MGT 427 Chapter 11 Sources of Capital
_____ refers to funds that come from sources within a company: profits, sale of assets, reduction in working capital, extended payment terms, and accounts receivable.
Internally generated funds
_____ includes (1) broad provisions created to simplify private offerings, (2) general definitions of what constitutes a private offering, and (3) specific operating rules—Rule 504, Rule 505, and Rule 506.
Regulation D
Identify a true statement about personal funds.
They are vital in attracting outside funding.
True or false: Real estate cannot be used in asset-based financing.
This is false. Real estate is also frequently used in asset-based financing.
When the business itself does not have the assets to support a loan, the entrepreneur may need a(n) _____.
character loan
The _____ refers to the tangible collateral valued higher than the amount of money borrowed.
asset base for loans
Which of the following are conventional bank loans? (Check all that apply.)
*Straight commercial loans *Lines of credit *Character loans
Bank Lending decisions
Banks are very cautious in lending money to new ventures. •Loan officers and loan committees review the borrower and the venture. •Decisions are both quantifiable and subjective. Lending decisions are made according to the five C's of lending. •Character, capacity, capital, collateral, and conditions. The loan application format is generally a "mini" business plan. •This provides information on how the venture will repay the loan. With satisfactory interest rates and terms, borrow the maximum that can be repaid. Evaluate several banks to find the most favorable terms.
Debt financing
obtaining borrowed funds for the company
An accurate statement about installment loans is that these _____.
short-term funds are frequently used to cover working capital needs for a period of time
When an entrepreneur is unable to secure a regular commercial bank loan, an alternative is a guaranty from _____.
the Small Business Administration
In the context of the types of investors, a similarity of Rule 504, Rule 505, and Rule 506, which are part of Regulation D, is that _____.
they do not permit general advertising or solicitation through public media
Match the types of partners in a research and development partnership (in the left column) with their descriptions (in the right column).
*Limited partner: The party that generally provides money in a partnership agreement and has a less responsibilities *General partner: The overall coordinating party in a partnership agreement
Identify an accurate statement about the Small Business Technology Transfer (STTR) program.
It requires a small business to formally work together with a research institution.
The _____ provides fixed-rate financing to enable small businesses to acquire machinery, equipment, or even real estate in order to expand or modernize.
504 loan program
_____ are most often the source of short-term funds commonly used by entrepreneurs when collateral is available.
Commercial banks
An accurate statement about real estate loans is that it is _____.
usually obtained to finance a company's land, plant, or another building
Which of the following scenarios exemplify the use of bootstrap financing by entrepreneurs? (Check all that apply.)
*An entrepreneur opts for the use of co-op advertising with a channel member. *An entrepreneur buys raw materials in bulk to avail discounts.
Which of the following statements are true about internal funding of new ventures? (Check all that apply.)
*Collecting bills more quickly is a method of internally generating funds. *Short-term, internal funds can be used to fund short-term assets.
Which of the following are categories of equipment financing? (Check all that apply.)
*Financing the purchase of new equipment *Sale-leaseback financing *Financing used equipment already owned by the company
Which of the following are true about using outside capital for funding a startup? (Check all that apply.)
*Outside capital is not provided without the expectation of getting a good return. *It generally takes around two to six months to raise outside capital or to conclude that there is no outside capital available.
Match the phases of the Small Business Innovation Research program (in the left column) with their descriptions (in the right column). Instructions
*Phase I = The purpose in this phase is to decide the technical feasibility of the research effort and evaluate the quality of the company's performance through a considerably small monetary commitment. *Phase II = The money granted is to be utilized to develop prototype products or services in this phase. *Phase III = Funds from the private sector or regular government procurement contracts are required to commercialize the developed technologies in this phase.
In the context of the types of investors, match the rules that are included in Regulation D (in the left column) with their features (in the right column).
*Rule 504: It permits a company to sell up to $500,000 of securities to any number of investors, irrespective of their sophistication, in any 12-month period. *Rule 505: It permits the sale of $5 million of unregistered securities in the private offering in any 12-month period to any 35 investors and to an unlimited number of accredited investors. *Rule 506: It permits an issuing company to sell an unlimited number of securities to 35 investors and an unlimited number of accredited investors and relatives of issuers.
