BUS 202 Financing_EQUITY Spring 2006 Financing a Small Business The Equity side of the picture…

Debt or Equity? DEBT is borrowed money…it becomes a liability on your balance statement (long term loan) EQUITY is an “investment” in your business (silent partner or venture capital) Remember the Accounting Equation Asset = Liabilities - Owners’ Equity

Equity vs. Debt Financing Advantages Debt Financing Advantages: Relatively Easy & Quick Maintain control & ownership Interest & other costs tax deductible May be able to save money Equity Financing Advantages: Brings in more cash Share of financial risk (partners) Less pressure & restrictions May be able to borrow more

Equity vs. Debt Financing Disadvantages Debt Financing Disadvantages: Interest Costs Expensive Risk of profits not covering repayment Easy to abuse & overuse Must share financial information Lender Restrictions & Limitations Equity Financing Disadvantages: Risk of destroying personal relationships Give up part of profits Give up part of ownership of business Give up some control of business Personal sacrifices Loss of savings

Debt: A Loan by any other name Debt Financing is most frequently used when there are minimal risks and the investment return is acceptable to the lender. Businesses that rely on debt financing are those in earlier stages of business development (primary & secondary levels of business growth) There are two specific types of debt financing: 1) Conventional Loan Programs 2) Government Guaranteed Loan Programs

Equity Financing Most frequently used to fund emerging businesses and to provide “seed” start- up early stage and expansion financing. For businesses in their 2 nd and 3 rd level of business development. Start-up businesses often have challenges attracting traditional equity investment. Start-ups often use the 3 F’s for equity investment.

Tips for Tapping the Family & Friends for Funds  Consider the impact the investment will have on all parties  Keep the arrangement strictly business  Keep it professional!  Settle the details upfront  Create a written document…put the agreement in writing  Treat the money as “bridge” financing  Develop a payment schedule

Equity or “Risk” Capital Equity capital represents the personal investment of the owner(s)…it is often called RISK capital. It is called RISK because the investors assume the primary risk of losing their funds if the business fails. In the 1990’s entrepreneurs began to turn more to equity financing to get their businesses up & running. Apart from personal savings, family and friends, equity capital is normally tough for a start-up to obtain.

The Equity Ladder 1.Start with your personal savings …lenders & investors EXPECT you to reach into your pockets first! 2.Three out of four start-ups tap their family members for capital; followed by friends. 3.Entrepreneurs can take on partners to expand the capital foundation of their business. 4.Angels fill a significant gap in the seed capital market. 5.Venture Capitalists & Capitalist Firms purchase equity positions in young businesses that have high-growth potential 6.Going Public- Public Stock Sale

What about Grants? Are you a for-profit or a non- profit business? The SBA has SBIR Grant (Small Business Innovative Research) i.e. bio-tech Very limited amount of “seed” grant funds for disabled re- training or disadvantaged businesses from federal and state agencies often tied to creating jobs.

The Bootstrapping Method Start small and reinvest the money in your business Don’t quit your day job Start a business you “don’t like” to get the capital you need to start a business you want (would not recommend)

Other “entrepreneurial” methods to grow your financing Internal Financing (customer pays in advance) Factoring Consignment & Flooring (inventory that doesn’t cost you) Concession (sub-lease) Vendor Credit (time is money) Trade for services (bartering)