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1. Chapter 11 Finding Sources of Financing In the Spotlight: The Potomac Group Inc. www.medifax.com • Small Business Management, 11th edition • Longenecker, Moore, and Petty • 2000 • South-Western College Publishing 11-1

2. Learning Objectives: Chapter 11 1. Evaluate the choice between debt financing and equity financing. 2. Describe various sources of financing available to small firms. 3. Explain how the Internet is being used to find sources of financing. 4. Discuss the most important factors in the process of obtaining startup financing. • Small Business Management, 11th edition • Longenecker, Moore, and Petty • 2000 • South-Western College Publishing 11-2

3. Three Basic Types of Financing • Spontaneous financing, which comes from sources that automatically increase with increases in sales. • Profit retention, which requires owners to forgo taking cash out of the business, letting it remain within the firm to finance growth. • External financing, which comes from outside investors. • Small Business Management, 11th edition • Longenecker, Moore, and Petty • 2000 • South-Western College Publishing 11-3

4. Potential Profitability As a general rule, as long as a firm’s return on its assets (operating income total assets) is greater than the cost of the debt (interest rate), the owner’s return on equity investment will be increased as the firm uses more debt. Tradeoffs in Selecting Between Debt and Equity Financial Risk Debt is risky. Use of debt financing not only increases potential returns when a firm is performing well; it also increases the possibility of lower, even negative, returns if the firm doesn’t attain its goals in a given year. Voting Control Debt increases risk, but it also permits the existing owners to retain all the stock and full ownership. • Small Business Management, 11th edition • Longenecker, Moore, and Petty • 2000 • South-Western College Publishing 11-4

5. Sources of Funds Personal Savings Friends and Relatives Other Individual Investors Business Suppliers Asset-Based Lenders Debt Equity Commercial Banks Government-Sponsored Programs Community-Based Financial Institutions Large Corporations Venture Capital Firms Sale of Stock • Small Business Management, 11th edition • Longenecker, Moore, and Petty • 2000 • South-Western College Publishing 11-5

6. Individuals as Sources of Funds • Personal Savings • This is the most frequently used source of equity financing for starting a new company. • In a new business, equity is needed to allow for a margin of error. • A banker will not loan a company money if the entrepreneur does not have his or her own money at risk. • Friends and Relatives • This source of financing is based more on personal relationships than on extensive financial analysis. • To minimize the chance of damaging important personal relationships, the entrepreneur should plan for repayment of such loans as soon as possible. • Other Individual Investors • These individuals provide informal capital; no established marketplace exists in which they regularly invest. • These investors have acquired the label of business angels. • The traditional path to informal investors is through contacts with business associates, accountants, and lawyers. • Small Business Management, 11th edition • Longenecker, Moore, and Petty • 2000 • South-Western College Publishing 11-6

7. Business Suppliers and Asset-Based Lenders as Sources of Funds • Trade Credit • Credit extended by suppliers is very important to a startup. • It is of short duration -- 30 days is the customary credit period. • The amount of trade credit available to a new firm depends on the type of business and the supplier’s confidence in the firm. • Equipment Loans and Leases • For an equipment loan, a down payment of 25 to 35 percent is usually required, and the contract period normally runs from three to five years. • Leases typically run for 36 to 60 months and cover 100 percent of the cost of the asset being leased, with a fixed rate of interest included in the lease payments. • The advantages of leasing are (1) the firm’s cash remains free for other purposes, (2) lines of credit can be used for other purposes, (3) leasing provides a hedge against equipment obsolescence. • Asset-Based Lending • Asset-based lending is financing secured by working-capital assets (accounts receivable, inventory). • Factoring is the most frequently used asset-based loan, making cash available to a business before accounts receivable payments are received from customers. • Small Business Management, 11th edition • Longenecker, Moore, and Petty • 2000 • South-Western College Publishing 11-7

