Entrepreneurship Chapter 11 - Sources of Capital

Textbook Reference: Entrepreneurship, 8th edition by R.H. Hisrich, M.P. Peters and D.A. Shepherd, Mc Graw Hill Irwin, Copyright 2010. Chapter 11: Sources of Capital One of the most difficult problems in the new venture creation process is obtaining financing. Debt Financing  Obtaining borrowed finds for the company.  It is usually an interest bearing instrument.  The payment is only indirectly related to sales & profit.  Typically it requires that some asset (car, house, machine, land, etc.) be used as collateral.  There is an additional fee called “points” for using the money.  Short term debt or one year debt is usually used to provide working capital to finance inventory, accounts receivable, or operations.  Long term debt or more than one year debt is used to purchase an asset. It will require collateral and only cover 50% to 80% of the value. The owner provides the difference.  The entrepreneur must be careful that the debt is not so large that repayment is difficult which will inhibit growth. Equity Financing  Obtaining funds for the company in exchange for ownership.  Does not require collateral and provides the investor with a portion of ownership and profits. Internal Funds  Most frequently generated funds.  Comes from several sources; 1. Profits. 2. Sales of assets. 3. Reduction in working capital. 4. Extended payment terms with a supplier. 5. Accounts receivable. 6. Reduction of inventory. External Funds  Alternative sources should be evaluated on three bases; 1. The length of time the funds are available. 2. The costs involved. 3. The amount of company control that is lost.  Most frequently used sources of funds: 1. Family & friends.  The amount may be small.  They may think they will have input.  Usually more patient that commercial lenders.  Write a loan agreement detailing time and control.  Consider the impact of this investment to a family member. 2. Commercial Banks.  Asset loans have tangible collateral valued at more than the amount borrowed.

3. 4.

5. 6. 7.

 Accounts Receivable Loans works if the customer base is trustworthy.  Inventory loans if the product is liquid and can be easily sold.  Equipment loans.  Real Estate Loans. Limited Partnerships. Government loan programs.  SBA provides a guarantee to a local bank.  Assists qualified small businesses to obtain financing when they cannot get a business loan through regular lending channels.  SBA can guarantee %85 up to $150,000.00 and %75 over $150,000.00. The owner is responsible for the difference.  The banks are guaranteed of their loan and are charged fees from the SBA. They pass the charges on to the entrepreneur. Grants. Venture capital. Personal funds.

Bank Lending Decisions  Banks are generally cautious and especially with new ventures.  Commercial loans are reviewed by the loan officer and loan committee who carefully review the borrower and the financial track record of the business.  These decisions are based both on quantifiable information and subjective judgments.  Based on the five C’s: 1. Character. The entrepreneur will always be scrutinized. 2. Capacity. Can this venture generate enough sales to justify the loan? 3. Capital. How much of the entrepreneur’s personal capital is involved? 4. Collateral. Assets that can be sold to recoup money not paid. 5. Conditions. What are the risks? What is the unique differential advantage in market growth?  Some of the concerns can be reduced by providing a good loan application.  Provide all information requested, three years of tax returns, spread sheet showing repayment, and a summary of the need for this loan and how it will help the venture grow.  The entrepreneur should evaluate several commercial banks. Choose the one that provided the most positive business experience.  The established protocol of the loan process should be understood and respected.  Generally, the entrepreneur should borrow the maximum amount that can possibly be repaid. Going back for more money will not be well accepted.  You must generate enough cash flow to repay the interest and principal according to the schedule.  You should investigate the track record of the bank through other entrepreneurs.  “Shopping” for banks will result in the needed funds at the most favorable rates. Government Grants  SBIR grants are U.S. grants for technology. Bootstrap Financing  Important in the early stages of the new venture.  Debt financing is extremely expensive and cash drain to the venture.  Raising capital is a long term process that takes a lot of time of the entrepreneur.

         

You usually need capital when you have the least amount of time. Outside capital decreases a firm’s drive for sales and profits. The availability of capital increases the impulse to spend. Outside capital can decrease the firm’s flexibility. Outside capital can be disruptive in that it requires a return on investment before the new venture has an opportunity to stabilize. Use every available method to conserve cash. Seek discounts from suppliers. Ask for bulk packaging and volume will create savings. Use as little cash to initiate as possible. The drawback is operating without cash reserves.