mariotti: entrepreneurship © 2007 pearson education. upper

Mariotti: Entrepreneurship

© 2007 Pearson Education. Upper Saddle River, NJ, 07458. All Rights Reserved.

Entrepreneurship

Chapter 8 Financing Strategy:

Debt or Equity?

Marriotti: Entrepreneurship


Financing: The Use and Manipulation of Money

Money used to start a business is called capital.

There are 2 ways to obtain capital to finance a business:

1. Borrow money (debt)2. Sell a share of the business

(equity)



Sources of Capital Family and friends (equity or debt) Accounts payable (debt) Angels (equity) Banks, credit unions (debt) Minority financing sources (equity or debt)

Small Business Investment Companies (SBICS—debt)



How Often Do Small Firms Fail? Myth: 4 out of 5 small businesses fail in the first 5 years of operation.

Truth: over half of new small firms survive for 8 or more years. (according to Dun & Bradstreet study)

A small business is a high risk-high return investment.



3 Categories of Financial Investment

1. Stocks—shares of companies (equity)2. Bonds—loans to companies or government

entities (debt)3. Cash—investments that can be liquidated

(turned into cash) within 24 hours (savings accounts, treasury bills)

The higher the reward an investment offers, the greater the risk.

There is no such thing as a low risk/high return investment!!



Compound Interest: Money Making Money

A compound rate of return is calculated on not just the original investment but also on interest that has been earned by the investment.

$100 invested at 10% per year (not compounded) earns $10 per year. In 10 years you’ll have $200.

$100 invested at a compound rate of 10% earns $110 the first year ($100 + $10 interest), $121 the second year ($110 + $11 interest), etc. In 10 years you’ll have $259.37.



Future Value of $1 After “N” Periods



The Present Value of MoneyRule of thumb: You always want your money now.

If you can’t have it now, you want to be compensated with a return.

There are 3 risks to your money when you lend or invest it:

1. Inflation—if prices rise, your money will be worth less when it comes back to you.

2. Risk of loss—if the investment fails, you will lose your money.

3. Opportunity—you might find a better investment.



Net Present Value Chart



How Can You Compensate Investors in Your Business?

1. Debt—Borrow money and promise to pay it back over a set period of time at a set rate of interest. Investor receives interest.

2. Equity—Sell a percentage (share) of ownership in your business for money. Investor receives share of profits.



Business Legal Structures

1. Sole Proprietorship Owned by one person May offer investors debt or

equity

2. Partnership Owned by 2 or more people May offer investors debt or

equity



Business Legal Structures (cont.)3. Corporation

Legal “person” composed of equity investors in company.

May sell stock (equity) or bonds (debt)

4. Nonprofit Corporation/501 (c) (3) Financed by donations; may not sell debt or

equity Tax exempt



Business Legal Structures (cont.)

5. Cooperative Owned by customer/members All customer/members own shares of

company but each has one vote



Debt Financing: Pros and ConsPros: Lender has no say in operation of business Loan payments are predictable Lenders do not share business profits

Cons: If loan payments are not made, lender can force business into bankruptcy

If business is not incorporated and defaults, lender can take house and other possessions of owner

Loan payments increase fixed costs, lower profit



Equity Financing: Pros and ConsPros: If business does not make profit, investor does not get paid

Equity investors want business to succeed, will share contacts and advice

Cons: Entrepreneur can lose control of business to equity investors

Equity investor takes more risk, wants higher return

Entrepreneur must share profits with equity investors



6 “Cs” of Bank Borrowing1. Collateral—does entrepreneur own property,

cars, etc. that bank can take if loan is not paid?

2. Cash Flow—do projected cash flow statements show business will be able to make loan payments?

3. Credit History—does entrepreneur have good credit?

4. Capacity—what are business’s expense? Can it afford to pay the loan?

5. Commitment—how much of own money has entrepreneur invested?

6. Conditions—general economic climate



Establish Good Credit “No credit” is not “good credit.”

Prove you can make regular payments on a debt. Open a charge account, charge some purchases and pay them off on time.

Check your credit reports every 6 months to make sure they are accurate.



Creative FinancingMicro-Loan financing: $100–$25,000, supported by federal government

Loan made based not on 6 Cs but on entrepreneur’s character and business plan

Line of credit: Pre-arranged loan business owner can draw on when needed

Short-term (under one year)—must be paid in full during the year



More Creative FinancingAngel Financing: Private investors seeking equity Typically $100,000–$500,00 rangeMinority Financing: MESBICs: charted by Small Business Administration to support minority business

MBDC: Minority Business Development Centers MBDA.gov



More Creative FinancingBootstrap Financing: Hire as few employees as possible. Lease rather than buy equipment. Use personal savings. Work from home, borrow office space (business

incubators). Put profits back into business.Floating Accounts Payable: Float—time between a payment is due and cash is

received by creditor. Accounts Payable—money a business owes its

suppliers. Negotiate with suppliers for best possible

terms. Try to get more time to pay bills.



You Need a Business Plan to Raise Capital

Business plan should include: Business idea Long and short-term goals Market research Marketing plan Start-up and fixed operating

costs Management Legal structure

Investors will not see an entrepreneur who does not have a business plan.

Time management plan Financing Breakeven analysis Accounting system Projected monthly income statement Projected yearly income statement Financial ratio analysis Balance sheet

mariotti: entrepreneurship © 2007 pearson education. upper

Documents

business equity

equity financing

money debt

debt financing

control of business

investors debt

business profits cons

small business administration