©2013 Cengage Learning. All Rights Reserved. Business Management, 13e Financing a Business Types of Business Capital Raising Capital Through Stock Sales Short- and Long-Term Debt Financing CHAPTER 16

©2013 Cengage Learning. All Rights Reserved. Business Management, 13e Types of Business Capital GOALS ● Explain three methods of financing a business. ● Describe the differences in equity financing based on the ownership structure of a business. 2 CHAPTER 16

©2013 Cengage Learning. All Rights Reserved. Business Management, 13e Methods of Obtaining Capital ● Capital—the money required to start or expand a business ● Equity capital or owner capital—business owners’ personal financial contributions ● Personal funds ● Accumulated savings ● Money borrow using homes ● Other property as a security for a loan 3 CHAPTER 16

©2013 Cengage Learning. All Rights Reserved. Business Management, 13e Methods of Obtaining Capital ● Retained earnings—the profits that are not taken out of the business but instead are saved for use by the business ● Type of capital since profits belong to the owner 4 CHAPTER 16

©2013 Cengage Learning. All Rights Reserved. Business Management, 13e Methods of Obtaining Capital ● Debt capital or creditor capital—money that others loan to a business ● Banks and other lending institutions will not lend money unless equity capital exceeds debt capital ● Businesses with financial difficulty have trouble get debt capital 5 CHAPTER 16

©2013 Cengage Learning. All Rights Reserved. Business Management, 13e ©2013 Cengage Learning. All Rights Reserved. Sources of Capital for Starting a Business 6 CHAPTER 16 Source: U.S. Chamber of Commerce © Cengage Learning 2013.

©2013 Cengage Learning. All Rights Reserved. Business Management, 13e Obtaining Equity Capital ● Sole proprietorships ● Owner relies on personal assets for capital ● Cash not available sell assets to raise money ● Funds are at risk if the business does not succeed 7 CHAPTER 16

©2013 Cengage Learning. All Rights Reserved. Business Management, 13e Obtaining Equity Capital ● Partnerships ● Partners usually invest personal resources to balance the financial risk ● Partnership agreements balance financial responsibility and how shares are to be distributed 8 CHAPTER 16

©2013 Cengage Learning. All Rights Reserved. Business Management, 13e Obtaining Equity Capital ● Corporations ● Brings in additional owners through sales of stock ● Provides owners greatest protection of personal assets if the business fails ● Investor can lose only the money invested if the business fails 9 CHAPTER 16

©2013 Cengage Learning. All Rights Reserved. Business Management, 13e Raising Capital Through Stock Sales GOALS ● Differentiate between common and preferred stock. ● Describe factors that affect the value of a company’s stock. 10 CHAPTER 16

©2013 Cengage Learning. All Rights Reserved. Business Management, 13e Types of Stock ● Common stock—gives holders the right to participate in managing the business through voting privileges and the right to share in any profits through dividends ● Owners can vote on basic issues at annual meetings ● Holders receive one vote per share of stock owned ● Board of directors decides on the number of shares of common stock to be issued 11 CHAPTER 16

©2013 Cengage Learning. All Rights Reserved. Business Management, 13e Types of Stock ● Common stock ● Par value—is somewhat arbitrary in that it may not be the price the stockholders pay for the shares ● Market value—the price at which stock is actually bought and sold 12 CHAPTER 16

©2013 Cengage Learning. All Rights Reserved. Business Management, 13e Types of Stock ● Preferred stock—is stock that gives the holders first claim on corporate dividends if a company earns a profit ● Usually have no voting rights ● Corporation ceases operation, assets belong to its owners, the stockholders ● Assets are first distributed to preferred stockholders ● Remaining assets go to common stockholders 13 CHAPTER 16

©2013 Cengage Learning. All Rights Reserved. Business Management, 13e The Value of Stock ● Issuing stock ● Existing corporations need additional equity, raise it through the sale of stock ● Common stockholders have the right to purchase stock first ● More shares result in lower stock prices ● Good practice to issue only common stock when starting a business 14 CHAPTER 16

©2013 Cengage Learning. All Rights Reserved. Business Management, 13e The Value of Stock ● Valuing a company’s stock ● Book value of a share of stock is calculated by dividing the corporation’s net worth (assets – liabilities) by the total number of shares outstanding ● Book value helps make judgment on the worth of a business 15 CHAPTER 16

