1. Small Business Finance:15
Small Business Finance:
Using Equity, Debt, and Gifts
McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

2. Chapter 15
Objectives
Know the three types of capital financing and their costs and trade-offs
Understand the characteristics of a business that determine its ability to raise capital
Know how to choose the right type of financing for your business
Understand the differing needs for financial management at each stage of business life
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3. Chapter 15 Focus on Small Business: Incell Corporation
“I’ve used my own savings, borrowed from banks, and obtained grants…Incell may be the only biotech company in the world to be bootstrapped.”
Problem is one of too much success
“Financial management is a daily, constant, on-going process for Incell.”
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4. Chapter 15 Sources of Financing
Number one source is from the owners themselves
Major sources:
Family and friends
Credit cards
Trade credit
Banks
Commercial lenders
Owners put their money where their idea is.
It is also a statement to banks and other investors that they believe in themselves and their company enough to risk their own wealth.
Other major source are those close to the owner.
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5. Chapter 15 Other sources: Angel investors Government programs
Community-based financiers
Stock sales
Venture capital
This final source of cash is impersonal.
These other sources require documentation such as the budgets created in the previous chapters to convince them to invest.
These investors also come with legal reporting requirements which the owner may or may not want to live up to.
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6. Finance Your Franchise
Chapter 15
Example
Finance Your Franchise
Infinite sources of financing available to help you launch the franchise of your dreams
Never invest more than 75 percent of your cash reserves
40-year-old Douglas York decided to purchase a Great Clips franchise with his wife, he found his best financing bet was with a nonbank lender
Example
Finance Your Franchise
Infinite sources of financing available to help you launch the franchise of your dreams
Never invest more than 75 percent of your cash reserves
40-year-old Douglas York decided to purchase a Great Clips franchise with his wife, he found his best financing bet was with a nonbank lender
had to come up with $120,000 for each location and decided to go with the nonbank lender
“I did talk to banks, but they couldn't offer anything better than Textron, and with Textron, I didn't have to put up my house [as collateral]."
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7. Chapter 15 Question What is outside equity? a) how much you are worth
b) money from other people
c) money from selling part of your business
d) revenue from business
Answer: c
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8. Chapter 15 Financing with equity: from the entrepreneur or from others
Personal equity: how much you are worth
Often people underestimate their personal worth
If you plan to get investments, they may ask to see your personal financial statements
If you are going to finance with equity you will have to estimate your personal worth.
Most people underestimate their worth forgetting equity in a car, house, or other non cash assets.
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9. Chapter 15 Financing with equity: cont.
Outside equity: money from selling part of your business
Outside equity investors:
Outside: not part of the business
Equity: legal ownership rights to your business
Investors: you are using their money
Partnership, corporation, limited liability
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10. Chapter 15 Getting Equity Investment
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
Lenders need to get more money from their investment in the company than they would at the bank.
Otherwise they could put it in a savings account.
Your business plan is a good tool here to show them your plans and your professionalism.
Most investors want to see growth.
You’ll have to show them where you expect it to come from and how you will stimulate it.
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11. Chapter 15
Time required to receive gains can be a deal killer for potential investors
Financing with equity is:
Expensive
Guaranteed to create problems of control and decision making
The question, then, is when will it grow. How long will it take.
Financing with outside investors is tricky because they now a piece of the business and as such have legal rights which diminish the entrepreneurs authority.
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12. Chapter 15 Getting outsiders to invest: Two primary reasons:
You will reduce your own exposure to financial loss
Your business will not have increased costs in the form of interest
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13. Chapter 15 Question a) Direct loans of cash
All of the following are ways to finance using debt, except:
a) Direct loans of cash
b) Guaranteeing loans made by commercial banks
c) Reducing taxes by allowing interest to be deducted
d) Family and Friends
Answer: d
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14. Chapter 15 Financing with Debt
Most common source of capital for established ongoing small businesses is borrowed funds
Three ways:
Direct loans of cash
Guaranteeing loans made by commercial banks
Reducing taxes by allowing interest to be deducted
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15. Chapter 15 Where can a small business get loans: Your current bank
Small Business Administration guaranteed loan programs
Numerous small business investment companies
Incubators or accelerators in your area
Loans are available from several sources.
Banks are the most obvious.
Most larger cities also have the SBA which can help small businesses get started.
The SBA also has a list of investment companies willing to help.
Many larger colleges also have incubator programs set up to help businesses grow.
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16. Chapter 15
The Four C’s of Borrowing
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17. Chapter 15 Gift financing:
Impression might be that a government or a foundation hands out money that never has to be repaid
Costs time and money to obtain
Often requires time and money for accounting and reporting to the granting agency
Two general sources of gift financing:
Institutional
Personal
Gift financing seems free but, in reality, it requires, research, reports, and paperwork to obtain.
