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Chapter 19Sources of Funding
What You’ll Learn Section 19.1
Explain the role of entrepreneurs. Differentiate between start-up costs, operating
costs, and reserve funds. Identify sources of personal and private financing. Discuss the options available through bank funding. Identify the factors banks consider to approve
commercial loans. Section 19.2
Describe the function of the Small Business Administration.
Identify alternative sources of funding for a business.
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Fast Cash
Q: My family runs a small business. Recently a lot of unexpected expenses came up, and now we need $4,000 in a hurry. We just expanded our business, so we have no cash in reserves. How can we obtain the money?
A: If you have outstanding (unpaid) invoices from customers whom you have billed for your products, you can take those invoices to a bank and borrow against those receivables. If you have orders to fill but need money for supplies, you can speak to a lender about a short-term commercial loan.
Go to finance07.glencoe.com to complete the Standard & Poor’s
Financial Focus activity.
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Is every business owner an entrepreneur?
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Main IdeaTo start or expand a business, you must accurately estimate the amount of funding you will need.
Section 19.1 Analyzing Financial Needs
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Section 19.1 Analyzing Financial Needs
Starting a New BusinessIn all business operations, you will need:
Cash Equipment Supplies Goods or services to sell
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Section 19.1 Analyzing Financial Needs
Business EntrepreneursEntrepreneurs are highly motivated people who transform ideas for products or services into real-world business.
Entrepreneurs are the backbone of the American economy.
entrepreneur
an individual who takes the risk of starting a new business
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Section 19.1 Analyzing Financial Needs
High School EntrepreneursIt is possible for a high school student to start his or her own business.
For example, Fred DeLuca, who created Subway, is one successful entrepreneur who started his business shortly after graduating from high school.
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Section 19.1 Analyzing Financial Needs
Funding a BusinessPeople who take on business ventures usually need far more money than they realize.
It is not easy to get funding for a new building from an outside source. Banks and other financial institutions:
Are very selective about who receives loans
Expect to get a good return on their investment
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Section 19.1 Analyzing Financial Needs
Determining Needed CapitalWhen you are starting a business, the first thing you must do is make a realistic estimate of how much capital you will need.
Capital is the money you need to: Establish a business. Operate it for the first few months. Expand the business.
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Section 19.1 Analyzing Financial Needs
Start-Up CostsThe first goal in determining needed capital is to identify start-up costs. To analyze your costs, you should:
List everything you will require to begin to operate.
Assign an estimated cost to each item.
Make sure you research and explore the industry you are entering.
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Section 19.1 Analyzing Financial Needs
Common Start-Up Costs
Most businesses have some common start-up costs: Inventory needed to open the business Equipment, fixtures, and display cases Security deposit for rented space Advertising and promotions Insurance Professional fees (such as lawyers’ fees) Remodeling costs (such as creating office
space) Legal permits and licenses Supplies
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Section 19.1 Analyzing Financial Needs
Operating CostsBusinesses have a number of common operating costs:
Payroll Rent Insurance premiums Utility bills Office expenses Advertising Delivery charges Bank charges and other fees
operating costs
the ongoing expenses for operating a business
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Section 19.1 Analyzing Financial Needs
Reserve FundBefore starting a business, you will also have to estimate the amount of money you may need at a later date for growth.
You may need this money in your reserve fund to:
Purchase merchandise or equipment. Lease a truck. Allow for growth. Help you avoid having to borrow
additional capital.
reserve fund
money that can be made available for the future expansion of a business
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Section 19.1 Analyzing Financial Needs
Other Reserve Fund Expenses
Other expenses that you may need to consider when looking ahead and estimating a reserve fund include:
Additional equipment for increased business Advertising and other promotional costs Capital for any unexpected costs or
decreased sales Maintaining a positive cash flow Expansion of facilities Getting and keeping the right amount of
inventory
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Section 19.1 Analyzing Financial Needs
Personal and Private FinancingGetting affordable and sufficient financing is often a major problem when starting or expanding a business.
However, there are many sources of funding available for businesses.
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LOCATION, LOCATION Besides having a great idea for a business, you must also find somewhere to operate it. What features would you look for when choosing a location for a local business?
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Section 19.1 Analyzing Financial Needs
Personal FinancingWhen starting a small business, you may have to rely on your own assets to finance the start-up and operating costs. You might use:
Your personal savings Investments such as stocks or bonds Loans from family members and friends
With these sources of capital, you may not have enough cash to get the business going.
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Section 19.1 Analyzing Financial Needs
Consumer Loans
In order to get the funds you need, consider applying for a consumer loan.
Most financial institutions require that consumer loans be secured with collateral, which:
Reduces the risk to the bank Gives you a much better chance at
getting funding Allows you receive better interest rates
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Section 19.1 Analyzing Financial Needs
Home Equity Loans
A home equity loan is a loan based on the difference between:
The current market value of a home The amount still owed on the mortgage
Since you will lose your home if your business fails, you should think seriously before you finance your business with a home equity loan.
