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Debt Financing

Debt Financing. ETP 3700. Courage: Risk and the Dimensions of Work. Life Cycle of a Business Venture. Bootstrapping. Self, Friends and Family. Equity Financing. Debt Financing. Short-term Debt. Expected to be paid within one year

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Debt Financing

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  1. Debt Financing ETP 3700

  2. Courage: Risk and the Dimensions of Work Life Cycle of a Business Venture Bootstrapping Self, Friends and Family Equity Financing Debt Financing

  3. Short-term Debt • Expected to be paid within one year • Most often used to finance short-term expenditures such as inventory, supplies, payroll, etc.

  4. Short-term Debt Trade debt • Not a given - need to establish a relationship • Communication critical if cash flow is tight • Build a relationship with long-term vendors

  5. Short-term Debt Banks • Some banks specialize in working with entrepreneurs • Smaller local community banks often more willing to work with local small businesses

  6. Short-term Debt Asset-based lenders • Lend money against assets • Cheaper than factors, but more expensive than banks

  7. Short-term Debt Factors • Advance money on accounts receivable through “purchase” of A/R • Good for businesses that are not “bankable” at current time • Expensive money: 4-7% per month (annual 50-85% equivalent financing rate) • Use for short term only whenever possible • Plan for transition to bank or other lower cost financing

  8. Long-term Debt • Beyond one year • Most often used to fund fixed asset purchases

  9. Long-term Debt • Banks: term loans • Leasing companies • Real estate lenders

  10. Overlooked Forms of Debt • Property leases • Long-term employment agreements • SBA or other government backed lending programs

  11. SBA Loans • Funds provided by independent lenders • Loan guaranty from SBA transfers risk of borrower non-payment, up to the amount of the guaranty, from the lender to SBA • SBA loans are commercial bank loans guaranteed by the SBA • http://www.sba.gov/financing/index.html

  12. Eligibility for SBA Loans • WHOLESALE - not more than 100 employees • RETAIL or SERVICE - Average (3 year) annual sales or receipts of not more than $6.0 million to $29.0 million, depending on business type • MANUFACTURING - Generally not more than 500 employees, but in some cases up to 1,500 employees • CONSTRUCTION - Average (3 year) annual sales or receipts of not more than $12.0 million to $28.5 million, depending on the specific business type

  13. Basic SBA Loan Programs Basic 7(a) Loan Guaranty • SBA’s primary business loan program • Helps qualified small businesses obtain financing when they might not be eligible for business loans through normal lending channels.  

  14. Basic SBA Loan Programs Basic 7(a) Loan Guaranty • Loan proceeds can be used for: • working capital • machinery and equipment • furniture and fixtures • land and building (including purchase, renovation and new construction) • leasehold improvements

  15. Basic SBA Loan Programs Basic 7(a) Loan Guaranty • Loan maturity is up to 10 years for working capital and generally up to 25 years for fixed assets.  • Start-up and existing small businesses • DELIVERED THROUGH: Commercial lending institutions

  16. Basic SBA Loan Programs 504 Loan Program • Provides long-term, fixed-rate financing to small businesses to acquire real estate or machinery or equipment for expansion or modernization. • Typically a 504 project includes a loan secured from • a private-sector lender with a senior lien • a loan secured from a Certified Development Company (funded by a 100 percent SBA-guaranteed debenture) with a junior lien covering up to 40 percent of the total cost • a contribution of at least 10 percent equity from the borrower. • Maximum SBA debenture generally is $1 million 

  17. Working with Bankers Initial contact • “There’s a bank on every corner.” • Get to know your banker’s boss • Make sure they get to know you and your business before you give them financial statements or plans

  18. Working with Bankers Criteria for Lending by Bankers • Ability of the business to generate enough cash flow to easily make interest and principle payments • Entrepreneur’s ability to personally pay back the loan if the business fails • Assets to serve as collateral

  19. Working with Bankers Key Loan Documents • Loan proposal • Loan document • Terms • Restrictions • Performance requirements • Personal guarantees • Major shareholders • Joint and several liability • Eventually becomes negotiable

  20. Working with Bankers On-going Communication • Bankers hate surprises • Give them a little more than they want, a little more often than they want it • Verbal and written

  21. Downside of Debt • Increased risk during economic slowdown • Impact on proceeds from business sale • Restrictive covenants • Personal guarantees

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