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LECTURE NOTES 8 SOURCES OF FINANCE MARCH 26, 2012

Introduction

Every entrepreneur planning a new venture confronts the dilemma of where to find start up capital. It is important to understand the source of capital and requirements of these sources Without this understanding an entrepreneur may be frustrated with attempts to find start-up capital.

Major source of finance


Debt Equity Bootstapping

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 repayment whereas equity forces the entrepreneur to relinquish some degree of control.

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 DEBT and EQUITY proves most appropriate.

Debt Finance
Many business find that debt financing is necessary Short term borrowing is often required for working capital and is repaid out the proceeds from sales. Long term borrowing is used to finance the purchase of property or equipment with the purchased assets serving as collateral for the loans.

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?

Advantages of Debt Financing

No relinquishing of ownership More borrowing allows for potentially greater return on equity. During periods of low interest rates the opportunity cost is justified because the cost of borrowing is low.

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.

Other Debt financing sources


Trade credit Finance coys Leasing coys Mutual savings and loans associations Insurance coys

Equity Finance
It is the money invested in the venture with no legal obligation for Entrepreneurs to repay the principal amount or pay interest on it. It requires sharing the ownership and profits with the funding source. Because no repayment is required, equity capital can be much safer for new ventures than debt financing.

Examples Equity
Loan with Warranties Convertible Debentures Preferred stock Common stock

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

Venture Capital

Venture capitalist a powerful source of equity funding. 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 do not have their own marketing departments Management consulting future Contacts with prospective customer Assistance in negotiating technical agreements Helping people management

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 experience Show financial commitment to company not just sweat equity Be strong with a proven track record in the industry unless the company is a start up or

Essential Elements for a successful capital contd

Product must:
Be

real and work Be unique Be proprietary Meet a well defined 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.

Essential Elements for a successful capital contd

Market must:
Have

current customers and the potential for many 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 the market place Have a potential to become a market leader Outline any barriers to entry.

Essential Elements for a successful capital contd

Business plan must: Tell the full story not just one chapter Promote a company not just a product Be compelling Show the potential for rapid growth and knowledge of your industry especially competition and market vision. Include milestone for measuring performance

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 two types of capital requirement.

Short term 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

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

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.

Sources of long-term finance

Internal sources (ownership capital) Equity shares Preference shares Reinvestment of earnings Personal funds Family and friend Venture capital Other sources

Sources of long-term finance

External sources (borrowed capital) Debentures Long-term loans Public loans Bank loans State financing Private lenders Institutional financing

Bootstrap Financing
Meaning Bootstrapping is building a business with little or no capital. The entrepreneur uses imagination, ingenuity and hard work instead of seeking outside finance. Bootstrap finance often has to do with not raising money and not spending it either, but finding creative ways to achieve your objectives. it is often not to do with obtaining finance at

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.

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 money through these routes. It also makes your business more valuable since no money was borrowed and no equity positions 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.

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 growth isn'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.

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 a vendor 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.

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.

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.