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Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall

Sources of Financing:Sources of Financing:

Debt and EquityDebt and Equity

Sources of Financing:Sources of Financing:

Debt and EquityDebt and Equity

CHAPTER CHAPTER 1313

Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall 13 - 2

Raising CapitalRaising Capital

Raising capital to launch or expand Raising capital to launch or expand a business is a challenge.a business is a challenge.

Many entrepreneurs are caught in a Many entrepreneurs are caught in a “credit crunch.”“credit crunch.”

Financing needs in the Financing needs in the $100,000 to $3 million $100,000 to $3 million range may be the most range may be the most challenging to fill.challenging to fill.

Ch. 13: Sources of Financing: Debt & Equity


The “Secrets” to The “Secrets” to Successful FinancingSuccessful Financing

1.1. Choosing the right sources of capital is a Choosing the right sources of capital is a decision that will influence a company for decision that will influence a company for a lifetime.a lifetime.

2.2. The money is out there; the key is The money is out there; the key is knowing where to look.knowing where to look.

3.3. Raising money takes time and effort. Raising money takes time and effort.

4.4. Creativity counts. Entrepreneurs have to Creativity counts. Entrepreneurs have to be as creative in their searches for capital be as creative in their searches for capital as they are in developing their business as they are in developing their business ideasideas. .



The “Secrets” to The “Secrets” to Successful FinancingSuccessful Financing

5.5. The Internet puts at entrepreneur’s The Internet puts at entrepreneur’s fingertips vast resources of information fingertips vast resources of information that can lead to financing. that can lead to financing.

6.6. Be thoroughly prepared before Be thoroughly prepared before approaching lenders and investors. approaching lenders and investors.

7.7. Entrepreneurs should not underestimate Entrepreneurs should not underestimate the importance of making sure that the the importance of making sure that the “chemistry” among themselves, their “chemistry” among themselves, their companies, and their funding sources companies, and their funding sources is good. is good.

(continued)



Financing a BusinessFinancing a Business

Entrepreneurs must cast a Entrepreneurs must cast a wide net to capture the wide net to capture the financing they need to financing they need to launch their businesses.launch their businesses.

Layered financing – piecing Layered financing – piecing together capital from together capital from multiple sources. multiple sources.



Three Types of CapitalThree Types of Capital

1.1. FixedFixed - Used to purchase the permanent - Used to purchase the permanent or fixed assets of the business (e.g., or fixed assets of the business (e.g., buildings, land, equipment, and others).buildings, land, equipment, and others).

2.2. WorkingWorking - Used to support the small - Used to support the small company's normal short-term operations company's normal short-term operations (e.g., buy inventory, pay bills, wages, or (e.g., buy inventory, pay bills, wages, or salaries, and others).salaries, and others).

3.3. GrowthGrowth - Used to help the small business - Used to help the small business expand or change its primary direction.expand or change its primary direction.

Capital is any form of wealth employed Capital is any form of wealth employed to produce more wealth for a firm.to produce more wealth for a firm.


In addition to the text


Equity CapitalEquity Capital

Represents the personal investment of Represents the personal investment of the owner(s) in the business.the owner(s) in the business.

Is called Is called risk capital risk capital because investors because investors assume the risk of losing their money assume the risk of losing their money if the business fails.if the business fails.

Does Does notnot have to be repaid have to be repaid with interest like a loan does.with interest like a loan does.

Means that an entrepreneur Means that an entrepreneur must give up some ownership must give up some ownership in the company to outside investors.in the company to outside investors.



Debt CapitalDebt Capital

Must be repaid with interest.Must be repaid with interest.

Is carried as a liability on the Is carried as a liability on the company’s balance sheet.company’s balance sheet.

Can be just as difficult to secure as equity Can be just as difficult to secure as equity financing, even though sources of debt financing, even though sources of debt financing are more numerous.financing are more numerous.

Can be expensive, especially for small Can be expensive, especially for small companies, because of the risk/return companies, because of the risk/return tradeoff.tradeoff.



Sources of Equity FinancingSources of Equity Financing

Personal savingsPersonal savings



Personal SavingsPersonal Savings

The The firstfirst place an entrepreneur should place an entrepreneur should look for money. look for money.

The most common source The most common source of equity capital for starting of equity capital for starting a business.a business.

Outside investors and lenders expect Outside investors and lenders expect entrepreneurs to put some of their entrepreneurs to put some of their own capital into the business own capital into the business beforebefore investing theirs.investing theirs.