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Section 19.1 Analyzing Financial Needs
Private FinancingIf you cannot get enough capital through personal financing, your next option might be private financing.
This type of funding is attractive because it: Involves little paperwork Often requires no collateral and low, or
no, interest payments
The disadvantage is that it can lead to personal conflicts if you are unable to repay the loan.
private financing
borrowing money from family or friends
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Section 19.1 Analyzing Financial Needs
Bank FundingIf personal and private financing are insufficient, you may have to apply for a business loan to get additional money.
A few of your options are: Commercial debt financing Commercial loan
You may want to consider local banks rather than larger banks when getting a commercial loan.
commercial debt financing
borrowing money from a bank or other financial institution to fund a business
commercial loan
a loan that finances a new or ongoing business
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Section 19.1 Analyzing Financial Needs
Funding from Local Banks
Getting funding from local banks has both advantages and disadvantages. Advantages might include:
They are highly experienced in dealing with small businesses.
They offer a wide variety of loan plans. They offer advice and other business
services. They are community-oriented and are
interested in seeing local businesses succeed.
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Section 19.1 Analyzing Financial Needs
Disadvantages of Funding from Local Banks
Disadvantages of receiving a loan from a local bank might include:
They are closely regulated by the government.
There is extensive paperwork, investigation, and documentation involved in the loan process.
They are conservative by nature and may reject your loan if your business appears too risky.
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Section 19.1 Analyzing Financial Needs
Short-Term Commercial LoansA short-term commercial loan is a business loan that is usually made for a term of one year or less.
These loans are typical for small businesses and are designed to:
Help the business meet short-term financial obligations
Help with cash flow during a specific time or season
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Section 19.1 Analyzing Financial Needs
Long-Term Commercial LoansA long-term commercial loan is a business loan that is made for a term of one to five years.
These loans are normally used by larger, established businesses that require great amounts of funding. They may use the funds for:
Expensive equipment The relocation of facilities The expansion of storage areas Other major expenses
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Section 19.1 Analyzing Financial Needs
Lines of CreditA line of credit makes funds available for:
Unexpected costs Routine expenses
The main advantage of this type of funding is that you do not pay any interest unless you access the funds.
Once you borrow an amount from the line of credit, the bank will:
Charge you interest Expect you to repay the money in a short
period of time
line of credit
an arrangement in which bank customers can borrow a certain amount of money from the bank immediately
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Section 19.1 Analyzing Financial Needs
Secured and Unsecured LoansBecause banks must be conservative in their loan policies, most business loans are secured loans.
Only a well-established, profitable business that has a good relationship with a bank can obtain unsecured loans.
An unsecured loan is usually: Short-term Subject to a higher interest rate
secured loan
a loan that is backed by collateral
unsecured loan
a loan that does not require collateral from the borrower
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Section 19.1 Analyzing Financial Needs
Commercial Loan ApplicationsBanks use certain standards to:
Judge a company’s financial position Determine how much risk to accept
Banks are conservative and selective as to which businesses they approve for financing.
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Section 19.1 Analyzing Financial Needs
The Five C’s of CreditIf you apply for a commercial loan, the bank will first examine the five C’s of credit:
Character Capacity Capital Collateral Credit history
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Paid in FullWhen you get your first credit card, use it wisely. Decide how much you can afford to charge each month and stick to that budget. Be sure to pay your bill in full every month. If you do, you will avoid high interest charges and save.How would good use of personal credit cards help you in starting up a business in the future?
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Section 19.1 Analyzing Financial Needs
Business PlanThe bank will also examine your business plan to make sure that:
Your business is financially sound. You have a clear vision of where you
want your business to go. You have identified the necessary steps
to achieve your goals.
Banks often base loan decisions on the business plan.
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What advantages might the federal government receive by operating the Small Business Administration (SBA)?
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Main IdeaEntrepreneurs can get funding through the help of the Small Business Administration and other sources.
Section 19.2 Sources of Funding
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Section 19.2 Sources of Funding
Small Business AdministrationThe federal government recognizes the importance of small businesses in the American economy and, therefore, provides assistance to them.
The Small Business Administration (SBA) has services that include:
Management training Organizational guidance Assistance in getting funding
Small Business Administration (SBA)
an independent agency of the federal government that offers assistance to people who are starting small businesses and to those who want to expand existing businesses
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Section 19.2 Sources of Funding
SBA Guaranteed LoansThe most common type of SBA loan is obtained through the Guaranteed Loan Program. With this kind of loan, the SBA:
Examines your application Approves the loan Authorizes the bank to give you the
funding Guarantees a major portion of the loan
With this guarantee by the federal government, banks are more willing to grant funding to a small business.
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Section 19.2 Sources of Funding
LowDoc ProgramIn the past many people were frustrated by:
The amount of paperwork The time it took to process loan
applications through the SBA
In response, the SBA introduced the LowDoc Program in 1993.