Which of the following statements are true about research and development (R&D) limited partnerships? (Check all that apply.)
*The restrictions placed on the technology developed as a by-product of the R&D effort can be substantial. *An R&D limited partnership typically takes a minimum of six months to establish.
The _____ is the Small Business Administration's primary business loan program.
Basic 7(a) Loan Guaranty
Cash flow Financing
Cash flow financing, or conventional bank loans, include: •Lines of credit are popular and ventures pay a commitment fee to ensure the bank will make the loan when requested. •Installment loans are possible with previous sales and profits. •Straight commercial loans are advanced for 30-90 days - used for seasonal financing. •Long-term loans (up to 10 years) are for strong, mature companies. •Where there are no business assets, a character loan is an option.
Identify a true statement about debt financing.
It is also termed asset-based financing.
Which of the following helps minimize possible difficulties in funding from family and friends?
Restricting the business arrangements to strictly business
True or false: The risk in a venture increases with the increase in the amount of leverage.
This is true. The higher the amount of leverage (debt/total assets), the greater the risk in the venture.
Personal funds are also termed _____.
blood equity
Commercial banks provide funds in the form of _____.
debt financing
The financing method that involves an interest-bearing instrument, usually a loan, the payment of which is not directly related to the sales and profits of the venture is referred to as _____.
debt financing
Conventional bank loan
standard way banks lend money to companies
A hybrid of the installment loan is the _____, by which funds are advanced to the company for 30 to 90 days.
straight commercial loan
Long-term loans are usually available only to _____.
strong, mature companies
Which of the following are disadvantages of using outside capital for funding a startup? (Check all that apply.)
*It often decreases the venture's drive for sales and profits. *It can reduce the venture's flexibility and impact the direction, drive, and creativity of the entrepreneur.
Benefits and Costs of a R&D Limited Partnership
Benefits. •Provides needed funds, minimum equity dilution and reduced risks. •Strengthens financial statements of sponsoring company through attraction of outside capital. Costs. •Requires considerable time and money - a minimum of six months and $50,000 in professional fees. •Most R&D limited partnerships are unsuccessful. •Restrictions placed on the technology may be substantial. •Exit from the partnership may be too complex and involve too much fiduciary responsibility.
Which of the following is true about agreements in a joint venture in a research and development partnership?
Companies can buy out the partnership interest at a specified time or when a specified volume of sales and profit has been achieved.
Debt or Equity Financing
Evaluate financing from perspective of debt versus equity, and then whether to use internal or external funds. •Debt financing involves an interest-bearing loan, with payment indirectly related to sales and profits - requires collateral. •Short-term financing provides working capital and long-term debt may be used to purchase an asset, using the asset as collateral. •Called leveraging the firm - more leverage equals more risk. •Equity financing requires no collateral and offers investors some form of ownership - the investor shares in the profits. Key factors in choosing include availability of funds, assets of the venture, and interest rates. Usually a combination of financing is used.
When strong creditworthy customers are involved in an accounts receivable loan, an entrepreneur can develop a factoring arrangement. Which of the following statements is true about this arrangement?
In the event that any of the receivables is not collectible, the factor (the bank) sustains the loss, not the business.
Which of the following is true about limited partners in a research and development partnership?
The limited partners share in the profits when the technology is successfully developed in the later years.
Identify a true statement about equity partnerships in research and development limited partnerships.
The limited partners' interest can be transferred to equity in the new corporation on a tax-free basis.
Limited partner
a party in a partnership agreement that usually supplies money and has a few responsibilities
Unlike public offerings, private offerings _____.
are faster and less costly when a limited number of sophisticated investors are involved who also have the ability to absorb risk
Generally, the application format for a bank loan is a _____.
mini business plan that consists of an executive summary and business description
Research and development limited partnerships
money given to a firm for developing a technology that involves a tax shelter
General partner
the overall coordinating party in a partnership agreement
Match the categories of equipment financing (in the left column) with their descriptions (in the right column). Instructions
*Lease financing: The company procures the use of the equipment through a small down payment amount and an assurance to make a specified number of payments over a period. *Sale-leaseback financing: The entrepreneur sells the equipment to a lender and then leases it again for the life of the equipment.
