1 SMALL BUSINESS MANAGEMENT Chapter Seven Financing the Small Business

2 Small Business Financing u Financing Ongoing Operations –New Products and Services –Acquisition / Joint Venture –Expansion –Capital expenditures –Working capital needs

3 Small Business Financing u Other management problems affecting financing –Underestimating financial requirements –lack of knowledge of sources of equity and debt capital –lack of skills in presenting a proposal for financing –failure to plan in advance for needs –poor financial control of operations

4 Determining the Amount of Funds Needed u Start-up Costs u Ongoing Operating Costs u The Owner’s Net Worth

5 Determining Types of Financing u Equity (Ownership) Financing –Private Investors –Corporate Investors –Government –Business Development bank of Canada (BDC) –Canada Development Corporation (CDC) –Provincial Programs

6 Advantages of Equity Financing F no obligations for dividends or interest F investor expertise F equity expands borrowing power F equity spreads risk of failure

7 Disadvantages of Equity Financing F dilutes ownership and independence F disagreements F compromises F legal costs

8 Debt Financing u Advantages of Debt Financing u Disadvantages of Debt Financing

9 Debt Financing u Advantages –obtain higher ROI by using leverage debt. –Interest costs are tax deductible; dividends from equity are not –No loss of ownership control with debt financing –easier to obtain than equity capital

10 Debt Financing u Disadvantages –Interest must be paid and interest rates are higher –increased paperwork requirements and lender monitoring –total risk on part of the owner

11 Sources of Debt Financing F Private lenders –shareholder loans F Corporate lenders F Regular Private Lending Institutions –Trust companies, credit unions, finance companies –chartered banks F Government Lenders

12 Determining Terms of Financing u Types –Short term (demand), medium term, long term u Sources –banks, private sources, factors, confirming houses; term lenders, leasing companies, foreign banks; trust companies

13 Preparing A Proposal to Obtain Financing u Criteria Used in the Loan Decision –1. The Applicant’s Management Ability F How much the Applicant Knows about the Business F How much care was taken in preparing the proposal

14 Preparing A Proposal to Obtain Financing –2. The Proposal F level of working capital F current ratio F quick ratio F debt-to-equity ratio

15 Preparing A Proposal to Obtain Financing –3. Applicant’s background and creditworthiness F personal information F present debt and past lending history F amount of equity the applicant has invested F will the applicant bank with the lender F lender relations

16 Appendices u Provincial Equity Programs u Federal Government Assistance Programs for Small Business u Provincial Government Assistance Programs for Small Business u Venture Capital Firms in Canada

17 Concept Checks u 1. What problems are often the result of lack of management competence and experience ? u 2. What are some of the operating costs involved in determining the start up capital needed ? u 3. Why is it important to determine the owner’s net worth?

18 Concept Checks u 4. What are the sources of equity financing for the small business ? u 5. What are the advantages and disadvantages of equity financing ? u 6. What are the advantages and disadvantages of debt financing ?

19 Concept Checks u 7. What are the major sources of debt financing ? u 8. What are the potential advantages and disadvantages of borrowing through government lenders ? u 9. What criteria do lenders use in making the loan decision ?

20 Concept Checks u 10. What can the entrepreneur do if he/she is unsuccessful in obtaining financing ?