Personal savingsPersonal savings Friends and family membersFriends and family members


(continued)


Friends and Family MembersFriends and Family Members

After emptying their own pockets, After emptying their own pockets, entrepreneurs should turn to entrepreneurs should turn to those most likely to invest in the those most likely to invest in the business: friends and family business: friends and family members.members.

Be careful! Inherent dangers Be careful! Inherent dangers lurk in family/friendly business lurk in family/friendly business deals, deals, especiallyespecially those that flop. those that flop.



Friends and Family MembersFriends and Family MembersGuidelines for family and friendship financing:Guidelines for family and friendship financing: Consider the impact of the investment on everyone Consider the impact of the investment on everyone

involved.involved. Keep the arrangement “strictly business.”Keep the arrangement “strictly business.” Prepare a business plan. Prepare a business plan. Settle the details up front.Settle the details up front. Never accept more than investors Never accept more than investors

can afford to lose. can afford to lose. Create a written contract.Create a written contract. Treat the money as “bridge financing.” Treat the money as “bridge financing.” Develop a payment schedule that suits both parties. Develop a payment schedule that suits both parties. Have an exit plan. Have an exit plan.




Personal savingsPersonal savings Friends and family membersFriends and family members AngelsAngels


(continued)


AngelsAngels

Wealthy individuals who invest in emerging Wealthy individuals who invest in emerging entrepreneurial companies in exchange for entrepreneurial companies in exchange for equity )ownership) stakes.equity )ownership) stakes.

An excellent source of “patient money” for An excellent source of “patient money” for investors needing relatively small amounts investors needing relatively small amounts of capital typically ranging from $100,000 of capital typically ranging from $100,000 (sometimes less) to as much as $5 million.(sometimes less) to as much as $5 million.

Willing to invest in the early stages of a Willing to invest in the early stages of a business. business.



AngelsAngels

An estimated 258,000 angels across An estimated 258,000 angels across the U.S. invest $26 billion a year in the U.S. invest $26 billion a year in 57,000 small companies. 57,000 small companies.

Their investments exceed those of Their investments exceed those of venture capital firms, providing more venture capital firms, providing more capital to 15 times as capital to 15 times as many small companies.many small companies.

Angels fill a gap in the seed capital Angels fill a gap in the seed capital market, specifically in the $10,000 to $2 market, specifically in the $10,000 to $2 million range.million range.



AngelsAngels

Average angel investment = $50,000.Average angel investment = $50,000.

Typical angel invests in 1 company per year, Typical angel invests in 1 company per year, and the average time to close a deal is 67 and the average time to close a deal is 67 days. days.

52% of angels’ investments lose money, but 52% of angels’ investments lose money, but 7% produce a return more than 10 times 7% produce a return more than 10 times their original investment. their original investment.

Angels can be an excellent source of Angels can be an excellent source of “patient” money. “patient” money.



AngelsAngels

The Challenge: Finding Them! The Challenge: Finding Them! NetworkNetwork Look nearby: within a 50- to 100-mile Look nearby: within a 50- to 100-mile

radiusradius 7 out of 10 angels invest in companies that are 7 out of 10 angels invest in companies that are

within 50 miles of their homes or offices. within 50 miles of their homes or offices.

Informal angel “clusters” and networksInformal angel “clusters” and networks 265 angel groups across the U.S. 265 angel groups across the U.S. Internet Internet


Copyright © 2011 Pearson Education, Inc. Publishing as Prentice HallCh. 13: Sources of Financing: Debt & Equity

FIGURE 13.1 Angel Financing Source: Center for Venture Financing, Whittemore School of Business,

University of New Hampshire, www.unh.edu/cvr.

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Personal savingsPersonal savings Friends and family membersFriends and family members AngelsAngels PartnersPartners


(continued)


PartnersPartners

Giving up personal controlGiving up personal control Diluting ownershipDiluting ownership Sharing profitsSharing profits ““For every penny you get in the door, For every penny you get in the door,

you have to give something up.”you have to give something up.”




Personal savingsPersonal savings Friends and family membersFriends and family members AngelsAngels PartnersPartners Venture capital companiesVenture capital companies


(continued)


FIGURE 13.2 Venture Capital FundingSource: Based on PriceWaterhouseCoopers http:/www.pwcmoneytree.com.



Venture Capital CompaniesVenture Capital Companies More than 740 venture capital firms More than 740 venture capital firms

operate across the U.S. operate across the U.S.

Most venture capitalists seek Most venture capitalists seek investments in the $3 million to $10 investments in the $3 million to $10 million range million range

Target companies with high-growth and Target companies with high-growth and high-profit potential. high-profit potential.

