FINANCING YOUR BUSINESS

Business Management

Today’s Objectives

Explore differences among various sources of capital.

Identify the cost of operations.

1. Equity Capital2. Debt Capital

Methods of Obtaining Capital

Owner Capital

The owner(s) personal contributions to the business

May come from personal savings or personal loans

Small businesses rely heavily on owner capital

Also known as equity capital

Retained Earnings

Also a type of equity capital because business profits belong to the owner(s)

Business profits saved for use by the business in the future

Debt Capital

Money that others loan to a business

Also known as creditor capital

Banks & other lenders usually will NOT lend to a business unless the equity capital exceeds the debt capital

Remember those business structures?

Obtaining Equity Capital

Sole Proprietorship

Invest more personal funds

Sell personal assets to raise $$$

Mortgage personal property Assets used as

securities are at risk if the business fails.

Other personal assets at risk

Change business structure Partnership Corporation

Partnership

Partners usually invest personal resources in the business in order to balance/share risk. Not mandatory for new

partners

A formal partnership agreement identifies the financial contributions of each partner and how profits will be shared.

If the assets of one partner are not enough to cover business debts, assets from other partners can be taken.

Owner gives up individual control over management and decision-making.

Corporation

Can raise capital quickly because the amount of money invested is much smaller

Stockholders are not involved in day-to-day management of business.

Investors are protected financially.

Obtaining Debt Capital

Short-Term Debt Capital

Must be repaid within a year Often 30-, 60-,

or 90-day loans

Usually obtained from a bank or other lending institutions

Short-Term Debt Capital

Business must supply bank with adequate financial information.

Bank usually obtains a financial report on the business from a credit company.

If the bank considers the business to be a good credit risk, the bank will grant a loan or a line of credit. Specific amount, set time period

Business owner(s) must sign a promissory note. Unconditional written promise to pay the lender a

certain sum of money at a particular time or on demand

Long-Term Debt Capital

Money borrowed for longer than a year

Usually obtained through: Long-term notes Bonds

Term Loans

Also known as long-term notes; medium- or long-term financing used for business operations or for improving fixed assets

Written for periods from 1 to 15 years … or longer

Significant source of capital for most businesses

Banks / lenders require the principal and interest to be repaid on a regular basis over the life of the note.

Bonds

Long-term written promise sold by the business to investors that promises payment of a definite sum of money at a specified time

Business receives the amount of the bond when it is initially sold.

Must pay bondholder the borrowed amount (principal) at the bond’s maturity date

Business pays bondholder interest at a specified rate at certain intervals

Bonds do NOT represent a share of ownership; they are investments.

Bondholders are creditors & have priority claim before stockholders.

3 things to consider…

Obtaining Capital

Cost of Capital

Costly to sell bonds, long-term notes, or issue stock Must file forms,

obtain approval, make agreements, find buyers

Usually only large or highly successful firms even consider stocks/bonds

Interest Rates

Rates fluctuate monthly, weekly, even daily

Best to borrow when rates are low (cheaper)

When rates are high, businesses usually borrow short-term debts.

Influence of Contributors

Short-term creditors usually have no control over management and operations of business.

Long-term credit agreements are tied to asset claims & may impose limitations on those assets.

Partners / stockholders gain a voice in control of business.

Where do you get the money?

Sources of Capital

Sources of Capital

Banks - most popular source of outside capital

Small Loan Companies - firms that lend money to “higher risk” business and individuals

Venture Capitalists People or companies that lend large sums

of money to promising new or growing businesses

Usually ask for a percentage of ownership rights in the company

Demand a carefully developed business plan that shows high potential for success

Sources of Capital

Commercial Credit Companies - lend money on current assets, such as accounts receivable

Sales Finance Companies - used primarily when installment sales are involved

Insurance Companies - portions of funds collected from policy holders may be loaned to firms

Individual Investors / Investment Groups Pension Funds - retirement funds collected

from employees may be loaned to firms

Sources of Capital

Investment Banking Organizations Specialize in selling new security issues

to the public Helps a business raise large sums of

capital through stocks / bonds Can assist a rapidly growing, privately

held company with IPO Equipment Manufacturers

Firms that do not lend money, but sell needed equipment on an extended-time payment plan

2 Methods of Obtaining CapitalTypes of Debt Capital3 Things to Consider when Obtaining Capital10 Sources of Capital

Review!

So how much money do you need?

Rent / mortgage

Facility maintenance

Utilities Transportation

Wages & Salaries

Equipment Supplies Raw Materials Inventory

Physical LocationCost of

Product / Service