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Financial instruments

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Presentation on theme: "Financial instruments"— Presentation transcript:

1 Financial instruments
Ways to finance your small business

2 Finances One of the crucial aspect of every business is how to finance it – either when you start, when you want to grow or when you face business difficulties

3 Ways to get financed Debt – various types of borrowing
- Friends, Family and Fools, Banks, Leasing, Factoring, Other Equity – giving up certain portion of your ownership in the company (by issuing ordinary (common) or preferred stocks or by incorporating partners) - Business Angels, Venture capitalists, Friends, Family and Fools

no interest to return, no obligation to repay back Improving credithworthiness Equity money can be used as collateral Shareholders may use their personal earnings history to raise bank loans Good networking possibilities (especially for start-ups) CONS Giving up piece of the ownership in the company Have to answer to someone else Most expensive way of financing (each investor receives a percentage of total value of the company) PROS Retain ownership in company Considered cheaper than equity financing If firm has assets (collateral) it can raise cheaper long-term loans CONS More risky (it becomes your fixed cost!) Lack of collateral or poor earnings history – no money or borrowing with high interest rates! It has to be returned

5 Rule of the thumb “Whether the price of the money is 2 percent or 20 percent, it should always be lower than the return you expect from spending it. That is to say, don't invest money in any project that won't generate enough profit to more than cover the loan payments, including interest.” David Worrell, Entrepreneur magazine online edition, 2006

6 Types of debt financing
Friends, Family, Fools (3F) Banks Leasing Factoring Other

7 Friends, family, fools (3F)
Perhaps the best way to borrow, with minimum interest rates (or none) Higher level of sympathy and ready to wait for the money to be returned Are sometimes eager to interfere in your business and give you advice whether you want it or not Might ask to become partners or partial owners – rarely, but it happens! Be sure to clarify things in written agreement, since memories tend to get fuzzy over time!

8 Banks Entrepreneurs are usually high risk clients for banks, unless they have a solid collateral (e.g. Fixed assets) and a good credit history Banks will also look closely at your cash flows, liquidity of your assets and a solid business plan Short-term loans – credit card loans, overdrafts (line of credit)– high interest rates – most commonly use for smaller investments and short-term lack of cash Long-term loans – lower interest rates, but demand solid collateral

9 Credit cards It has become increasingly common among entrepreneurs (almost 50% of entrepreneurs have used it once in their business) More easily available money than regular bank loan, no justificiations required on how you will spend it, no business plan needed to back up your claim Beware of the high interest rates Demands discipline in spending

10 Line of credit (overdraft)
a flexible loan from a bank or financial institution to an individual or business. a line of credit is a limited/specified amount of money that an individual can access as needed and then repay immediately or over a pre-specified period of time. As a loan, a line of credit will charge interest as soon as money is borrowed, and borrowers must be approved by the bank. If you don’t use it, no interest is charged Useful for shortages of cash, so best to apply for it when sufficient funds are on your bank account Interest is higher than in regular bank loans

11 Long-term loans Require some kind of collateral – mortgage
Two types of mortgage – chattel (inventory or movable property serves as collateral and owner cannot sell it without bank’s permission) and real estate (immobile property – house, flat etc.) Lower interest rates, but it demands solid business plana and purpose of spending is set,

12 Before you apply for loan
Check yourself – if you have personal track record of late payments, chances of getting a loan are slim Check your business – have you been blocked, are you paying taxes and other obligations, how are your cash flows and overall business results What assets do you own – check what do you own, and are you willing to put is a collateral to secure loan Whom do you know – does your banker know you? Do they know your business? Personal touch can be of great help in advocating for your loan! How much do you need – are you purchasing equipment or seeking cash cushion. What would be the ideal? What would be minimum? How will you pay it back - Put together a realistic plan of action for improving the cash flow in your business and paying back the debt. Identify your marketing strategy and projected sales results over an expected time frame. Source: O'Berry, D „Finding and Keeping Cash in Your Company“, in Small Business Cash Flow: Strategies for Making Your Business a Financial Success, USA: John Wiley and Sons, p.49-50

13 Leasing Good way to obtain an asset without necessarily owning it (used for buying equipment, vehicles etc.) Types: Operating Financial (Capital)

14 Operating leasing Allows the use of item without getting ownership.
Legal and economic owner is leasing agency – takes all risks, user can return the item after the leasing contract has expired Used for short-term leases (e.g. Copy machine, Office equipment, Computers etc.) Lesee (the person who is leasing) pays monthly instalments including VAT – calculate it in operating expenses as rental expenses

15 Financial (capital) leasing
used for long-term leases and for items that not become technologically obsolete, e.g. machinery. give the lessee the economic ownership and risk, so they are considered as assets, and they may be depreciated. In general, the items leased are shown in lesees Balance sheet (Asset/Debt), and depreciation plus cost of interest go to operating costs (in Income statement)

16 Factoring Short-term debt, where Factor buys up accounts receivables and takes % factor fee In theory, 70-90% of the amount is paid immediately, and 10-30% after the receivables have been collected

17 Other Merchant credit – delayed payment to suppliers (based on contracts signed, e.g days waiting period) Grants and credits from non-banking institutions (state and local municipality)

18 Equity They don’t mind losing part of their control to the others
Entrepreneurs – owners use this option when: They don’t mind losing part of their control to the others Cash flows are not sufficient to cover existing debt Credit history and collateral is not sufficient to raise bank loans Bank loans (amounts) do not cover necessary investment

19 The usual sources of equity financing
Business angels Venture capitalists

20 Business angels Succesful entrepreneurs (or entrepreneurial associations) willing to invest money Work alone or in syndicates Will invest in start-ups and young companies – will also provide managerial advice and networking opportunities Invest up to 1 mil euros, but in average around – euros for period of 2-10 years Expect 15-45% return “Patient money”

21 Business angels - Methods of working
Different from country to country Either borrow you money (debt) or ask to form new company where they enter as partners Issuing of stocks – either as private placement (directly sell stocks to business angels and do not place them on stock exchange – cheaper and simpler) or going public (Initial public offering – IPO – stocks are offered as stock exchange – expensive and more complex)

22 Venture capitalists Institutional firms raising a pool of capital from different sources (including business angels) Used for big investments, 1-30 mil euros Usually invest in high-growth, more mature companies (experts do not recommend it for start-ups) Demand good management, solid revenues and cash flows, good business plan and their own EXIT strategy Expect high returns in 3-5 years

23 Methods of working They never enter the company without good exit strategy – will ask for public stock offering (IPO) Will appoint someone to the supervisory board and will in most cases ask for prefered stocks (it pays dividends and has preference in case of liquidation)

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