1. Entrepreneurship and Small Business Management Chapter 15 Financing Strategy: Debt, Equity, or Both?

2. © 2012 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved. 2 Entrepreneurship and Small Business Management, 1/e By Steve Mariotti and Caroline Glackin Ch. 15 Performance Objectives Explore your financing preferences. Identify the types of business financing. Compare the pros and cons of debt and equity financing. Identify sources of capital for your business. Understand stocks and bonds as investment alternatives.

3. © 2012 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved. 3 Entrepreneurship and Small Business Management, 1/e By Steve Mariotti and Caroline Glackin What Is Financing? The act of providing or raising funds (capital) for a purpose Ways to start or expand a business: Use personal savings Use company profits (finance with earnings) Obtain gifts and grants Borrow money (finance with debt) Exchange a share of the business for money (finance with equity)

4. © 2012 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved. 4 Entrepreneurship and Small Business Management, 1/e By Steve Mariotti and Caroline Glackin Gifts Repayment not required but may come with conditions or “strings attached” Examples: Cash Free use of facilities and equipment Unpaid labor by friends and family Forgiveness or deferral of debts Tax abatements—legal reductions in taxes Tax credits—direct reductions of taxes

5. © 2012 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved. 5 Entrepreneurship and Small Business Management, 1/e By Steve Mariotti and Caroline Glackin Grants No repayment, but may have specific requirements Primarily provided for research and commercialization efforts Difficult for start-up or low-technology companies to obtain

6. © 2012 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved. 6 Entrepreneurship and Small Business Management, 1/e By Steve Mariotti and Caroline Glackin Forms of Debt Financing Commercial loans—business loans typically provided by a bank Real estate—up to 20 yrs. Equipment and improvements—up to 7 yrs. Working capital—1 year or less Asset based—depends on type of asset pledged Accounts receivable factoring—often 30 days

7. © 2012 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved. 7 Entrepreneurship and Small Business Management, 1/e By Steve Mariotti and Caroline Glackin Forms of Debt Financing (continued) Personal loans—taken out on personal credit and used for the business Credit cards—”revolving” terms Home equity loans—variable terms; some are lines of credit Title loans—short-term fixed repayment Payday loans—short-term fixed repayment

8. © 2012 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved. 8 Entrepreneurship and Small Business Management, 1/e By Steve Mariotti and Caroline Glackin Forms of Debt Financing (continued) Leases—debts incurred for the rights to use specific property Vehicle leases Equipment leases Bonds—long-term debt used to raise large sums of money

9. © 2012 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved. 9 Entrepreneurship and Small Business Management, 1/e By Steve Mariotti and Caroline Glackin Debt Financing: Pros and Cons Advantages Lenders have no say in business management. Payments are predictable. Payments can be set up to coincide with seasonal sales. Lenders have no share in business profits. Disadvantages Lenders can force bankruptcy. Lenders can take owner’s home and possessions. Payments increase fixed costs, lowering profits. Repayment reduces available cash. Lenders expect financial reporting and compliance.

10. © 2012 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved. 10 Entrepreneurship and Small Business Management, 1/e By Steve Mariotti and Caroline Glackin Equity Financing: Pros and Cons Advantages If no profit is made, investors are not paid. There are no required regular payments of principal or interest. Investors cannot force bankruptcy. Investors may provide valuable advice and contacts. Disadvantages Giving up too much ownership may lead to loss of business control. Investors may interfere with the business. Investors may want to influence business management and receive higher rate of return. Investors share in profits.

11. © 2012 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved. 11 Entrepreneurship and Small Business Management, 1/e By Steve Mariotti and Caroline Glackin Bankers Operate on the Five Cs of Credit Collateral—property or assets that lender can take if loan is not repaid Character—measured by your ability to borrow and your credit history Capacity—sufficient business cash flow Capital—personal resources invested Conditions—industrial/economic “climate”

12. © 2012 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved. 12 Entrepreneurship and Small Business Management, 1/e By Steve Mariotti and Caroline Glackin Community Development Financial Institutions (CDFIs) Lenders that share a vision of expanding economic opportunity and improving quality of life for low-income communities Four sectors: Community development banks (CDBs) Community development credit unions (CDCUs) Community development loan funds (CDLFs) Community development venture capital funds (CDVCs)

13. © 2012 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved. 13 Entrepreneurship and Small Business Management, 1/e By Steve Mariotti and Caroline Glackin Venture Capitalists Investors or investment companies seeking equity Expect 6 times their money back over 5 years, or a 45% rate of return Desire candidates likely to generate at least $50 million in sales within 5 years Sometimes seek a majority interest

14. © 2012 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved. 14 Entrepreneurship and Small Business Management, 1/e By Steve Mariotti and Caroline Glackin Angels Wealthy, private individual investors Usual investment is between $100,000 and $500,000 Typically seek a return of 10 times the investment at the end of 5 years Best strategy: recruit one angel who finds others

15. © 2012 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved. 15 Entrepreneurship and Small Business Management, 1/e By Steve Mariotti and Caroline Glackin Other Financing Options Insurance companies provide loans based on the surrender value of a policy. Vendor financing is achieved by extending the “float” time between receiving bills and paying bills. Federally supported investment companies provide loans to minorities, rural enterprises, and small businesses in low- income geographic areas.

16. © 2012 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved. 16 Entrepreneurship and Small Business Management, 1/e By Steve Mariotti and Caroline Glackin Other Financing Options (continued) U.S. Department of Agriculture—provides assistance to rural/agricultural businesses Youth financing—grants, scholarships, and other awards for entrepreneurs who are 25 years old and younger Bootstrap financing—creative ways of “stretching” existing capital resources

17. © 2012 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved. 17 Entrepreneurship and Small Business Management, 1/e By Steve Mariotti and Caroline Glackin Three Categories of Investment Stocks—shares of companies (equity) Bonds—loans (debt) to companies or government entities Cash—investments easily liquidated (turned into cash) within 24 hours, such as savings accounts and treasury bills High Risk = High Reward Low Risk = Low Reward

18. © 2012 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved. 18 Entrepreneurship and Small Business Management, 1/e By Steve Mariotti and Caroline Glackin Stocks Shares of stock represent a percentage of ownership in a corporation. Public corporations sell stock to the general public to raise capital. Stock prices reflect investors’ opinions about business performance and value. Investors make money by selling stock at a price higher than the one they paid.

19. © 2012 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved. 19 Entrepreneurship and Small Business Management, 1/e By Steve Mariotti and Caroline Glackin Bonds: A re interest-bearing certificates that corporations and governments issue to raise capital Have a lower risk and lower return expected than stocks Are a form of debt financing with a specific rate of return to investors Pay a yearly interest rate semi-annually to bondholders until “maturity” when they are redeemable at face value