0 business and personal finance unit 6 chapter 19 © 2007 glencoe/mcgraw-hill


Chapter 19Sources of Funding

What You’ll Learn Section 19.1

Explain the role of entrepreneurs. Differentiate between start-up costs, operating

costs, and reserve funds. Identify sources of personal and private financing. Discuss the options available through bank funding. Identify the factors banks consider to approve

commercial loans. Section 19.2

Describe the function of the Small Business Administration.

Identify alternative sources of funding for a business.


Fast Cash

Q: My family runs a small business. Recently a lot of unexpected expenses came up, and now we need $4,000 in a hurry. We just expanded our business, so we have no cash in reserves. How can we obtain the money?

A: If you have outstanding (unpaid) invoices from customers whom you have billed for your products, you can take those invoices to a bank and borrow against those receivables. If you have orders to fill but need money for supplies, you can speak to a lender about a short-term commercial loan.

Go to finance07.glencoe.com to complete the Standard & Poor’s

Financial Focus activity.

2Business and Personal Finance Unit 6 Chapter 19 © 2007 Glencoe/McGraw-Hill


Is every business owner an entrepreneur?


Main IdeaTo start or expand a business, you must accurately estimate the amount of funding you will need.

Section 19.1 Analyzing Financial Needs



Starting a New BusinessIn all business operations, you will need:

Cash Equipment Supplies Goods or services to sell



Business EntrepreneursEntrepreneurs are highly motivated people who transform ideas for products or services into real-world business.

Entrepreneurs are the backbone of the American economy.

entrepreneur

an individual who takes the risk of starting a new business



High School EntrepreneursIt is possible for a high school student to start his or her own business.

For example, Fred DeLuca, who created Subway, is one successful entrepreneur who started his business shortly after graduating from high school.



Funding a BusinessPeople who take on business ventures usually need far more money than they realize.

It is not easy to get funding for a new building from an outside source. Banks and other financial institutions:

Are very selective about who receives loans

Expect to get a good return on their investment



Determining Needed CapitalWhen you are starting a business, the first thing you must do is make a realistic estimate of how much capital you will need.

Capital is the money you need to: Establish a business. Operate it for the first few months. Expand the business.



Start-Up CostsThe first goal in determining needed capital is to identify start-up costs. To analyze your costs, you should:

List everything you will require to begin to operate.

Assign an estimated cost to each item.

Make sure you research and explore the industry you are entering.



Common Start-Up Costs

Most businesses have some common start-up costs: Inventory needed to open the business Equipment, fixtures, and display cases Security deposit for rented space Advertising and promotions Insurance Professional fees (such as lawyers’ fees) Remodeling costs (such as creating office

space) Legal permits and licenses Supplies



Operating CostsBusinesses have a number of common operating costs:

Payroll Rent Insurance premiums Utility bills Office expenses Advertising Delivery charges Bank charges and other fees

operating costs

the ongoing expenses for operating a business



Reserve FundBefore starting a business, you will also have to estimate the amount of money you may need at a later date for growth.

You may need this money in your reserve fund to:

Purchase merchandise or equipment. Lease a truck. Allow for growth. Help you avoid having to borrow

additional capital.

reserve fund

money that can be made available for the future expansion of a business



Other Reserve Fund Expenses

Other expenses that you may need to consider when looking ahead and estimating a reserve fund include:

Additional equipment for increased business Advertising and other promotional costs Capital for any unexpected costs or

decreased sales Maintaining a positive cash flow Expansion of facilities Getting and keeping the right amount of

inventory



Personal and Private FinancingGetting affordable and sufficient financing is often a major problem when starting or expanding a business.

However, there are many sources of funding available for businesses.


LOCATION, LOCATION Besides having a great idea for a business, you must also find somewhere to operate it. What features would you look for when choosing a location for a local business?



Personal FinancingWhen starting a small business, you may have to rely on your own assets to finance the start-up and operating costs. You might use:

Your personal savings Investments such as stocks or bonds Loans from family members and friends

With these sources of capital, you may not have enough cash to get the business going.



Consumer Loans

In order to get the funds you need, consider applying for a consumer loan.

Most financial institutions require that consumer loans be secured with collateral, which:

Reduces the risk to the bank Gives you a much better chance at

getting funding Allows you receive better interest rates



Home Equity Loans

A home equity loan is a loan based on the difference between:

The current market value of a home The amount still owed on the mortgage

Since you will lose your home if your business fails, you should think seriously before you finance your business with a home equity loan.



