Company Financing , Start- up & Internationalization

1. Company Financing, Start- up & Internationalization Lesson May 28th 2013 - Università degli Studi di Torino Alberto Iodice e-mail alberto_iodice@hotmail.com

2. Today’s AGENDA/1st part • Profit & Loss Statement and Balance Sheet • Corporate Finance area in a company • Financing options: Equity financing & Debt financing • Auto-financing sources • Sources of external financing • Best capital Structure

3. Profit & Loss Statement P&L statement summarizes the revenues, costs, and expenses incurred during a specific period of time, usually a year. These records provide information that shows the ability of a company to generate profit.

4. Balance Sheet- what communicates? ASSETS LIABILITIES Assets/ Investments Financing Sources How is the money invested?? Where the money comes from??

5. Balance Sheet sample Balance Sheet Statement summarizes company's assets, liabilities and shareholders' equity at a specific point in time. These three segments give investors an idea as to what the company owns and owes, as well as the amount invested by the shareholders.

6. Concept of opportunity cost • Also equity capital costs! • Opportunity cost: value of the next-highest-valued alternative use of that resource. • Cost of Equity: question “what rate of return will Investors require to invest in your company?” Cost of Equity = Bond Yield + Additional Risk premium Base interest rate plus some extra amount for the risk of investment, equity investments imply more risk than debt investments, equity investors need higher returns Also retained earnings have cost of opportunity

7. Corporate Finance Area What is the focus?? Research, acquisition, use of financial resources necessary for company’s activities • ASSETS show how the money is invested • LIABILITIES show where the financial resources necessary for company’s functioning come from

8. Planning for Capital Needs • Capital: wealth employed to produce more wealth. It exists in many forms in a typical business including cash, inventory, plant and equipment. • Three different types of capital: • Fixed Capital: company’s permanent fixed Assets, money “frozen” • Working Capital: business’s temporary funds, to support a company normal short term operations= Current Assets- Current Liabilities • Growth Capital: when an existing business is expanding or changing its primary direction

9. Sources of Financing Disinvestments Internal Financing Operating Cash flow Sources of Financing Equity capital Private equity Public shares External Financing Debt Capital Banks Issuing bonds

10. Internal Financing: Auto-financing • expresses firms ability to provide coverage of their financial needs independently with: • Retained Earnings • Current operations: positive cash flow Main consequences: • Capital Increase not decided by shareholders, shareholders have little control • Tax disadvantage associated with lower dividend distribution • Shareholders benefit if new investments performance > cost of capital (opportunity cost) • Value transfer from shareholders to creditors • Sharpen the agency problems between shareholders and management

11. Internal Financing: Asset Based Financing e Asset restructuring • Additional liquidity with the sale of specific Assets • Strategic View Main consequences: • Expansion of funding opportunities, often at lower costs than the cost of capital • Improvement of capital ratios • Concentrate resources on core business activities and redefining organizational boundaries in a reductive way • Re-engineering operations, improving efficiency, effectiveness and flexibility of management • Unlock "hidden” value • Defense against hostile takeovers • Particularly useful in situations of crisis / recovery

12. Internal Financing: Securitization COMPANY Transfer of Assets • Definition: financial technique that allows to dispose of asset classes transforming illiquid balance sheet positions in negotiable securities • Consequences : • Diversification of funding sources • Risk diversification • Reducing the cost of financing through ABS securities (Securitization and subprime bubble - USA) Special Purpose vehicle (SPV) Securities on the financial market

13. Internal financing: factoring accounts receivable • Instead of carrying credit sales on its own books, sell outright its accounts receivable to a factor. • A Factor buys company’s accounts receivable in 2 parts: first payment immediately (50% to 80%), second payment (15% to 18%) when original customer’s pay the invoice. • Factoring deals: • With recourse: company retains responsibility for customers who fail to pay their accounts • Without recourse: if the customers fail to pay, the factor bears the loss Factors discount from 40% to 2% depending: • Customers’ financial strength and credit ratings • Reputation of Industry • History7track record Discounted rate without recourse. Higher cost

