Lecture Notes 8 on Sources of Finance

8/13/2019 Lecture Notes 8 on Sources of Finance

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Introduction

Every entrepreneur planning a new venture

confronts the dilemma of where to find start

up capital.

It is important to understand the source ofcapital and requirements of these sources

Without this understanding an entrepreneur

may be frustrated with attempts to find start-upcapital.


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Major source of finance

Debt

Equity

Bootstapping


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Debt versus Equity

The use of DEBT to finance a

business involves a payback of funds

plus a fee (interest)EQUITY financing involves the sale of

some of the ownership in the venture.

Debt places a burden of repaymentwhereas equity forces the

entrepreneur to relinquish some

degree of control.


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Choice

The choice of the entrepreneur

To take on debt without giving up

ownership in the venture or To relinquish a percentage of ownership

in order to avoid having to borrow.

In most cases, a combination of DEBTand EQUITY proves most appropriate.


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Key Questions

To secure a bank loan an entrepreneur will

have to answer a number of questions

such as the following:

How much do you need?

When do you need it?

What do you plan to do with the money?


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Advantages of Debt Financing

No relinquishing of ownership

More borrowing allows for potentiallygreater return on equity.

During periods of low interest rates theopportunity cost is justified because the

cost of borrowing is low.


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Disadvantages of Debt

Financing

Remember (monthly) interest payments

are refunded.

Continual cash-flow problems can be

intensified because of paybacks

responsibility

Heavy use of debt can inhibit growth and

development.


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Other Debt financing sources

Trade credit

Finance coys

Leasing coysMutual savings and loans

associations

Insurance coys


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Examples Equity

Loan with Warranties

Convertible Debentures

Preferred stock Common stock


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Public Offering

Going public is a term used to refer to a

business raising capital through the sale of

securities on the public markets

Advantages Disadvantages

Size of capital Cost

Liquidity Disclosures

Value Requirements

Image Shareholders

pressure


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Venture Capital

Venture capitalista powerful source of equityfunding.

They provide a full range of services for new or

growing venture including the following:Capital for start-up and expansion

Market research and strategy for businesses that donot have their own marketing departments

Management consulting futureContacts with prospective customer

Assistance in negotiating technical agreements

Helping people management


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Essential Elements for a

successful capital

Team Must:

Be able to adopt

Know the competition

Be able to manage rapid growth

Be able to manage an industry leader

Have relevant background and industry

experienceShow financial commitment to company not just

sweat equity

Be strong with a proven track record in the

industry unless the company is a startup or


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successful capital contd

Product must:

Be real and work

Be unique

Be proprietary

Meet a welldefined need in the marketplace

Demonstrate potential for product expansion, to

avoid being a one-product company

Emphasize usability

Solve a problem or improve a process significantly

Be for mass production with potential for cost

reduction.


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successful capital contd

Market must:

Have current customers and the potential formany more

Grow rapidly (25% to 45% per year)Have a potential for market size in excess of GH

250 million cedis

Show where and how you are competing in themarket place

Have a potential to become a market leader

Outline any barriers to entry.


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Short-term and Long-term

Finance

The entrepreneur should have the

right amount of capital at the right

time to meet his financial requirement

Basing on the period, the

entrepreneur should arrange for twotypes of capital requirement.


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Shortterm capital

requirement

Current assets (cash in hand)

Raw materials

Promotion of value

Operating losses

Advance to suppliers

Commission to getting agents

Interest on loans

Wages/salary

Consumables


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Sources of short-term finance

Sales of fixed assets

Reserves

Provision of taxation

Accrued expenses

Credit papers Customers credit

Commercial banks

Indigenous bankers

Government assistance Loans from directors

Security of employees

Factoring


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Long-term capital requirement

Some assets are needed the whole life

of he entrepreneur or five years and

above.

Long-term capital is required to meet

for example, the following items:

Building intangible assets like goodwill,vehicles, plants etc.


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Sources of long-term finance

Internal sources (ownership capital)

Equity shares

Preference sharesReinvestment of earnings

Personal funds

Family and friendVenture capital

Other sources


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Sources of long-term finance

External sources (borrowed capital)

Debentures

Long-term loans

Public loans

Bank loans

State financingPrivate lenders

Institutional financing


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Bootstrap Financing

Meaning

Bootstrapping is building a business with little

or no capital.

The entrepreneur uses imagination, ingenuityand hard work instead of seeking outside

finance.

Bootstrap finance often has to do with notraising money and not spending it either, but

finding creative ways to achieve your

objectives.

it is often not to do with obtaining finance at


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BOOTSTRAP FINANCE

Principles:

Get operational fast

Look for quick break-even

Cash generating projects

Offer high-value products or services that can

sustain direct personal selling

Dont try to hire the crack team Keep growth in check

Focus on cash and

Cultivate banks early.

M it


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Merits

It is one of the most inexpensive ways to raise

capital for your business.

Bootstrap financing also looks good to outside

lenders when the time comes to raise moneythrough these routes.

It also makes your business more valuable

since no money was borrowed and no equitypositions of the company had to be given up.

Also there is no interest that must be

paid since the money you get is generated

from your own business and it's resources.

D it


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Demerit

The biggest downside of bootstrapping is that

self-financed firms are on a low-cash diet.

They tend to be capital-starved, making it

difficult to grow quickly. Of course, fast growthisn't necessarily a goal of most business

founders. Very often, taking the frugal path is

the best or only option for getting a business

off the ground.


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Types of Bootstrap Financing

Factoring- Using your accounts receivable to

generate cashflow by selling them to a

"Factor," at a discount, in exchange for cash.

Trade Credit- If your business can find avendor or supplier to extend trade credit and

allow you to order goods on net 30, 60, or 90

day terms, that is another form of bootstrap

financing you could use.


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Customers- Your business can use a letter of

credit from your customer to purchase

materials without using any company

resources. Real Estate-Leasing, refinancing, and

borrowing against equity is a great way for a

company to generate capital by using its own

assets.

Leasing-Free up cash by leasing equipment

rather than purchasing outright.

S t b t t


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Seven ways to bootstrap your

business

1. Slow down supplier payments.

2. Speed up customer payments.

3. Frugal businesses start at home.

4. Start out part-time.5. Share your office.

6. Lease, don't buy equipment.

7. Barter for services and products.

Documents

Lecture Notes 8 on Sources of Finance