1. Financing a business

2. Make the owners of the business more wealthy
What does a business do
Make the owners of the business more wealthy
Raise Funds
Invest Funds

3. Finance Policy RISK REWARD
The value of a business is the sum of its future cash flows
discounted at its cost of capital

4. BUSINESS LIFE CYCLE: Financing
Start up
Usually financed with funds of the owner (equity) or with borrowings and usually some combination of both.
Share capital is likely to be issued to only a few members and the shareholders, as the owners of the company are usually also involved in the management of the Company.
Angel investors are a significant and important source of funding for start ups.

5. BUSINESS LIFE CYCLE: Financing
Growing a business
To grow companies will need to make profits and retain them within the business (retained earnings).
Growing companies need to seek external finance to fund assets and invest in the business to position it to be able to take advantage of opportunities.

6. BUSINESS LIFE CYCLE: Financing
Mature Business
The more mature a business the more options become available in terms of debt and equity financing
Once a company becomes a PLC they have much broader access to shareholder financing, and once listed on an exchange (such as the London Stock Exchange) they can publically sell their shares
Larger companies can have publicly traded debt i.e ddebentures which are usually 5-10 years with a fixed rate of interest & can be convertible

7. BUSINESS LIFE CYCLE: Financing
Other financing available for non listed smaller companies include venture capital options including: Venture Capital Investment, Angel Investors and Private Equity Funds

8. Financing a business Equity / Shares Borrowings
Retained profits & other sources of finance

9. Financing a business
DEBT
EQUITY

10. EXAMPLE COMPANY A COMPANY B Equity 180 50 Debt (11%) 20 150
Capital employed
200
Operating Profit yr 1 19
Operating Profit yr 2
22.8
Operating Profit yr 3
15.2
Taxation rate
25%
What is the profit for shareholders for each of the three years?

11. Financing a business Equity / Shares Borrowings
Retained profits & other sources of finance

12. Financing: Share Capital
Companies issue share capital when they are first established.
Shareholders own the company and bear most of the RISK.
All creditors have to be paid before anything is returned to the shareholders and therefore the shareholders risk losing everything.
Liability is limited to the amount invested
The cost of equity is based on the required return of shareholders

13. Financing: the cost of Share Capital
DIVIDEND – there is no requirement for dividends to be paid LIQUIDITY ISSUES – shares listed on a public exchange are more liquid PREFERENCE SHARES – usually have a fixed return and are paid before ordinary shares AIM – Alternative Investment Market IPO - Initial public offering of shares when you first list on a stock exchange

14. Financing a business Equity / Shares Borrowings
Retained profits & other sources of finance

15. Financing: External Borrowings
TYPES
Bank Loans
Debentures
Finance Lease
Revolving credit facility
Debt factoring

16. Financing: External Borrowings
ADVANTAGES
RISKS
Tax
Cashflow risk
Returns > Cost
The more debt you have the more costly it becomes
Control / Regularity of payment
Flexible – ie revolving credit facility

17. EXAMPLe Company A has a ROCE of 10% and borrows £1m at 7%
Cost of additional borrowing
Additional earnings
Net additional earnings

18. Cost of capital (WACC) WACC = (E/(E+D)* e) + (D/(E+D)*d(1-t))
The value of a business is the sum of its future cash flows discounted at its cost of capital
WACC = (E/(E+D)* e) + (D/(E+D)*d(1-t))

19. WACC = (E/(E+D)* e) + (D/(E+D)*d(1-t))
WACC CALCULATION
Cost of Equity (e)
15%
Cost of Debt (d)
10%
Tax (t)
30%
E:D
40:60
WACC = (E/(E+D)* e) + (D/(E+D)*d(1-t))

20. Financing a business Equity / Shares Borrowings
Retained Profits & Other Sources of finance

21. Financing Retained Profits
Raise money for investment through making profits
Net profit can be reinvested in the business or paid out as dividends
It is not “free” as it has an opportunity cost
Retained profits are those profits surplus to the funds needed by the business to: replace assets,working capital needs,meet interest and tax obligations, and pay dividends.

22. Financing Risk = Overtrading
Working capital
Businesses use working capital as a form of finance. They may buy on credit, they will also have to have sufficient financing to fund any credit which they allow to their customers.
How to tie up less money in working capital:
Collect in funds faster
Pay suppliers later
Hold less inventory
Risk = Overtrading

23. Financing external investment
Venture capital: Equity finance given to smaller companies, usually newer or expanding entrepreneurial businesses

24. Financing external investment
Venture capital:
Long term financing for smaller and medium sized businesses
Usually invested through managed funds
Often higher risk companies balanced off with the opportunity for higher growth
Usually potential for high growth and need additional financial support and often expertise/support
Can be used to support management buy out (MBO) a company or a new management team buy in to a company (MBI)
Can also be used in a rescue scenario when a company is in trouble

25. Business Angel investors: Interested in investing in early stage
Most significant source of start up funding
estimated at £1.5bn per annum.
The market is subject to a regulatory framework to protect the angel and the investor i.e angels do not take more than 30% equity
Usually wealthy individuals or may invest as a syndicate
Usually take a minority stake and involved themselves in the management of the business (although not the day-to-day running)

26. Why is Angel Investing different to Venture Capital Finance: more personal (rather than through a fund), direct engagement, angels conduct due diligence and then often take an active role on the board.
Angel investors are prepared to support the business through growth to exit and thus is not a investment expecting a rapid return.

27. Dragons Den Which business do you want to invest in…. Competitiveness
Solving a problem
Protected
Scalability
Ability to realize growth