Small Business Finance: Using Equity, Debt, and Gifts Chapter 15 © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Learning Objectives LO1 Describe the three types of capital financing and their costs and trade-offs. LO2 Explain the characteristics of a business that determine its ability to raise capital. LO3 Explain which type of financing is best for your business. LO4 Describe the differing needs for financial management at each stage of business life © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Sources of Financing for Small Businesses  The number one source is from the owners (or potential owners) themselves.  The other major sources include family and friends, credit cards, trade credit, banks, and other commercial lenders © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Sources of Financing for Small Businesses  Debt  A legal obligation to pay money in the future.  Equity capital  Money contributed to the businesses in return for part ownership of the business © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Sources of Financing for Small Businesses  Gift  Valuable assets or services donated to the business without any obligation to repay or give up any ownership interest.  Debt capital  Money borrowed for the purpose of investment in a business © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Use of Debt and Equity in Start-Ups from the PSED 15-6 Figure 15.1 © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Financing with Equity  Outside equity  Money from selling part of your business to people who are not and will not be involved in the management of the business © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Legal Forms of Business  Partnership  Two or more people cooperating to conduct a business enterprise.  Corporation  A legal “artificial” entity that is formed by filing specific documents with a state government © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Legal Forms of Business  Limited liability company (LLC)  A legal form of business organization that is created by filing required documentation with a state government.  Have a choice, under federal tax law, of being taxed as either corporations or partnerships © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Legal Forms of Business  Limited partnership  A legal form of business organization that is created by filing required documentation with a state government  One or more partners may have no liability for the debts and actions of the partnership © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Legal Forms of Business  Sole proprietorship  A business owned by a single individual who is responsible for all debts and claims against the business © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Legal Forms of Business © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Getting Equity Investment for Your Business  Interest  A charge for the use of money, usually figured as a percentage of the principal.  Dividends  Payments of profits to the owners of corporations © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Getting Equity Investment for Your Business  Gain on investment  The percentage amount that the payout of an investment differs from original cost  Calculated as (payout − investment + dividends)/ investment © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Equity Capital from the Investor’s View  Risk  The level of probability that an investment will not produce expected gains.  Diversify  To invest in multiple investments of differing risk profiles for the purpose of reducing overall investment risk © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Equity Capital from the Investor’s View  Owners and investors want to make money  Lenders expect a return on this money  To get money from other people, you’ve got to show them that your business probably can make gains for them  Growth potential is a primary concern for equity investors © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Methods to Obtain Equity Capital  External equity capital is not available for most small business start-ups.  Banks do not loan to start-up businesses.  Owners often do not want to share ownership.  Owners usually want to be their own bosses.  Owners typically do not want to be responsible to others for losses of the business. © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part

The Pecking Order of Funding Sources for New Firms Figure 15.2 © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Methods to Obtain Equity Capital  Bootstrapping  Using funds generated by business operations to capitalize growth © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part

Minimize Overhead Costs Cloud computing Virtual storefronts Business incubators Business office co-ops © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part

Maximize Returns from Employee Expense  Student interns often provide high talent and strong motivation at a low cost to you.  Overtime is usually much less expensive than hiring more full-time workers during times of increased business.  Contractors exist to complete tasks that have a clear beginning, middle, and end. © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part

Minimize Operating Costs  Outsource the production of your service or product  Subcontract parts of your business that are not your core competency  Rent space that is unused or underutilized by other ongoing businesses  Rent equipment  Work from home © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part

Maximize the Results of Marketing  Word of Mouth  Discounts, Local signage, Facebook, Cooperative advertising  Publicity  Press releases, Public speaking, Donate your product or service © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part

Crowdfunding for Equity Document your business Make a business plan Create a compelling story Create a professional-looking video Develop a list of potential investors © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part

Angel Investors  Angel investor  A wealthy individual who invests in companies in relatively early stages of development. © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part

Types of Angel Investment © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Equity Capital from the Owner’s View  Financing with equity is (1) expensive and (2) guaranteed to create problems of control and decision making.  Suppose you sell half your business to raise capital. You have just sold half of all your future profits, half of all your future growth, half of all your future wealth © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Why Use Equity Capital? 1.You will reduce your own exposure to financial loss 2.Your business will not have increased costs in the form of interest 3.Bringing outside investors into an existing business can often reenergize it by providing new ideas, procedures, and processes © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Financing with Debt: Getting a Loan for Your Business 1.Direct loans of cash 2.Guaranteeing loans made by commercial banks 3.Reducing taxes by allowing interest to be deducted © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Financing with Debt: Getting a Loan for Your Business  Community development organization  An organization authorized by the SBA to make insured loans to small businesses that are expected to increase economic activity within a specific geographic area © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Financing with Debt: Getting a Loan for Your Business  Small business investment companies  Private businesses that are authorized to make SBA insured loans to start-ups and small businesses © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

The Four Cs of Borrowing Figure 15.3 © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Financing with Debt: Getting a Loan for Your Business  Accelerator  An organization that supports startup technology businesses by providing inexpensive office space, a variety of support services, and resources  Most are associated with universities © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Financing with Debt: Getting a Loan for Your Business  Credit reporting agency  A business that collects, collates, and reports information concerning an entity’s use of debt.  Fair Credit Reporting Act  U.S. federal legislation specifying consumers’ rights vis à vis credit reporting agencies © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Financing with Debt: Getting a Loan for Your Business  Collateral  Something of value given or pledged as security for payment of a loan  May consist of financial instruments, such as stocks, bonds, and negotiable paper, or of physical goods, such as trucks, machinery, land, or buildings © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Gift Financing  Tax abatement  A legal reduction in taxes by a government.  Tax credits  Direct reductions in the amount of taxes that must be paid, dependent upon meeting some legal criteria.  Grants  Gifts of money made to a business for a specific purpose © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Gift Financing  Foundation  An institution to which private wealth is contributed and from which private wealth is distributed for public purposes © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Forms of Personal Gifts Exhibit 15.1 © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

When Giving a Gift 1.Put your agreement into writing 2.If it is a gift, have the agreement specifically say so. 3.If it is a loan, have the agreement specify the exact interest and payment terms. 4.If it is an equity investment, consider nonvoting stock. © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part

What Type of Financing Is Right for Your Business?  Cost of capital  The percentage cost of obtaining future funds.  Weighted average cost of capital (WAC)  The expected average future cost of funds. © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part

What Type of Financing Is Right for Your Business?  Financial leverage  A measure of the amount of debt relative to total investment.  Optimum capital structure  The ratio of debt to equity that provides the maximum level of profits. © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part

Interaction among Profitability, Control, and Risk © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part Figure 15.4

Tools for Financial Management The obvious comparisons:  With your planned position and results (your master budget)  With prior years’ position and results,  With the position and results of other firms.  Using relevant financial ratios. © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part