Chapter 11: Sources of Funds1 Copyright 2002 Prentice Hall Publishing Company Sources of Funds:...

Chapter 11: Sources of Funds 1Copyright 2002 Prentice Hall Publishing Company

Sources of Funds:Equity and Debt

Sources of Funds:Equity and Debt


The “Secrets” to Successful The “Secrets” to Successful FinancingFinancing

1. Choosing the right sources of capital is a 1. Choosing the right sources of capital is a decision that will influence a company for a decision that will influence a company for a lifetime.lifetime.

2. The money is out there; the key is knowing 2. The money is out there; the key is knowing where to look.where to look.

3. Creativity counts. Entrepreneurs have to be as 3. Creativity counts. Entrepreneurs have to be as creative in their searches for capital as they are creative in their searches for capital as they are in developing their business ideas.in developing their business ideas.


The “Secrets” to Successful The “Secrets” to Successful FinancingFinancing

(continued)(continued)

4. The World Wide Web puts at entrepreneur’s 4. The World Wide Web puts at entrepreneur’s fingertips vast resources of information that fingertips vast resources of information that can lead to financing. can lead to financing.

5. Be thoroughly prepared before approaching 5. Be thoroughly prepared before approaching lenders and investors. lenders and investors.

6. Entrepreneurs should not underestimate the 6. Entrepreneurs should not underestimate the importance of making sure that the importance of making sure that the “chemistry” between themselves, their “chemistry” between themselves, their companies, and their funding sources is a good companies, and their funding sources is a good one. one.


Three Types of CapitalThree Types of Capital

FixedFixed - used to purchase the permanent or - used to purchase the permanent or fixed assets of the business (e.g., buildings, land, fixed assets of the business (e.g., buildings, land, equipment, etc.)equipment, etc.)

WorkingWorking - used to support the small company’s - used to support the small company’s normal short-term operations (e.g., buy normal short-term operations (e.g., buy inventory, pay bills, wages, salaries, etc.)inventory, pay bills, wages, salaries, etc.)

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.

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


Equity CapitalEquity Capital

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

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

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

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


Sources of Equity Sources of Equity FinancingFinancing

Personal savingsPersonal savings Friends and family membersFriends and family members AngelsAngels PartnersPartners CorporationsCorporations Venture capital companiesVenture capital companies Public stock salePublic stock sale


Personal SavingsPersonal Savings

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

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

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


Friends and Family MembersFriends and Family Members

After emptying her own pockets, an After emptying her own pockets, an entrepreneur should turn to those entrepreneur should turn to those most likely to invest in the business most likely to invest in the business –– friends and family members.friends and family members.

Survey: 10% of business owners turn Survey: 10% of business owners turn to family and friends for capital. to family and friends for capital.

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


Friends and Family MembersFriends and Family Members

Guidelines for Family and Friendship Guidelines for Family and Friendship Financing Deals:Financing Deals: Consider the impact of the investment on Consider the impact of the investment on

everyone involved. Keep the arrangement everyone involved. Keep the arrangement “strictly business.”“strictly business.”

Settle the details up front.Settle the details up front. 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 Develop a payment schedule that suits both

parties. parties.


AngelsAngels

Angels - private investors who back Angels - private investors who back emerging entrepreneurial companies emerging entrepreneurial companies with their own money.with their own money.

Fastest growing segment of the small Fastest growing segment of the small business capital market. business capital market.

An excellent source of “patient money” An excellent source of “patient money” for investors needing relatively small for investors needing relatively small amounts of capital – often less than amounts of capital – often less than $500,000.$500,000.


AngelsAngels

Key: finding them! Key: finding them! Angels almost always invest their money Angels almost always invest their money

locally and can be found through locally and can be found through “networks.”“networks.”

The typical angel accepts 30% of the The typical angel accepts 30% of the proposals presented to him and has proposals presented to him and has invested an average of $131,000 in 3.5 invested an average of $131,000 in 3.5 businesses. businesses.


Angel ProfileAngel Profile

47 year old white male earning $100,000 a year47 year old white male earning $100,000 a year College educatedCollege educated Net worth of $1 millionNet worth of $1 million Typically accepts 30% of the companyTypically accepts 30% of the company Averages 2 investments a yearAverages 2 investments a year


Corporate Venture CapitalCorporate Venture Capital

30% of all venture capital investments 30% of all venture capital investments come from corporations.come from corporations.

About 900 large corporations across the About 900 large corporations across the globe invest in start-up companies.globe invest in start-up companies.

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


Venture Capitalist CompaniesVenture Capitalist Companies

More than 3,000 venture capital firms More than 3,000 venture capital firms operate across the United States. operate across the United States.

Most venture capitalists seek investments Most venture capitalists seek investments in the $3,000,000 - $10,000,000 range in in the $3,000,000 - $10,000,000 range in companies with high-growth and high-companies with high-growth and high-profit potential. profit potential.

Business plans are subjected to an Business plans are subjected to an extremely rigorous review extremely rigorous review –– less than 1% less than 1% accepted.accepted.


Venture Capitalist CompaniesVenture Capitalist Companies

Most venture capitalists take an active Most venture capitalists take an active role in managing the companies in which role in managing the companies in which they invest.they invest.

