This contribution is then matched by state or local money, so the total reserve ranges from 6-14% of the loan. This amount is used to cover any loan losses.

Purchase Order Financing

Company offers up its purchase orders as collateral for a loan (purpose is similar to that of factoring)

Commercial Finance Companies

Considered when the business is unable to secure funding from banks/other commercial sources These companies are more willing the rely on the quality of the collateral to repay the loan (rather than track record/profit projections) Hence, if the business does not have substantial personal assets or collateral, it should NOT look to commercial finance companies for funding

Describe the "Contingency" aspect of the 4 C's of Credit

Contingency refers to risk in any business' future Entrepreneurs must show investors that they have a back up plan in case things go wrong

Customer Financing

Customers provide business with capital, either in the form of a direct loan payment or as a down payment on a future order

Supplier Financing

Delaying payment of bills to suppliers by having supplier extend invoice terms Supplier may sometimes give a direct loan

Describe the "Capital" aspect of the 4 C's of Credit

Does the business have in house funds? Having more in-house funds means that entrepreneurs give up less equity, and investors have confidence in investing in the business (A well-capitalized business is less risky than undercapitalized business)

Describe the "Character" aspect of the 4 C's of Credit

Does the entrepreneur have good character? Can the investor trust him to make repayments? The entrepreneur's character reflects his willingness to pay Is determined by record of nonpayment or bankruptcy

Describe the "Capacity" aspect of the 4 C's of Credit

Does the entrepreneur/business have the financial ability to repay the investor? Capacity: the ability to carry out on intent to pay

Person-to-Person (P2P) Lending

Entrepreneurs connect online with people who want to lend small amounts of money to strangers in exchange for the promise of higher returns than they might see with their personal banking options Individuals lend to each other at a set rate for a fixed period There are built-in solutions for loan repayments & tracking Employs social networking capabilities

Government Grants

Federal and state governments often offer financial assistance in the form of grants/tax credits for start-ups or expanding businesses May have special grants for people of minority groups who want to start a business, or for businesses who hire certain types of people (i.e., veterans) There are grants & tax credits for businesses that open in certain areas of California that need economic growth (i.e., East LA). These are called "Empowerment" or "Enterprise Zones"

Equity Financing through Personal Savings

Getting money from your own savings or equity Examples of personal resources 1) Profit-sharing/early retirement funds 2) Real-estate equity loans 3) Cash value insurance policies

Equity Financing through Home Equity Loans

Home Equity Loan--a loan where the borrower uses the equity (value) of his home as collateral If your home is paid off, you can generate funds from the entire value of your home If your home has an existing mortgage, you generate funds on the difference between the value of your home and the unpaid mortgage amount

Initial Public Offerings

IPO: the first sale of stock by a company to the public Used when companies have profitable operations, management stability, and a strong demand for their products/services Generally does not happen until companies have been in business for several years/gone through several rounds of financing

Angel Investors

Individuals/businesses interested in helping small businesses survive & grow Objective is more than economic return Can provide equity (more often) or debt financing

What is the maturity of a SBA Basic 7(a) Loan Guaranty?

Loan maturity is up to 10 years for working capital, and up to 25 years for fixed assets If you want a longer loan maturity, you have to carve out a piece of the loan that is not for working capital and show that it is going towards fixed assets

Banks and other commercial lenders

Most popular sources of business financing Require a) solid business plan b) positive track record c) plenty of collateral. These are hard to come by for a start-up business. Once business is underway, company may be able to borrow additional funds.

Rewards-Based Crowdfunding

Pre-sell a product or service to launch a business concept without incurring debt or giving up equity (Kickstarter/Indiegogo)

Private Equity

Private equity investors acquire businesses that are in distress. They look for a business that has some operating history, and the goal is to improve the business (fix a problem) and then sell it for a sizeable profit.

Pros and Cons of Crowdfunding

Pros: Way to raise capital potentially without incurring debt or giving up equity Way to test the market/interest level for your product Creates a buzz for the product/business Cons: Does not provide a network of professional investors that can give connections/strategic advice Coordinating/communicating with hundreds of investors can be cumbersome Most crowdfunding sources take 3-5% cut of the money

Pros and Cons of Equity Financing through Friends and Family

Pros: Get better terms than those offered by an outside investor Cons: Friends and family are not "value-added" investors, loose out the expertise that could be offered from outside investors; may ruin relationships

Equity/debt-based Crowdfunding

Raise money from large pool of small investors (Crowdfunder.com/Seedrs) and non-bank lending sources (Somolend, Lending Club, & Prosper.com)

At what stages should a business raise capital?

Raising capital occurs throughout the course of a business's life cycle (it is not a one time thing!)

Crowdfunding

Raising money from a large number of people via the internet

Equity Financing through Friends and Family

Receiving money from friends and family, and giving them ownership interests in the business *These investments should be treated with the same level of formality that would be used with outside investors

SBA Loans

SBA loans are loans made by private lenders (i.e., banks) and then guaranteed by the SBA agency. The SBA can guarantee up to 85% of the loan. Looking for businesses with unusual growth potential

Equity Financing

Selling shares of stock to investors in return for their investment. As shareholders, investors receive ownership interests in the company.

Who can get a SBA Basic 7(a) Loan Guaranty?

Start-ups or small businesses

What are the four eligibility requirements to qualify for an SBA loan?

The business must be 1) Be a small business 2) Be a for-profit business 3) Not already have internal resources to provide financing 4) Be able to demonstrate repayment ability

Government Programs

There are federal, state, and local government programs designed to to assist in the financing of new ventures/small businesses Assistance usually comes in the form of a government guarantee of the repayment of loan from a conventional lender Guarantee provides the lender with assurance for the loan to a business that may have limited collateral

Venture Capital

VC refers to financing that comes companies or individuals in the business of investing in young, privately held businesses Provide capital to young businesses in exchange for ownership share of the business Prefer to invest in businesses that received significant equity investments from founders and already profitable *They want to invest in businesses early on and help them grow. The focus is on the idea, the market size, and the people

Value-Added Investors

Value-Added investors offer more to entrepreneurs than the cash they contribute. They could provide insights to the entrepreneur, or give the company creditability and legitimacy because of their reputation.

What can the loan proceeds from a SBA Basic 7(a) Loan Guaranty be used for?

Working Capital Machinery & Equipment Furniture & Fixtures Land & Building (purchase, new construction, + renovation) Leasehold Improvements

Is it risky for investors to raise capital for entrepreneurs?

Yes, capital providers take on a major risk when financing entrepreneurial ventures 50% of businesses fail w/i the first 4 yrs 70% of businesses fail w/i the first 10 yrs