Chapter 15
Choice of Financing
Copyright¸ 2003 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in
Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful.
Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. Instructors may make
copies of the PowerPoint Presentations contained herein for classroom distribution only. The Publisher assumes no responsibility for
errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.
Learning Objectives
• Factors that influence the choice of financing.
• Effects of immediacy on the range of alternatives.
• Effects of size and duration of need on the range of
alternatives.
• Effects of financial condition and stage of development
on the range of alternatives.
• Advantages and disadvantages of relational financing.
• Why financial distress affects availability of financing.
• The difference between financial distress and failure.
• Effects of collateral, reputation, and relationships on
availability of financing.
• How bilateral negotiation affects deal terms and timing.
©2003, Entrepreneurial Finance, Smith and Kiholm Smith
Chapter 15
A Partial List of Financing Sources for
New Ventures and Private Business
• Asset-based Lending
• Business Angels
• Capital Leasing
(Venture Leasing)
• Commercial Bank
Lending (various forms)
• Corporate
Entrepreneurship
• Customer Financing
• Direct Public Offering
• Economic Development
Program Financing
©2003, Entrepreneurial Finance, Smith and Kiholm Smith
• Registered Initial Public
Offering
• Research and
Development Limited
Partnerships
• Relational Investing or
Strategic Partnering
• Royalty Financing
• Self (bootstrapping)
• Small Business
Administration
Financing
Chapter 15
A Partial List of Financing Sources for
New Ventures and Private Business
• Employee-provided
Financing
• Equity Private
Placement
• Export/Import Bank
Financing
• Factoring
• Franchising
• Friends and Family
• Public Debt Issue
©2003, Entrepreneurial Finance, Smith and Kiholm Smith
• Small Business
Investment Company
Financing
• Term Loan
• Vendor Financing
• Venture Capital
Chapter 15
Basic Factors Affecting
Financing
• Capital Providers can diversify their risk at lower cost
• Cost of managing external capital
– Expectation of periodic reporting
– Negotiation and transaction costs
• Leverage is good
– Well diversified investors do not need to be compensated for
bearing non-market risk
– Investor benefits by using equity for financing
• Resource providers benefit from functions that enhance value
– Monitoring and advising can destroy value, however
• Taxes can affect financing choice, depending on organizational
form
– Debt has different effects than equity
– Timing of taxation can be of benefit to parties
– If tax benefits cannot be achieved, it affects decision
•
•
•
•
•
•
Factors That Affect the
Choice of Financing
Financial needs of the venture
Stage of Development
Financial Condition
Product-Market Considerations
Organizational Considerations
Track Record/Reputation/Relationships
©2003, Entrepreneurial Finance, Smith and Kiholm Smith
Chapter 15
Steps in Determining
Financing
• Step 1 Assess Needs of venture
• Step 2 Assess Current Condition of Venture
• Step 3 Assess Relation Between Financing choices
and Organizational Structure
Financial Needs of the
Venture
• Immediacy of the need
– Based on time required for negotiation
• Personal relationships help with trust
– Immediate  timing constrains choice
– Near-term  Milestone based
– Cumulative  Connects near-term and ultimate needs
• Limits
– Ability of source to respond
– Negotiation time
– Regulation
– Near term financing is expensive
– Prior financing may limit subsequent financing
©2003, Entrepreneurial Finance, Smith and Kiholm Smith
Chapter 15
Financial Needs of the
Venture
• Size of the immediate need
– Friends, angels, SBA/Development, IPO
– One cannot use a source that does not have the capacity
• Duration of the immediate need
– Shouldn’t use short term sources for long-term needs or vice
versa
– Transactions costs for short-term sources are lower due to
less due-diligence
– Short-term  debt secured by assets
– Sale of assets (AR) or sale and lease-back
– Vendor Financing is expensive because payments can be
delayed
– Long-term financing (except for passive equity) usually
comes with more restrictions
Financial Needs of the
Venture
• Cumulative need
– Early financing should be arranged so as to avoid
the effects of covenants or to allow subsequent
financing rounds
– If long-term needs are expected to be lower,
arrange to pay off near term financing without
penalty later
Current Condition of Venture
•
•
•
•
•
•
•
Stage of Development
Value of outside advice to firm
Organizational Structure and tax status
Track Record
Level and Stability of earnings and cash flows
Asset base - Collateralization
Existing financing
•
•
•
•
•
Current Condition - Stage of
Development
Ability to create stable cash flow  Debt
Completeness of the management team
Ease of communicating the venture’s merit
Value of managerial/consulting services
Importance of flexibility/adaptability
©2003, Entrepreneurial Finance, Smith and Kiholm Smith
Chapter 15
•
•
•
•
•
•
•
Current Condition - Financial
Condition
Risk/Return characteristics of the venture
Taxable income status
Operating cash flow status
Time to a liquidity event
Transferability of tax benefits to investors
Available collateral
Cash flow cycle
©2003, Entrepreneurial Finance, Smith and Kiholm Smith
Chapter 15
Financing Distressed Firms
• Financial distress is not the same as need for cash
– Distress = disappointing investors
– Violation of covenants
– Defaulted on repayment obligations
– Inability to carry out plans
– Missed milestones
• Distress means not able to meet expectations
– Failure undermines credibility and increases cost
of capital and increases likelihood of investor
failsafe
• Turning around a distressed firm is more difficult than
an initial funding event
– One exception is bankruptcy protection
Product-market and
Organizational Considerations
• Importance of rapid growth as a part of productmarket strategy
• Nature and importance of relationship with a supplier
or distributor
• Dedication of distributors to the product
• Cost s and benefits of centralization of control
©2003, Entrepreneurial Finance, Smith and Kiholm Smith
Chapter 15
•
•
•
•
•
•
Track Record/
Reputation/relationships
Track record of the venture
Importance of future financing needs
Past failure or financial distress
Likely failure in the near future
Reputation of the entrepreneur
Relationships with financing sources
©2003, Entrepreneurial Finance, Smith and Kiholm Smith
Chapter 15
Figure 15-2
©2003, Entrepreneurial Finance, Smith and Kiholm Smith
Chapter 15
Figure 15-3
©2003, Entrepreneurial Finance, Smith and Kiholm Smith
Chapter 15