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Raising Money to Grow a Business

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Presentation on theme: "Raising Money to Grow a Business"— Presentation transcript:

1 Raising Money to Grow a Business
Lesson 1 Taking Loans and Issuing Bonds

2 How Companies Expand Aim: Do Now:
What are the pros and cons of borrowing the money you need to grow your business? Do Now: From your experience hearing about loans people take to buy homes and cars, identify the essential elements of every loan. Do Now answer: There are at least three for a conventional term loan: $ amount borrowed, the rate of interest, and how long the borrower has to pay it off. These will be used to calculate the monthly payment.

3 How Companies Expand Do Now answers: The dollar amount borrowed.
The annual interest rate applied to the borrowed money. The amount of time, usually in years or months, the borrower has to pay it back.

4 Frizzle, Inc. Ice cream and restaurant.
Opening new Frizzle’s around the world for the past five years. One of the most popular ice cream restaurants in the United States and Europe. 20% market share. 25,000 employees in multiple locations in the United States and Europe. Headquartered in New York, NY. Looking to expand to China or Russia. Needs $500 million in order to expand. Financial statements indicate a healthy, profitable company.

5 Frizzle, Inc. has 2 choices to borrow money Borrow money from a bank
Issue Bonds Borrow money from a bank

6 Company can take a loan from a
Borrowing from a Bank Company can take a loan from a bank in order to get the capital (ie: cash to use for a long while) it needs Similar to an individual borrowing money Must be paid back in a certain time by a specified date with interest

7 Borrowing from a Bank Advantages Disadvantages
May be able to secure loan quickly Owners don’t give up control Less restrictions on what the money can be used for May be more expensive and have to pay a higher rate of interest (than the other form of borrowing, a bond) Potential prepayment penalty Could decrease cash flow if repayment starts right away

8 Borrowing with Bonds What is a bond?
A document (ie: security) that represents an amount of money (usually $1,000), which is clearly printed on the bond (ie: Principal) For each $1,000 an investor wants to lend to a governent or business, it receives one bond Lender/Bondholder – We say the investor “buys” the bond because he or she pays (the Principal $ amount) for it. Issuer – The company or government that borrows the money. It has this name because it issues the bonds!

9 Bonds Lender Issuer The issuer is repaying the lender’s/bondholder’s original investment (Principal) when the term of the bond is due. This date, also printed on the bond, is called the Maturity Date)

10 Bonds In the days before computers, the bond was issued with coupons. Every six months, one would be torn off and turned in to receive interest. The coupons went away, but we continue to call the interest rate the coupon rate, and the payment itself the coupon payment. The issuer pays interest to the bondholder during the term of the bond. The coupon payments end when the bond reaches maturity.

11 Bonds Principal (aka “Face Value”): The original investment is repaid when the bond matures. Maturity Date: Predetermined date in the future when the bond matures and the lender/bondholder receives the principal investment. Coupon Rate (%): The interest that the lender/bondholder receives. Coupon Payment ($): A dollar amount that is paid to the lender/bondholder regularly until the bond matures (payment is based on the Coupon Rate and Principal)

12 Bonds Cash Flows of a Bond Principal 1 2 3 4 5 Maturity Year + Coupon
Payment Cash Flows of a Bond Coupon Payment Coupon Payment Coupon Payment Coupon Payment 1 2 3 4 5 Maturity Year

13 Bonds Credit risk is the chance that a bond issuer will fail to repay the principal and interest on the specified date Coupon Payment Coupon Payment Coupon Payment Coupon Payment 1 2 3 4 5 Year

14 Rating Process For Bonds
To assess a company’s risk of failing, bond investors turn to the following three credit ratings agencies: Ratings are based on whether or not the issuer will be able to make their principal and interest payments, to the bond holder, on time A “AAA” high grade bond offers more security but a lower yield than a “C” bond A “C” bond is more risky but has a higher yield

STRONGEST Aaa AAA Aa AA A Baa BBB NON-INVESTMENT GRADE WEAKEST Ba BB B Caa CCC Ca CC C D *These credit ratings are reflective of obligations with long-term maturities.

16 Maturity Date Bonds Coupon Rate Face Value (Prin.) Coupon Payment

17 Issuing a Bond (vs. Borrowing From a Bank)
Advantages Disadvantages Company can borrow at a lower interest rate than they would have to pay the bank Company will be able to raise a large sum of money from the large community of bond investors Company may have difficulty issuing bonds if they are experiencing financial difficulties within their company Company may not be large enough to issue bonds

18 Lesson Summary What are the two choices corporations have if they want to borrow money? What are the relative pros and cons of each? What are the major elements of a bond? Identify the three big bond ratings agencies What are the highest and lowest available ratings? What are the pros and cons of borrowing the money you need to grow your business? Take a loan from a bank or issue bonds. A bank loan may be able to be secured by companies not big enough to issue bonds. The rate, however, will be higher than with bonds. On the downside, a bank loan may require the lender to begin repayment right away, which lessens the amount of cash the company can use. On the plus side, however, a bank loan may provide the company with more freedom to use the money in the way it believes will provide the most benefit. It’s Principal dollar amount, the coupon rate, and the maturity date. Moody’s, Standard & Poors, and Fitch. AAA (for Fitch and S&P) Aaa for Moody’s. D (for Fitch and S&P), which actually stands for Default! When money is borrowed, the lender does not have a say in the running of the business. It is only entitled to be paid back. When the occurs, the relationship ends. On the downside, any money that is borrowed must be paid back. It is critical that a business use the borrowed money to make a profitable product or service because it is those profits that will allow the borrowing to be repaid.

19 Web Challenge #1 Q: The Federal Reserve has tried to keep down the interest rate at which people and corporations can borrow money. Will this cause there to be more or less money borrowed? A: It will encourage more borrowing because low rates means less interest costs. Challenge: Find corporations that have issued bonds because it’s just cheap to borrow and they want to lock in a low rate. Hint: Look for the explanation that the money will be used for “general corporate purposes”.

20 Web Challenge #2 Challenge: Not any company can walk into a bank and get a loan. Research the characteristics a business must have to qualify for a bank loan. Prepare a checklist of five to 10 requirements. Indicate the most challenging one, explaining why. (Hint: the evaluation by the bank is formally called “underwriting”.)

21 Web Challenge #3 Q: The Small Business Administration is a government department that was created to help small businesses, including providing loans to them. Challenge 3a: Visit Identify three ways that it can help a small business. Challenge 3b: Prepare one argument for and one against having the government loan money to businesses. After all, who loses if the business fails and can’t repay the loan?

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