Entrepreneurship

BM019-3-3

SOURCES OF FINANCE FOR

ENTREPRENEURS
Anita.Apiit.
 LEARNING OUTCOMES

• To learn about the options for financing a new

business venture.

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 WHAT IS CAPITAL?
• Capital is any form of wealth employed
to produce more wealth for a firm.

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 Three Types of Capital

• Fixed - used to purchase the permanent or

fixed assets of the business (e.g., buildings,
land, equipment, etc.)

• Working - used to support the small

company’s normal short-term operations (e.g.,
buy inventory, pay bills, wages, salaries, etc.)

• Growth - used to help the small business

expand or change its primary direction.

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 WHAT ARE THE
START UP COST
THAT WILL INCCUR
IN A BUSINESS?
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 Start-up Costs

• Merchandise Inventory
• Wages
• Rent
• Equipment and furniture
• Tools
• Vehicles
• Licenses & permits
• Insurance
• Supplies
• Advertising & promotion
• Deposits (Telephone & Utilities)
• Initial Working Capital

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 OPTIONS FOR FINANCING

• One of the most difficult problems in a new

venture is obtaining financing.

• The two types of financing needs to be

considered would be :

-Debt financing
-Equity financing
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 Debt Financing

• Obtaining borrowed funds for the company.

• Must be repaid with interest.
• Is carried as a liability on the company's
balance sheet.
• Can be expensive, especially for small
companies, because of the risk/return
tradeoff.
• Requires some asset to be used as
collateral.

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 Purposes of Borrowing
Short Term(less than a year)
• provide working capital to finance inventory/stock.
• increase your work force
• Refinance existing debt
• or other operations of business

Long term(more than a year)

• Gain market share
• Purchase new equipment, assets or building

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 Debt
Short Term
• Used to finance assets which
are liquidated in the short term
(usually one year maximum)
short-term loans are usually
used to finance inventory,
accounts receivable, and other
situations where cash is needed
for only a short period of time.
• Can provide funds for working
capital
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Long Term
• Used to purchase real property
such as land, buildings and
equipment & other assets that
generally have a long life.
• Usually paid off over long
periods of time (several years).
• Purchase of physical assets is
important for business expansion
and growth.
 What the lender review

• Credit – credit history

• Character – commitment, education, exp.
• Cash flow - repayment ability
• Collateral – security for the loan
• Conditions – state of economy, timing,
preparation, past history of business,
business type

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 Sources of Debt Capital

• Commercial banks
• Family and friends
• Credit cards
• Commercial lenders
• Credit unions

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 Sources of Debt Capital
COMMERCIAL BANKS

• Lenders of first resort for small business owners

• 80% of all loans to existing businesses come

from banks

• Focus on a company’s ability to generate

positive cash flow when evaluating loan
proposals

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 Sources of Debt Capital
• Commercial Bank loans:
– Business owners may have some trepidation about
borrowing from a financial institution, as it means
relinquishing some cash profits. But it could be a good
option so long as you expect to have sufficient cash
flow to pay back the loans, plus interest.

– The major benefit for debt financing, unlike with equity

financing, you'll retain full ownership of your business.
The interest on business loans is also tax-deductible,
and you’ll build your credit. Small businesses
frequently take bank loans.

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 Sources of Debt Capital

• Credit cards:
– Credit card use and lines of credit by small businesses
has increased significantly since 1993.
– Small business owners' use of business credit cards
(48.1%) has eclipsed their use of personal cards (46.7%)
and is expected to grow.
– The majority (74%) of small business owners use credit
cards as ‘charge' cards for transactional purposes and
pay their balances in full each month.
– Approximately one-in-four use credit cards as a source
of interim or long-term financing, incurring interest costs.

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 Sources of Debt Capital

• Commercial Lenders

-Licensed money lenders

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 Sources of Debt Capital

• Credit Unions

- cooperative financial institution and operated for

the purpose of promoting thrift, providing credit
at reasonable rates, and providing other
financial services to its members. Many credit
unions exist to further community development
or sustainable instituitional development

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 Preparing for a Loan Request
1. Are additional funds really needed in the business?
2. Why are the additional funds needed?
3. What increase in revenue and/or profit will be generated by
added funds?
4. When will these added funds be needed?
5. For how long a period will these added funds be needed?
6. How much is needed in the way of added additional
financial resources?
7. Where can these additional funds be obtained?
8. How much will these additional funds cost the business?
9. If the funds are borrowed, how will the indebtedness be
repaid?
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 Business Credit Sources
• Equity Financing:

– Small business owners when weighing debt (bank) and equity

financing options often opt for equity financing because they
have concerns about either qualifying for a loan or having to
channel too much of their profits into repaying the loan.
– Investors and partners can provide equity financing, and they
generally expect to profit from their investments.
– No debt payments means more cash on hand. Moreover, if no
profit materializes, you aren’t obligated to pay back equity
contributions.