Business plans are subjected to an Business plans are subjected to an extremelyextremely rigorous review - less than 1% rigorous review - less than 1% accepted.accepted.



Venture Capital CompaniesVenture Capital Companies

Most often, venture capitalists invest in Most often, venture capitalists invest in a company across several stages.a company across several stages.

On average, 98% of venture capital goes On average, 98% of venture capital goes to:to: Early stage investments (companies in Early stage investments (companies in

the early stages of development).the early stages of development). Expansion stage investments (companies Expansion stage investments (companies

in the rapid growth phase).in the rapid growth phase). Only 2% of venture capital goes to Only 2% of venture capital goes to

businesses in the startup or seed phase. businesses in the startup or seed phase.


(continued)


FIGURE 13.4 Angel Investing and Venture Capital InvestingSource: Robert Wiltbank and Warren Bocker, Returns to Angel Investors in Groups, Angel Capital Education Foundation, http://www.kauffman.org/Details.aspx?id=1032, and PWC Moneytree Report, Pricewaterhouse Coopers, https://www.pwcmonnneytree.com/MTPublic/nc/indes.jsp.

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What Do Venture CapitalWhat Do Venture CapitalCompanies Look For?Companies Look For?

Competent managementCompetent management Competitive edgeCompetitive edge Growth industryGrowth industry Viable exit strategyViable exit strategy Intangibles factorsIntangibles factors


Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall 13 - 29Ch. 13: Sources of Financing: Debt & Equity

FIGURE 13.5 Which Factors Are Most Important to Venture Capitalists?Source: Dee Powers and Brian E. Hill, Venture Capital Survey, The Capital Connection, http//www.capital-connection.com/survey-value.html.



Personal savingsPersonal savings Friends and family membersFriends and family members AngelsAngels PartnersPartners Venture capital companiesVenture capital companies Corporate venture capitalCorporate venture capital


(continued)


Corporate Venture CapitalCorporate Venture Capital

About 300 large corporations across About 300 large corporations across the globe invest in start-up companies.the globe invest in start-up companies.

Approximately 6 to 8% of all venture Approximately 6 to 8% of all venture capital invested is from corporations. capital invested is from corporations.

Capital infusions are just one benefit; Capital infusions are just one benefit; corporate partners may share corporate partners may share marketing and technical expertise. marketing and technical expertise.




Personal savingsPersonal savings Friends and family membersFriends and family members AngelsAngels PartnersPartners Venture capital companiesVenture capital companies Corporate venture capitalCorporate venture capital Public stock sale – “going public” Public stock sale – “going public”


(continued)


Going PublicGoing Public

Initial public offering (IPO) - when a Initial public offering (IPO) - when a company raises capital by selling company raises capital by selling shares of its stock to the public for shares of its stock to the public for the first time. the first time.

Since 2000, the average number of Since 2000, the average number of companies making IPOs each year is companies making IPOs each year is 173.173.

Few companies with less than $25 Few companies with less than $25 million in annual sales make IPOs. million in annual sales make IPOs.


Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall 6 - 34Ch. 6: Franchising and the Entrepreneur

FIGURE 13.6 Initial Public Offerings (IPOs) Source: Thompson Financial Securities Data.


Successful IPO Candidates Successful IPO Candidates Have…Have…

Consistently high growth ratesConsistently high growth rates

Strong record of earningsStrong record of earnings

3 to 5 years of audited financial statements 3 to 5 years of audited financial statements that meet or exceed SEC standardsthat meet or exceed SEC standards

Solid position in a rapidly-growing industry: Solid position in a rapidly-growing industry: Average company age is 14 yearsAverage company age is 14 years

Sound management team with experience Sound management team with experience and a strong board of directorsand a strong board of directors



Advantages of Advantages of “Going Public”“Going Public”

Ability to raise large amounts of capitalAbility to raise large amounts of capital

Improved corporate imageImproved corporate image

Improved access to future financingImproved access to future financing

Attracting and retaining key employeesAttracting and retaining key employees

Using stock for acquisitionsUsing stock for acquisitions

Listing on a stock exchangeListing on a stock exchange




Disadvantages of Disadvantages of “Going Public”“Going Public”

Dilution of founder’s ownershipDilution of founder’s ownership

Loss of controlLoss of control

Loss of privacyLoss of privacy

Reporting to the SECReporting to the SEC

Filing expensesFiling expenses

Accountability to shareholdersAccountability to shareholders

Pressure for short-term performancePressure for short-term performance

Timing Timing




TimeTime ActionAction

Week 1Week 1 Conduct organizational meeting with IPO team, including underwriter, attorneys, accountants, and others. Begin drafting registration statement.

