Chapter 15 Debt Financing Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall 15-1 Sources of Debt Financing

Chapter 15 Debt Financing Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall 15-2 Debt Financing Financing that must be repaid with interest Financing that must be repaid with interest SBA: lenders make $700 billion in loans of less than $1 million to small companies each year SBA: lenders make $700 billion in loans of less than $1 million to small companies each year Total small business borrowing approaches $1 trillion per year Total small business borrowing approaches $1 trillion per year NFIB survey: Crises on Wall Street have created a credit crunch for small businesses NFIB survey: Crises on Wall Street have created a credit crunch for small businesses  Just 50% of business owners received what they sought

Chapter 15 Debt Financing Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall 15-3 Debt Financing Is carried as a liability on the company's balance sheet Is carried as a liability on the company's balance sheet Can be just as difficult to secure as equity financing, even though sources of debt financing are more numerous Can be just as difficult to secure as equity financing, even though sources of debt financing are more numerous Can be expensive, especially for small companies, because of the risk/return tradeoff – “prime-plus…” Can be expensive, especially for small companies, because of the risk/return tradeoff – “prime-plus…”

Chapter 15 Debt Financing Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall 15-4 Consider Borrowing Money to… Increase your work force and/or inventory to boost sales Increase your work force and/or inventory to boost sales Gain market share Gain market share Purchase new equipment Purchase new equipment Refinance existing debt Refinance existing debt Take advantage of cash discounts Take advantage of cash discounts

Chapter 15 Debt Financing Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall 15-5 Consider Borrowing Money to… Buy the building in which your business is located Buy the building in which your business is located Establish a relationship with a lender Establish a relationship with a lender Retire debt held by a “non- relationship” creditor Retire debt held by a “non- relationship” creditor Deal with a downturn in business Deal with a downturn in business

Source: 2010 Mid-Year Economic Report, National Small Business Association, p 8. Small Business Financing Strategies Copyright ©2012 Pearson Education, Inc. publishing as Prentice HallChapter 15 Debt Financing15-6

Chapter 15 Debt Financing Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall 15-7 Sources of Debt Capital Commercial banks Commercial banks

Source: The Small Business Economy: A Report to the President, 2009, p. 74. Commercial Bank Loans to Small Businesses Copyright ©2012 Pearson Education, Inc. publishing as Prentice HallChapter 15 Debt Financing15-8

Chapter 15 Debt Financing Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall 15-9 Commercial Banks Lenders of first resort for small business owners Lenders of first resort for small business owners SBA study: Banks provide 50% of all traditional debt to small businesses SBA study: Banks provide 50% of all traditional debt to small businesses Small banks (<$10 billion in assets) are most likely to lend money to small businesses Small banks (<$10 billion in assets) are most likely to lend money to small businesses Focus on a company’s ability to generate positive cash flow when evaluating loan proposals Focus on a company’s ability to generate positive cash flow when evaluating loan proposals

Chapter 15 Debt Financing Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Commercial Banks Conservative lenders Conservative lenders  Significant owner investment  Sufficient cash flow for repayment  Ample collateral as security  SBA loan guarantee  Personal guarantee

Chapter 15 Debt Financing Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Commercial Banks Short-term loans – the commercial banks’ specialty Short-term loans – the commercial banks’ specialty  Commercial loans  Lines of credit...the heart of the financial market for small businesses!

How large a line of credit? Example: Average collection period ratio 49 days Average collection period ratio 49 days + Average inventory turnover ratio + 53 days = Total 102 days - Average payable period ratio - 39 days = Cash flow cycle63 days Annual sales $5,800,000 Average daily sales (Annual sales ÷ 365 days) $15,890 Cash Flow cycle 63 days x Average daily sales x $15,890 Equals $1,001,096 - Forecasted profit (Annual sales x net profit margin) - $377,000 = Line of credit requirement $624,096 Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chapter 15 Debt Financing15-12

Chapter 15 Debt Financing Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Commercial Banks Short-term loans – the commercial banks’ specialty Short-term loans – the commercial banks’ specialty  Commercial loans  Lines of credit...the heart of the financial market for small businesses!  Floor planning

Chapter 15 Debt Financing Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Intermediate and long-term loans Intermediate and long-term loans  Term loans  Installment loans  Character loans Commercial Banks...the heart of the financial market for small businesses!

