Chapter 12 Packet notes- Test 3 Flashcards
- Spontaneous Financing
- External financing
- Profit retention
Basic Types of Financing: Sources of Financing
- Firms economic potential
- Company size and maturity
- Types of assets
- Owner preferences for debt or equity
Factors that Determine Financing
Growth prospects and long-term profitability
Firm’s Economic Potential
Life-cycle position in business (beginning or mature).
Company Size and Maturity
Tangible or intangible.
Types of Assets
Tradeoffs required for debt and equity.
Owner Preferences for Debt or Equity
- Voting control: owners must share control with other equity investors who buy the stock or make a large investment.
- Financial Risk: Lower
- Protential profitability: Lower potential return on investment for the owners.
High Equity and Low Debt Financing
- Voting control: Owners maintain control without having to make a large investment.
- Financial risk: Higher
- Potential Profitability: Higher potential return on investment for the owners.
High Debt and Low Equity Financing
- Return on assets
- Return on equity
Debt or Equity Financing?
- Rate of return earned on a firm’s total assets invested.
- Computed as operating income divided by total assets
Return on Assets
- Rate of return earned on the owner’s equity investment.
- Computed as net income divided by owner’s equity investment.
Return on Equity
- Personal savings
- Friends and family
- Other individual investors
- Venture capital firms
- Large corporations
- Public sale of stock
Equity
- Friends and family
- Other individual investors
- Commercial banks
- Business suppliers
- Asset-based lenders
- Government-sponsored programs
- Venture capital firms
- Community-based financial institutions
- Large corporations
Debt
- Personal savings
- Family and friends
- Credit cards
Three Sources of Financing (Sources Close to Home)
Owner equity is expected by other investors.
Personal Savings
Borrowing puts personal relationships at risk.
Family and Friends
Provides easy access to funds and assets; cards should be a method of payment and not a source of credit.
Credit Cards
- Line of credit
- Term loans
- Mortgages
Types of Loans
An informal agreement between a borrower and a bank as to the maximum amount of funds the bank will provide at any one time.
- Revolving Credit Agreement
Line of Credit
A commitment by a bank to lend up to a maximum amount.
Revolving Credit Agreement
Money loaned for a 5-10 year term, corresponding to the length of time the investment will bring in profits.
- generally used to finance equipment
Term Loans
Two types which represent a long-term source of debt capital:
- Chattel
- Real Estate
Mortgage
A loan or which items of inventory or other moveable property serve as collateral.
Chattel Mortgage
A long-term loan with real property held as collateral.
Real Estate Mortgage
- How much the bank will earn on the loan
- What is the likelihood that the lender will be able to repay the loan?
Banker’s Concerns
- Character of the borrower
- Capacity of the borrower to repay the loan
- Capital invested in the venture by the borrower
- Conditions of the industry and economy
- Collateral available to secure the loan
The Five C’s of Credit
- Do the purpose and amount of loan make sense, both for the bank and for the borrower?
- Does the borrower have strong charcter and reasonable ability?
- Does the loan have a certain secondary source of repayment?
- Does the loan have a certain primary source of repayment?
- Can the loan be priced profitabily to the customer and to the bank, and are this loan and the relationship good for both the customer and the bank?
- Can the loan be properly structured and documented?
Lender’s Questions
- How much money is needed?
- What is the venture going to do with the money?
- When will the money be needed?
- When and how will the money be paid back?
Banker’s Concerns
- Three years of the firm’s historical statements
- The firm’s pro forma financial statements
- Personal financial statements
Financial Information Required for a Bank Loan
Balance sheets, income statements, and statements of cash flow.
Three Years of the Firm’s Financial Statements
- Reports that show the firm’s financial condition
- The timing and amounts of the debt repayment included as part of the forecasts.
The Firm’s Pro Forma Financial Statements
The borrower’s personal net worth (assets-debts) and estimated annual income.
Personal Financial Statements
- Prime rate
- LIBOR
- Fixed Interest Rates
- Floating Interest Rates
Negotiating a Loan: Interest Rate
Interest rate charged by a commercial bank on loans to its most creditworthy customers.
Prime Rate
Interest rate charged by London banks on loans to other London banks.
LIBOR (London InterBank Offered Rate)
Interest rate remains the same for the term of the loan.
Fixed Interest Rate
Interest rate varies with the changes in the prime rate.
Floating Interest Rate
- Loan maturity date
- Repayment schedule
- Loan covenants
Negotiating a Loan
Maturity rate shoud match use of funds.
Loan Maturity Date
- Equal monthly or annual payments
- Decreasing monthly or annual payments
Repayment Schedule
Bank imposed restrictions on a borrower that enhance the chances of timely payment.
- Financial statements
- Loan use restrictions and salary limits
- Equity requirements
- Personal guarantees by borrower
Loan Covenants
Supplier provided financing of inventory to a company, which sets up an account payable for the amount.
- Short-duration financing (30 days)
- Amount of credit available depends on type of firm and suppliers willingness to extend credit.
Accounts Payable (Trade Credit)
- Installment loan
- Equipment leased from a supplier
Equipment Loan and Leases
From the seller of machinery purchased by a business.
Installment Loan (Mortgage on Equipment)
- Frees up cash for other purposes
- Leaves lines of credit open
- Provides a hedge against obsolescence
Equipment Leased from a Supplier
A line of credit secured by working-capital assets.
- Factoring
- Purchase-order financing
Asset-Based Lending
Obtaining cash by selling accounts receivable to factor at discount to invoice value.
- Factor can refuse questionable accounts
- Factor charges fees for servicing accounts and for amount advanced to firm prior to collection.
Factoring
Lender advances the amount of the borrower’s cost of goods sold for a specific customer order.
Purchase-Order Financing
- Business angels
- Informal Venture Capital
- Formal Venture Capitalists
Private Equity Investors
Private individuals who invest in others’ entrepreneurial ventures.
Business Angels
Funds provided by wealthy private individuals (business angels) to high-risk ventures.
Informal Venture Capital
Individuals who informed limited partnerships for the purpose of raising venture capital from large industrial investors.
- The firm’s expected profits in future years
- The venture capitalist’s required rate of return.
Formal Venture Capitalists
- Small Business Administration (SBA) loans
- State and local government assistance
- Community-based financial institutions
The Government
- The 7 Guaranty Loan program
- SBA guarantees repayment of loan to lender.
- The Certified Development Company (CDC) 504 Loan Program
- The 7(m) Microloan Program
- Small Business Investment Companies (SBICs)
- Small Business Innovative Research (SBIR)
Small Business Administration (SBA) Loans
- Loan guarantees help to lower down payment
- Focus on enhancing specific industries of facilitating certain community goals.
State and Local Government Assistance
Lenders that provide financing to small business in low-income communities for the purpose of encouraging economic development.
Community-Based Financial Institutions
- Large corporations
- Stock sales
Where Else to Look
Provide financing and technical assistance to critical suppliers and technology developers.
Large Corporations
- Private placement
- Initial public offering (IPO)
Stock Sales
The sale of a firm’s capital stock to selected individuals.
Private Placements
The issuance of stock that is to be traded in public financial markets.
- Places firm under SEC securities regulations
Initial Public Offering (IPO)
