Chapter 15 Debt Financing Copyright 2006 Prentice Hall Publishing Company 1 Sources of Debt Financing

Chapter 15 Debt Financing Copyright 2006 Prentice Hall Publishing Company 2 Debt Financing Must be repaid with interest. Must be repaid with interest. Is carried as a liability on the company's balance sheet. Is carried as a liability on the company's balance sheet. Can be just as difficult to secure as equity financing, even though sources of debt financing are more numerous. Can be just as difficult to secure as equity financing, even though sources of debt financing are more numerous. Can be expensive, especially for small companies, because of the risk/return tradeoff – “prime-plus….” Can be expensive, especially for small companies, because of the risk/return tradeoff – “prime-plus….”

Chapter 15 Debt Financing Copyright 2006 Prentice Hall Publishing Company 3 Consider Borrowing Money to… Increase your work force and/or inventory to boost sales Increase your work force and/or inventory to boost sales Gain market share Gain market share Purchase new equipment Purchase new equipment Refinance existing debt Refinance existing debt Take advantage of cash discounts Take advantage of cash discounts

Chapter 15 Debt Financing Copyright 2006 Prentice Hall Publishing Company 4 Consider Borrowing Money to… Buy the building in which your business is located Buy the building in which your business is located Establish a relationship with a lender Establish a relationship with a lender Retire debt held by a “non- relationship” creditor Retire debt held by a “non- relationship” creditor Deal with a downturn in business Deal with a downturn in business

Chapter 15 Debt Financing Copyright 2006 Prentice Hall Publishing Company 5 Sources of Debt Capital Commercial banks Commercial banks

Source: Small Business and Micro Business Lending in the United States, U.S. Small Business Administration

Chapter 15 Debt Financing Copyright 2006 Prentice Hall Publishing Company 7 Commercial Banks Lenders of first resort for small business owners Lenders of first resort for small business owners 80% of all loans to existing businesses come from banks 80% of all loans to existing businesses come from banks Focus on a company’s ability to generate positive cash flow when evaluating loan proposals Focus on a company’s ability to generate positive cash flow when evaluating loan proposals

Chapter 15 Debt Financing Copyright 2006 Prentice Hall Publishing Company 8 Commercial Banks Conservative lenders Conservative lenders  Significant owner investment  Sufficient cash flow for repayment  Ample collateral as security  SBA loan guarantee  Personal guarantee

Chapter 15 Debt Financing Copyright 2006 Prentice Hall Publishing Company 9 Commercial Banks Short-term loans – the commercial banks’ specialty Short-term loans – the commercial banks’ specialty  Commercial loans  Lines of credit...the heart of the financial market for small businesses!

How large a line of credit? Example: Average collection period ratio 49 days Average collection period ratio 49 days + Average inventory turnover ratio + 53 days = Total 102 days - Average payable period ratio - 39 days = Cash flow cycle63 days Annual sales $5,800,000 Average daily sales (Annual sales ÷ 365 days) $15,890 Cash Flow cycle 63 days x Average daily sales x $15,890 Equals $1,001,096 - Forecasted profit (Annual sales x net profit margin) - $377,000 = Line of credit requirement $624,096

Chapter 15 Debt Financing Copyright 2006 Prentice Hall Publishing Company 11 Commercial Banks Short-term loans – the commercial banks’ specialty Short-term loans – the commercial banks’ specialty  Commercial loans  Lines of credit...the heart of the financial market for small businesses!  Floor planning

Chapter 15 Debt Financing Copyright 2006 Prentice Hall Publishing Company 12 Intermediate and long term loans Intermediate and long term loans  Term loans  Installment loans  Discounted installment contracts  Character loans Commercial Banks...the heart of the financial market for small businesses!

Chapter 15 Debt Financing Copyright 2006 Prentice Hall Publishing Company 13 Sources of Debt Capital Commercial banks Commercial banks Asset-based lenders Asset-based lenders

Chapter 15 Debt Financing Copyright 2006 Prentice Hall Publishing Company 14 Asset-Based Borrowing Discounting accounts receivable Discounting accounts receivable Accounts Receivable Inventory financing Inventory financing

Source: Commercial Finance Association

Chapter 15 Debt Financing Copyright 2006 Prentice Hall Publishing Company 16 Sources of Debt Capital Commercial banks Commercial banks Trade credit Trade credit Equipment suppliers Equipment suppliers Commercial finance companies Commercial finance companies Saving and loan associations Saving and loan associations Asset-based lenders Asset-based lenders

