Oct 14 ecd lecture 5 financing the business i(1)

ENTERPRISE CREATION & DEVELOPMENT

Lecture 5

Financing the Business 1Mr Nicholas Tan Tian Leng(nicholas@np.edu.sg)

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Lecture objectives

Sources of financing

Types of financing

◦ Equity financing

◦ Debt financing

How different finance options will affect profitability/cash flow

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Recommended reading

• Donald F. Kuratko ENTREPRENEURSHIP –THEORY, PROCESS AND PRACTICE, 9th Edition, CENGAGE, Chp 7,9 & 15

• Justin G. Longenecker, Carlos W. Moore, J. William Petty and Leslie E. Patch, SMALL BUSINESS MANAGEMENT – AN ENTREPRENEURIAL EMPHASIS, International Edition, Thomson South-Western, Chp 12

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After deciding on how to start your business, & which business structure to use (in the last lecture), you need to ask:

1. Where are you getting the money for your new ventures?

2. What about later?

We will go through the different Financing options in this lecture.

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Sources of funding

5

Dependent on:

- Level of risk

- Stage of firm’s

development

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Types of financing

Equity financing

Debt financing

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Equity financing

Money invested in the venture with nolegal obligation for entrepreneurs torepay the principal amount or payinterest on it.

But entrepreneurs will need to shareownership & profits with the fundingsource

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Sources of equity financing

a) Personal savings

b) Informal investors

c) Public offerings

d) Private placements

e) Venture capitalists

f) Angel investors

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b) Informal investors

Usually

◦ Friends

◦ Families

◦ Colleagues

◦ Strangers

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c) Public offerings Initial public offering (IPO) refers to a corporation raising

capital through the sale of securities on the public markets.

Advantages:

◦ Able to raise huge sums of capital in a short period.

◦ Public market provides liquidity for owners since they can readily sell their shares.

◦ The marketplace puts a value on the company’s shares, which in turns allows value to be placed on the corporation.

◦ The image of a publicly traded corporation is stronger in the eyes of suppliers, financiers & customers.

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c) Public offerings

Disadvantages:

◦ Costs involved with a public offering are much higher. Egaccounting fees, legal fees, prospectus printing, costs ofunderwriting shares.

◦ Detailed disclosures of the company’s affairs must bemade public.

◦ Paperwork involved with government regulations etcdrains a lot of time, energy & money.

◦ Pressure from shareholders could lead to short termviews of the company.

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d) Private placements Money invested by private investors.

May be possible to avoid issuing a prospectus(rules differ from country to country).

Suitable for an injection of capital to jump tothe next level of growth.

And have a proven track record ofprofitability.

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e) Venture capitalists (VCs) Professionals that provide a full range of financial

services for new or growing ventures, including:Capital for start–ups and expansion Market research and strategy Management consulting functions Contacts with prospective customers and suppliers Assistance in negotiating technical agreements Help in management and accounting controls Help in employee recruitment Help in risk management Guidance with government regulation

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e) Venture capitalists’ objectives

Different from other investors

VCs will carefully measure both product/serviceand management

Concerned with return on investment (ROI)

Returns are expected to be consistently high

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e) Evaluating the venture

capitalist

Don’t hesitate to evaluate the venture capitalist – Does the venture capitalist understand the

proposal?

– Is the individual familiar with the business?

– Is this someone I can work with?

‘You can divorce your spouse, but you can’t divorce your investor’

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More on Venture Capitalists

Financing, With Strings Attached (The

New York Times)

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f) Angel investors

An angel investor has already made theirmoney and now seeks out promisingyoung ventures.

Currently expecting lower valuationsand more control.

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f) Angel investors

Corporate angels– Senior managers laid off or retired with generous payouts

Entrepreneurial angels– Own and operate successful businesses

Enthusiast angels– Independently wealthy from success in a business they

started

Micro-management angels– Attempt to impose their management style

Professional angels– Invest in companies with products/services they know

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Debt financing

• Debt involves borrowing money, with anobligation to pay it back with interest andusually to a deadline or timeline.

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Debt financing

1) Commercial banks

2)Trade credit

3) Accounts receivable financing

4) Factoring

5) Hire purchase

6) Finance companies

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1) Commercial banks

A major source of small business debt financing.

Loans are secured by fixed assets, receivables,inventories, or other assets.

Generally require collateral and systematicpayments.

Not interested in future prospects.

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2) Trade credit◦ Credit given by suppliers who sell goods on

account, usually 30 – 90 days.

◦ Many small, new businesses obtain thiscredit when no other form of financing isavailable.

◦ Suppliers typically offer this credit to attract new customers.

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3) Accounts receivable financing

Short-term financing that involvesthe pledge of receivables as acollateral for a loan.

Accounts receivable bank loans aremade on a discounted value of thereceivables pledged.

Made by commercial banks.

Notification or non-notification plan.

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4) Factoring Sale of a business’s accounts receivables

to a factoring company.

Usually the factor will buy the client’sreceivables outright, without recourse,as soon as the clients creates them byshipment of goods to customers.

Common in industries such as textiles,furniture manufacturing, clothingmanufacturing, toys, shoes and plastics.

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5) Hire purchase

Extended payment scheme enteredinto between the entrepreneur/hirerand owner (equipment manufactureror financial institution)

Hirer only needs to pay a small depositup front and then make regularinstalment payments

Only on final instalment does the hireracquire ownership

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6) Finance companies

Asset-based lenders that lend moneyagainst assets such as receivables,inventory and equipment.

Often make loans that banks do not.

Interest higher than banks.

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Equity & debt financing

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