The two sources of gift financing are discussed to further slides.
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18. Chapter 15 Sources of gift financing:
Institutional: most common is reduced taxes
Tax abatement: a legal reduction in taxes
Encourage specific activities to improve blighted areas
Tax credits: direct reductions dependent on meeting some legal criteria
Encouraging investment in specific assets, to increase economic activity, supporting industries
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19. Chapter 15 Sources of gift financing: cont. Institutional:
Grants: require very accurate record-keeping and reporting
Small Business Innovation Research program
Small Business Technology Transfer program
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20. Chapter 15 Sources of gift financing: cont.
Personal gifts: forms are as varied as human imagination
Tremendously popular
1/3 of small businesses report having unpaid labor contributed by family members
Always more than just a gift
Loaded with special meanings
Personal gifts are a mixed blessing.
Sometimes the receiver may take it as a gift, but after the company becomes successful the family member may not only want repayment, but may want a piece of the company.
Misunderstands make Holiday dinners uncomfortable for everyone.
To prevent misunderstandings put everything in writing.
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21. Chapter 15 Forms of Personal Gifts: Cash Picking up the tab
Accelerated cash-outs
Free use
Free work
Overpayment
Forgiveness
Piggybacking
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22. Chapter 15 Sources of gift financing: cont. Personal gifts:
Giving a gift also has tax implications
Put your agreement into writing
If it is a gift, have the agreement say so
If it is a loan, have the agreement specify the exact interest and payment terms
If it is an equity investment, consider nonvoting stock
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23. Chapter 15 Example Choosing Between Debt and Equity Financing
Entrepreneurs would much prefer to raise money in the form of equity rather than debt
Why is equity so appealing?
it feels like you're getting "free" money during the startup stage
usually no repayment obligations and no interest payments due to equity investors
have some say in negotiating the price of your stock, any dividend payments and the position the investor will have in your company
Example
Choosing Between Debt and Equity Financing
Entrepreneurs would much prefer to raise money in the form of equity rather than debt
Why is equity so appealing?
it feels like you're getting "free" money during the startup stage
usually no repayment obligations and no interest payments due to equity investors
have some say in negotiating the price of your stock, any dividend payments and the position the investor will have in your company
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24. Chapter 15 What Type of Financing is Right for Your Business?
Cost of both equity and debt capital changes as their relative percentages of total capital change
Few, if any, small business owners even attempt to estimate the optimum capital structure of their business
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25. Chapter 15 Why should you borrow?
Borrowing enhances the potential for higher rates of return for the owners
Borrowing allows the owners to keep a greater level of control of the business
Borrowing increases potential profits by:
Lowering the weighted average cost of capital
Providing capital funds that allow the business to consider additional opportunities
When making to decision to borrow or sell shares it come down to money and control.
The higher percentage of shares the owner controls, the more profit and control he has.
Most small business owners do not start a business to share it with someone they don’t know.
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26. Chapter 15 Question a) balance sheet
A firm’s financial position is expressed on the…
a) balance sheet
b) income statement
c) cash flow statement
d) statement of retained earnings
Answer: a
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27. Chapter 15 Financial Management
Requires some method to measure and compare your financial position and financial results
Financial position – expressed on balance sheet
Financial results – expressed on income statement
Most financial comparisons are made using ratios
Activity ratios
Profitability ratios
Liquidity ratios
Leverage ratios
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28. Chapter 15 Financial Management Financial management for start-up:
Primary need is to obtain sufficient funds to pay for equipment, buildings, inventory, and other costs of starting and running a business
Funds for start-ups are usually obtained through founder’s personal resources, personal credit worthiness, and internally generated cash flows
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29. Chapter 15
Pecking Order of Funding Sources for New Firms
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30. Chapter 15 Financial management for growth: “Bad news-good news” joke
Bad news is that the business has greater capital needs than ever
Good news is that more sources of money are available to meet those needs
Emphasis is to obtain increasing amounts of cash inflows to pay for added inventory, productive assets, and employees
Small business owners should celebrate growth.
However, during a period of growth more capital is needed to finance the growth.
Luckily, investors and lenders are more free with their money due to the growth.
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31. Chapter 15 Financial management for operations
Emphasis of financial management is to build owner wealth, to conserve assets, to match cash inflows to outflows, and to maximize the return on capital assets by making optimum investing decisions
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32. Chapter 15 Financial management for business exit
Successfully leaving your business requires maximizing the value of your business for your successors
The emphasis is to create effective internal control of assets and liabilities, develop business systems to replace your specific skills and knowledge, and to ensure that the processes of the business and personal transactions of the owners are completely separate
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