8. Commercial Banks as Sources of Funds • Lines of Credit • An informal agreement or understanding is established between the borrower and the bank as to the maximum amount of credit the bank will provide the borrower at any one time. • Under this type of agreement, the bank has no legal obligation to provide the stated capital. • Term Loans • Under certain circumstances, a bank will loan money on a five- to ten-year term. • Term loans are generally used to finance equipment with an economically useful life that corresponds with the loan’s term. • Mortgages • A chattel mortgage is a loan for which certain items of inventory or other moveable property serve as collateral. • A real estate mortgage is a loan for which real property, such as land or a building, provides the collateral. • Small Business Management, 11th edition • Longenecker, Moore, and Petty • 2000 • South-Western College Publishing 11-8

9. The Five C’s of Credit 1. The borrower’s character 2. The borrower’s capacity to repay the loan 3. The capital being invested in the venture by the borrower 4. The conditions of the industry and economy 5. The collateral available to secure the loan • Small Business Management, 11th edition • Longenecker, Moore, and Petty • 2000 • South-Western College Publishing 11-9

10. Financial Information Required for a Bank Loan • Three years of the firm’s historical statements, if available, including balance sheets, income statements, and statements of cash flow • The firm’s pro forma financial statements, in which the timing and amounts of the debt repayment are included as part of the forecasts • Personal financial statements, showing the borrower’s personal net worth and estimated annual income • Small Business Management, 11th edition • Longenecker, Moore, and Petty • 2000 • South-Western College Publishing 11-10

11. Government-Sponsored Agencies as Sources of Funds • Federal Assistance to Small Business • Small Business Administration (SBA) loans • Small business investment centers (SBICs) • Small Business Innovative Research (SBIR) program • State and Local Government Assistance to Small Business • Small Business Management, 11th edition • Longenecker, Moore, and Petty • 2000 • South-Western College Publishing 11-11

12. Other Sources of Financing • Community-based financial institutions • Large corporations • Venture capital firms • Stock sales • Small Business Management, 11th edition • Longenecker, Moore, and Petty • 2000 • South-Western College Publishing 11-12

13. Internet Services That Match Entrepreneurs and Investors • Wit Capital Corporation: www.witcapital.com • Quicken Business CashFinder: www.cashfinder.com • ACE-Net: http://ace.org/gils/SBA1998Mar05.101626.html • PriCap: www.pricap.com • NVST: www.nvst.com • America’s Business Funding Directory: www.businessfinance.com • Small Business Management, 11th edition • Longenecker, Moore, and Petty • 2000 • South-Western College Publishing 11-13

14. Amar Bhide’s Recommendations for Startup Businesses • Get operational. At some point, it is time to stop planning and just make things happen. • Go for quick break-even and high cash-flow generating projects whenever possible. • Fit growth goals to available personal resources. • Have a preference for high-ticket, high-profit-margin products and services that can sustain direct personal selling. • Start up with only a single product that satisfies a clear need. • Forget about needing a crack management team with textbook credentials. • Focus on cash, rather than profits, market share, or anything else. • Cultivate the banker. • Small Business Management, 11th edition • Longenecker, Moore, and Petty • 2000 • South-Western College Publishing 11-14

15. BizPlanExpress on Microlenders (p. 130) In the 1990s, microloans have become popular in areas where ready access to business funding has traditionally been limited. Microlender programs tend to be revolving funds offering a few hundred dollars to $25,000 loans. This money is usually provided at high market-rate interest and is often coupled with training and technical assistance to the qualifying entrepreneur. • Small Business Management, 11th edition • Longenecker, Moore, and Petty • 2000 • South-Western College Publishing 11-15

16. BizPlanExpress on “Boutiques” (p. 131) A variation on investment banking firms is investment “boutiques.” The “boutiques” operate on a smaller scale, aiming at local or regional companies who need capital in the $1 to $10 million range. They raise funding for ventures through private individuals, banks, finance companies, and investing their own capital. • Small Business Management, 11th edition • Longenecker, Moore, and Petty • 2000 • South-Western College Publishing 11-16