Private FinancingIf you cannot get enough capital through personal financing, your next option might be private financing.

This type of funding is attractive because it: Involves little paperwork Often requires no collateral and low, or

no, interest payments

The disadvantage is that it can lead to personal conflicts if you are unable to repay the loan.

private financing

borrowing money from family or friends



Bank FundingIf personal and private financing are insufficient, you may have to apply for a business loan to get additional money.

A few of your options are: Commercial debt financing Commercial loan

You may want to consider local banks rather than larger banks when getting a commercial loan.

commercial debt financing

borrowing money from a bank or other financial institution to fund a business

commercial loan

a loan that finances a new or ongoing business



Funding from Local Banks

Getting funding from local banks has both advantages and disadvantages. Advantages might include:

They are highly experienced in dealing with small businesses.

They offer a wide variety of loan plans. They offer advice and other business

services. They are community-oriented and are

interested in seeing local businesses succeed.



Disadvantages of Funding from Local Banks

Disadvantages of receiving a loan from a local bank might include:

They are closely regulated by the government.

There is extensive paperwork, investigation, and documentation involved in the loan process.

They are conservative by nature and may reject your loan if your business appears too risky.



Short-Term Commercial LoansA short-term commercial loan is a business loan that is usually made for a term of one year or less.

These loans are typical for small businesses and are designed to:

Help the business meet short-term financial obligations

Help with cash flow during a specific time or season



Long-Term Commercial LoansA long-term commercial loan is a business loan that is made for a term of one to five years.

These loans are normally used by larger, established businesses that require great amounts of funding. They may use the funds for:

Expensive equipment The relocation of facilities The expansion of storage areas Other major expenses



Lines of CreditA line of credit makes funds available for:

Unexpected costs Routine expenses

The main advantage of this type of funding is that you do not pay any interest unless you access the funds.

Once you borrow an amount from the line of credit, the bank will:

Charge you interest Expect you to repay the money in a short

period of time

line of credit

an arrangement in which bank customers can borrow a certain amount of money from the bank immediately



Secured and Unsecured LoansBecause banks must be conservative in their loan policies, most business loans are secured loans.

Only a well-established, profitable business that has a good relationship with a bank can obtain unsecured loans.

An unsecured loan is usually: Short-term Subject to a higher interest rate

secured loan

a loan that is backed by collateral

unsecured loan

a loan that does not require collateral from the borrower



Commercial Loan ApplicationsBanks use certain standards to:

Judge a company’s financial position Determine how much risk to accept

Banks are conservative and selective as to which businesses they approve for financing.



The Five C’s of CreditIf you apply for a commercial loan, the bank will first examine the five C’s of credit:

Character Capacity Capital Collateral Credit history


Paid in FullWhen you get your first credit card, use it wisely. Decide how much you can afford to charge each month and stick to that budget. Be sure to pay your bill in full every month. If you do, you will avoid high interest charges and save.How would good use of personal credit cards help you in starting up a business in the future?

Business and Personal Finance Unit 6 Chapter 19 © 2007 Glencoe/McGraw-Hill



Business PlanThe bank will also examine your business plan to make sure that:

Your business is financially sound. You have a clear vision of where you

want your business to go. You have identified the necessary steps

to achieve your goals.

Banks often base loan decisions on the business plan.


What advantages might the federal government receive by operating the Small Business Administration (SBA)?


Main IdeaEntrepreneurs can get funding through the help of the Small Business Administration and other sources.

Section 19.2 Sources of Funding



Small Business AdministrationThe federal government recognizes the importance of small businesses in the American economy and, therefore, provides assistance to them.

The Small Business Administration (SBA) has services that include:

Management training Organizational guidance Assistance in getting funding

Small Business Administration (SBA)

an independent agency of the federal government that offers assistance to people who are starting small businesses and to those who want to expand existing businesses



SBA Guaranteed LoansThe most common type of SBA loan is obtained through the Guaranteed Loan Program. With this kind of loan, the SBA:

Examines your application Approves the loan Authorizes the bank to give you the

funding Guarantees a major portion of the loan

With this guarantee by the federal government, banks are more willing to grant funding to a small business.



LowDoc ProgramIn the past many people were frustrated by:

The amount of paperwork The time it took to process loan

applications through the SBA

In response, the SBA introduced the LowDoc Program in 1993.

LowDoc Program

a government loan program that allows businesses applying for loans of less than $150,000 to submit a one-page application with a small amount of documentation



Other Sources of FundingYou can also get funding through:

A business credit card Private investors Commercial finance companies Venture capital firms State and local governments



Business Credit CardThe use of business credit cards has become a major source of short-term financing for small businesses.

