Entrepreneurship

Financing Strategy: Debt, Equity or Both?

Financing
Ways to obtain capital for a small business: 1. Put more of your money into the business 2. Exchange a share of the business for money allow buy-ins (equity) 3. Borrow the money from others (debt) 4. Obtain gifts & grants from others

Entrepreneurship, 2nd Edition

Mariotti and Glackin and NFTE

2010 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Gifts & Grants

Gifts

Cash, free use of facilities & equipment, unpaid labor from friends & family, & forgiveness of debts Tax abatements & tax credits

Grants

Primarily for research & commercialization Difficult to get for low-tech, start-ups

+ Do not require repayment, loss of ownership, or financing costs - Gifts/grants often have restrictionscome with strings attached DONT STAKE YOUR BUSINESS ONLY ON GIFTS & GRANTS
Entrepreneurship, 2nd Edition
2010 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Mariotti and Glackin and NFTE

Ways to Secure Growth Funding

Finance with equity

Incorporated firms can sell stock Take on a partner and have them put $$$ into the firm

Finance with debt

Borrow the money. Is the business credit worthy?

Government sources of funding

Grants, guaranteed loans, etc.

Customers and suppliers

Using special terms and float

Finance with earnings (future)

Is the firm profitable? Does the firm have positive cash flow?
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2010 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Entrepreneurship, 2nd Edition

Mariotti and Glackin and NFTE

Finance Sources
Financing with Equity Sources Getting an ownership stake No guaranteed returns No protection against losses Appreciation in value through

growth in earnings and growth in assets Takes time arrange

Entrepreneurship, 2nd Edition

Mariotti and Glackin and NFTE

2010 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Stocks

Shares of stock represent a percentage ownership in a corporation. Public corporations sell stock to the general public to raise capital. Prices of stocks reflect investors opinions about business performance & value. Traded on stock exchanges.

Entrepreneurship, 2nd Edition

Mariotti and Glackin and NFTE

2010 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Other Equity Financing Options

Venture Capitalists:

Private investors seeking equity want to have influence on decisions Wont invest in company with less than $25 million in sales over 5 years Want return of 6 times investment over 5 years (45% ROI/yr) Want a business with 30-50% growth/yr and 20% pre-tax profit margins Typically invest sizable amounts in businesses Private investors seeking equity Net worth > $1 Million Want return of 10 times investment over 5 years (60% ROI/yr) Typically invest $100,000$500,000 Hire as few employees as possible Lease rather than buy equipment Use vendor financingget suppliers to extend your credit terms Use personal savings, second mortgages, loans from friends & relatives Work from home, borrow office space, or use business incubators Put profits back into business
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2010 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Angel Financing:

Bootstrap Financing:

Entrepreneurship, 2nd Edition

Mariotti and Glackin and NFTE

Equity Financing: Pros and Cons

Pros: If business doesnt make profit, investor dont get paid Equity investor cant force bankruptcy to recoup investment Equity investors want business success; will share contacts & advice Cons: Entrepreneur can lose control of business to equity investorsstock holdings become diluted Equity investors take more risk, want higher returns and influence over how the company is run Entrepreneur must share profits with equity investors

Entrepreneurship, 2nd Edition

Mariotti and Glackin and NFTE

2010 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Debt Financing: Pros and Cons

Pros: Lender has no say in operation of business Loan payments are predictable Lenders do not share businesss profits Cons: If loan payments are not made, lender can force business into bankruptcy If business is not incorporated & defaults, lender can take house & other possessions of owner Loan payments increase fixed costs, lower profit Payments reduce available cash in the company Compliance with the contract is expectedno skips
Entrepreneurship, 2nd Edition
Mariotti and Glackin and NFTE

2010 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Finance Sources
Financing with Debt Commercial Banks & Finance Companies Personal Loans Leases Convertible Debt Bonds
Getty Images

Entrepreneurship, 2nd Edition

Mariotti and Glackin and NFTE

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2010 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Debt Financing
Available in many forms

Commercial loans

REAL ESTATE - up to 20 years EQUIPMENT - up to 7 years WORKING CAPITAL - less than 1 year ACCOUNTS RECEIVABLE FACTORING - 30 to 90 dys

Personal loans

CREDIT CARDS HOME EQUITY LOANS PAY DAY LOAN

Leases

VEHICLE LEASE - 2 to 3 years with option to purchase at the end EQUIPMENT LEASES - why buy what you can rent?