Week 5Week 5 Distribute first draft of registration statement to IPO team and make revisions.

Week 6Week 6 Distribute second draft of registration statement and make revisions.

Week 7Week 7 Distribute third draft of registration statement and make revisions.

Week 8Week 8 File registration statement with the SEC. Begin preparing presentations for road show to attract other investment bankers to the syndicate. Comply with Blue Sky laws in states where offering will be sold.

Week 12Week 12 Receive comment letter on registration statement from SEC. Amend registration statement to satisfy SEC comments.

Week 13Week 13 File amended registration statement with SEC. Prepare and distribute preliminary offering prospectus (called a “red herring”) to members of underwriting syndicate. Begin road show meetings.

Week 15Week 15 Receive approval for offering from SEC (unless further amendments are required). Issuing company and lead underwriter agree on final offering price. Prepare, file, and distribute final offering prospectus.

Week 16Week 16 Company and underwriter sign the final agreement. Underwriter issues stock, collects the proceeds from the sale, and delivers proceeds to company.

Timetable for an IPOTimetable for an IPO



The Registration ProcessThe Registration Process

Choose the underwriterChoose the underwriter Negotiate a letter of intentNegotiate a letter of intent Prepare the registration statementPrepare the registration statement File with the SECFile with the SEC Wait to “go effective” and road showWait to “go effective” and road show Meet all state requirementsMeet all state requirements




Personal savingsPersonal savings Friends and family membersFriends and family members AngelsAngels PartnersPartners Venture capital companiesVenture capital companies Corporate venture capitalCorporate venture capital Public stock sale – “going public” Public stock sale – “going public” Simplified registrations and exemptionsSimplified registrations and exemptions


(continued)


Simplified RegistrationsSimplified Registrationsand Exemptionsand Exemptions

Goal: Goal:

To give small companies easy To give small companies easy access to capital markets with access to capital markets with simplified registration simplified registration requirements requirements



Simplified RegistrationsSimplified Registrationsand Exemptionsand Exemptions

Regulation S-BRegulation S-B Regulation D (Rule 504): Small Regulation D (Rule 504): Small

Company Offering Registration (SCOR)Company Offering Registration (SCOR) Regulation D (Rule 505 and 506): Private Regulation D (Rule 505 and 506): Private

PlacementsPlacements Section 4 (6) Private PlacementsSection 4 (6) Private Placements Intrastate Offerings (Rule 147)Intrastate Offerings (Rule 147) Regulation ARegulation A



Sources of Debt CapitalSources of Debt Capital

Commercial banksCommercial banks Lenders of first resort for small Lenders of first resort for small

businessesbusinesses Average micro-business loan = $7,400Average micro-business loan = $7,400 Average small business loan = $181,000Average small business loan = $181,000 Study: 12% of entrepreneurs receive bank Study: 12% of entrepreneurs receive bank

loans to start their businesses. loans to start their businesses.



Sources of Debt Capital Sources of Debt Capital From Commercial BanksFrom Commercial Banks

Short-term loans Short-term loans Home Equity LoansHome Equity Loans Commercial LoansCommercial Loans Lines of CreditLines of Credit Floor planningFloor planning

Immediate and Long-Term LoansImmediate and Long-Term Loans Installment LoansInstallment Loans Term LoansTerm Loans



Six Common Reasons Bankers Six Common Reasons Bankers Reject Small Business LoansReject Small Business Loans

1.1. ““Our bank doesn’t make small business Our bank doesn’t make small business loans.” loans.”

Cure: Before applying for a loan, Cure: Before applying for a loan, research banks to find out which ones research banks to find out which ones seek the type of loan you need. seek the type of loan you need.

2.2. ““I don’t know enough about you or your I don’t know enough about you or your business.”business.”

Cure: Develop a detailed business plan Cure: Develop a detailed business plan to present to the banker. to present to the banker.




3.3. “You haven’t told me why you need the “You haven’t told me why you need the money.” money.”

Cure: Your business plan should explain Cure: Your business plan should explain how much money you need and how you how much money you need and how you plan to use it. plan to use it.

4.4. “Your numbers don’t support your loan “Your numbers don’t support your loan request.”request.”

Cure: Include a cash flow forecast in Cure: Include a cash flow forecast in your business plan. your business plan.

(continued)(continued)





5.5. “You don’t have enough collateral.” “You don’t have enough collateral.” Cure: Be prepared to pledge your Cure: Be prepared to pledge your

company’s assets – and perhaps your company’s assets – and perhaps your personal assets – as collateral for the personal assets – as collateral for the loan. loan.

