(F) Chapter 8: Debt Financing Flashcards
Involves a payback of funds plus a fee for the use of money
Debt Financing
Raising capital for a venture by getting a loan.
Debt Financing
Two types of Debt Financing
- Short-term
- Long-term
Type of Debt Financing
One year or less
Often required to obtain working capital
Repaid out of proceeds from sales
Short-term
Type of Debt Financing
One to five years or maturing more than five years
Used to finance the purchase of property or equipment, with the purchased asset serving as collateral for the loans
Long-term borrowing
Debt Financing Advantage or Disadvantage
No relinquishment of ownership is required.
Advantage
Debt Financing Advantage or Disadvantage
More borrowing, potentially, allows for greater return on equity.
Advantage
Debt Financing Advantage or Disadvantage
Low interest rates reduce the opportunity cost of borrowing.
Advantage
Debt Financing Advantage or Disadvantage
Regular (monthly) interest payments are required
Disadvantage
Debt Financing Advantage or Disadvantage
Cash-flow problems can intensify because of payback responsibilities
Disadvantage
Debt Financing Advantage or Disadvantage
Heavy use of debt can inhibit growth and development
Disadvantage
What are the three Debt Financing Sources?
Commercial Banks
P2P Lending
Other Sources
Debt Financing Sources
They make a large number of intermediate term loans with maturities of one to five years
Commercial Banks
Debt Financing Sources
In about 90 percent of these cases, these banks require collateral (stocks, machinery, equipment, and real estate, and systematic repayment over the life of the loan required).
Commercial Banks
Enumerate/Familiarize the common questions that commercial banks will ask a borrower before lending money
- What do you plan to do with the money?
- How much do you need?
- When will you need it?
- How long will you need it?
- How will you repay the loan?
Common questions commercial banks will ask a borrower:
Do not plan on using bank loans for high-risk ventures.
Banks lend only to the surest of all possible ventures.
Wht do you plan to do with the money?
Common questions banks will ask a borrower
Some go with no clear idea of how much money they need; all they know is they need cash.
The more precisely this question is answered, the more likely the loan will be granted.
How much do you need?
Common questions banks will ask a borrower
Never rush a bank with immediate requests for money.
Poor planners never attract lenders.
When do you need it?
Common questions banks will ask a borrower
The shorter the period of time entrepreneurs need the money, the more likely they are to get loans.
The time at which the loan will be repaid should correspond to some important milestone in the business plan.
How long will you need it?
Common questions banks will ask a borrower
Most important question
What if plans go awry? Can other income be diverted to pay off the loan? Does collateral exist?
The bank may be unimpressed.
How will you repay the loan?
P2P Lending is also called what?
Debt-based crowdfunding and/or Social loaning
Debt Financing Sources
The practice of lending money to unrelated individuals (peer) without going through a bank or other traditional financial institutions
P2P Lending
Debt Financing Sources
Takes place on internet sites that pool money from investors willing to lend money at agreed-upon rates. (e.g., kiva.org)
P2P Lending
T of F: Commercial banks charge fees for brokering and servicing loans and collect penalties for late payments as well.
F (P2P Lenders)
When did P2P lending first appear?
2005
Amounts to be lended in P2P lending
$17,000 to $250,000
Interest rates in P2P lending
5.6% to 35.8%
Default rates in P2P lending
1.5% to 10%
Disadvantages in P2P Lending
Most loans are difficult to complete; so the funding success rate could be questionable
Funding success rate
Disadvantages in P2P Lending
The business plan is now released to the public domain
Business plan disclosure
Disadvantages in P2P Lending
The entrepreneur does not receive any advice or gain experience from the lender
There are no future rounds of lending or investments
No ongoing counseling relationship
Disadvantages in P2P Lending
There are tax implications for the borrower and the lender.
Potential tax liability
Disadvantages in P2P Lending
The SEC continues to review these sites for potential regulatory policies
Uncertain regulatory environment
What are the other sources of Debt Financing?
Trade Credit
Accounts Receivable Financing
Factoring
Finance Companies
Other sources
Credit given by suppliers who sell goods on account
Trade Credit
Other sources
Reflected on the entrepreneur’s balance sheet as accounts payable
Trade Credit
Other sources
Many small, new businesses obtain this credit when no other form of financing is available to them.
Suppliers offer this to attract new customers.
Trade Credit
Other sources
Short-term financing that involves either (1) the pledge of receivables as collateral for a loan, or (2) the sale of receivables.
Accounts Receivable Financing
The two plans which banks may make receivable loans on
Notification and Nonnotification
Accounts Receivable Plan
purchasers of goods are informed that their accounts have been assigned to the bank; then they make payments directly to the bank, which then credits them to the borrower’s account
Notification
Accounts Receivanle Plan
borrowers collect their accounts as usual and then pay off the bank loan.
Nonnotification Plan
Other sources
The sale of accounts receivable.
Under this, the receivables are sold at a discounted value to a factoring company;
Under the standard arrangement, the factor will buy the client’s receivables outright, without recourse, as soon as the client creates them by its shipment of goods to customers
Factoring
Other sources
Common in textiles, furniture manufacturing, clothing manufacturing, toys, shoes, and plastics.
Factoring
Other sources
Asset-based lenders that lend money against assets such as receivables, inventory, and equipment
Finance Companies