Chapter 15 Debt Financing Copyright 2006 Prentice Hall Publishing Company 17 Sources of Debt Capital Stock brokerage houses Stock brokerage houses Insurance companies Insurance companies Credit unions Credit unions Bonds Bonds Private placements Private placements Small Business Investment Companies (SBICs) Small Business Investment Companies (SBICs) (Continued)

Chapter 15 Debt Financing Copyright 2006 Prentice Hall Publishing Company 18 Small Business Investment Companies (SBICs) 400+ SBICs operate in the U.S SBICs operate in the U.S. Use a combination of private capital and federally guaranteed debt to provide long-term capital to small companies. Use a combination of private capital and federally guaranteed debt to provide long-term capital to small companies. Since 1960, SBICs have provided more than $36.5 billion in financing to some 109,000 small companies. Since 1960, SBICs have provided more than $36.5 billion in financing to some 109,000 small companies.

Source: SBIC Program Statistical Package, US Small Business Administration.

Chapter 15 Debt Financing Copyright 2006 Prentice Hall Publishing Company 20 Sources of Debt Capital Stock brokerage houses Stock brokerage houses Insurance companies Insurance companies Credit unions Credit unions Bonds Bonds Private placements Private placements Small Business Investment Companies (SBICs) Small Business Investment Companies (SBICs) (Continued) Small Business Lending Companies (SBLCs) Small Business Lending Companies (SBLCs)

Chapter 15 Debt Financing Copyright 2006 Prentice Hall Publishing Company 21 Sources of Debt Capital Economic Development Administration (EDA) Economic Development Administration (EDA) Department of Housing and Urban Development (HUD) Department of Housing and Urban Development (HUD) U.S. Department of Agriculture’s Rural Business-Cooperative Service U.S. Department of Agriculture’s Rural Business-Cooperative Service Federally Sponsored Programs: (Continued)

Chapter 15 Debt Financing Copyright 2006 Prentice Hall Publishing Company 22 Small Business Innovation Research (SBIR) Small Business Innovation Research (SBIR) Small Business Technology Transfer programs Small Business Technology Transfer programs Small Business Administration (SBA) – largest single backer of small businesses in the nation Small Business Administration (SBA) – largest single backer of small businesses in the nation Sources of Debt Capital Federally Sponsored Programs: (Continued)

Chapter 15 Debt Financing Copyright 2006 Prentice Hall Publishing Company 23 Small Business Administration Loan Programs Low Doc Loan Program Low Doc Loan Program SBAExpress Program SBAExpress Program 7(A) Loan Guaranty Program – the most popular SBA loan program 7(A) Loan Guaranty Program – the most popular SBA loan program

Source: U.S. Small Business Administration

Chapter 15 Debt Financing Copyright 2006 Prentice Hall Publishing Company 25 Low Doc Loan Program Low Doc Loan Program SBAExpress Program SBAExpress Program 7(A) Loan Guaranty Program – the most popular SBA loan program 7(A) Loan Guaranty Program – the most popular SBA loan program CAPLine Program CAPLine Program International Trade Programs International Trade Programs  Export Working Capital Program  International Trade Program Small Business Administration Loan Programs

Chapter 15 Debt Financing Copyright 2006 Prentice Hall Publishing Company 26 Section 504 Certified Development Company Program Section 504 Certified Development Company Program Microloan Program Microloan Program Prequalification Loan Program Prequalification Loan Program Disaster Loans Disaster Loans 8(A) Loan Program 8(A) Loan Program Small Business Administration Loan Programs

Chapter 15 Debt Financing Copyright 2006 Prentice Hall Publishing Company 27 State and Local Loan Programs Capital Access Programs (CAPs) – now offered in 22 states and are designed to encourage lenders to make loans to businesses that do not qualify for traditional financing. Capital Access Programs (CAPs) – now offered in 22 states and are designed to encourage lenders to make loans to businesses that do not qualify for traditional financing. Revolving Loan Fund (RLFs) – combine private and public funds to make small business loans. Revolving Loan Fund (RLFs) – combine private and public funds to make small business loans.

Chapter 15 Debt Financing Copyright 2006 Prentice Hall Publishing Company 28 Internal Methods of Financing Factoring - selling accounts receivable outright. Factoring - selling accounts receivable outright.

Source: Commercial Finance Association

Chapter 15 Debt Financing Copyright 2006 Prentice Hall Publishing Company 30 Factoring - selling accounts receivable outright Factoring - selling accounts receivable outright Leasing assets rather than buying them Leasing assets rather than buying them Credit cards Credit cards Internal Methods of Financing

Chapter 15 Debt Financing Copyright 2006 Prentice Hall Publishing Company 31 Web Sites American Bankers Association American Bankers Association National Association of Small Business Investment Companies National Association of Small Business Investment Companies U.S. Small Business Administration U.S. Small Business Administration