6.6. “Your business does not support the loan “Your business does not support the loan on its own.”on its own.”

Cure: Be prepared to provide a personal Cure: Be prepared to provide a personal guarantee on the loan. guarantee on the loan.

(continued)(continued)





Asset-Based LendersAsset-Based Lenders

Businesses can borrow money by Businesses can borrow money by pledging as collateral otherwise idle pledging as collateral otherwise idle assets – accounts receivable, assets – accounts receivable, inventory, and othersinventory, and others

Advance rateAdvance rate – the percentage of an – the percentage of an asset’s value that a lender will lend. asset’s value that a lender will lend.



Asset-Based BorrowingAsset-Based Borrowing

Discounting accounts receivableDiscounting accounts receivable

� Inventory financingInventory financing



Other Sources of Debt CapitalOther Sources of Debt Capital

Vendor financing (trade credit)Vendor financing (trade credit)

Equipment suppliersEquipment suppliers

Commercial finance companiesCommercial finance companies

Saving and loan associationsSaving and loan associations

Stock brokersStock brokers



Other Sources of Debt CapitalOther Sources of Debt Capital

Credit unionsCredit unions

Private placementsPrivate placements

Small Business Investment Small Business Investment Companies (SBIC)Companies (SBIC)

Small Business Lending Small Business Lending Companies (SBLCs) Companies (SBLCs)

(continued)



Federally Sponsored ProgramsFederally Sponsored Programs

Economic Development Administration (EDA)Economic Development Administration (EDA)

Department of Housing and Urban Department of Housing and Urban Development (HUD)Development (HUD)

U.S. Department of Agriculture’s Rural U.S. Department of Agriculture’s Rural Business (USDA) - Cooperative ServiceBusiness (USDA) - Cooperative Service

Small Business Innovation Research (SBIR) Small Business Innovation Research (SBIR)

Small Business Technology Transfer Small Business Technology Transfer programs (STTR)programs (STTR)

Small Business Administration (SBA) Small Business Administration (SBA)



SBA Loan ProgramsSBA Loan Programs

Patriot Express ProgramPatriot Express Program

CommunityCommunityExpress Express ProgramProgram

7(A) Loan Guaranty Program7(A) Loan Guaranty Program

Average 7(a) loan = $183,000 Average 7(a) loan = $183,000



FIGURE 13.7 SBA 7(A) Guaranteed Loans Source: U.S Small Business Administration.




Patriot Express ProgramPatriot Express Program

CommunityCommunityExpress Express ProgramProgram

7(A) Loan Guaranty Program7(A) Loan Guaranty Program

Average 7(a) loan = $183,000 Average 7(a) loan = $183,000


Section 504 Certified Development Company Section 504 Certified Development Company ProgramProgram

Microloan ProgramMicroloan Program

Average microloan = $13,000Average microloan = $13,000



The Capline ProgramThe Capline Program Loans involving international tradeLoans involving international trade

Export Working CapitalExport Working Capital

International Trade ProgramInternational Trade Program

Disaster LoansDisaster Loans

(continued)



State and Local Loan ProgramsState and Local Loan Programs

Capital Access Programs (CAPs)Capital Access Programs (CAPs) – –Designed to encourage lenders to make Designed to encourage lenders to make loans to businesses that do not qualify for loans to businesses that do not qualify for traditional financing traditional financing

Revolving Loan Fund (RLFs)Revolving Loan Fund (RLFs) – – Combine private and public funds to make Combine private and public funds to make small business loans small business loans



Internal Methods of FinancingInternal Methods of Financing

Factoring Accounts Receivable – Factoring Accounts Receivable – selling accounts receivable outrightselling accounts receivable outright

Leasing – Leasing – assets rather than buying themassets rather than buying them

Credit cardsCredit cards



FIGURE 13.8 Where Do Small Businesses Get Their Financing?Source: Based on 2008 Survey of Small and Mid-Sized Businesses, National Small Business Association, Washington, DC, 2009.

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Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall

ConclusionConclusion Capital is key for entrepreneurs. Capital is key for entrepreneurs. In the face of a capital crunch, business’s In the face of a capital crunch, business’s

need for capital has never been greater. need for capital has never been greater. Sources of capital may include: Sources of capital may include:

Family and FriendsFamily and Friends Angel InvestorsAngel Investors Initial Public OfferingInitial Public Offering Traditional Bank LoanTraditional Bank Loan Asset-based BorrowingAsset-based Borrowing Federal, SBA Loans, and others Federal, SBA Loans, and others

13 - 60Ch. 13: Sources of Financing: Debt & Equity


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