FINANCING YOUR BUSINESS Business Management

Today’s Lesson We will explore differences among various sources of capital.  What are the two methods for obtaining capital?  How is debt capital categorized?  What should a business owner take into consideration when obtaining capital?  What sources of capital are available for businesses? O BJECTIVE E SSENTIAL Q UESTIONS

1. Equity Capital 2. Debt Capital Methods of Obtaining Capital What are the two methods for obtaining capital?

Owner Capital  The owner(s) personal contributions to the business  May come from personal savings or personal loans  Small businesses rely heavily on owner capital  a.k.a. equity capital What are the two methods for obtaining capital?

Retained Earnings  Also a type of equity capital because business profits belong to the owner(s)  Business profits saved for use by the business in the future What are the two methods for obtaining capital?

Debt Capital  Money that others loan to a business  Also known as creditor capital  Banks & other lenders usually will NOT lend to a business unless the equity capital exceeds the debt capital What are the two methods for obtaining capital?

Remember those business structures? Obtaining Equity Capital

Sole Proprietorship  Invest more personal funds  Sell personal assets to raise $$$  Mortgage personal property  Assets used as securities are at risk if the business fails.  Other personal assets at risk  Change business structure  Partnership  Corporation

Partnership  Partners usually invest personal resources in the business in order to balance/share risk.  Not mandatory for new partners  A formal partnership agreement identifies the financial contributions of each partner and how profits will be shared.  If the assets of one partner are not enough to cover business debts, assets from other partners can be taken.  Owner gives up individual control over management and decision-making.

Corporation  Can raise capital quickly because the amount of money invested is much smaller  Stockholders are not involved in day-to-day management of business.  Investors are protected financially.

Obtaining Debt Capital How is debt capital categorized?

Short-Term Debt Capital  Must be repaid within a year  Often 30-, 60-, or 90-day loans  Usually obtained from a bank or other lending institutions How is debt capital categorized?

Short-Term Debt Capital  Business must supply bank with adequate financial information.  Bank usually obtains a financial report on the business from a credit company.  If the bank considers the business to be a good credit risk, the bank will grant a loan or a line of credit.  Specific amount, set time period  Business owner(s) must sign a promissory note.  Unconditional written promise to pay the lender a certain sum of money at a particular time or on demand How is debt capital categorized?

Long-Term Debt Capital  Money borrowed for longer than a year  Usually obtained through:  Long-term notes  Bonds How is debt capital categorized?

Term Loans  Also known as long-term notes; medium- or long-term financing used for business operations or for improving fixed assets  Written for periods from 1 to 15 years … or longer  Significant source of capital for most businesses  Banks / lenders require the principal and interest to be repaid on a regular basis over the life of the note. How is debt capital categorized?

Bonds  Long-term written promise sold by the business to investors that promises payment of a definite sum of money at a specified time  Business receives the amount of the bond when it is initially sold.  Must pay bondholder the borrowed amount (principal) at the bond’s maturity date  Business pays bondholder interest at a specified rate at certain intervals  Bonds do NOT represent a share of ownership; they are investments.  Bondholders are creditors & have priority claim before stockholders. How is debt capital categorized?

3 things to consider… Obtaining Capital Considerations when Obtaining Capital

Cost of Capital  Costly to sell bonds, long-term notes, or issue stock  Must file forms, obtain approval, make agreements, find buyers  Usually only large or highly successful firms even consider stocks/bonds Considerations when Obtaining Capital

Interest Rates  Rates fluctuate monthly, weekly, even daily  Best to borrow when rates are low (cheaper)  When rates are high, businesses usually borrow short-term debts. Considerations when Obtaining Capital

Influence of Contributors  Short-term creditors usually have no control over management and operations of business.  Long-term credit agreements are tied to asset claims & may impose limitations on those assets.  Partners / stockholders gain a voice in control of business. Considerations when Obtaining Capital

Where do you get the money? Sources of Capital Sources of Capital Avaialble to Businesses

Sources of Capital  Banks - most popular source of capital  Small Loan Companies - firms that lend money to “higher risk” businesses  Venture Capitalists  People or companies that lend large sums of money to promising new or growing businesses  Usually ask for a percentage of ownership rights in the company  Demand a carefully developed business plan that shows high potential for success Sources of Capital Avaialble to Businesses

Sources of Capital  Commercial Credit Companies - lend money on current assets, such as accounts receivable  Sales Finance Companies - used primarily when installment sales are involved  Insurance Companies - portions of funds collected from policy holders may be loaned to firms  Individual Investors / Investment Groups  Pension Funds - retirement funds collected from employees may be loaned to firms Sources of Capital Avaialble to Businesses

Sources of Capital  Investment Banking Organizations  Specialize in selling new security issues to the public  Helps a business raise large sums of capital through stocks / bonds  Can assist a rapidly growing, privately held company with IPO  Equipment Manufacturers  Firms that do not lend money, but sell needed equipment on an extended-time payment plan Sources of Capital Avaialble to Businesses

1) Identify 2 methods of obtaining capital. 2) Debt capital can be categorized as _____ or _____ debt capital. 3) What are three (3) things to consider when obtaining capital? 4) List at least two (2) of the ten sources of capital discussed in class. Closing Task!

So how much money do you need?  Rent / mortgage  Facility maintenance  Utilities  Transportation  Wages & Salaries  Equipment  Supplies  Raw Materials  Inventory Physical LocationCost of Product / Service

F OR THE R EST OF C LASS … 1) Complete the finance worksheets – do some research & use realistic figures. 2) Decide how much money your business needs to start up & operate for six months. Write the ‘Financial Plan’ section of your business plan.