1. Chapter 8 Financing Strategy: Debt or Equity?
Entrepreneurship
Chapter 8
Financing Strategy: Debt or Equity?
Mariotti: Entrepreneurship

2. Financing: The Use and Manipulation of Money
Money used to start a business is called capital.
There are 2 ways to obtain capital to finance a business:
Borrow money (debt)
Sell a share of the business (equity)
Marriotti: Entrepreneurship

3. Sources of Capital Family and friends (equity or debt)
Accounts payable (debt)
Angels (equity)
Banks, credit unions (debt)
Minority financing sources (equity or debt)
Small Business Investment Companies (SBICS—debt)
Marriotti: Entrepreneurship

4. How Often Do Small Firms Fail?
Myth: 4 out of 5 small businesses fail in the first 5 years of operation.
Truth: over half of new small firms survive for 8 or more years. (according to Dun & Bradstreet study)
A small business is a high risk-high return investment.
Marriotti: Entrepreneurship

5. 3 Categories of Financial Investment
Stocks—shares of companies (equity)
Bonds—loans to companies or government entities (debt)
Cash—investments that can be liquidated (turned into cash) within 24 hours (savings accounts, treasury bills)
The higher the reward an investment offers, the greater the risk.
There is no such thing as a low risk/high return investment!!
Marriotti: Entrepreneurship

6. Compound Interest: Money Making Money
A compound rate of return is calculated on not just the original investment but also on interest that has been earned by the investment.
$100 invested at 10% per year (not compounded) earns $10 per year. In 10 years you’ll have $200.
$100 invested at a compound rate of 10% earns $110 the first year ($100 + $10 interest), $121 the second year ($110 + $11 interest), etc. In 10 years you’ll have $
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7. Future Value of $1 After “N” Periods
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8. The Present Value of Money
Rule of thumb: You always want your money now.
If you can’t have it now, you want to be compensated with a return.
There are 3 risks to your money when you lend or invest it:
Inflation—if prices rise, your money will be worth less when it comes back to you.
Risk of loss—if the investment fails, you will lose your money.
Opportunity—you might find a better investment.
Marriotti: Entrepreneurship

9. Net Present Value Chart
Marriotti: Entrepreneurship

10. How Can You Compensate Investors in Your Business?
1. Debt—Borrow money and promise to pay it back over a set period of time at a set rate of interest. Investor receives interest.
2. Equity—Sell a percentage (share) of ownership in your business for money. Investor receives share of profits.
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11. Business Legal Structures
Sole Proprietorship
Owned by one person
May offer investors debt or equity
Partnership
Owned by 2 or more people
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12. Business Legal Structures (cont.)
Corporation
Legal “person” composed of equity investors in company.
May sell stock (equity) or bonds (debt)
Nonprofit Corporation/501 (c) (3)
Financed by donations; may not sell debt or equity
Tax exempt
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13. Business Legal Structures (cont.)
Cooperative
Owned by customer/members
All customer/members own shares of company but each has one vote
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14. Debt Financing: Pros and Cons
Lender has no say in operation of business
Loan payments are predictable
Lenders do not share business profits
Cons:
If loan payments are not made, lender can force business into bankruptcy
If business is not incorporated and defaults, lender can take house and other possessions of owner
Loan payments increase fixed costs, lower profit
Marriotti: Entrepreneurship

15. Equity Financing: Pros and Cons
If business does not make profit, investor does not get paid
Equity investors want business to succeed, will share contacts and advice
Cons:
Entrepreneur can lose control of business to equity investors
Equity investor takes more risk, wants higher return
Entrepreneur must share profits with equity investors
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16. 6 “Cs” of Bank Borrowing
Collateral—does entrepreneur own property, cars, etc. that bank can take if loan is not paid?
Cash Flow—do projected cash flow statements show business will be able to make loan payments?
Credit History—does entrepreneur have good credit?
Capacity—what are business’s expense? Can it afford to pay the loan?
Commitment—how much of own money has entrepreneur invested?
Conditions—general economic climate
Marriotti: Entrepreneurship

17. Establish Good Credit “No credit” is not “good credit.”
Prove you can make regular payments on a debt. Open a charge account, charge some purchases and pay them off on time.
Check your credit reports every 6 months to make sure they are accurate.
Marriotti: Entrepreneurship

18. Creative Financing Micro-Loan financing:
$100–$25,000, supported by federal government
Loan made based not on 6 Cs but on entrepreneur’s character and business plan
Line of credit:
Pre-arranged loan business owner can draw on when needed
Short-term (under one year)—must be paid in full during the year
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19. More Creative Financing
Angel Financing:
Private investors seeking equity
Typically $100,000–$500,00 range
Minority Financing:
MESBICs: charted by Small Business Administration to support minority business
MBDC: Minority Business Development Centers MBDA.gov
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20. More Creative Financing
Bootstrap Financing:
Hire as few employees as possible.
Lease rather than buy equipment.
Use personal savings.
Work from home, borrow office space (business incubators).
Put profits back into business.
Floating Accounts Payable:
Float—time between a payment is due and cash is received by creditor.
Accounts Payable—money a business owes its suppliers.
Negotiate with suppliers for best possible terms. Try to get more time to pay bills.
Marriotti: Entrepreneurship

21. You Need a Business Plan to Raise Capital
Investors will not see an entrepreneur who does not have a business plan.
Business plan should include:
Business idea
Long and short-term goals
Market research
Marketing plan
Start-up and fixed operating costs
Management
Legal structure
Time management plan
Financing
Breakeven analysis
Accounting system
Projected monthly income statement
Projected yearly income statement
Financial ratio analysis
Balance sheet
Marriotti: Entrepreneurship