Download Small Business Management 12e - Longenecker, Moore

IPFW Business Plan Competition
Pre-competition Program
Financing and Capital Sourcing
Options
By
Dr. Bill Todorovic
Department of Management and Marketing
Neff Hall 340L, Tel. (260) 481 6940
E-mail: [email protected]
Web: http://users.ipfw.edu/todorovz/
Copyright © by South-Western College Publishing. All rights reserved.
13–1
The Nature of a Firm and
Its Financing Sources
• Factors That Determine Financing
–Firm’s economic potential
–Maturity of the company
–Nature of its assets
–Owners’ preferences for debt or equity
Copyright © by South-Western College Publishing. All rights reserved.
13–2
Sources Of Funds
Start-up
Beginning of
Production ?
Going Concern
Company
Size
Personal
IPO
Friends and Family
Angels
Venture Capitalist
Banks
Government
Customers/Suppliers
Amount
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13–3
Sources of Financing
Sources of Financing
Other
Venture Capital
Mortgaged Property
Private Investors
Bank Loans
Friends
Personal Charge Cards
Partners
Family Members
Personal Savings
0
10
20
30
40
50
60
70
80
Percentage of Entrepreneurs
Using Source of Financing
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13–4
Critical Financing Factors
•Accomplishments and performance to date.
•Investor’s perceived risk.
•Industry and technology.
•Venture upside potential and anticipated exit
timing.
•Venture anticipated growth rate
•Venture age and stage of development.
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13–5
Debt or Equity?
• Entrepreneurs typically prefer debt
– Allows them to appropriate as much as of the benefit as
possible + retain sole control
– Can default
• Debt is unattractive to investors in emerging
technology
– Usually little collateral or predictable cash flow
– Information asymmetry is lessened by ownership position
– shared ownership gives some control
– High interest rate to offset risk will stifle growth or cause
default
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13–7
Debt or Equity Financing?
• Potential Profitability
• Financial Risk
• Voting / Control
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13–8
Tradeoffs Among Potential Profitability,
Financial Risk, and Voting
HIGH
Potential
Profitability
Equity
Equity
financing
Financing
Debt
Financing
financing
LOW
LOW
HIGH
Financial Risk/Control
Fig. 13.1
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13–9
Debt Versus Equity
With no debt and all equity:
No debt
$28,000
income on
total assets
of $200,000
14% return
14% return
on assets
on $200,000
($28,000÷ $200,000)
($28,000÷$200,000)
equals
$200,000
equity
Equity: Owners get to keep all of the profits in
return for accepting the risk of lower returns
Copyright © by South-Western College Publishing. All rights reserved.
13–10
Debt Versus Equity (Cont’d)
With $100,000 debt and $100,000 equity:
$100,000 debt
(10% cost)
$28,000
income on
total assets
of $200,000
14% return
18% return
on assets
on $100,000
($28,000 ÷ $200,000)
($18,000÷$100,000)
equals
$100,000
equity
Debt is Risky: Lenders have first claim on profits
and must be paid even if there are no profits.
Copyright © by South-Western College Publishing. All rights reserved.
13–11
The Banker’s Perspective
• Bankers’ Concerns!
• The Five C’s of Credit
–Character of the borrower
–Capacity of the borrower to repay the loan
–Capital invested in the venture by the borrower
–Conditions of the industry and economy
–Collateral available to secure the loan
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13–13
Financial Information Required
for a Bank Loan
• Three years of the firm’s historical statements
• The firm’s pro forma financial statements
• Personal financial statements
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13–15
Getting to know your friendly neighborhood
Venture Capitalist…
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13–17
The myth… and the reality
• The myth: VCs support good people and good ideas
• The reality: VCs invest in industries with double digit
growth in the middle of the S-curve
– Appropriate management team
– Specialty funds (earlier and later stages on the Scurve)
– Limits the risk to management risk
– Produces attractive exit opportunities
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13–18
Present Day Situation
Myth: There is less available capital
Fact: The industry has plenty of money,
but limited appetite for new investment
Fact: Investor attitudes toward risk have
changed
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13–19
VC fills a void
• Gap between innovation and traditional sources of debt
• Risk inherent in startups typically justify interest rates
higher than allowed by law
• VCs must balance high returns for their investors
against sufficient upside potential for entrepreneurs to
keep them motivated
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13–21
What VCs get out of it
• 10X return of capital over 5 years
• VCs management fees and high growth funds
• Fund structured with limited and general partners and a
life of 7-10 years
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13–22
What VCs Do?
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13–23
The Overhang: Uninvested Capital
Buyouts
200
Venture
150
100
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
1987
1986
1985
1984
1983
1982
0
1981
50
1980
Annual Committed Capital ($M)
250
Year
Complements of Thompson Venture Economics
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13–25
Angels
• Well to do private individuals
• Geography and industry specific
• Invest lower amount than VC
• Often a good source of industry experience
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13–26
Finding Angels
• Private Individuals
• Professionals (lawyers, accountants, bankers)
• Local small business development centers
• Internet associations (e.g., Technology Capital
Network at MIT)
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13–27
Other Sources of Financing
• Community-based financial institutions
• Large corporations
• Stock Sales
–Private placement
–Initial public offering (IPO)
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13–28
Why Companies Invest?
• Preemption of new rivals
• Replace core earnings lost because of an
emerging technology
• Apply existing competitive advantage in a
rapidly growing market
• And some degree of autonomy:
– JVs, alliances, flexible internal management
structures
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13–29
Government-Sponsored Programs
and Agencies
• Small Business Administration (SBA) loans
–Guaranty loan
–Direct loan
• Small business investment centers (SBICs)
• Small Business Innovative Research (SBIR)
• State and Local Government Assistance
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13–30
Business Suppliers and
Asset-Based Lenders
• Trade Credit (Accounts Payable)
Short-duration financing (30 days)
Amount of credit available is
dependent on type of firm
and supplier’s willingness
to extend credit
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13–31
Business Suppliers and
Asset-Based Lenders (cont’d)
• Equipment Loan and Leases
• Leases
Free up cash for other purposes
Leaves lines of credit open
Provides a hedge against
obsolescence
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13–32
Business Suppliers and
Asset-Based Lenders (cont’d)
• Asset-based Loan
• Factoring
Accounts are sold to factor at a discount to invoice value
Factor can refuse questionable accounts
Factor charges fees for servicing accounts and for
amount advanced to firm prior to collection
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13–33
Business Suppliers and
Asset-Based Lenders (cont’d)
• Commercial Banks
–Line of credit
–Revolving credit agreement
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13–34
Business Suppliers and
Asset-Based Lenders (cont’d)
• Commercial Banks (cont’d)
–Term loans
–Chattel mortgage
–Real estate mortgage
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13–35
Formal Vs. Informal Investors
• Funding structure and flexibility
• The fit to the mold
• Involvement in the business
• Rigidity of relationship with the firm
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13–36
Discussion?
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13–37