Financing Your Business

Financing Your Business Business Management

Today’s Objectives • Explore differences among various sources of capital. • Identify the cost of operations.

Methods of Obtaining Capital Equity Capital Debt Capital

Owner Capital • The owner(s) personal contributions to the business • May come from personal savings or personal loans • Small businesses rely heavily on owner capital • Also known as equity capital

Retained Earnings • Also a type of equity capital because business profits belong to the owner(s) • Business profits saved for use by the business in the future

Debt Capital • Money that others loan to a business • Also known as creditor capital • Banks & other lenders usually will NOT lend to a business unless the equity capital exceeds the debt capital

Obtaining Equity Capital Remember those business structures?

Sole Proprietorship • Invest more personal funds • Sell personal assets to raise $$$ • Mortgage personal property • Assets used as securities are at risk if the business fails. • Other personal assets at risk • Change business structure • Partnership • Corporation

Partnership • Partners usually invest personal resources in the business in order to balance/share risk. • Not mandatory for new partners • A formal partnership agreement identifies the financial contributions of each partner and how profits will be shared. • If the assets of one partner are not enough to cover business debts, assets from other partners can be taken. • Owner gives up individual control over management and decision-making.

Corporation • Can raise capital quickly because the amount of money invested is much smaller • Stockholders are not involved in day-to-day management of business. • Investors are protected financially.

Obtaining Debt Capital

Short-Term Debt Capital • Must be repaid within a year • Often 30-, 60-, or 90-day loans • Usually obtained from a bank or other lending institutions

Short-Term Debt Capital • Business must supply bank with adequate financial information. • Bank usually obtains a financial report on the business from a credit company. • If the bank considers the business to be a good credit risk, the bank will grant a loan or a line of credit. • Specific amount, set time period • Business owner(s) must sign a promissory note. • Unconditional written promise to pay the lender a certain sum of money at a particular time or on demand

Long-Term Debt Capital • Money borrowed for longer than a year • Usually obtained through: • Long-term notes • Bonds

Term Loans • Also known as long-term notes; medium- or long-term financing used for business operations or for improving fixed assets • Written for periods from 1 to 15 years … or longer • Significant source of capital for most businesses • Banks / lenders require the principal and interest to be repaid on a regular basis over the life of the note.

Bonds • Long-term written promise sold by the business to investors that promises payment of a definite sum of money at a specified time • Business receives the amount of the bond when it is initially sold. • Must pay bondholder the borrowed amount (principal) at the bond’s maturity date • Business pays bondholder interest at a specified rate at certain intervals • Bonds do NOT represent a share of ownership; they are investments. • Bondholders are creditors & have priority claim before stockholders.

Obtaining Capital 3 things to consider…

Cost of Capital • Costly to sell bonds, long-term notes, or issue stock • Must file forms, obtain approval, make agreements, find buyers • Usually only large or highly successful firms even consider stocks/bonds

Interest Rates • Rates fluctuate monthly, weekly, even daily • Best to borrow when rates are low (cheaper) • When rates are high, businesses usually borrow short-term debts.

Influence of Contributors • Short-term creditors usually have no control over management and operations of business. • Long-term credit agreements are tied to asset claims & may impose limitations on those assets. • Partners / stockholders gain a voice in control of business.

Sources of Capital Where do you get the money?

Sources of Capital • Banks - most popular source of outside capital • Small Loan Companies - firms that lend money to “higher risk” business and individuals • Venture Capitalists • People or companies that lend large sums of money to promising new or growing businesses • Usually ask for a percentage of ownership rights in the company • Demand a carefully developed business plan that shows high potential for success

Sources of Capital • Commercial Credit Companies - lend money on current assets, such as accounts receivable • Sales Finance Companies - used primarily when installment sales are involved • Insurance Companies - portions of funds collected from policy holders may be loaned to firms • Individual Investors / Investment Groups • Pension Funds - retirement funds collected from employees may be loaned to firms

Sources of Capital • Investment Banking Organizations • Specialize in selling new security issues to the public • Helps a business raise large sums of capital through stocks / bonds • Can assist a rapidly growing, privately held company with IPO • Equipment Manufacturers • Firms that do not lend money, but sell needed equipment on an extended-time payment plan

Review! 2 Methods of Obtaining Capital Types of Debt Capital 3 Things to Consider when Obtaining Capital 10 Sources of Capital

So how much money do you need? Physical Location Cost of Product / Service • Rent / mortgage • Facility maintenance • Utilities • Transportation • Wages & Salaries • Equipment • Supplies • Raw Materials • Inventory

Financing Your Business