small business finance: using equity, debt, and gifts chapter 15 © 2014 by mcgraw-hill education....

Small Business Finance: Using Equity, Debt,

and Gifts

Chapter 15

© 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.


Learning Objectives

LO1 Describe the three types of capital financing and their costs and trade-offs.

LO2 Explain the characteristics of a business that determine its ability to raise capital.

LO3 Explain which type of financing is best for your business.

LO4 Describe the differing needs for financial management at each stage of business life.

15-2


Sources of Financing for Small Businesses

The number one source is from the owners (or potential owners) themselves.

The other major sources include family and friends, credit cards, trade credit, banks, and other commercial lenders.

15-3



Debt A legal obligation to pay money in the future.

Equity capital Money contributed to the businesses in return

for part ownership of the business.

15-4



Gift Valuable assets or services donated to the

business without any obligation to repay or give up any ownership interest.

Debt capital Money borrowed for the purpose of investment

in a business.

15-5


Use of Debt and Equityin Start-Ups from the PSED

15-6

Figure 15.1


Financing with Equity

Outside equity Money from selling part of your business to

people who are not and will not be involved in the management of the business.

15-7


Legal Forms of Business

Partnership Two or more people

cooperating to conduct a business enterprise.

Corporation A legal “artificial”

entity that is formed by filing specific documents with a state government.

15-8



Limited liability company (LLC) A legal form of business organization that is

created by filing required documentation with a state government.

Have a choice, under federal tax law, of being taxed as either corporations or partnerships.

15-9



Limited partnership A legal form of business organization that is

created by filing required documentation with a state government

One or more partners may have no liability for the debts and actions of the partnership.

15-10



Sole proprietorship A business owned by a single individual who is

responsible for all debts and claims against the business.

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15-12


Getting Equity Investmentfor Your Business

Interest A charge for the use

of money, usually figured as a percentage of the principal.

Dividends Payments of profits

to the owners of corporations.

15-13


Getting Equity Investmentfor Your Business

Gain on investment The percentage amount that the payout of an

investment differs from original cost Calculated as (payout − investment + dividends)/

investment.

15-14


Equity Capital from the Investor’s View

Risk The level of probability that an investment will

not produce expected gains.Diversify

To invest in multiple investments of differing risk profiles for the purpose of reducing overall investment risk.

15-15


Equity Capital from the Investor’s View

Owners and investors want to make money Lenders expect a return on this money

To get money from other people, you’ve got to show them that your business probably can make gains for them

Growth potential is a primary concern for equity investors

15-16


Methods to Obtain Equity Capital

External equity capital is not available for most small business start-ups.

Banks do not loan to start-up businesses.Owners often do not want to share ownership.Owners usually want to be their own bosses.Owners typically do not want to be responsible

to others for losses of the business.

15-17


The Pecking Order of Funding Sources for New Firms

15-18

Figure 15.2


Methods to Obtain Equity Capital

Bootstrapping Using funds

generated by business operations to capitalize growth

15-19


Minimize Overhead Costs

Cloud computing

Virtual storefronts

Business incubators

Business office co-ops

15-20


Maximize Returns from Employee Expense

Student interns often provide high talent and strong motivation at a low cost to you.

Overtime is usually much less expensive than hiring more full-time workers during times of increased business.

Contractors exist to complete tasks that have a clear beginning, middle, and end.

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Minimize Operating Costs

Outsource the production of your service or product

Subcontract parts of your business that are not your core competency

Rent space that is unused or underutilized by other ongoing businesses

Rent equipmentWork from home

15-22


Maximize the Results of Marketing

Word of Mouth Discounts, Local

signage, Facebook, Cooperative advertising

Publicity Press releases,

Public speaking, Donate your product or service

15-23


Crowdfunding for Equity

Document your business

Make a business plan

Create a compelling story

Create a professional-looking video

Develop a list of potential investors

15-24


Angel Investors

Angel investor A wealthy individual

who invests in companies in relatively early stages of development.

15-25


Types of Angel Investment

15-26


Equity Capital from the Owner’s View

Financing with equity is (1) expensive and (2) guaranteed to create problems of control and decision making.

Suppose you sell half your business to raise capital. You have just sold half of all your future profits, half of all your future growth, half of all your future wealth.

15-27


Why Use Equity Capital?

1. You will reduce your own exposure to financial loss

2. Your business will not have increased costs in the form of interest

3. Bringing outside investors into an existing business can often reenergize it by providing new ideas, procedures, and processes

15-28


Financing with Debt: Getting a Loan for Your Business

1. Direct loans of cash2. Guaranteeing loans made by commercial

banks 3. Reducing taxes by allowing interest to be

deducted

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Community development organization An organization authorized by the SBA to make

insured loans to small businesses that are expected to increase economic activity within a specific geographic area.

15-30



Small business investment companies Private businesses that are authorized to make

SBA insured loans to start-ups and small businesses.

15-31


The Four Cs of Borrowing

15-32

Figure 15.3



Accelerator An organization that supports startup technology

businesses by providing inexpensive office space, a variety of support services, and resources

Most are associated with universities.

15-33



Credit reporting agency A business that collects, collates, and reports

information concerning an entity’s use of debt.Fair Credit Reporting Act

U.S. federal legislation specifying consumers’ rights vis à vis credit reporting agencies.

15-34



Collateral Something of value given or pledged as security

for payment of a loan May consist of financial instruments, such as

stocks, bonds, and negotiable paper, or of physical goods, such as trucks, machinery, land, or buildings.

15-35


Gift Financing

Tax abatement A legal reduction in taxes by a government.

Tax credits Direct reductions in the amount of taxes that

must be paid, dependent upon meeting some legal criteria.

Grants Gifts of money made to a business for a specific

purpose.15-36


Gift Financing

Foundation An institution to which private wealth is

contributed and from which private wealth is distributed for public purposes.

15-37


Forms of Personal Gifts

15-38

Exhibit 15.1


When Giving a Gift

1. Put your agreement into writing2. If it is a gift, have the agreement specifically

say so.3. If it is a loan, have the agreement specify the

exact interest and payment terms.4. If it is an equity investment, consider

nonvoting stock.

15-39


What Type of Financing Is Rightfor Your Business?

Cost of capital The percentage cost of obtaining future funds.

Weighted average cost of capital (WAC) The expected average future cost of funds.

15-40


What Type of Financing Is Rightfor Your Business?

Financial leverage A measure of the amount of debt relative to total

investment.Optimum capital structure

The ratio of debt to equity that provides the maximum level of profits.

15-41


Interaction among Profitability, Control, and Risk

15-42

Figure 15.4


Tools for Financial Management

The obvious comparisons: With your planned position and results

(your master budget)With prior years’ position and results, With the position and results of other firms.Using relevant financial ratios.

15-43

small business finance: using equity, debt, and gifts chapter 15 © 2014 by mcgraw-hill education....

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