2 Today’s ObjectivesExplore differences among various sources of capital.Identify the cost of operations.
3 Methods of Obtaining Capital Equity CapitalDebt Capital
4 Owner Capital The owner(s) personal contributions to the business May come from personal savings or personal loansSmall businesses rely heavily on owner capitalAlso known as equity capital
5 Retained EarningsAlso a type of equity capital because business profits belong to the owner(s)Business profits saved for use by the business in the future
6 Debt Capital Money that others loan to a business Also known as creditor capitalBanks & other lenders usually will NOT lend to a business unless the equity capital exceeds the debt capital
7 Obtaining Equity Capital Remember those business structures?
8 Sole Proprietorship Invest more personal funds Sell personal assets to raise $$$Mortgage personal propertyAssets used as securities are at risk if the business fails.Other personal assets at riskChange business structurePartnershipCorporation
9 PartnershipPartners usually invest personal resources in the business in order to balance/share risk.Not mandatory for new partnersA 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.
10 CorporationCan raise capital quickly because the amount of money invested is much smallerStockholders are not involved in day-to-day management of business.Investors are protected financially.
12 Short-Term Debt Capital Must be repaid within a yearOften 30-, 60-, or 90-day loansUsually obtained from a bank or other lending institutions
13 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 periodBusiness 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
14 Long-Term Debt Capital Money borrowed for longer than a yearUsually obtained through:Long-term notesBonds
15 Term LoansAlso known as long-term notes; medium- or long-term financing used for business operations or for improving fixed assetsWritten for periods from 1 to 15 years … or longerSignificant source of capital for most businessesBanks / lenders require the principal and interest to be repaid on a regular basis over the life of the note.
16 BondsLong-term written promise sold by the business to investors that promises payment of a definite sum of money at a specified timeBusiness receives the amount of the bond when it is initially sold.Must pay bondholder the borrowed amount (principal) at the bond’s maturity dateBusiness pays bondholder interest at a specified rate at certain intervalsBonds do NOT represent a share of ownership; they are investments.Bondholders are creditors & have priority claim before stockholders.
18 Cost of Capital Costly to sell bonds, long-term notes, or issue stock Must file forms, obtain approval, make agreements, find buyersUsually only large or highly successful firms even consider stocks/bonds
19 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.
20 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.
22 Sources of Capital Banks - most popular source of outside capital Small Loan Companies - firms that lend money to “higher risk” business and individualsVenture CapitalistsPeople or companies that lend large sums of money to promising new or growing businessesUsually ask for a percentage of ownership rights in the companyDemand a carefully developed business plan that shows high potential for success
23 Sources of CapitalCommercial Credit Companies - lend money on current assets, such as accounts receivableSales Finance Companies - used primarily when installment sales are involvedInsurance Companies - portions of funds collected from policy holders may be loaned to firmsIndividual Investors / Investment GroupsPension Funds - retirement funds collected from employees may be loaned to firms
24 Sources of Capital Investment Banking Organizations Specialize in selling new security issues to the publicHelps a business raise large sums of capital through stocks / bondsCan assist a rapidly growing, privately held company with IPOEquipment ManufacturersFirms that do not lend money, but sell needed equipment on an extended-time payment plan
25 Review! 2 Methods of Obtaining Capital Types of Debt Capital 3 Things to Consider when Obtaining Capital10 Sources of Capital
26 So how much money do you need? Physical LocationCost of Product / ServiceRent / mortgageFacility maintenanceUtilitiesTransportationWages & SalariesEquipmentSuppliesRaw MaterialsInventory