14. Internal financing: factoring accounts receivable • Factoring of accounts receivable (ST) COMPANY WORKING CAPITAL/ACCOUNTS RECEIVABLE BANK CUSTOMERS of the COMPANY/ DEBTORS Shorten time lag between the date of billing and payment collection OBJECTIVE Discount and collection charges COSTS

15. Leasing • It is another bootstrap technique: by leasing Assets, company is able to use them without locking money in valuable capital for an extended period of time • Reduce long term capital requirements by leasing. • Equipment • Facilities

16. External Financing • Equity Financing • Debt Financing • The two categories differ in: • return obligation • timeframe • financiers • remuneration for financiers • risk for financiers

17. External financing Equity financing: • Issue and placement of own shares Homogeneity, standardization, indivisibility, autonomy, free transferability 2) Subscribed capital increase 3) Private equity: investment by private individuals or institutions specialized / dynamic sectors • venture capital • expansion financing • acquisition/buyout financing

18. Private Equity • Cons of Private Equity: • Use of excessive leverage • Short terminism • Effects of quality and quantity of jobs

19. External financing in the form of debit • Commercial line of credit, a short term loan with a pre-set limit • Elastic to the company needs • It is risky form for the bank • Cover temporary imbalances/ “liquidity margin” • It does not stimulate financial planning • Without a pledge Interest expenses on the used ammount COSTS Commission % applied on an annual basis on the amount granted

20. External financing in the form of debit Medium- Long term financing (MLT) Bank loans • MORTGAGE Definition: Loan maturity extended . The beneficiary is obliged to pay interest and the gradual return of capital • UNSECURED LOAN Definition: similar to mortgage but without requiring to pledge any specific collateral to support the loan in case of default. • Syndicated Loans

21. MORTGAGE/ Secured Intermediate and long Term Loan Main features: • Pledge on real goods/real estate • Normally from 60% to 80% of the value • Ability to pay off before the loan by paying penalties • Main costs: • Interest expenses • Credit assessment • Expertise charges • Insurance costs • Notary public costs • Flat tax (in Italy)

22. Unsecured loans Main characteristics: • collateral is not a necessary condition • maximum duration shorter, no more than 5/7 years • Inability to pay off the loan earlier • Higher interest rates but not technical expertise and legal costs • In Italy often guarantees issued by CONFIDI (consortium for Joint Credit guarantees – ConsorzidiGaranziaCollettivaFidi) • Importance of CONFIDI per SMI

23. Syndicated Loans Main characteristics: • provided by a bank pool • Purpose: risk sharing and effort funding; the pool dissolves after completion of the operation. • Group of credit Institutions: lenders;borrower. There is a distinction normally between: the arranger Bank bears the burden of the organization, the leading bank (that often coincides with the arranger bank), which coordinates after the syndication the agent bank that takes care of all administrative aspects of the loan after the operation the participating bank which pays a portion of the loan.

24. External financing Market Debt • Bonds (MLT) • Private placements • Commercial paper (BT) maturities between 1 and 3 months Hybrid Forms of Financing: • Subordinated loans • Convertible bonds

25. External Financing: Assets based lenders • Asset-based lenders, (which are normally smaller commercial banks, commercial finance companies or specialty lenders) borrow money for pledging otherwise idle Assets as collateral: • accounts receivable, • inventory (inventory financing), • purchased orders, • Stocks and bonds (Stock brokerage Houses – margin (maintenance call) It works especially well for: • Manufactures, wholesalers, distributors with significant stocks of inventory and accounts receivable. • Even unprofitable companies • Finance rapid growth Lenders: Interested in the quality of Assets used as pledge High quality pledge: up to 85% advance rate

