Post on 24-Dec-2015
Small Business Finance: Using Equity, Debt,
and Gifts
Chapter 15
© 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
© 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Learning Objectives
LO1 Describe the three types of capital financing and their costs and trade-offs.
LO2 Explain the characteristics of a business that determine its ability to raise capital.
LO3 Explain which type of financing is best for your business.
LO4 Describe the differing needs for financial management at each stage of business life.
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© 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Sources of Financing for Small Businesses
The number one source is from the owners (or potential owners) themselves.
The other major sources include family and friends, credit cards, trade credit, banks, and other commercial lenders.
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Sources of Financing for Small Businesses
Debt A legal obligation to pay money in the future.
Equity capital Money contributed to the businesses in return
for part ownership of the business.
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Sources of Financing for Small Businesses
Gift Valuable assets or services donated to the
business without any obligation to repay or give up any ownership interest.
Debt capital Money borrowed for the purpose of investment
in a business.
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Use of Debt and Equityin Start-Ups from the PSED
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Figure 15.1
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Financing with Equity
Outside equity Money from selling part of your business to
people who are not and will not be involved in the management of the business.
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Legal Forms of Business
Partnership Two or more people
cooperating to conduct a business enterprise.
Corporation A legal “artificial”
entity that is formed by filing specific documents with a state government.
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Legal Forms of Business
Limited liability company (LLC) A legal form of business organization that is
created by filing required documentation with a state government.
Have a choice, under federal tax law, of being taxed as either corporations or partnerships.
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Legal Forms of Business
Limited partnership A legal form of business organization that is
created by filing required documentation with a state government
One or more partners may have no liability for the debts and actions of the partnership.
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Legal Forms of Business
Sole proprietorship A business owned by a single individual who is
responsible for all debts and claims against the business.
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Legal Forms of Business
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Getting Equity Investmentfor Your Business
Interest A charge for the use
of money, usually figured as a percentage of the principal.
Dividends Payments of profits
to the owners of corporations.
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Getting Equity Investmentfor Your Business
Gain on investment The percentage amount that the payout of an
investment differs from original cost Calculated as (payout − investment + dividends)/
investment.
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Equity Capital from the Investor’s View
Risk The level of probability that an investment will
not produce expected gains.Diversify
To invest in multiple investments of differing risk profiles for the purpose of reducing overall investment risk.
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Equity Capital from the Investor’s View
Owners and investors want to make money Lenders expect a return on this money
To get money from other people, you’ve got to show them that your business probably can make gains for them
Growth potential is a primary concern for equity investors
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Methods to Obtain Equity Capital
External equity capital is not available for most small business start-ups.
Banks do not loan to start-up businesses.Owners often do not want to share ownership.Owners usually want to be their own bosses.Owners typically do not want to be responsible
to others for losses of the business.
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The Pecking Order of Funding Sources for New Firms
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Figure 15.2
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Methods to Obtain Equity Capital
Bootstrapping Using funds
generated by business operations to capitalize growth
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Minimize Overhead Costs
Cloud computing
Virtual storefronts
Business incubators
Business office co-ops
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Maximize Returns from Employee Expense
Student interns often provide high talent and strong motivation at a low cost to you.
Overtime is usually much less expensive than hiring more full-time workers during times of increased business.
Contractors exist to complete tasks that have a clear beginning, middle, and end.
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Minimize Operating Costs
Outsource the production of your service or product
Subcontract parts of your business that are not your core competency
Rent space that is unused or underutilized by other ongoing businesses
Rent equipmentWork from home
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Maximize the Results of Marketing
Word of Mouth Discounts, Local
signage, Facebook, Cooperative advertising
Publicity Press releases,
Public speaking, Donate your product or service
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Crowdfunding for Equity
Document your business
Make a business plan
Create a compelling story
Create a professional-looking video
Develop a list of potential investors
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Angel Investors
Angel investor A wealthy individual
who invests in companies in relatively early stages of development.
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Types of Angel Investment
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Equity Capital from the Owner’s View
Financing with equity is (1) expensive and (2) guaranteed to create problems of control and decision making.
Suppose you sell half your business to raise capital. You have just sold half of all your future profits, half of all your future growth, half of all your future wealth.
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Why Use Equity Capital?
1. You will reduce your own exposure to financial loss
2. Your business will not have increased costs in the form of interest
3. Bringing outside investors into an existing business can often reenergize it by providing new ideas, procedures, and processes
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Financing with Debt: Getting a Loan for Your Business
1. Direct loans of cash2. Guaranteeing loans made by commercial
banks 3. Reducing taxes by allowing interest to be
deducted
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Financing with Debt: Getting a Loan for Your Business
Community development organization An organization authorized by the SBA to make
insured loans to small businesses that are expected to increase economic activity within a specific geographic area.
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Financing with Debt: Getting a Loan for Your Business
Small business investment companies Private businesses that are authorized to make
SBA insured loans to start-ups and small businesses.
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The Four Cs of Borrowing
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Figure 15.3
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Financing with Debt: Getting a Loan for Your Business
Accelerator An organization that supports startup technology
businesses by providing inexpensive office space, a variety of support services, and resources
Most are associated with universities.
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Financing with Debt: Getting a Loan for Your Business
Credit reporting agency A business that collects, collates, and reports
information concerning an entity’s use of debt.Fair Credit Reporting Act
U.S. federal legislation specifying consumers’ rights vis à vis credit reporting agencies.
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Financing with Debt: Getting a Loan for Your Business
Collateral Something of value given or pledged as security
for payment of a loan May consist of financial instruments, such as
stocks, bonds, and negotiable paper, or of physical goods, such as trucks, machinery, land, or buildings.
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Gift Financing
Tax abatement A legal reduction in taxes by a government.
Tax credits Direct reductions in the amount of taxes that
must be paid, dependent upon meeting some legal criteria.
Grants Gifts of money made to a business for a specific
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Gift Financing
Foundation An institution to which private wealth is
contributed and from which private wealth is distributed for public purposes.
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Forms of Personal Gifts
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Exhibit 15.1
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When Giving a Gift
1. Put your agreement into writing2. If it is a gift, have the agreement specifically
say so.3. If it is a loan, have the agreement specify the
exact interest and payment terms.4. If it is an equity investment, consider
nonvoting stock.
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What Type of Financing Is Rightfor Your Business?
Cost of capital The percentage cost of obtaining future funds.
Weighted average cost of capital (WAC) The expected average future cost of funds.
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What Type of Financing Is Rightfor Your Business?
Financial leverage A measure of the amount of debt relative to total
investment.Optimum capital structure
The ratio of debt to equity that provides the maximum level of profits.
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Interaction among Profitability, Control, and Risk
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Figure 15.4
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Tools for Financial Management
The obvious comparisons: With your planned position and results
(your master budget)With prior years’ position and results, With the position and results of other firms.Using relevant financial ratios.
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