Many venture capitalists focus their Many venture capitalists focus their investments in specific industries with investments in specific industries with which they are familiar.which they are familiar.

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

Venture Capital Financing

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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”Intangibles”


Going PublicGoing Public

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

Typical year: about 550 companies make Typical year: about 550 companies make IPOs.IPOs.

Few companies with sales below $10 Few companies with sales below $10 million in annual sales make IPOs. million in annual sales make IPOs.

Initial Public Offerings

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

Ability to raise large amounts of Ability to raise large amounts of capitalcapital

Improved corporate imageImproved corporate image Improved access to future financingImproved access to future financing Attracting and retaining key Attracting and retaining key

employeesemployees Using stock for acquisitionsUsing stock for acquisitions Listing on a stock exchangeListing on a stock exchange


Disadvantages of “Going Public”Disadvantages of “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 Pressure for short-term

performanceperformance TimingTiming


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”Wait to “go effective” Meet state requirementsMeet state requirements


Simplified RegistrationsSimplified Registrationsand Exemptionsand Exemptions

Regulation S-BRegulation S-B Regulation D: Rule 504 - Small Company Regulation D: Rule 504 - Small Company

Offering Registration (SCOR)Offering Registration (SCOR) Regulation D: Rule 505 and 506Regulation D: Rule 505 and 506 Section 4 (6)Section 4 (6)


Simplified RegistrationsSimplified Registrationsand Exemptionsand Exemptions


Rule 147 (Intrastate offerings)Rule 147 (Intrastate offerings) Regulation ARegulation A Direct Stock Offering on the World Wide Direct Stock Offering on the World Wide

Web (WWW)Web (WWW) Foreign Stock MarketsForeign Stock Markets


Debt FinancingDebt Financing

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 Can be just as difficult to secure as

equity financing, even though sources equity financing, even though sources of debt financing are more numerous.of debt 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 Debt CapitalSources of Debt Capital

Commercial banksCommercial banks


Commercial BanksCommercial Banks

Short-term loansShort-term loans Commercial loansCommercial loans Lines of creditLines of credit Floor planningFloor planning

Intermediate and long-term Intermediate and long-term loansloans Installment loans and contractsInstallment loans and contracts

...the heart of the financial market for small ...the heart of the financial market for small

businesses!businesses!



Commercial banksCommercial banks Asset-based lendersAsset-based lenders


Asset-Based BorrowingAsset-Based Borrowing

Discounting accounts Discounting accounts receivablereceivable

AccountsReceivable

Inventory financingInventory financing



Commercial banksCommercial banks

Trade creditTrade credit Equipment suppliersEquipment suppliers Commercial finance companiesCommercial finance companies Saving and loan associationsSaving and loan associations

Asset-based lendersAsset-based lenders $$



Stock brokerage housesStock brokerage houses Insurance companiesInsurance companies Credit unionsCredit unions BondsBonds Private placementsPrivate placements Small Business Investment Companies Small Business Investment Companies

(SBICs)(SBICs) Small Business Lending Companies Small Business Lending Companies

(SBLCs)(SBLCs)




Economic Development Administration (EDA)Economic Development Administration (EDA) Department of Housing and Urban Development Department of Housing and Urban Development

(HUD)(HUD) U.S. Department of Agriculture’s Rural Business-U.S. Department of Agriculture’s Rural Business-

Cooperative ServiceCooperative Service Local Development Companies (LDCs)Local Development Companies (LDCs) Small Business Innovation Research (SBIR) Small Business Innovation Research (SBIR) Small Business Technology Transfer programsSmall Business Technology Transfer programs Small Business Administration (SBA)Small Business Administration (SBA)

(concluded)(concluded)

Federally Sponsored Programs:Federally Sponsored Programs:


Small Business Administration Small Business Administration Loan ProgramsLoan Programs

Low Doc Loan ProgramLow Doc Loan Program SBASBAExpressExpress Program Program 7(A) Loan Guarantee Program – the 7(A) Loan Guarantee Program – the

most popular SBA loan programmost popular SBA loan program CAPLine ProgramCAPLine Program International Trade ProgramsInternational Trade Programs

Export Working Capital ProgramExport Working Capital Program International Trade ProgramInternational Trade Program


SBA Loan ProgramsSBA Loan Programs

Section 504 Certified Development Section 504 Certified Development Company ProgramCompany Program

Microloan ProgramMicroloan Program Prequalification Loan ProgramPrequalification Loan Program Disaster LoansDisaster Loans 8(A) Loan Program8(A) Loan Program


State and Local Loan ProgramsState and Local Loan Programs

Capital Access Programs (CAPs) – now Capital Access Programs (CAPs) – now offered in 22 states and are designed to offered in 22 states and are designed to encourage lenders to make loans to encourage lenders to make loans to businesses that do not qualify for businesses that do not qualify for traditional financing. traditional financing.

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


Internal Methods of FinancingInternal Methods of Financing

Factoring - selling accounts receivable Factoring - selling accounts receivable outrightoutright

Leasing assets rather than buying themLeasing assets rather than buying them Credit cardsCredit cards

Chapter 11: Sources of Funds1 Copyright 2002 Prentice Hall Publishing Company Sources of Funds:...

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