Entrepreneurship and small business management chapter 15

Entrepreneurship and Small Business Management Chapter 15 Financing Strategy: Debt, Equity, or Both? Ch 15 Performance Objectives      Explore your financing preferences Identify the types of business financing Compare the pros and cons of debt and equity financing Identify sources of capital for your business Understand stocks and bonds as investment alternatives Entrepreneurship and Small Business Management, 1/e © 2012 Pearson Education, Upper Saddle River, NJ 07458 What Is Financing?  The act of providing or raising funds (capital) for a purpose  Ways to start or expand a business:      Use personal savings Use company profits (finance with earnings) Obtain gifts and grants Borrow money (finance with debt) Exchange a share of the business for money (finance with equity) Entrepreneurship and Small Business Management, 1/e © 2012 Pearson Education, Upper Saddle River, NJ 07458 Gifts   Repayment not required but may come with conditions or “strings attached” Examples:       Cash Free use of facilities and equipment Unpaid labor by friends and family Forgiveness or deferral of debts Tax abatements—legal reductions in taxes Tax credits—direct reductions of taxes Entrepreneurship and Small Business Management, 1/e © 2012 Pearson Education, Upper Saddle River, NJ 07458 Grants  No repayment, but may have specific requirements  Primarily provided for research and commercialization efforts  Difficult for start-up or low-technology companies to obtain Entrepreneurship and Small Business Management, 1/e © 2012 Pearson Education, Upper Saddle River, NJ 07458 Forms of Debt Financing  Commercial loans—business loans typically provided by a bank      Real estate—up to 20 yrs Equipment and improvements—up to yrs Working capital—1 year or less Asset based—depends on type of asset pledged Accounts receivable factoring—often 30 days Entrepreneurship and Small Business Management, 1/e © 2012 Pearson Education, Upper Saddle River, NJ 07458 Forms of Debt Financing (continued)  Personal loans—taken out on personal credit and used for the business  Credit cards—”revolving” terms  Home equity loans—variable terms; some are lines of credit  Title loans—short-term fixed repayment  Payday loans—short-term fixed repayment Entrepreneurship and Small Business Management, 1/e © 2012 Pearson Education, Upper Saddle River, NJ 07458 Forms of Debt Financing (continued)   Leases—debts incurred for the rights to use specific property  Vehicle leases  Equipment leases Bonds—long-term debt used to raise large sums of money Entrepreneurship and Small Business Management, 1/e © 2012 Pearson Education, Upper Saddle River, NJ 07458 Debt Financing: Pros and Cons Advantages  Lenders have no say in business management  Payments are predictable  Payments can be set up to coincide with seasonal sales  Lenders have no share in business profits Entrepreneurship and Small Business Management, 1/e Disadvantages      Lenders can force bankruptcy Lenders can take owner’s home and possessions Payments increase fixed costs, lowering profits Repayment reduces available cash Lenders expect financial reporting and compliance © 2012 Pearson Education, Upper Saddle River, NJ 07458 Equity Financing: Pros and Cons Advantages  If no profit is made, investors are not paid  There are no required regular payments of principal or interest  Investors cannot force bankruptcy  Investors may provide valuable advice and contacts Entrepreneurship and Small Business Management, 1/e Disadvantages     10 Giving up too much ownership may lead to loss of business control Investors may interfere with the business Investors may want to influence business management and receive higher rate of return Investors share in profits © 2012 Pearson Education, Upper Saddle River, NJ 07458 Bankers Operate on the Five Cs of Credit  Collateral—property or assets that lender can take if loan is not repaid  Character—measured by your ability to borrow and your credit history  Capacity—sufficient business cash flow  Capital—personal resources invested  Conditions—industrial/economic “climate” Entrepreneurship and Small Business Management, 1/e 11 © 2012 Pearson Education, Upper Saddle River, NJ 07458 Community Development Financial Institutions (CDFIs)   Lenders that share a vision of expanding economic opportunity and improving quality of life for low-income communities Four sectors:     Community Community Community Community (CDVCs) Entrepreneurship and Small Business Management, 1/e development development development development 12 banks (CDBs) credit unions (CDCUs) loan funds (CDLFs) venture capital funds © 2012 Pearson Education, Upper Saddle River, NJ 07458 Venture Capitalists  Investors or investment companies seeking equity  Expect times their money back over years, or a 45% rate of return  Desire candidates likely to generate at least $50 million in sales within years  Sometimes seek a majority interest Entrepreneurship and Small Business Management, 1/e 13 © 2012 Pearson Education, Upper Saddle River, NJ 07458 Angels  Wealthy, private individual investors  Usual investment is between $100,000 and $500,000  Typically seek a return of 10 times the investment at the end of years  Best strategy: recruit one angel who finds others Entrepreneurship and Small Business Management, 1/e 14 © 2012 Pearson Education, Upper Saddle River, NJ 07458 Other Financing Options    Insurance companies provide loans based on the surrender value of a policy Vendor financing is achieved by extending the “float” time between receiving bills and paying bills Federally supported investment companies provide loans to minorities, rural enterprises, and small businesses in low-income geographic areas Entrepreneurship and Small Business Management, 1/e 15 © 2012 Pearson Education, Upper Saddle River, NJ 07458 Other Financing Options (continued)  U.S Department of Agriculture— provides assistance to rural/agricultural businesses  Youth financing—grants, scholarships, and other awards for entrepreneurs who are 25 years old and younger  Bootstrap financing—creative ways of “stretching” existing capital resources Entrepreneurship and Small Business Management, 1/e 16 © 2012 Pearson Education, Upper Saddle River, NJ 07458 Three Categories of Investment    Stocks—shares of companies (equity) Bonds—loans (debt) to companies or government entities Cash—investments easily liquidated (turned into cash) within 24 hours, such as savings accounts and treasury bills High Risk = High Reward Low Risk = Low Reward Entrepreneurship and Small Business Management, 1/e 17 © 2012 Pearson Education, Upper Saddle River, NJ 07458 Stocks  Shares of stock represent a percentage of ownership in a corporation  Public corporations sell stock to the general public to raise capital  Stock prices reflect investors’ opinions about business performance and value  Investors make money by selling stock at a price higher than the one they paid Entrepreneurship and Small Business Management, 1/e 18 © 2012 Pearson Education, Upper Saddle River, NJ 07458 Bonds:     Are interest-bearing certificates that corporations and governments issue to raise capital Have a lower risk and lower return expected than stocks Are a form of debt financing with a specific rate of return to investors Pay a yearly interest rate semi-annually to bondholders until “maturity” when they are redeemable at face value Entrepreneurship and Small Business Management, 1/e 19 © 2012 Pearson Education, Upper Saddle River, NJ 07458  ... financing Identify sources of capital for your business Understand stocks and bonds as investment alternatives Entrepreneurship and Small Business Management, 1/e © 2012 Pearson Education, Upper... money Entrepreneurship and Small Business Management, 1/e © 2012 Pearson Education, Upper Saddle River, NJ 07458 Debt Financing: Pros and Cons Advantages  Lenders have no say in business management. .. advice and contacts Entrepreneurship and Small Business Management, 1/e Disadvantages     10 Giving up too much ownership may lead to loss of business control Investors may interfere with the business