26. External Financing: Vendor Financing & Equipment Suppliers • Vendor financing. Companies borrow money from their vendors and suppliers in the form of trade credit • Getting vendors to extend credit in the form of delayed payments, • short term interest free-loan for the amounts of good purchased • Equipment Suppliers: encourage business owners to purchase their equipment by offering for finance the purchase: • Modest down payment • Balance financed over the life of the equipment

27. Objective of Financial Management Financial Balance The company must be able to : • Determine its grossfinancial need • Determine its net financial need • Optimize its financial structure Structure of balance sheet (Coordination Assets-Funding) Managing cash flow (Coordination inflows- outflows) Ideal mix of sources (different types of financing)

28. The ideal financial structure • Financial structure is the composition, the "weight" of the individual sources of financing that are liabilities and shareholders‘ equity. • In order to obtain the ideal/optimal financial structure, i.e. the best combination of funding sources, it is necessary to connect the opportunities offered by the financial market with the structural and functional characteristics of the enterprise. • The determination of the optimal financial structure requires consideration of several variables : • The legal form of the company, the sector of activity; company size; the eventual rating; • The characteristics of the production cycle; the opportunities offered by international and domestic financial market; the cost and the tax treatment of different forms of financing; • The type of financial need.

29. Corporate financing and the business life cycle • 4 distinct phases impacted on financial decisions • Investments increasingly complex; • Expansion of the number of lenders; • In the growth stage equity/ own funds resources may be insufficient; • Market oriented Model and Credit oriented model

30. Tax variable in financing decisions • The tax legislation of many countries provides - although with different nuances - that companies can deduct from their income the interests paid to their creditors during the borrowing period. • Full or partial deductibility of interest charges • Tax advantage of a certain degree of leverage • Dividends and retained earnings are not normally tax deductible

31. Optimal Capital Structure • Analysis of the type of financial needs and in particular the relationship between Assets and funding sources. • The financial sources must in fact always be "homogeneous" with respect to the types of needs to be covered. intended to short-term investments Capital goods Short-term sources long-term sources

32. Interdependence between uses and sources SOURCES USES • FIXED ASSETS • Intangible • Material • Financial EQUITY MEDIUM AND LONG-TERM DEBTS/ LIABILITIES • CURRENT ASSETS • Inventories • Short-term receivables • Current financial assets • cash and cash equivalents • Accruals and Deferrals SHORT-TERM LIABILITIES

33. What is the right balance between financing with debt or equity? • Financial Leverage is used to measure the relationship among funding sources. The "calculation of leverage," is according to the following formula : • TOTAL LIABILITIES/SHAREHOLDERS EQUITY • if the leverage assumes the value of 1 means that the company has not made ​​use of third-party capital(no debts); • if the leverage assumes values ​​between 1 and 2 means that the equity is greater than the third-party capital; • if the leverage assumes values ​​greater than 2 means that the borrowed capital is greater than the equity. • Expanding debt - increased risk of insolvency

34. Modigliani–Miller Theorem • Modigliani–Miller theorem (1958) • Assumptions underlying the model : • Companies can finance themselves with only two sources: debt capital and equity capital; • The financial markets are perfect and without frictions; • Businesses and individuals can borrow at the same interest rate; • There is no corporate taxation; • There are no transaction costs (the use of debt or equity capital does not generate additional costs in the form of commissions, legal fees and so on) • There are no bankruptcy costs, direct or indirect; • The insiders of the company and outsiders have the same information (no subject has informational advantages); • The management operates solely in the interests of shareholders and the latter in turn do not take actions to harm the interests of the creditors.

35. Modigliani–Miller Theorem • Under the assumptions the value of a firm is unaffected by how that firm is financed. In a MM world, we should look to completely randomdebt ratios and highly changeable over time.