Match the types of financing based on their duration (in the left column) with their descriptions (in the right column).
*Long-term financing: It is often used to buy a specific asset, with part of the value of the asset being used as collateral. *Short-term financing: The money is generally used to provide working capital to finance inventory, accounts receivable, or the operation of business.
Identify a true statement about the Small Business Innovation Research (SBIR) program that was created as part of the Small Business Innovation Development Act.
It offers research and development funds to small businesses from all federal agencies with budgets in excess of $100 million.
Identify a true statement about lines of credit financing.
The loan must be repaid or reduced to a certain agreed-upon level on a periodic basis.
Identify a true statement about long-term loans.
The principal can sometimes start being repaid in the second or third year of the loan, with only interest paid the first year.
Identify a true statement about character loans.
These loans frequently must have the assets of the entrepreneur or other individual pledged as collateral or the loan cosigned by another individual.
Identify a true statement about self-liquidating loans.
They are often used for seasonal financing and for building up inventories.
_____ is referred to as leveraging the firm.
Using debt as a financing instrument
Role of the SBA in Small Business Financing
When unable to secure a commercial bank loan, an alternative is a guaranty loan from the Small Business Administration (SBA). •The Basic 7(a) Loan Guaranty is the SBA's primary program. •Repayment ability from cash flow is essential to obtain this loan. The SBA guarantees 85% of loans up to$150,000, and 75% of loans above that. •SBA Express loans have a maximum guarantee of 50% and export working capital loans guarantee 90%. •The 504 loan program provides funds to buy machinery, equipment, or real estate. •The SBA Microloan provides short-term loans up to $50,000. •Other loan types are available through the SBA.
To ensure repayment, bank loans are based on the _____.
assets or the cash flow of the venture
Obtaining funds for a company in exchange for ownership is referred to as _____.
equity financing
A difficulty for entrepreneurs to raise funds from family and friends is that these kind of investors _____.
feel they always have a right to interfere in the venture's operations
SBIR grants program
grants from the U.S. government to small technology-based businesses
Regulation D
laws governing a private offering
Equity financing
obtaining funds for the company in exchange for ownership
An accurate statement about equity financing is that it _____.
provides an investor some form of ownership position in the venture
Asset base for loans
tangible collateral valued at more than the amount of money borrowed
R&D Limited Partnerships
A typical R&D partnership is between a company developing the technology and funded by a limited partnership of investors. •Research and development limited partnerships are good when the project involves a high degree of risk and significant expense. Three major components are the contract, the sponsoring company, and the limited partnership. •The contract specifies the agreement. •The limited partners have limited liability and any tax benefits of losses in the early stages are passed on to the partners. •The sponsoring company acts as the general partner.
Unlike short-term debts, long-term debts _____.
are dependent on the requirement of a collateral
Which of the following is true about accounts receivable loans?
Accounts receivable act as a good basis for a loan when the customer is well known and creditworthy.
Family and Friends
Family and friends provide a small amount of equity funding. •The amount may be small but it is relatively easy to obtain. •It is a form of equity funding and there is now an ownership position. To avoid problems, present the positive and negative aspects and nature of the risks of the investment. •Keep arrangements strictly business - put it in writing. •Any loan should specify interest rate and payment schedule. •Family members and friends investing in the venture should receive regular financial statements. Carefully consider the impact before accepting funds.
Self (Personal Funds)
Few new ventures begin without personal funds. •Least expensive in terms of cost and control. •They are essential in attracting outside funding. •Often referred to as blood equity, sources include savings, life insurance, or mortgage on a house or car. Outside investors want financial commitment. •The percentage of available total assets committed to the venture demonstrates commitment level. •Outside investors want all available assets committed.
R&D Limited Partnership Procedure
In the funding stage, a contract is established and money invested. The actual research is performed in the development stage. If the technology is successfully developed, the exit stage begins. •In a typical equity partnership, the sponsoring company and limited partners form a new jointly owned corporation. •An alternative is to incorporate the R&D partnership itself and either merge it into the sponsoring company or continue as a new entity. •A third exit strategy is a royalty partnership where a royalty based on the sale of the products is paid by the company to the limited partners. •The company and limited partners may form a joint venture to manufacture and market the product.
