11-1© 2005 The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

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ChapterChapter1111

Sources of CapitalSources of Capital

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OverviewOverview

Debt Financing- Interest-Bearing Debt Financing- Interest-Bearing Instrument Requiring Collateral Instrument Requiring Collateral (Asset)(Asset)

Equity Financing- Investor Equity Financing- Investor Receives Ownership PositionReceives Ownership Position

Financing Usually A Combination Financing Usually A Combination Of Debt And EquityOf Debt And Equity

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Factors AffectingFactors AffectingType Of FinancingType Of Financing

1)1) Availability of FundsAvailability of Funds

2)2) Assets of VentureAssets of Venture

3)3) Prevailing Interest Prevailing Interest RatesRates

4)4) All Financing Requires All Financing Requires Some Level of EquitySome Level of Equity

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Internal FundsInternal FundsProfitsProfitsSale of Assets- Rent Instead Of PurchaseSale of Assets- Rent Instead Of PurchaseWorking Capital ReductionWorking Capital ReductionExtended/Discounted Payment Terms- Extended/Discounted Payment Terms-

SuppliersSuppliersAccounts Receivable- Speed Up Accounts Receivable- Speed Up

CollectionCollectionReduction of:Reduction of:

InventoryInventory CashCash Working Capital ItemsWorking Capital Items

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External FundsExternal Funds

SelfSelfFamily & FriendsFamily & FriendsSuppliers & Suppliers & Trade CreditTrade Credit

Commercial Commercial BanksBanks

Government Government Loan ProgramsLoan Programs

R & D Limited R & D Limited PartnershipsPartnerships

Venture CapitalVenture CapitalPrivate Equity Private Equity

PlacementsPlacementsPublic Equity Public Equity

OfferingsOfferingsOther Government Other Government

ProgramsPrograms

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Personal FundsPersonal FundsEssential To Attract Outside Essential To Attract Outside Capital- Indicates Owner Capital- Indicates Owner Commitment, % Of Personal Commitment, % Of Personal AssetsAssets

Sources:Sources:SavingsSavingsLife InsuranceLife InsuranceHouse/Car MortgageHouse/Car Mortgage

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Family & FriendsFamily & FriendsRequires Knowledge Of EntrepreneurRequires Knowledge Of EntrepreneurDisadvantage- Direct Input Into Disadvantage- Direct Input Into OperationsOperations

Advantage- Often More PatientAdvantage- Often More PatientMust Be Done In Business-Like, Must Be Done In Business-Like, Written Manner With Terms, etc.Written Manner With Terms, etc.

Will Loss Have Severe Financial Will Loss Have Severe Financial Impact On Family/Friends?Impact On Family/Friends?

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Private PlacementPrivate PlacementFormalized Method For Obtaining Formalized Method For Obtaining

Funds From Private InvestorsFunds From Private Investors

Regulation D- Governs Private Regulation D- Governs Private

OfferingsOfferings Broad Provision To SimplifyBroad Provision To Simplify

Defines Private OfferingDefines Private Offering

Specific Operating RulesSpecific Operating Rules

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Commercial BanksCommercial BanksBank Loans- Asset BasedBank Loans- Asset Based

Accounts ReceivableAccounts Receivable InventoryInventory EquipmentEquipment Real EstateReal Estate

Cash Flow FinancingCash Flow Financing InstallmentInstallment Straight CommercialStraight Commercial Long-TermLong-Term CharacterCharacter

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Lending DecisionsLending Decisions

Based On Quantifiable Information Based On Quantifiable Information & Subjective Judgment& Subjective Judgment

Five “C’s”Five “C’s”1.1. CharacterCharacter 4. 4. CollateralCollateral

2.2. CapacityCapacity 5. 5. ConditionsConditions

3.3. CapitalCapital

Review Financial StatementsReview Financial Statements Review Projections = Reality?Review Projections = Reality?

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Lending QuestionsLending QuestionsDoes Entrepreneur Expect To Be Does Entrepreneur Expect To Be Carried By Loan?Carried By Loan?

Is Entrepreneur Committed To Is Entrepreneur Committed To Spend Effort To Succeed?Spend Effort To Succeed?

Business Have Unique Business Have Unique Advantage?Advantage?

Downside Risks?Downside Risks?Protection Against Disasters?Protection Against Disasters?