36. The Weighted Average Cost of Capital (WACC) • Calculating the WACC • Determine the target amount of each type of capital • Determine the weights • Determine the cost of each type of capital • Calculate the weighted average

37. Spread on the real economy - Financing companies - Italy • Interest rates on new loans granted to companies regardless of size, industry membership and so on.. • Weighted average • There are clear signals that are not encouraging …

38. Spread on the real economy - Financing companies - Italy • …. especially on the long run curve WHY? • cost of refinancing of Italian banks reflects the Italy country risk • How do banks refinance • Risk: core competitive disadvantage of Italian businesses which adds to the costs of bureaucracy, low productivity, energy costs and increased taxation

39. Why Italian Banks have higher cost of refinancing? Balance Sheet example of an Italian bank at the end of 2011 ASSETS LIABILITIES

40. Funding for Banks: higher cost in Italy than in northern Europe • Forms the main part of the sources of funds as debt and includes : Current account deposits, savings deposits (deposit accounts); Bonds • Current account deposits • form of liabilities on demand with monetary function • Important in Italy; less in other countries as USA. • Savings accounts • They are distinguished by maturity or amount • In Italy they have become increasingly important • Bonds • Important in Italy; equilibrium Assets/Liabilities

41. Funding from Financial Institutions: higher cost • Some main items: the interbank debt and the central bank refinancing • Interbank Debts • the interbank market is an important part of themoney market • The banks manage their treasury adjusting interbank surplus and deficit temporary counterpart with other banks • However, there are banks that have structural deficits of customer deposits and owe permanently in the interbank market • Central bank refinancing : cost between countries unchanged (only case) • The banks operate with the central bank to manage liquidity reserves (deposits at the central bank) • Refinancing operations are important in regulating the liquidity and influencing the level of interest rates

42. Consequence • Since loans are the main component of Assets and also represent what identifies the core business of a bank • They are the most important source of contribution to net interest income / earnings • Even lending to private customers and business will suffer from having a higher cost since the Bank has to make profits • For example, if funding costs 4%, Bank to make profits should ask more than 4% for the loans granted to corporates Takes money from third parties Lends money to third parties BANK

43. CONCLUSIONS 1° part • Summary • Questions & Answers E-mail: alberto_iodice@hotmail.com

44. Today’s AGENDA/2nd part • Start-UP Companies • Internationalization Strategies

45. START-UP • Definition: A start-up is a company that is for the first time launched on the market or acquired and re-launched through a new start Elementary components of the strategy for a start-up BUSINESS IDEA ASPIRINGENTREPRENEUR BUSINESS PLAN

46. BUSINESS IDEA • Innovation:original, unique or consist in the new combination of existing factors. New and breaking • Motivation • Feasibility : constraints in the market, legislation and technical & scientific context Product Technological Process Response to the market Business Organization

47. Aspiring Entrepreneur Desirable Features: • Know-how, danger of knowledge gap • Manage more people • Collaborate and charisma • Patients negotiators • Take responsibility, risk and decide • Investigate new solutions with curiosity

48. Business Plan 1) What produce, deliver and sell? Product system; 2) To whom sell? The market segment 3) How to produce and sell? The company structure 4) What image of itself transmit? Communication policy 5) How to finance the idea? Financing policy Important: market analysis /SWOT analysis and Porter 5 Forces Design tools and presentation to various stakeholders: Elevator pitch: Idea, background of the project (management experience), business model (competitive advantage), future perspectives and financing Business plan

49. Financing the start-up phase • Financial Gap in a start-up: financial requirement against which there is a substantial lack of revenues associated with an increasing use of capital and negative cash flow in the early stages of the business life cycle. • 4 components of financial requirement: 1) investments to develop the project 2) structural investments in productive capacity 3) investments in working capital 4) investments for further development

50. Corporate financing and the business life cycle • 4 distinct phases impacted on financial decisions • Investments increasingly complex; • Expansion of the number of lenders; • In the growth stage equity/ own funds resources may be insufficient; • Market oriented Model and Credit oriented model