©2013 Cengage Learning. All Rights Reserved. Business Management, 13e The Value of Stock ● Retained earnings ● Business holds some of its profits in reserve (not cash only) ● Business reinvests earnings for the following reasons: 1. Replacement of buildings and equipment as the result of depreciation 2. Replacement of obsolete equipment 3. Addition of new capital assets for expanding the business 4. Availability of cash to serve as financial protection during periods of low sales and profits, such as recessions and tough competitive times 16 CHAPTER 16

©2013 Cengage Learning. All Rights Reserved. Business Management, 13e ©2013 Cengage Learning. All Rights Reserved. Division of Profits 17 CHAPTER 16

©2013 Cengage Learning. All Rights Reserved. Business Management, 13e Short- and Long-Term Debt Financing GOALS ● Differentiate between short-term and long- term debt. ● Explain the factors that businesses should consider when choosing debt financing. ● Describe several sources from which businesses can obtain additional capital. 18 CHAPTER 16

©2013 Cengage Learning. All Rights Reserved. Business Management, 13e Debt Capital ● Short-term debt capital—a loan that must be repaid with interest within a year ● Obtaining funds from banks ● Line of credit—the authorization to borrow up to a maximum amount for a specified period of time ● Promissory note—is an unconditional written promise to pay to the lender a certain sum of money at a particular time or on demand ● Security (security collateral)—is something of value pledged as assurance to the fulfillment of an obligation 19 CHAPTER 16

©2013 Cengage Learning. All Rights Reserved. Business Management, 13e Debt Capital ● Short-term debt capital ● Obtaining funds from other sources ● Trade credit—is obtained by buying goods and services that do not require immediate payment ● Common form of short-term financing for businesses ● Factor—is a firm that specializes in lending money to businesses based on the business’s accounts receivable ● Sales finance company—provides capital to a business based on installment sales contracts 20 CHAPTER 16

©2013 Cengage Learning. All Rights Reserved. Business Management, 13e Debt Capital ● Long-term debt capital—a business usually obtains this type of debt capital by obtaining term loans or issuing bonds ● Term loans ● Term loan—is a medium or long term financing used for operating funds or the purchase or improvement of fixed assets (1-15 years or longer) ● Lease—is a contract that allows the use of an asset for a fee paid on a schedule (monthly) ● Maintenance of the equipment and the cost of insuring it are not included in the lease agreement 21 CHAPTER 16

©2013 Cengage Learning. All Rights Reserved. Business Management, 13e Debt Capital ● Long-term debt capital ● Bonds ● Bond—is a long-term debt instrument sold by the business to investors ● Contains written promise by the business to pay the bondholder a definite sum of money at a specified period of time ● Business receives the amount of the bond when it is initially sold ● Must pay bondholder the amount borrowed (the principal or par value) 22 CHAPTER 16

©2013 Cengage Learning. All Rights Reserved. Business Management, 13e Debt Capital ● Long-term debt capital ● Bonds ● Debentures—are unsecured bonds ● No specific assets pledged as security ● Backed by financial strength and credit history of the corporation that issues them ● Mortgage bonds—are bonds secured by specific long- term assets of the issuer ● Convertible bond—permits a bondholder to exchange bonds for a prescribed number of shares of common stock 23 CHAPTER 16

©2013 Cengage Learning. All Rights Reserved. Business Management, 13e Obtaining Capital ● Cost of capital ● Interest rates ● Fluctuate monthly, weekly, or daily ● Influence of capital contributors ● Obligations not paid creditors take legal action 24 CHAPTER 16

©2013 Cengage Learning. All Rights Reserved. Business Management, 13e Sources of Outside Capital ● Underwriting ● Investment bank—an organization that helps a business raise large sums of capital through the sales of stocks and bonds ● Assist in rapidly growing, privately held company through and initial public offering ● Initial public offering (IPO)—is the first time a company sells stock to the public 25 CHAPTER 16

©2013 Cengage Learning. All Rights Reserved. Business Management, 13e Sources of Outside Capital ● Stock options ● Stock options-is a right granted by a corporation that allows current stockholders to buy additional shares when issued at a fixed price for a specific period of time ● Employee stock ownership plan (ESOP)—is a plan that allows employees to become owners of the company they work for through the purchase stock 26 CHAPTER 16

©2013 Cengage Learning. All Rights Reserved. Business Management, 13e Sources of Outside Capital ● Venture capital ● Venture capital—is financing obtained from an investor or investment group that lends large sums of money to promising new or expanding small companies ● Ask for a percentage of ownership rights in the company in return for the investment 27 CHAPTER 16