Internal or External Funds
Internally generated funds are the most frequently used. •In the startup years, profits are plowed back into the venture. •Assets, whenever possible, should be rented, not owned. •Extended payments from suppliers is one short-term source of funds. •Another is collecting accounts receivable quicker. Evaluate external fund sources by: •The length of time the funds are available. •Costs involved. •The terms of the contract.
Identify a feature of inventory loans.
Inventory can usually act as the basis of a loan, when the inventory is more liquid and can be easily sold.
Which of the following is most likely true about bootstrap financing used by entrepreneurs?
It involves the use of any possible method for obtaining and conserving cash.
Identify a benefit of a research and development (R&D) limited partnership for companies.
It supplies the required funds with a minimum amount of equity dilution while reducing the risks involved.
Bootstrap Financing
Outside capital has many costs. •It takes time when a company can least afford it. •It decreases the drive for profit and increases impulse to spend. •It can decrease the company's flexibility and hamper creativity. •Emphasis on short-term can be at the expense of long-term success. Bootstrap financing involves using any possible method for obtaining and conserving cash. •Can involve: delayed supplier payments; volume, promotional, or customer discounts; "obsolescence money," and bulk packaging. •The only possible limitation of bootstrap financing is the imagination of the entrepreneur.
The _____ provides short-term loans of up to $50,000 to small businesses for working capital or the purchase of inventory, supplies, furniture, fixtures, machinery, or equipment.
SBA Microloan program
The Small Business Technology Transfer Program
The STTR program was established by the Small Business Technology Transfer Act of 1992. •Five federal agencies with budgets of $1 billion set aside 0.3% for small businesses - DOD, DOE, DHHS, NASA, NSF. The SBIR and the STTR programs differ in regulations. •In the SBIR, the principal investigator must be employed by the company, the STTR program has no such stipulation. •The SBIR has a maximum of 33% in Phase 1 and 50% in Phase 2 in consulting costs. There are many other grants available at the federal, state, and local levels across the country.
Government Grants
The Small Business Innovation Research (SBIR) grants program is funded by the twelve federal agencies with a R&D budget. •Each agency solicits for a topic and small businesses make proposals. The SBIR grant program has three phases. •Phase 1 awards up to $10,000 for 6-months of theoretical research. •Phase 2 awards up to $750,000 for 24 months of further R&D. •Phase 3 provides funds from the private sector or government contracts to commercialize the developed technology. Any patent rights or research data is owned by the company.
True or false: Bank lending decisions are solely based on quantifiable information.
This is false. Bank lending decisions are based on both quantifiable information and subjective judgments. The bank lending decisions are made according to the five Cs of lending: character, capacity, capital, collateral, and conditions.
True or false: Regulation D fails to provide rules governing the notices of sale and the payment of any commissions involved.
This is false. Regulation D requires the issuer of a private offering to file five copies of Form D with the Securities and Exchange Commission 15 days after the first sale, every 6 months thereafter, and 30 days after the final sale. It also provides rules governing the notices of sale and the payment of any commissions involved.
True or false: Unlike the Small Business Technology Transfer (STTR) program, the Small Business Innovation Research (SBIR) program requires that a principal investigator (PI) must spend a minimum of 10 percent effort on a project and have a formal appointment with or commitment to a small-business concern (SBC).
This is false. Unlike the SBIR program, the STTR program requires that a PI must spend a minimum of 10 percent effort on a project and have a formal appointment with or commitment to a SBC.
_____ are a specific type of inventory loan that is utilized to finance floor plans of retailers, such as automobile and appliance dealers.
Trust receipts
Commercial Banks
When collateral is available, banks can provide short-term funds. •Collateral can be business assets, personal assets or cosigner's assets. The asset base for loans is usually accounts receivable, inventory, equipment, or real estate. •A bank can finance up to 80% of the value of accounts receivable or use a factoring agreement. •Finished goods inventory can be financed up to 50% of its value and some retailers, such as auto dealers, use trust receipts. •Equipment loans are for 3-5 years for the purchase of new or used equipment, sale-leaseback financing, or lease financing. •Real estate loans are easily obtained for up to 75% of its value.
Private offering
a formalized method for obtaining funds from private investors
Installment loans can be obtained by a venture _____.
with a track record of sales and profits