You can get a business credit card through: Visa MasterCard American Express

Business credit cards are good for emergencies, but balances should be paid as quickly as possible.

business credit card

a credit card that is issued to a business rather than to an individual



Private InvestorsPrivate investors:

Will usually leave the management of the business to the owner

Are interested in getting a good return on their money

May want a share of ownership

If you cannot locate private investors in your area, the SBA may be able to help.

private investor

a person outside an entrepreneur’s circle of friends and relatives who provides funding because he or she is interested in helping a new business to succeed



Commercial Finance CompaniesCommercial finance companies insist that all loans be secured with collateral, such as:

Equipment Inventory

These companies are helpful to existing businesses that need short-term financing.

commercial finance company

a firm that lends money only to businesses



Venture Capital FirmsVenture capital firms will lend money to high-risk small businesses but often expect a large return of 25 to 40 percent on their investment.

Since venture capital firms are investing in your business, they will:

Expect to have a voice in major business decisions

Examine a business’s financial position carefully throughout the year

venture capital firm

a company that provides private funding for small businesses that need a substantial amount of immediate cash



Small Business Investment Companies

Most venture capital firms are private, but the SBA created a public venture capital program called the Small Business Investment Company Program.

The advantages in dealing with the SBIC program are that:

The SBA regulates lenders. Financing terms must meet SBA

guidelines.

Small Business Investment Companies (SBICs)

private investment firms that work with the SBA to provide longer-term funding for small businesses



State and Local FundingMany states provide opportunities for small businesses to get funding through a variety of programs.

These funding programs are available in cities where local and state governments are encouraging individuals to open businesses in economically depressed neighborhoods.



Funding Your DreamsThe American economy has been built by entrepreneurs who were willing to:

Take risks Explore new ventures

The funding of small businesses is essential to the American economy.



Key Term Review entrepreneur operating costs reserve fund private financing commercial debt financing commercial loan line of credit secured loan unsecured loan Small Business Administration (SBA) LowDoc Program

business credit card private investor commercial finance company venture capital firm Small Business Investment

Companies (SBICs)



Reviewing Key Concepts1. Explain why entrepreneurs are considered part of the

backbone of the American economy.

Entrepreneurs are highly motivated people who transform ideas for

products or services into real-world business.

Almost all of the nation’s Fortune 500 companies started as small

businesses.



Reviewing Key Concepts2. Identify some differences between start-up costs, operating

costs, and reserve funds.

Start-up costs include money for the purchase of assets needed

to run a business.

Operating capital is the money needed to operate a business for

the first few years.

Reserve capital is money set aside for unexpected costs or

opportunities.



Reviewing Key Concepts3. Explain the pros and cons of taking out a home equity loan

to start a business.

Home equity loans are: Fairly safe for financial institutions because they are

secured by property Easier to get than consumer loans

You may lose your home if your business fails and you are unable

to repay your loan.



Reviewing Key Concepts4. List one advantage and one disadvantage of secured loans,

unsecured loans, and lines of credit.

A secured loan is a loan that is backed by collateral.

An unsecured loan is a loan that does not require collateral from

the borrower.

A line of credit is an arrangement in which bank customers can

borrow a certain amount of money from the bank immediately.

The main advantage of this type of funding is that you do not pay

any interest unless you access the funds.



Reviewing Key Concepts5. Describe the five C’s of credit and how they apply to a

business loan.

If you apply for a commercial loan, the bank will first examine the

five C’s of credit: Character Capacity Capital Collateral Credit history



Reviewing Key Concepts6. List one reason that loans guaranteed by the Small

Business Administration are a win-win situation for the entrepreneur and the lending institution.

The federal government recognizes the importance of small

businesses in the American economy and, therefore, provides

assistance to them.



Reviewing Key Concepts7. Explain the role of a venture capital firm.

Since venture capital firms are investing in your business, they

will: Expect to have a voice in major business decisions. Examine a business’s financial position carefully

throughout the year.


Newsclip: Finding CapitalTo be your own boss, you need to find capital for starting up your

business. There are more options available to entrepreneurs

today than in the past.

Log On Go to finance07.glencoe.com and open Chapter 19.

Learn about different options to help you find the funding needed

to start a new business. Write a paragraph about which option you

would choose and why.

0 business and personal finance unit 6 chapter 19 © 2007 glencoe/mcgraw-hill

Documents