The Financial Plan,
Part: Finding
Sources of Funds
Part 3 Developing the New
Venture Business Plan
PowerPoint Presentation by Charlie Cook
The University of West Alabama
Copyright © 2006 Thomson Business & Professional Publishing.
All rights reserved.
Looking Ahead
After studying this chapter, you should be able to:
1.
2.
3.
4.
5.
6.
7.
8.
Describe how the nature of a firm affects its financing sources.
Evaluate the choice between debt financing and equity financing.
Identify the typical sources of financing used at the outset of a
new venture.
Discuss the process for acquiring and structuring a bank loan.
Explain how business relationships can be used to finance a
small firm.
Describe the two types of private equity investors that offer
financing to small firms.
Distinguish among the different government loan programs
available to small companies.
Explain when large companies and public stock offerings can be
a source of financing.
Copyright © 2006 Thomson Business & Professional Publishing. All rights reserved.
Student 11–2
Factors Affecting Financing
• There are four basic factors that determine how a firm is
financed:
– (1) the firm’s economic potential
– (2) the size and maturity of the company
– (3) the nature of the firm’s assets
– (4) the personal preference of the owners as they consider the
tradeoffs between debt and equity
• An entrepreneurial firm that has high growth potential
has many more possible sources of financing than does
a firm that provides a good lifestyle for the owner but
nothing in the way of attractive returns to investors.
Copyright © 2006 Thomson Business & Professional Publishing. All rights reserved.
Student 11–3
Factors Affecting Financing (cont’d.)
• The size and maturity of a company have a direct
bearing on the types of financing that are available.
• Tangible assets serve as great collateral when a
business is requesting a bank loan; intangible assets
have little value as collateral.
Copyright © 2006 Thomson Business & Professional Publishing. All rights reserved.
Student 11–4
Debt and Equity Financing
• Choosing between debt and equity financing involves
tradeoffs with regard to potential profitability, financial
risk, and voting control.
• Borrowing money rather than issuing common stock
(ownership equity) creates the potential for higher rates
of return to the owners and allows the owners to retain
voting control of the company, but it also exposes the
owners to greater financial risk.
• Issuing common stock rather than borrowing money
results in lower potential rates of return to the owners
and the loss of some voting control, but it does reduce
their financial risk.
Copyright © 2006 Thomson Business & Professional Publishing. All rights reserved.
Student 11–5
Sources of Financing
• The aspiring entrepreneur basically has three sources of
early financing:
– (1) personal savings
– (2) friends and family
– (3) credit cards
• Personal savings is the primary source of equity
financing used in starting a new business; a banker or
other lender is unlikely to loan a venture money if the
entrepreneur does not have his or her own money at
risk.
Copyright © 2006 Thomson Business & Professional Publishing. All rights reserved.
Student 11–6
Sources of Financing (cont’d.)
• Loans from friends and family may be the only available
source of financing and are often easy and fast to
obtain, though such borrowing can place important
personal relationships in jeopardy.
• Credit card financing provides easily accessible
financing, but with high interest costs that may become
overwhelming at times.
• Only if these sources are inadequate will the
entrepreneur turn to more formal channels of financing,
such as banks and outside investors.
Copyright © 2006 Thomson Business & Professional Publishing. All rights reserved.
Student 11–7
Bank Loans
• Bankers primarily make business loans in one of three
forms: lines of credit, term loans, and mortgages.
• In making a loan decision, a banker always considers
the “five Cs of credit”:
– (1) the borrower’s character
– (2) the borrower’s capacity to repay the loan
– (3) the capital being invested in the venture by the borrower
– (4) the conditions of the industry and economy
– (5) the collateral available to secure the loan
Copyright © 2006 Thomson Business & Professional Publishing. All rights reserved.
Student 11–8
Bank Loans (cont’d.)
• Obtaining a bank loan requires cultivation of a banker
and personal selling, including a presentation that
addresses:
– (1) how much money is needed
– (2) what the venture is going to do with the money
– (3) when the money is needed
– (4) when and how the money will be paid back
• Other detailed financial information might be requested,
including three years of the firm’s historical financial
statements, the firm’s pro forma financial statements,
and personal financial statements showing the
borrower’s net worth and estimated annual income.
Copyright © 2006 Thomson Business & Professional Publishing. All rights reserved.
Student 11–9
Bank Loans (cont’d.)
• An entrepreneur should carefully evaluate available
banks before choosing one, basing the decision on
factors such as the bank’s location, the extent of
services provided, and the bank’s lending policies.
• In negotiating a bank loan, the owner must consider the
accompanying terms, which typically include the interest
rate, the loan maturity date, the repayment schedule,
and the loan covenants.
Copyright © 2006 Thomson Business & Professional Publishing. All rights reserved.
Student 11–10
Business Relationship Financing
• Business suppliers can offer trade credit (accounts
payable), which is the source of short-term funds most
widely used by small firms.
• Suppliers also offer equipment loans and leases, which
allow small businesses to use equipment purchased on
an installment basis.
• Asset-based lending is financing secured by workingcapital assets, such as accounts receivable and
inventory.
Copyright © 2006 Thomson Business & Professional Publishing. All rights reserved.
Student 11–11
Private Equity Financing
• Business angels are private individuals, generally having
moderate to significant business experience, who invest
in others’ entrepreneurial ventures.
• Formal venture capitalists are groups of individuals who
form limited partnerships for the purpose of raising
capital from large institutional investors, such as pension
plans and university endowments.
Copyright © 2006 Thomson Business & Professional Publishing. All rights reserved.
Student 11–12
Government Loan Programs
• The federal government helps new businesses get
started through the programs and agencies of the Small
Business Administration (SBA), which include:
– the 7(a) Loan Guaranty Program, the Certified Development
Company (CDC) 504 Loan Program
– the 7(m) Microloan Program
– small business investment companies (SBICs)
– the Small Business Innovative Research (SBIR) Program
• State and local governments finance new businesses in
varying manners, though programs are generally geared
to augmenting other sources of funding.
Copyright © 2006 Thomson Business & Professional Publishing. All rights reserved.
Student 11–13
Government Loan Programs (cont’d.)
• Community-based financial institutions are lenders that
use funds from federal, state, and private sources to
serve low-income communities and small companies
that otherwise would have little or no access to startup
funding.
Copyright © 2006 Thomson Business & Professional Publishing. All rights reserved.
Student 11–14
Other Sources of Financing
• Large companies may finance smaller businesses when
it is in their self-interest to have a close relationship with
the smaller company.
• Stock sales, in the form of either private placements or
public sales, may provide a few high-potential ventures
with equity capital.
Copyright © 2006 Thomson Business & Professional Publishing. All rights reserved.
Student 11–15
Key Terms
return on assets
factoring
return on equity
informal venture capital
line of credit
business angels
revolving credit agreement
formal venture capitalists
term loan
7(a) Loan Guaranty Program Certified
Development Company
chattel mortgage
real estate mortgage
prime rate
LIBOR (London InterBank Offered
Rate)
(CDC) 504 Loan Program 7(m)
Microloan Program
small business investment companies
(SBICs)
balloon payment
Small Business Innovative Research
(SBIR) Program
loan covenants
community-based financial institution
limited liability
private placement
accounts payable (trade credit)
initial public offering (IPO)
equipment loan
asset-based loan
Copyright © 2006 Thomson Business & Professional Publishing. All rights reserved.
Student 11–16