Obtaining Debt Capital Venture Planning Chapter 16 Dowling Fall 2005.

Obtaining Debt Obtaining Debt CapitalCapital

Venture PlanningVenture PlanningChapter 16Chapter 16

DowlingDowlingFall 2005Fall 2005

Obtaining Debt CapitalObtaining Debt Capital

Sources of debt capitalSources of debt capital Trade creditTrade credit Commercial banksCommercial banks Finance companiesFinance companies FactorsFactors Leasing companiesLeasing companies


Trade creditTrade credit 30-40 percent of current liabilities of 30-40 percent of current liabilities of

nonfinancial companiesnonfinancial companies The smaller the firm, the higher this The smaller the firm, the higher this

percentagepercentage Suppliers offer trade credit to attract new Suppliers offer trade credit to attract new

customerscustomers Bad debt risk is built into pricesBad debt risk is built into prices Costs of trade credit include lost Costs of trade credit include lost

discounts for prompt paymentdiscounts for prompt payment


Commercial Bank FinancingCommercial Bank Financing Generally more readily available to Generally more readily available to

existing businesses with a track record existing businesses with a track record of sales, profits, satisfied customers and of sales, profits, satisfied customers and a current backloga current backlog

Positive cash flow and collateralPositive cash flow and collateral Great importance placed on quality of Great importance placed on quality of

management teammanagement team


Line of credit loansLine of credit loans Agreement setting out maximum loan Agreement setting out maximum loan

balance a bank will allow the borrower for a balance a bank will allow the borrower for a one-year periodone-year period

Used for such seasonal financings as Used for such seasonal financings as inventory buildup and receivables financinginventory buildup and receivables financing

For “prime risk” (financially sound) For “prime risk” (financially sound) companies, lines of credit generally companies, lines of credit generally available at 1 to 2 percent over Fed’s available at 1 to 2 percent over Fed’s rediscount raterediscount rate


Accounts receivable financingAccounts receivable financing Short-term financing involving either Short-term financing involving either

pledge of receivables as collateral for a pledge of receivables as collateral for a loan or the sale of receivables loan or the sale of receivables

Made on a discounted value of the Made on a discounted value of the receivables pledgedreceivables pledged


Time-sales financeTime-sales finance Way of obtaining short-term financing Way of obtaining short-term financing

from long-term installment accounts from long-term installment accounts receivablereceivable

Bank purchases installment contracts at Bank purchases installment contracts at discount rate from their full value and discount rate from their full value and takes as security an assignment of the takes as security an assignment of the manufacturer/dealer’s interest in the manufacturer/dealer’s interest in the conditional sales contractconditional sales contract


Unsecured term loansUnsecured term loans Provide needed growth capital to those Provide needed growth capital to those

that can’t obtain the capital from the that can’t obtain the capital from the sale of stocksale of stock

Substitute for a series of short-term Substitute for a series of short-term loans made with the anticipation of loans made with the anticipation of renewal by both the borrower and the renewal by both the borrower and the lenderlender


Chattel Mortgages and Equipment Chattel Mortgages and Equipment LoansLoans Chattel is any machinery, equipment, or Chattel is any machinery, equipment, or

business property that is made the business property that is made the collateral of a loan in the same way as a collateral of a loan in the same way as a mortgage on real estatemortgage on real estate


Conditional sales contractsConditional sales contracts Effective rate of interest on a conditional Effective rate of interest on a conditional

sales contract is high, running to as high sales contract is high, running to as high as 15-18 percent if the effect of as 15-18 percent if the effect of installment features is consideredinstallment features is considered

Plant improvement loansPlant improvement loans Can be intermediate- and long-term, and Can be intermediate- and long-term, and

are generally secured by first mortgage on are generally secured by first mortgage on that part of the property that is being that part of the property that is being improvedimproved


Commercial finance companiesCommercial finance companies FactoringFactoring Leasing companiesLeasing companies


Managing and orchestrating the Managing and orchestrating the banking relationshipbanking relationship The lending decisionThe lending decision

Need more today than a good relationship Need more today than a good relationship with a loan officer to secure funding. with a loan officer to secure funding. Analysis and documentation are generally Analysis and documentation are generally required.required.


Lending criteriaLending criteria Quality and track record of Quality and track record of

management teammanagement team Historical financial statements show 3-5 Historical financial statements show 3-5

years of profitabilityyears of profitability Well-developed business planWell-developed business plan Analysis of debt capacityAnalysis of debt capacity Ability of company to repay both Ability of company to repay both

principal and interest on timeprincipal and interest on time


After the loan decisionAfter the loan decision Loan restrictionsLoan restrictions

Negative covenantsNegative covenants Positive covenantsPositive covenants


Personal guarantees and the loanPersonal guarantees and the loan When to expect themWhen to expect them

You’re undercollateralizedYou’re undercollateralized You’ve had poor or erratic performanceYou’ve had poor or erratic performance You’ve had management problemsYou’ve had management problems Your relationship with your banker is strainedYour relationship with your banker is strained You have a new loan officerYou have a new loan officer There is turbulence in credit marketsThere is turbulence in credit markets Wave of bad loans made by lending Wave of bad loans made by lending

institutionsinstitutions


Personal guarantees and the loanPersonal guarantees and the loan How to avoid themHow to avoid them

Good to spectacular performanceGood to spectacular performance Conservative financial managementConservative financial management Adequate collateralAdequate collateral Careful management of the balance sheetCareful management of the balance sheet

Obtaining Debt CapitalObtaining Debt Capital The TLC of a banker or other lenderThe TLC of a banker or other lender

Your banker is your partner, not a difficult Your banker is your partner, not a difficult minority shareholderminority shareholder

Be honest and straightforward in sharing Be honest and straightforward in sharing infoinfo

Invite the banker to see your business in Invite the banker to see your business in operationoperation

Always avoid overdrafts, late payments and Always avoid overdrafts, late payments and late financial statementslate financial statements

Answer questions frankly and honestly. Tell Answer questions frankly and honestly. Tell the truth. Lying is illegal and undoubtedly the truth. Lying is illegal and undoubtedly violates covenants.violates covenants.


Beware of leverage: the ROE mirageBeware of leverage: the ROE mirage Leverage creates an unforgiving capital Leverage creates an unforgiving capital

structure and the potential additional structure and the potential additional ROI often is not worth the riskROI often is not worth the risk

Obtaining Debt Capital Venture Planning Chapter 16 Dowling Fall 2005.

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