Financed bySupported byImplemented in cooperation with Financed bySupported byImplemented in cooperation with Financial instruments Ways to finance your

Financed by Supported by Implemented in cooperation with


Financial instrumentsWays to finance your small business


FinancesOne of the crucial aspect of every business is how to

finance it – either when you start, when you want to grow or when you face business difficulties


Ways to get financedDebt – various types of borrowing- Friends, Family and Fools, Banks, Leasing, Factoring, OtherEquity – giving up certain portion of your ownership in

the company (by issuing ordinary (common) or preferred stocks or by incorporating partners)

- Business Angels, Venture capitalists, Friends, Family and Fools


Debt vs. EquityDEBTPROS- Retain ownership in company- Considered cheaper than equity financing- If firm has assets (collateral) it can raise

cheaper long-term loans

CONS- More risky (it becomes your fixed cost!)- Lack of collateral or poor earnings history –

no money or borrowing with high interest rates!

- It has to be returned

EQUITYPROS- no interest to return, no obligation to repay back- Improving credithworthiness- Equity money can be used as collateral- Shareholders may use their personal earnings

history to raise bank loans- Good networking possibilities (especially for

start-ups)

CONS- Giving up piece of the ownership in the company - Have to answer to someone else- Most expensive way of financing (each investor

receives a percentage of total value of the company)


Rule of the thumb“Whether the price of the money is 2 percent or 20

percent, it should always be lower than the return you expect from spending it. That is to say, don't invest money in any project that won't generate enough profit to more than cover the loan payments, including interest.”

David Worrell, Entrepreneur magazine online edition, 2006


Types of debt financingFriends, Family, Fools (3F)BanksLeasingFactoringOther


Friends, family, fools (3F)Perhaps the best way to borrow, with minimum interest rates (or none)Higher level of sympathy and ready to wait for the money to be

returnedAre sometimes eager to interfere in your business and give you advice

whether you want it or notMight ask to become partners or partial owners – rarely, but it

happens!Be sure to clarify things in written agreement, since memories tend to

get fuzzy over time!


BanksEntrepreneurs are usually high risk clients for banks, unless they

have a solid collateral (e.g. Fixed assets) and a good credit historyBanks will also look closely at your cash flows, liquidity of your

assets and a solid business planShort-term loans – credit card loans, overdrafts (line of credit)–

high interest rates – most commonly use for smaller investments and short-term lack of cash

Long-term loans – lower interest rates, but demand solid collateral


Credit cardsIt has become increasingly common among entrepreneurs

(almost 50% of entrepreneurs have used it once in their business)

More easily available money than regular bank loan, no justificiations required on how you will spend it, no business plan needed to back up your claim

Beware of the high interest ratesDemands discipline in spending


Line of credit (overdraft)a flexible loan from a bank or financial institution to an individual or business. a line of credit is a limited/specified amount of money that an individual can

access as needed and then repay immediately or over a pre-specified period of time.

As a loan, a line of credit will charge interest as soon as money is borrowed, and borrowers must be approved by the bank. If you don’t use it, no interest is charged

Useful for shortages of cash, so best to apply for it when sufficient funds are on your bank account

Interest is higher than in regular bank loans


Long-term loansRequire some kind of collateral – mortgageTwo types of mortgage – chattel (inventory or movable

property serves as collateral and owner cannot sell it without bank’s permission) and real estate (immobile property – house, flat etc.)

Lower interest rates, but it demands solid business plana and purpose of spending is set,


Before you apply for loan Check yourself – if you have personal track record of late payments, chances of getting a

loan are slim Check your business – have you been blocked, are you paying taxes and other

obligations, how are your cash flows and overall business results What assets do you own – check what do you own, and are you willing to put is a

collateral to secure loan Whom do you know – does your banker know you? Do they know your business?

Personal touch can be of great help in advocating for your loan! How much do you need – are you purchasing equipment or seeking cash cushion. What

would be the ideal? What would be minimum? How will you pay it back - Put together a realistic plan of action for improving the cash

flow in your business and paying back the debt. Identify your marketing strategy and projected sales results over an expected time frame.

Source: O'Berry, D. 2007.„Finding and Keeping Cash in Your Company“, in Small Business Cash Flow: Strategies for Making Your Business a Financial Success, USA: John Wiley and Sons, p.49-50


LeasingGood way to obtain an asset without necessarily owning

it (used for buying equipment, vehicles etc.)Types: - Operating - Financial (Capital)


Operating leasingAllows the use of item without getting ownership. Legal and economic owner is leasing agency – takes all risks,

user can return the item after the leasing contract has expiredUsed for short-term leases (e.g. Copy machine, Office

equipment, Computers etc.)Lesee (the person who is leasing) pays monthly instalments

including VAT – calculate it in operating expenses as rental expenses


Financial (capital) leasingused for long-term leases and for items that not become

technologically obsolete, e.g. machinery. give the lessee the economic ownership and risk, so they

are considered as assets, and they may be depreciated.In general, the items leased are shown in lesees Balance

sheet (Asset/Debt), and depreciation plus cost of interest go to operating costs (in Income statement)


FactoringShort-term debt, where Factor buys up accounts

receivables and takes % factor feeIn theory, 70-90% of the amount is paid immediately, and

10-30% after the receivables have been collected


OtherMerchant credit – delayed payment to suppliers (based

on contracts signed, e.g. 30-60 days waiting period)Grants and credits from non-banking institutions (state

and local municipality)


EquityEntrepreneurs – owners use this option when:- They don’t mind losing part of their control to the others- Cash flows are not sufficient to cover existing debt- Credit history and collateral is not sufficient to raise bank

loans- Bank loans (amounts) do not cover necessary investment


The usual sources of equity financing

Business angelsVenture capitalists


Business angels

Succesful entrepreneurs (or entrepreneurial associations) willing to invest money

Work alone or in syndicatesWill invest in start-ups and young companies – will also provide

managerial advice and networking opportunitiesInvest up to 1 mil euros, but in average around 50.000 – 100.000 euros

for period of 2-10 yearsExpect 15-45% return“Patient money”


Business angels - Methods of workingDifferent from country to countryEither borrow you money (debt) or ask to form new

company where they enter as partnersIssuing of stocks – either as private placement (directly sell

stocks to business angels and do not place them on stock exchange – cheaper and simpler) or going public (Initial public offering – IPO – stocks are offered as stock exchange – expensive and more complex)


Venture capitalistsInstitutional firms raising a pool of capital from different

sources (including business angels)Used for big investments, 1-30 mil eurosUsually invest in high-growth, more mature companies

(experts do not recommend it for start-ups)Demand good management, solid revenues and cash flows,

good business plan and their own EXIT strategyExpect high returns in 3-5 years


Methods of workingThey never enter the company without good exit strategy

– will ask for public stock offering (IPO)Will appoint someone to the supervisory board and will in

most cases ask for prefered stocks (it pays dividends and has preference in case of liquidation)

Documents

Financed bySupported byImplemented in cooperation with Financed bySupported byImplemented in cooperation with Financial instruments Ways to finance your