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Bank “Shopping” ProcessBank “Shopping” Process

1.1. Complete Business Plan & Complete Business Plan & ApplicationApplication

2.2. Evaluate Several Alternative BanksEvaluate Several Alternative Banks

3.3. Select One With Positive Select One With Positive Experience in Business AreaExperience in Business Area

4.4. Set AppointmentSet Appointment

5.5. Present Case/PlanPresent Case/Plan

6.6. Borrow Maximum Amount PossibleBorrow Maximum Amount Possible

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SBA FinancingSBA FinancingWhen Entrepreneur Doesn’t Have:When Entrepreneur Doesn’t Have:

Track RecordTrack Record AssetsAssets

SBA-Guarantee For:SBA-Guarantee For:Working CapitalWorking CapitalMachinery/EquipmentMachinery/EquipmentFurniture/FixturesFurniture/FixturesLand/BuildingLand/BuildingLeasehold ImprovementsLeasehold ImprovementsDebt RefinancingDebt Refinancing

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SBA ConditionsSBA ConditionsBusiness Cash FlowBusiness Cash FlowFive “C’s”- 20%+ Ownership Five “C’s”- 20%+ Ownership Requires Personal GuaranteeRequires Personal Guarantee

Eligibility:Eligibility: SizeSize Type Of BusinessType Of Business Use Of ProceedsUse Of Proceeds Availability Of Funds From Other SourcesAvailability Of Funds From Other Sources

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SBA 7(a) LoanSBA 7(a) Loan

Up To $2 Million- SBA Exposure No Up To $2 Million- SBA Exposure No More Than $1 MillionMore Than $1 Million

Interest Rate Negotiated & Pegged To Interest Rate Negotiated & Pegged To Prime RatePrime Rate

Guarantee 85% On Loan < $150,000Guarantee 85% On Loan < $150,000

Guarantee 75% On Loan $150,000 To Guarantee 75% On Loan $150,000 To $1 Million$1 Million

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Other SBA ProgramsOther SBA Programs504 Loan Program- Fixed Rate504 Loan Program- Fixed Rate

Acquire Machinery, Equipment, Real EstateAcquire Machinery, Equipment, Real Estate Expand/ModernizeExpand/Modernize <$1 Million<$1 Million

Microloan- 7(m)Microloan- 7(m) Short-Term < $35,000Short-Term < $35,000 Working Capital, Inventory, Supplies, Working Capital, Inventory, Supplies,

Furniture, Fixtures, Machinery, EquipmentFurniture, Fixtures, Machinery, Equipment Not For Existing DebtNot For Existing Debt

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R & D Limited PartnershipsR & D Limited Partnerships

Tax Sheltered Money For Developing A Tax Sheltered Money For Developing A

Technology- No GuaranteeTechnology- No Guarantee

Elements:Elements:1.1. ContractContract

2.2. Sponsoring Company- General PartnerSponsoring Company- General Partner

3.3. Limited Partnership- Limited LiabilityLimited Partnership- Limited Liability

Useful When:Useful When: High RiskHigh Risk

Significant ExpenseSignificant Expense

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R & D Contract FeaturesR & D Contract Features

1)1) Loss Liability Borne By Limited Loss Liability Borne By Limited PartnersPartners

2)2) Tax Advantages To Limited Tax Advantages To Limited Partnership & Sponsoring Partnership & Sponsoring CompanyCompany

3)3) Benefits/CostsBenefits/Costsa)a) Provides Funds With Minimum Equity Provides Funds With Minimum Equity

DilutionDilutionb)b) Expensive To EstablishExpensive To Establish

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Government (SBIR) GrantsGovernment (SBIR) Grants

Phase I- Up To $100,000 For 6 Months Phase I- Up To $100,000 For 6 Months Feasibility StudyFeasibility Study

Phase II- Principal R & D Effort, Up to Phase II- Principal R & D Effort, Up to $750,000 For 24 Months, Develop $750,000 For 24 Months, Develop Prototype Products/ServicesPrototype Products/Services

Phase III- Commercialization, No Phase III- Commercialization, No SBIR FundingSBIR Funding

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R & D Limited Liability StagesR & D Limited Liability Stages

I.I. FundingFundingA.A. Contract Established- Contract Established-

Terms/Conditions Of OwnershipTerms/Conditions Of OwnershipB.B. Money InvestedMoney Invested

II.II. Development- Research Development- Research PerformedPerformed

III.III. Exit- Reap BenefitsExit- Reap BenefitsA.A. Equity PartnershipEquity PartnershipB.B. Royalty PartnershipRoyalty PartnershipC.C. Joint VentureJoint Venture