SMALL BUSINESS MANAGEMENT Chapter 7 Financing the Small Business

Class notes

Cottage Cheesecake Industry  What aspects of Brad Miller's background would be positive for him to obtain financing for his business? What aspects would be negative?  What are the advantages and disadvantages of equity financing for this business?  What other sources of financing might he have accessed? Cottage cheese cake

Small Business Financing  Reasons For Financing of Ongoing Operations New Products and Services Acquisition / Joint Venture Expansion Capital expenditures Working capital needs

Small Business Financing  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

Determining the Amount of Funds Needed Start-up Costs Ongoing Operating Costs The Owner’s Net Worth Capital requirements = start-up costs + operating requirements – owner assets available for investment

Determining the Amount of Funds Needed Start-up Costs  Initial inventory, hiring costs, physical space  First few months rent, payroll, advertising  Prepaid items --utility & rent deposits, insurance  Licenses & permits Ongoing Operating Costs  Prepare cash flow statement (chapter 10) The Owner’s Net Worth

new business is a retail establishment promotion, you plan to give buyers 90 days to pay Buy initial inventory Buy replacement inventory + plan for this working capital need in advance, If not,you probably won't even stay in business for 90 days.

Determining Types of Financing  Equity (Ownership) Financing Private Investors  Self, bootstrapping, friends, family, private, employees, sale of shares Corporate Investors  Venture capitalist (vulture capitalists) Government  Business Development bank of Canada (BDC)  Canada Development Corporation (CDC)  Provincial Programs Surviving High Tech

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

Disadvantages of Equity Financing F dilutes ownership and independence F Disagreements F Compromises F legal costs

Debt Financing  Advantages Obtain higher ROI by using leverage debt Interest costs are tax deductible; dividends from equity are not No loss of ownership control and greater flexibility with debt financing Easier to obtain than equity capital

Financial leverage sold sold-- $110,000 Profit= $110K-$100K Profit --$10,000 Return on Investment ROI = $100K/$100K = 100% Cost-- $100,000 Invest --$10,000 purchasesold sold-- $110,000 Profit= $110K-$100K Profit --$10,000 Return on Investment ROI = $10K/$100K = 10% Cost-- $100,000 Invest --$100,000 purchase

Debt Financing  Disadvantages Interest must be paid on borrowed money Increased paperwork requirements and lender monitoring Total risk on part of the owner

Sources of Debt Financing Private lenders  shareholder loans Corporate lenders  regular private lending institutions trust companies, credit unions, finance companies chartered banks Government Lenders  May finance high debt, low equity firms  May be flexible, lower rates, counseling  More paper work, time to process is longer, more monitoring & control

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

Preparing A Proposal to Obtain Financing  Criteria Used in the Loan Decision 1. The Applicant’s Management Ability  How much the applicant knows about the business  How much care was taken in preparing the proposal Lending proposal document (fig 7-10) cash flow & income statement & Balance sheet ( chapters 3 & 10 ) Owners Salary & contingencies

Preparing A Proposal to Obtain Financing  Criteria Used in the Loan Decision 2.The Proposal level of working capital  Current assets – current liabilities current ratio 2:1 quick ratio 1:1 debt-to-equity ratio  Collateral

Preparing A Proposal to Obtain Financing  Criteria Used in the Loan Decision 3. Applicant’s background and creditworthiness  personal information  present debt and past lending history  amount of equity the applicant has invested  will the applicant bank with the lender  Lender Relations

Clarks Sporting Goods  Q 1. Estimate how much money Dave will need from outside sources to start his business.  Q 2. Assuming Dave receives start ‑ up financing from a bank, as calculated in question 1, will he require an operating line of credit during the first four months of operation? If so how much?  Q 3. Should Dave pursue debt or equity sources of funds to get started?

“ Avery Wine “ or Lotus Land“ Avery Wine “ Lotus Land  What aspects of David & Liz Avery’s background would be positive for them to obtain financing for their business? What aspects would be negative?  What are the advantages and disadvantages of equity financing for this business?  What other sources of financing might he have accessed? BrandMan

Appendices  Provincial Equity Capital Programs  Federal Government Assistance Programs for Small Business  Provincial Government Financial Assistance Programs and Agencies for Small Business  Venture Capital Firms in Canada