Chapter 11: Sources of Funds1 Copyright 2002 Prentice Hall Publishing Company Sources of Funds: Equity and Debt

Chapter 11: Sources of Funds2 Copyright 2002 Prentice Hall Publishing Company The “Secrets” to Successful Financing 1. Choosing the right sources of capital is a decision that will influence a company for a lifetime. 2. The money is out there; the key is knowing where to look. 3. Creativity counts. Entrepreneurs have to be as creative in their searches for capital as they are in developing their business ideas.

Chapter 11: Sources of Funds3 Copyright 2002 Prentice Hall Publishing Company The “Secrets” to Successful Financing (continued) 4. The World Wide Web puts at entrepreneur’s fingertips vast resources of information that can lead to financing. 5. Be thoroughly prepared before approaching lenders and investors. 6. Entrepreneurs should not underestimate the importance of making sure that the “chemistry” between themselves, their companies, and their funding sources is a good one.

Chapter 11: Sources of Funds4 Copyright 2002 Prentice Hall Publishing Company Three Types of Capital n Fixed - used to purchase the permanent or fixed assets of the business (e.g., buildings, land, equipment, etc.) n Working - used to support the small company’s normal short-term operations (e.g., buy inventory, pay bills, wages, salaries, etc.) n Growth - used to help the small business expand or change its primary direction. Capital is any form of wealth employed to produce more wealth for a firm.

Chapter 11: Sources of Funds5 Copyright 2002 Prentice Hall Publishing Company Equity Capital n Represents the personal investment of the owner(s) in the business. n Is called risk capital because investors assume the risk of losing their money if the business fails. n Does not have to be repaid with interest like a loan does. n Means that an entrepreneur must give up some ownership in the company to outside investors.

Chapter 11: Sources of Funds6 Copyright 2002 Prentice Hall Publishing Company Sources of Equity Financing n Personal savings n Friends and family members n Angels n Partners n Corporations n Venture capital companies n Public stock sale

Chapter 11: Sources of Funds7 Copyright 2002 Prentice Hall Publishing Company Personal Savings n The first place an entrepreneur should look for money. n The most common source of equity capital for starting a business. n Outside investors and lenders expect the entrepreneur to put some of her own capital into the business before investing theirs.

Chapter 11: Sources of Funds8 Copyright 2002 Prentice Hall Publishing Company Friends and Family Members n After emptying her own pockets, an entrepreneur should turn to those most likely to invest in the business – friends and family members. n Survey: 10% of business owners turn to family and friends for capital. n Careful!!! Inherent dangers lurk in family/friendly business deals, especially those that flop.

Chapter 11: Sources of Funds9 Copyright 2002 Prentice Hall Publishing Company Friends and Family Members n Guidelines for Family and Friendship Financing Deals:  Consider the impact of the investment on everyone involved. Keep the arrangement “strictly business.”  Settle the details up front.  Create a written contract.  Treat the money as “bridge financing.”  Develop a payment schedule that suits both parties.

Chapter 11: Sources of Funds10 Copyright 2002 Prentice Hall Publishing Company Angels n Angels - private investors who back emerging entrepreneurial companies with their own money. n Fastest growing segment of the small business capital market. n An excellent source of “patient money” for investors needing relatively small amounts of capital – often less than $500,000.

Chapter 11: Sources of Funds11 Copyright 2002 Prentice Hall Publishing Company Angels n Key: finding them! n Angels almost always invest their money locally and can be found through “networks.” n The typical angel accepts 30% of the proposals presented to him and has invested an average of $131,000 in 3.5 businesses.

Chapter 11: Sources of Funds12 Copyright 2002 Prentice Hall Publishing Company Angel Profile 47 year old white male earning $100,000 a year 47 year old white male earning $100,000 a year College educated College educated Net worth of $1 million Net worth of $1 million Typically accepts 30% of the company Typically accepts 30% of the company Averages 2 investments a year Averages 2 investments a year

Chapter 11: Sources of Funds13 Copyright 2002 Prentice Hall Publishing Company Corporate Venture Capital n 30% of all venture capital investments come from corporations. n About 900 large corporations across the globe invest in start-up companies. n Capital infusions are just one benefit; corporate partners may share marketing and technical expertise.

Chapter 11: Sources of Funds14 Copyright 2002 Prentice Hall Publishing Company Venture Capitalist Companies n More than 3,000 venture capital firms operate across the United States. n Most venture capitalists seek investments in the $3,000,000 - $10,000,000 range in companies with high-growth and high- profit potential. n Business plans are subjected to an extremely rigorous review – less than 1% accepted.

Chapter 11: Sources of Funds15 Copyright 2002 Prentice Hall Publishing Company Venture Capitalist Companies n Most venture capitalists take an active role in managing the companies in which they invest. n Many venture capitalists focus their investments in specific industries with which they are familiar. n Most often, venture capitalists invest in a company across several stages.