LowDoc Program
a government loan program that allows businesses applying for loans of less than $150,000 to submit a one-page application with a small amount of documentation
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Section 19.2 Sources of Funding
Other Sources of FundingYou can also get funding through:
A business credit card Private investors Commercial finance companies Venture capital firms State and local governments
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Section 19.2 Sources of Funding
Business Credit CardThe use of business credit cards has become a major source of short-term financing for small businesses.
You can get a business credit card through: Visa MasterCard American Express
Business credit cards are good for emergencies, but balances should be paid as quickly as possible.
business credit card
a credit card that is issued to a business rather than to an individual
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Section 19.2 Sources of Funding
Private InvestorsPrivate investors:
Will usually leave the management of the business to the owner
Are interested in getting a good return on their money
May want a share of ownership
If you cannot locate private investors in your area, the SBA may be able to help.
private investor
a person outside an entrepreneur’s circle of friends and relatives who provides funding because he or she is interested in helping a new business to succeed
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Section 19.2 Sources of Funding
Commercial Finance CompaniesCommercial finance companies insist that all loans be secured with collateral, such as:
Equipment Inventory
These companies are helpful to existing businesses that need short-term financing.
commercial finance company
a firm that lends money only to businesses
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Section 19.2 Sources of Funding
Venture Capital FirmsVenture capital firms will lend money to high-risk small businesses but often expect a large return of 25 to 40 percent on their investment.
Since venture capital firms are investing in your business, they will:
Expect to have a voice in major business decisions
Examine a business’s financial position carefully throughout the year
venture capital firm
a company that provides private funding for small businesses that need a substantial amount of immediate cash
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Section 19.2 Sources of Funding
Small Business Investment Companies
Most venture capital firms are private, but the SBA created a public venture capital program called the Small Business Investment Company Program.
The advantages in dealing with the SBIC program are that:
The SBA regulates lenders. Financing terms must meet SBA
guidelines.
Small Business Investment Companies (SBICs)
private investment firms that work with the SBA to provide longer-term funding for small businesses
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Section 19.2 Sources of Funding
State and Local FundingMany states provide opportunities for small businesses to get funding through a variety of programs.
These funding programs are available in cities where local and state governments are encouraging individuals to open businesses in economically depressed neighborhoods.
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Section 19.2 Sources of Funding
Funding Your DreamsThe American economy has been built by entrepreneurs who were willing to:
Take risks Explore new ventures
The funding of small businesses is essential to the American economy.
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Chapter 19Sources of Funding
Key Term Review entrepreneur operating costs reserve fund private financing commercial debt financing commercial loan line of credit secured loan unsecured loan Small Business Administration (SBA) LowDoc Program
business credit card private investor commercial finance company venture capital firm Small Business Investment
Companies (SBICs)
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Chapter 19Sources of Funding
Reviewing Key Concepts1. Explain why entrepreneurs are considered part of the
backbone of the American economy.
Entrepreneurs are highly motivated people who transform ideas for
products or services into real-world business.
Almost all of the nation’s Fortune 500 companies started as small
businesses.
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Chapter 19Sources of Funding
Reviewing Key Concepts2. Identify some differences between start-up costs, operating
costs, and reserve funds.
Start-up costs include money for the purchase of assets needed
to run a business.
Operating capital is the money needed to operate a business for
the first few years.
Reserve capital is money set aside for unexpected costs or
opportunities.
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Chapter 19Sources of Funding
Reviewing Key Concepts3. Explain the pros and cons of taking out a home equity loan
to start a business.
Home equity loans are: Fairly safe for financial institutions because they are
secured by property Easier to get than consumer loans
You may lose your home if your business fails and you are unable
to repay your loan.
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Chapter 19Sources of Funding
Reviewing Key Concepts4. List one advantage and one disadvantage of secured loans,
unsecured loans, and lines of credit.
A secured loan is a loan that is backed by collateral.
An unsecured loan is a loan that does not require collateral from
the borrower.
A line of credit is an arrangement in which bank customers can
borrow a certain amount of money from the bank immediately.
The main advantage of this type of funding is that you do not pay
any interest unless you access the funds.
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Chapter 19Sources of Funding
Reviewing Key Concepts5. Describe the five C’s of credit and how they apply to a
business loan.
If you apply for a commercial loan, the bank will first examine the
five C’s of credit: Character Capacity Capital Collateral Credit history
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Chapter 19Sources of Funding
Reviewing Key Concepts6. List one reason that loans guaranteed by the Small
Business Administration are a win-win situation for the entrepreneur and the lending institution.
The federal government recognizes the importance of small
businesses in the American economy and, therefore, provides
assistance to them.
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Chapter 19Sources of Funding
Reviewing Key Concepts7. Explain the role of a venture capital firm.
Since venture capital firms are investing in your business, they
will: Expect to have a voice in major business decisions. Examine a business’s financial position carefully
throughout the year.
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Newsclip: Finding CapitalTo be your own boss, you need to find capital for starting up your
business. There are more options available to entrepreneurs
today than in the past.
Log On Go to finance07.glencoe.com and open Chapter 19.
Learn about different options to help you find the funding needed
to start a new business. Write a paragraph about which option you
would choose and why.