Entrepreneurship, 2nd Edition

Mariotti and Glackin and NFTE

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2010 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Finance Sources
Commercial Banks Are highly regulated Look at the five Cs: character, capacity, capital, collateral, conditions Favor ventures that can give hard assets as collateral Are difficult to get financing from

Entrepreneurship, 2nd Edition

Mariotti and Glackin and NFTE

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2010 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

The 5 Cs of Credit
Collateral
Property and assets to pledge.

Character
What is your credit history?

Capacity
Sufficient cash flow to make the monthly payments?

Capital
How much investment (skin) do the owners have in this business?

Conditions
Industry and economic climate ARE YOU WILLING TO SIGN A PERSONAL GUARANTEE TO GET THE LOAN?
Entrepreneurship, 2nd Edition
2010 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

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Finance Sources
Commercial finance companies or asset based lenders: Are less rigid compared to regular banks Often charge a higher rate of interest Consider the quality of the assets of the business

Entrepreneurship, 2nd Edition

Mariotti and Glackin and NFTE

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2010 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Finance Sources
Using Convertible Debt Better returns to lenders Lenders get returns from day one Possibility to get back the loan amount Venture gets immediate use of funds Conversion relieves the burden of debt Planning the timing is possible

Entrepreneurship, 2nd Edition

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2010 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Bonds

Long-term interest bearing certificates that corporations & governments issue to raise capital. Lower risk & return expected than with stocks. A form of debt financing with a guaranteed rate of return to investors. Trade at premiums or discounts.

Entrepreneurship, 2nd Edition

Mariotti and Glackin and NFTE

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2010 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Government Finance Sources

Government Sources of Funding

Small Business Investment Company (SBIC)
Long-term loans or equity capital invested in small growing companies over a longer period of time

Venture Capital Institutes and Networks

Found on university campusesacts as a conduit so entrepreneurs can easily locate interested investors

Small Business Administration (SBA)

Counseling, micro-loans, guarantees to debtors

State-Funded Assistance
Tax holidays, infrastructure investments, forgiveness programs

Entrepreneurship, 2nd Edition

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2010 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Government Finance Sources

Small Business Administration (SBA) Loans

provide aid, counsel, and protection Many loan programs: Micro loans-up to $35,000 LowDoc Loans -- up to $150,000 SBA Express loans -- up to $250,000 Guarantees given to intermediaries who sanction loan

Entrepreneurship, 2nd Edition

Mariotti and Glackin and NFTE

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2010 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Government Finance Sources

State-Funded Assistance

States give incentives like

Tax holidays Tax exemption and relief (Enterprise Zones) Equity participation infrastructure improvements Loan programs Convertible debt & forgiveness programs

Entrepreneurship, 2nd Edition

Mariotti and Glackin and NFTE

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2010 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Financing from Customers and Suppliers

Customers and Suppliers

Understand the entrepreneurs business Have a vested interest in your business remaining healthy and cooperative Customers may pay earlymake down payments on future orders (pay on date of order, and on date of delivery) Suppliers may offer special terms favorable to the business (instead of net 30 on invoices, for younet 60 or net 90)

Entrepreneurship, 2nd Edition

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2010 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Financing with Future Earnings

Will stable (predictable) profits be generated by the business? Will positive cash flows be achieved each year? Can we safely withdraw large amounts of cash from the business each year?

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Mariotti and Glackin and NFTE

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2010 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.