Chapter 15 Debt Financing Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Sources of Debt Capital Commercial banks Commercial banks Asset-based lenders Asset-based lenders

Chapter 15 Debt Financing Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Asset-Based Borrowing Two common methods: Discounting accounts receivable Discounting accounts receivable Accounts Receivable Inventory financing Inventory financing

Source: Commercial Finance Association Asset-Based Loans Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chapter 15 Debt Financing 15-17

Chapter 15 Debt Financing Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Sources of Debt Capital Commercial banks Commercial banks Trade credit Trade credit Equipment suppliers Equipment suppliers Commercial finance companies Commercial finance companies Savings and loan associations Savings and loan associations Asset-based lenders Asset-based lenders

Chapter 15 Debt Financing Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Sources of Debt Capital Stock brokerage houses Stock brokerage houses Insurance companies Insurance companies Credit unions Credit unions Bonds Bonds Private placements Private placements Small Business Investment Companies (SBICs) Small Business Investment Companies (SBICs) (Continued)

Chapter 15 Debt Financing Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Small Business Investment Companies (SBICs) About 307 SBICs operate in the U.S. About 307 SBICs operate in the U.S. Use a combination of private capital and federally guaranteed debt to provide long-term capital to small companies Use a combination of private capital and federally guaranteed debt to provide long-term capital to small companies Since 1958, SBICs have provided more than $57.2 billion in financing to 107,000 small companies Since 1958, SBICs have provided more than $57.2 billion in financing to 107,000 small companies

Copyright ©2012 Pearson Education, Inc. publishing as Prentice HallChapter 15 Debt Financing15-21

Chapter 15 Debt Financing Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Sources of Debt Capital Stock brokerage houses Stock brokerage houses Insurance companies Insurance companies Credit unions Credit unions Bonds Bonds Private placements Private placements Small Business Investment Companies (SBICs) Small Business Investment Companies (SBICs) (Continued) Small Business Lending Companies (SBLCs) Small Business Lending Companies (SBLCs)

Chapter 15 Debt Financing Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Sources of Debt Capital Economic Development Administration (EDA) Economic Development Administration (EDA) Department of Housing and Urban Development (HUD) Department of Housing and Urban Development (HUD) U.S. Department of Agriculture’s Rural Business-Cooperative Service U.S. Department of Agriculture’s Rural Business-Cooperative Service Federally Sponsored Programs: (Continued)

Chapter 15 Debt Financing Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Small Business Innovation Research (SBIR) Small Business Innovation Research (SBIR) Small Business Technology Transfer programs Small Business Technology Transfer programs Small Business Administration (SBA) – largest single backer of small businesses in the nation Small Business Administration (SBA) – largest single backer of small businesses in the nation Sources of Debt Capital Federally Sponsored Programs: (Continued)

Chapter 15 Debt Financing Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Small Business Administration Loan Programs SBA has helped 20 million small companies acquire the capital they need for start-up and growth SBAExpress Program – loan guarantees of up to 50% on loans up to $350,000 SBAExpress Program – loan guarantees of up to 50% on loans up to $350,000

Chapter 15 Debt Financing Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall (A) Loan Guaranty Program 7(A) Loan Guaranty Program Small Business Administration Loan Programs

Source: U.S. Small Business Administration SBA 7(A) Guaranteed Loans Copyright ©2012 Pearson Education, Inc. publishing as Prentice HallChapter 15 Debt Financing 15-27

Chapter 15 Debt Financing Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall (A) Loan Guaranty Program 7(A) Loan Guaranty Program CAPLine Program CAPLine Program Section 504 Certified Development Company Program Section 504 Certified Development Company Program Small Business Administration Loan Programs

Chapter 15 Debt Financing Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Microloan Program Microloan Program  Average loan is $13,550 with a maturity of 3 years (Maximum is 6 years)  37% go to business start-ups International Trade Loans International Trade Loans  Export Working Capital Program  International Trade Loan Program Disaster Assistance Loans Disaster Assistance Loans Small Business Administration Loan Programs

Chapter 15 Debt Financing Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall State and Local Loan Programs 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 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 Revolving Loan Fund (RLFs) – combine private and public funds to make small business loans Revolving Loan Fund (RLFs) – combine private and public funds to make small business loans

Chapter 15 Debt Financing Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Internal Methods of Financing Factoring - selling accounts receivable outright Factoring - selling accounts receivable outright

Source: "Annual Asset-Based Lending and Factoring Surveys 2006," Commercial Finance Association, July 2, 2007, p. 15. Copyright ©2012 Pearson Education, Inc. publishing as Prentice HallChapter 15 Debt Financing15-32

Chapter 15 Debt Financing Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Factoring - selling accounts receivable outright Factoring - selling accounts receivable outright Leasing assets rather than buying them Leasing assets rather than buying them Credit cards Credit cards Internal Methods of Financing

Chapter 15 Debt Financing Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Web Sites American Bankers Association American Bankers Association National Association of Small Business Investment Companies National Association of Small Business Investment Companies U.S. Small Business Administration U.S. Small Business Administration

Chapter 15 Debt Financing Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of America. Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall