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ENTERPRISE CREATION & DEVELOPMENT
Lecture 5
Financing the Business 1Mr Nicholas Tan Tian Leng([email protected])
ECD Oct 14 / Lecture 5 / ttl 1
Lecture objectives
Sources of financing
Types of financing
◦ Equity financing
◦ Debt financing
How different finance options will affect profitability/cash flow
2ECD Oct 14 / Lecture 5 / ttl
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
3ECD Oct 14 / Lecture 5 / ttl
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.
4ECD Oct 14 / Lecture 5 / ttl
Sources of funding
5
Dependent on:
- Level of risk
- Stage of firm’s
development
ECD Oct 14 / Lecture 5 / ttl
Types of financing
Equity financing
Debt financing
6ECD Oct 14 / Lecture 5 / ttl
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
7ECD Oct 14 / Lecture 5 / ttl
Sources of equity financing
a) Personal savings
b) Informal investors
c) Public offerings
d) Private placements
e) Venture capitalists
f) Angel investors
8ECD Oct 14 / Lecture 5 / ttl
b) Informal investors
Usually
◦ Friends
◦ Families
◦ Colleagues
◦ Strangers
ECD Oct 14 / Lecture 5 / ttl 9
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.
10ECD Oct 14 / Lecture 5 / ttl
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.
11ECD Oct 14 / Lecture 5 / ttl
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.
12ECD Oct 14 / Lecture 5 / ttl
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
ECD Oct 14 / Lecture 5 / ttl 13
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
14ECD Oct 14 / Lecture 5 / ttl
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’
15ECD Oct 14 / Lecture 5 / ttl
More on Venture Capitalists
Financing, With Strings Attached (The
New York Times)
16ECD Oct 14 / Lecture 5 / ttl
f) Angel investors
An angel investor has already made theirmoney and now seeks out promisingyoung ventures.
Currently expecting lower valuationsand more control.
ECD Oct 14 / Lecture 5 / ttl 17
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
18ECD Oct 14 / Lecture 5 / ttl
Debt financing
• Debt involves borrowing money, with anobligation to pay it back with interest andusually to a deadline or timeline.
19ECD Oct 14 / Lecture 5 / ttl
Debt financing
1) Commercial banks
2)Trade credit
3) Accounts receivable financing
4) Factoring
5) Hire purchase
6) Finance companies
20ECD Oct 14 / Lecture 5 / ttl
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.
21ECD Oct 14 / Lecture 5 / ttl
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.
22ECD Oct 14 / Lecture 5 / ttl
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.
23ECD Oct 14 / Lecture 5 / ttl
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.
24ECD Oct 14 / Lecture 5 / ttl
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
25ECD Oct 14 / Lecture 5 / ttl
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.
26ECD Oct 14 / Lecture 5 / ttl
Equity & debt financing
27ECD Oct 14 / Lecture 5 / ttl