Chapter 11 Sources of Capital McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

Learning Objectives To identify the types of financing available To understand the role of commercial banks in financing new ventures, the types of loans available, and bank lending decisions To discuss Small Business Administration (SBA) loans To understand the aspects of research and development limited partnerships

Learning Objectives To discuss government grants, particularly Small Business Innovation Research grants To understand the role of private placement as a source of funds

Debt or Equity Financing Debt financing: Obtaining borrowed funds for the company Requires asset to be used as collateral Equity financing: Obtaining funds for the company in exchange for ownership Does not require collateral Offers investor some form of ownership position

Internal or External Funds Internal funds- Generated from sources within the company Profits Sale of assets Working capital reduction Accounts receivable Short-term internal source of funds: Reducing short-term assets Extended payment terms from suppliers.

Personal Funds Least expensive in terms of cost and control Essential for attracting outside funding Sources include: Savings Life insurance Mortgage on a house or car

Family and Friends Likely to invest due to relationship with entrepreneur Advantage - Easy to obtain money Disadvantage - Direct input into operations of a venture

Family and Friends A formal agreement must include: Amount of money involved Terms of the money Rights and responsibilities of the investor Steps to be taken when a business fails

Commercial Banks Asset base for loan Tangible collateral valued at more than the amount of money borrowed Types of bank loans Accounts receivable Inventory Equipment Real-estate

Commercial Banks Conventional bank loans: Standard way banks lend money to companies Types of loans Installment Straight commercial Long-term Character

Commercial Banks Bank lending decisions - Based on: Quantifiable information and subjective judgments Five Cs of lending - Character, Capacity, Capital, Collateral, and Conditions Review of past financial statements and future projections Ability to repay the loan

Role of the SBA in Small-Business Financing Small Business Administration (SBA) Guarantor of loans made by private and other institutions Proceeds can be used for: Working capital Machinery and equipment Furniture and fixtures Land and building Leasehold improvements Debt refinancing

Role of the SBA in Small-Business Financing Eligibility criteria Repayment ability Five “C’s” Size Type of business Use of proceeds Availability of funds from other sources

Role of the SBA in Small-Business Financing Interest rates are: Negotiated Subject to SBA maximums May be fixed or variable

Role of the SBA in Small-Business Financing 504 loan program - Provides fixed-rate financing To acquire machinery, equipment, or even real estate For maximum value of $1 million SBA Microloan – 7(m) loan program Short-term loans of up to $35,000 Working capital, purchase of inventory, supplies, furniture, fixtures, machinery, or equipment Cannot be used to pay existing debts

Private Placement Private offerings Formalized method for obtaining funds from private investors Faster and less costly

Private Placement Regulation D: Laws governing a private offering Contains broad provisions designed to simplify private offerings General definitions of what constitutes a private offering Provides specific operating rules—Rule 504,505, and 506

Bootstrap Financing Disadvantages of using outside capital Takes between three and six months to raise Decreases a firm’s drive for sales and profits Increases the impulse to spend Decreases the company’s flexibility May cause disruption and problems in the venture

Bootstrap Financing Involves using any possible method for conserving cash, such as: Use of discounts for volume Frequent customer discounts Promotional discounts Obsolescence money Savings through bulk packaging Consignment financing