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 Equity Capital
• Represents the personal investment of the
owner(s) in the business.
• Is called risk capital because investors assume
the risk of losing their money if the business
fails.
• Does not have to be repaid with interest like a
loan does.
• Means that an entrepreneur must give up some
ownership in the company to outside investors.

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 Sources of Equity Financing

• Personal savings
• Friends and family members
• Angels
• Partners
• Corporations
• Venture capital companies
• Public stock sale

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 Personal Savings

• The first place an entrepreneur

should look for money.
• The most common source of equity
capital for starting a business.
• Outside investors and lenders
expect the entrepreneur to put some
of her own capital into the business
before investing theirs.
• Sweat equity and personal risk
equity (non-monitary)

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 Friends and Family Members

• After emptying her own pockets, an

entrepreneur should turn to those
most likely to invest in the business –
friends and family members.
• Survey: 10% of business owners turn
to family and friends for capital.
• Careful!!! Inherent dangers lurk in
family/friendly business deals,
especially those that flop.

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 Friends and Family Members
• Guidelines for Family and Friendship
Financing Deals:
– Consider the impact of the investment on
everyone involved. Keep the arrangement
“strictly business.”
– Settle the details up front.
– Create a written contract.
– Treat the money as “bridge financing.”
– Develop a payment schedule that suits
both parties.

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 Angel
Investors

• Angels - private investors who back emerging

entrepreneurial companies with their own
money.

• Fastest growing segment of the small

business capital market.

• An excellent source of “patient money” for

investors needing relatively small amounts of
capital – often less than $500,000.

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 Angels
• Angel investors" will mentor a company and provide
needed capital and expertise to help develop
companies.
• Angel investors may either be wealthy people with
management expertise or retired business men and
women who seek the opportunity for first-hand
business development.
• Angels almost always invest their money locally and
can be found through “networks.”
• What do angels look for?
– Exciting ideas (with clear potential)
– A way to help a trusted friend

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 Venture Capital

• Venture capital is money provided by

professionals who invest alongside
management in young, rapidly growing
companies that have the potential to
develop into significant economic
contributors.
• Venture capital is an important source of
equity for start-up companies.

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 Corporate Venture Capital

• 30% of all venture capital investments

come from corporations.
• About 900 large corporations across the
globe invest in start-up companies.
• Capital infusions are just one benefit;
corporate partners may share marketing
and technical expertise.

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 Venture Capitalist Companies
• More than 3,000 venture capital firms
operate across the United States.
• Most venture capitalists seek
investments in the $3,000,000 -
$10,000,000 range in companies with
high-growth and high-profit potential.
• Business plans are subjected to an
extremely rigorous review – less than
1% accepted.

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 Venture Capitalist Companies
• Most venture capitalists take an active
role in managing the companies in
which they invest.
• Many venture capitalists focus their
investments in specific industries with
which they are familiar.
• Most often, venture capitalists invest in
a company across several stages.

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 The “Secrets” to Successful
Financing
1. Choosing the right sources of capital is a
decision that will influence a company for a
lifetime.
2. The money is out there; the key is knowing
where to look.
3. Creativity counts. Entrepreneurs have to be as
creative in their searches for capital as they are
in developing their business ideas.

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 The “Secrets” to Successful
Financing (continued)

4. The World Wide Web puts at entrepreneur’s

fingertips vast resources of information that can
lead to financing.
5. Be thoroughly prepared before approaching
lenders and investors.
6. Entrepreneurs should not underestimate the
importance of making sure that the “chemistry”
between themselves, their companies, and their
funding sources is a good one.

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 TUTORIAL QUESTIONS

1. Differentiate between debt financing and

equity financing for entrepreneurs?
2. Which in your opinion is a better option?
3. What would lenders or investors be
looking for in a business plan?

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SHORT CASE FOR APPLICATION
David Bernstein needs help financing his New Jersey-based Access
Direct Inc., a six-year old , 3.5 million company. “We’re ready to get
to the next level,” says Bernstein. “ But we’re not sure which way to
go.” Access Direct spruces up and then sells used computer
equipment for corporations; it is looking for up to 2 million in order to
expand. “Venture capitalists, individual investors, or banks,” says
Bernstein, who owns the company with four partners, “We’ve thought
about them all.”

1. What is your impression of Bernstein’s perspective on raising capital to ‘get

to the next level”?

2. What advice would you offer Bernstein as to both appropriate and

inappropriate sources of financing in his situation?

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 WORKSHEET OF COMPARISON

Advantages Advantages

Disadvantages Disadvantages

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