Chapter 11: Sources of Funds17 Copyright 2002 Prentice Hall Publishing Company What Do Venture Capital Companies Look For? n Competent management n Competitive edge n Growth industry n Viable exit strategy n “Intangibles”

Chapter 11: Sources of Funds18 Copyright 2002 Prentice Hall Publishing Company Going Public n Initial public offering (IPO) - when a company raises capital by selling shares of its stock to the public for the first time. n Typical year: about 550 companies make IPOs. n Few companies with sales below $10 million in annual sales make IPOs.

Chapter 11: Sources of Funds20 Copyright 2002 Prentice Hall Publishing Company Advantages of “Going Public” n Ability to raise large amounts of capital n Improved corporate image n Improved access to future financing n Attracting and retaining key employees Using stock for acquisitions Using stock for acquisitions n Listing on a stock exchange

Chapter 11: Sources of Funds21 Copyright 2002 Prentice Hall Publishing Company Disadvantages of “Going Public” n Dilution of founder’s ownership n Loss of control n Loss of privacy n Reporting to the SEC Filing expenses Filing expenses n Accountability to shareholders n Pressure for short-term performance n Timing

Chapter 11: Sources of Funds22 Copyright 2002 Prentice Hall Publishing Company The Registration Process n Choose the underwriter n Negotiate a letter of intent n Prepare the registration statement File with the SEC File with the SEC n Wait to “go effective” n Meet state requirements

Chapter 11: Sources of Funds23 Copyright 2002 Prentice Hall Publishing Company Simplified Registrations and Exemptions n Regulation S-B n Regulation D: Rule Small Company Offering Registration (SCOR) n Regulation D: Rule 505 and 506 n Section 4 (6)

Chapter 11: Sources of Funds24 Copyright 2002 Prentice Hall Publishing Company Simplified Registrations and Exemptions (continued) n Rule 147 (Intrastate offerings) n Regulation A n Direct Stock Offering on the World Wide Web (WWW) n Foreign Stock Markets

Chapter 11: Sources of Funds25 Copyright 2002 Prentice Hall Publishing Company Debt Financing n Must be repaid with interest. n Is carried as a liability on the company’s balance sheet. n Can be just as difficult to secure as equity financing, even though sources of debt financing are more numerous. n Can be expensive, especially for small companies, because of the risk/return tradeoff.

Chapter 11: Sources of Funds26 Copyright 2002 Prentice Hall Publishing Company Sources of Debt Capital n Commercial banks

Chapter 11: Sources of Funds27 Copyright 2002 Prentice Hall Publishing Company Commercial Banks n Short-term loans  Commercial loans  Lines of credit  Floor planning n Intermediate and long-term loans  Installment loans and contracts...the heart of the financial market for small businesses!

Chapter 11: Sources of Funds28 Copyright 2002 Prentice Hall Publishing Company Sources of Debt Capital n Commercial banks n Asset-based lenders

Chapter 11: Sources of Funds29 Copyright 2002 Prentice Hall Publishing Company Asset-Based Borrowing n Discounting accounts receivable Accounts Receivable n Inventory financing

Chapter 11: Sources of Funds30 Copyright 2002 Prentice Hall Publishing Company Sources of Debt Capital n Commercial banks n Trade credit n Equipment suppliers n Commercial finance companies n Saving and loan associations n Asset-based lenders $$

Chapter 11: Sources of Funds31 Copyright 2002 Prentice Hall Publishing Company Sources of Debt Capital n Stock brokerage houses n Insurance companies n Credit unions n Bonds n Private placements n Small Business Investment Companies (SBICs) n Small Business Lending Companies (SBLCs) (continued)

Chapter 11: Sources of Funds32 Copyright 2002 Prentice Hall Publishing Company Sources of Debt Capital n Economic Development Administration (EDA) n Department of Housing and Urban Development (HUD) n U.S. Department of Agriculture’s Rural Business- Cooperative Service n Local Development Companies (LDCs) n Small Business Innovation Research (SBIR) n Small Business Technology Transfer programs n Small Business Administration (SBA) (concluded) Federally Sponsored Programs:

Chapter 11: Sources of Funds33 Copyright 2002 Prentice Hall Publishing Company Small Business Administration Loan Programs n Low Doc Loan Program n SBAExpress Program n 7(A) Loan Guarantee Program – the most popular SBA loan program n CAPLine Program n International Trade Programs  Export Working Capital Program  International Trade Program

Chapter 11: Sources of Funds34 Copyright 2002 Prentice Hall Publishing Company SBA Loan Programs n Section 504 Certified Development Company Program n Microloan Program n Prequalification Loan Program n Disaster Loans n 8(A) Loan Program

Chapter 11: Sources of Funds35 Copyright 2002 Prentice Hall Publishing Company State and Local Loan Programs n Capital Access Programs (CAPs) – now offered in 22 states and are designed to encourage lenders to make loans to businesses that do not qualify for traditional financing. n Revolving Loan Fund (RLFs) – combine private and public funds to make small business loans.

Chapter 11: Sources of Funds36 Copyright 2002 Prentice Hall Publishing Company Internal Methods of Financing n Factoring - selling accounts receivable outright n Leasing assets rather than buying them n Credit cards