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Chapter 12 - Debt and other forms of financing. In this chapter, students will be able to understand: Figure out how much you need, financing is a continuing activity, align your sources & uses of funds, mature firms enjoy greater access to funds, start with internal funds sources, optimize your cash collection cycle (CCC), obtain working capital from receivables and inventories,...
DEBT AND OTHER FORMS OF FI NANCI NG Chapt e r 12 Zacharakis, Bygrave and Corbett, Entrepreneurship, New York: Wiley, 2017 © Figure out how much you need q Know the four basic ways to value your business Ø Earning capitalization valuation Ø Present value of future cash flows Ø Market – comparable valuation Ø Asset-based valuation q Knowing the value of your business is the first step in figuring out how much you need to get funded q These methods offer tangible formulas but often Zacharakis, Bygrave and Corbett, Entrepreneurship, New York: Wiley, 2017 © Financing is a continuing activity q q Factors within, and outside of, your control impact your cash needs & can change suddenly Cash needs must be frequently forecasted with a margin of error Ø Plan for the most likely case Ø Be prepared for the worst case (maintain access to a reserve) q Remember the “Rules of Cash” Ø More cash is better than less cash Ø Cash now is better than cash later Zacharakis, Bygrave and Corbett, Entrepreneurship, New York: Wiley, 2017 © Align your sources & uses of funds q Uses of funds Ø Start-up costs Ø Working capital Ø Growth q Sources of funds (cash flow) Ø External • Require external analysts or investors to independently appraise the worthiness of capital investments before releasing funds Ø Internal • Funds you control directly & absolutely Zacharakis, Bygrave and Corbett, Entrepreneurship, New York: Wiley, 2017 © Mature firms enjoy greater access to funds FIRM MATURITY INTERNAL SOURCES OF FUNDS EXTERNAL SOURCES OF FUNDS Zacharakis, Bygrave and Corbett, Entrepreneurship, New York: Wiley, 2017 © Start with internal funds sources q Home equity lines of credit Ø Interest Ø Better q rates are comparatively low for mid to longer term debt Credit cards Ø Higher interest rates Ø Miles/points Ø Better may be available for short term debt to minimize cost of capital q Use personal funds to “de-risk” your venture Zacharakis, Bygrave and Corbett, Entrepreneurship, New York: Wiley, 2017 © Optimize your cash collection cycle (CCC) q Ideal - a negative cycle Ø Customer pays you before you pay suppliers Ø Highest q liquidity Next best – Customers pay cash, you pay credit Ø Influenced q by industry norms Optimize your CCC Ø Extend payables Zacharakis, Bygrave and Corbett, Entrepreneurship, New York: Wiley, 2017 © Obtain working capital from receivables and inventories q New working capital doesn’t equal liquidity q Some working capital is tied up in operating assets q Operating assets can be liquidated prematurely at a cost, if no other sources of funds exist Zacharakis, Bygrave and Corbett, Entrepreneurship, New York: Wiley, 2017 © Obtain working capital from receivables by adjusting… q the pattern of your sales ü q the ratio of cash vs credit ü q Forecast sales to plan working capital Credit vs credit cards vs cash your terms for credit sales ü A competitive factor within industries ü Consider demand elasticity Zacharakis, Bygrave and Corbett, Entrepreneurship, New York: Wiley, 2017 © Increase payables & decrease receivables for short term cash q q q Receivables secure a bank loan Maximize existing trade credits Negotiate extended trade credits q Use seasonal trade credits q Emphasize cash sales Accept credit cards q Zacharakis, Bygrave and Corbett, Entrepreneurship, New York: Wiley, 2017 © Get short term cash from banks by financing receivables q Pledging Ø Receivable Ø Loan become collateral is given for a percentage of collateral full value q Pledging with notification Ø Customer q instructed to pay the lender directly Factoring Ø Sell receivables at a discount to a “factor” Ø Factor collects receivable payments Zacharakis, Bygrave and Corbett, Entrepreneurship, New York: Wiley, 2017 © Obtain working capital with bank loans against inventory q Chattel Mortgage q Secured by property assets (i.e “Widget #2873B4”) q Floating Lien q Secured by blanket assets (i.e entire inventory) q Field Warehousing q Lender secures your inventory on your premises Zacharakis, Bygrave and Corbett, Entrepreneurship, New York: Wiley, 2017 q © “Finance” working capital through customer prepayments q q q Goes back to the ideal negative cycle not easy Common in large, complex, long-term projects Customers pay ahead in installments to fund phases of work until completion Zacharakis, Bygrave and Corbett, Entrepreneurship, New York: Wiley, 2017 © Obtain Small Business Administration (SBA) loans q For those unable to get conventional bank loans q Government backs loans Ø 90% under $155,000 Ø Up to 85%, between $155,000 and $750,000 (max.) q q q Must be for-profit Used for working capital, CAPEX, & line of credit 3:1 Debt-to-equity ratio required Zacharakis, Bygrave and Corbett, Entrepreneurship, New York: Wiley, 2017 © Many factors to consider in acquiring short term bank loans q Maturity of loans q Interest rates q Collateral q Loan applications q Restrictive covenants q General provisions q Routine provisions q Specific provisions Zacharakis, Bygrave and Corbett, Entrepreneurship, New York: Wiley, 2017 © Finance equipment needs q q q q Non-bank companies charge interest higher than banks Collateral (i.e the equipment) must exceed loan balance Loan repayment schedule stays ahead of depreciation schedule Conditional sales contracts extend purchase over 2-5 years Zacharakis, Bygrave and Corbett, Entrepreneurship, New York: Wiley, 2017 © When selecting the right shortterm financing mix, consider… q your needs Ø Current Ø Future q cost of alternatives Ø Current Ø Future Zacharakis, Bygrave and Corbett, Entrepreneurship, New York: Wiley, 2017 © Plan cash flows & profits q Profitability vs Solvency Ø An unprofitable venture can recover… measure of health Ø An Insolvent venture ceases to exist because it cannot pay its’ suppliers (insufficient working capital)…vital sign q Profits doesn’t equal cash flow Ø Some cash transactions not impact profits Ø Non-cash transaction not impact cash flow Free cash flow (FCF); matters to bank q Zacharakis, Bygrave and Corbett, Entrepreneurship, New York: Wiley, 2017 © 18 Recap q Working capital doesn’t equal liquidity q Most of working capital is tied up in operations q q q Cash flow forecasts help to determine financing needs Manage customer and supplier payments Debt options when actual cash doesn’t meet needs: banks, private placement, leases, suppliers, government agencies, customers Zacharakis, Bygrave and Corbett, Entrepreneurship, New York: Wiley, 2017 © ... and $750,000 (max.) q q q Must be for-profit Used for working capital, CAPEX, & line of credit 3:1 Debt-to-equity ratio required Zacharakis, Bygrave and Corbett, Entrepreneurship, New York: Wiley,... Use personal funds to “de-risk” your venture Zacharakis, Bygrave and Corbett, Entrepreneurship, New York: Wiley, 2017 © Optimize your cash collection cycle (CCC) q Ideal - a negative cycle Ø Customer... now is better than cash later Zacharakis, Bygrave and Corbett, Entrepreneurship, New York: Wiley, 2017 © Align your sources & uses of funds q Uses of funds Ø Start-up costs Ø Working capital Ø