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Techno 11-Sources of Capital

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    11-1

    Sources

    ofCapital

    McGraw-Hill/IrwinEntrepreneurship, 7/e Copyright 2008 The McGraw-Hill Companies, Inc. All rights reserved.

    Chapter 11

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    11-2

    Debt or Equity Financing

    ` Debt financing: obtaining borrowed funds for thecompany.

    `Asset-based financing; requires some asset to be usedas a collateral.

    ` Borrowed funds plus an interest rate need to be paidback.

    ` Equity financing: obtaining funds for the company inexchange for ownership.

    ` Does not require collateral.

    ` Offers investor some form of ownership position.

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    11-3

    Factors Affecting Type of Financing

    ` Availability of funds.

    ` Assets of the venture.

    ` Prevailing interest rates.

    ` All financing requires some level of equity.`Amount of equity will vary by nature and size of venture.

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    11-4

    Sources for Internal Funds

    ` Profits.

    ` Sale of assets and little-used assets.

    ` Working capital reduction.

    ` Extended or discounted payment terms suppliers.` Collecting bills (accounts receivable) more quickly.

    ` Short-term internal source of funds:

    ` Reducing short-term assets: inventory, cash, and otherworking-capital items.

    ` Extended payment terms from suppliers.

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    11-5

    External Funds

    ` Criteria for evaluatingexternal sources of funds:

    ` Length of time the fundsare available.

    ` Costs involved.

    `Amount of companycontrol lost.

    ` Sources of funds:

    ` Self

    ` Family and friends.

    ` Commercial banks.` R&D limited

    partnerships.

    ` Government loanprograms.

    ` Grants.

    `Venture capital.

    ` Private placement.

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    11-6

    Personal Funds

    ` Least expensive funds in terms of cost and control.

    ` Absolutely essential in attracting outside funding.

    ` Typical sources of personal funds:` Savings.

    ` Life insurance.

    ` Mortgage on a house or car.

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    11-7

    Family and Friends

    ` Likely to invest due to relationship with entrepreneur.

    `Advantage: easy to obtain money; more patient thanother investors.

    ` Disadvantage: direct input into operations of venture.

    ` A formal agreement must be written to include:

    `Amount of money involved.

    ` Terms of the money.

    ` Rights and responsibilities of the investor.` What happens if the business fails.

    ` Entrepreneur must consider impact on personalrelationship.

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    11-8

    Commercial Bank Loans

    ` Bank loans (asset

    based): tangible collateral

    valued at more than the

    amount of money

    borrowed.

    ` Accounts receivable.

    ` Inventory loans.

    ` Equipment loans.

    ` Real-estate loans.

    ` Cash flow financing:

    conventional bank loans;

    standard way banks lend

    money to companies.

    ` Installment loans.

    ` Straight commercial

    loans.

    ` Long-term loans.

    ` Character loans.

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    11-9

    Lending: Decisions

    ` Based on quantifiable information and subjective judgments.

    ` Decisions are made according to the five Cs of lending:

    ` Character - Owners character

    ` Capacity- cash flow. The firms ability to meet its regular financial

    obligations and to repay the bank loan and that takes cash.` Capital- Lenders expect the business to have an equity base of

    investment by the owner/s

    ` Collateral-any assets the owner pledges to the bank as security forrepayment of the loan.

    ` Conditions- Interest rates, nations economy, industry growth rate.` Review of past financial statements.

    ` Evaluation of future projections.

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    11-10

    Lending: Questions

    ` Does the entrepreneur expect to be carried by the loanfor an extended period of time?

    ` Is the entrepreneur committed to spend the required

    effort to make the business a success?` Does the business have a unique differential advantage

    in a growth market?

    ` What are the downside risks?

    ` Is there protection against disasters?

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    11-11

    Bank Shopping Procedure

    ` Complete an application format, which is a minibusiness plan.

    ` Evaluate alternative banks.

    ` Select one with a positive loan experience in thebusiness area.

    ` Set an appointment.

    ` Carefully present the case for the loan.

    ` Borrow the maximum amount possible.

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    11-12

    SBA Financing

    ` An alternative when entrepreneur lack:

    ` Necessary track record.

    `Asset.

    ` Proceeds from such a loan can be used:

    ` Working capital.

    ` Machinery and equipment.

    ` Furniture and fixtures.` Land and building.

    ` Leasehold improvements.

    ` Under some conditions, debt refinancing.

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    11-13

    SBA Conditions

    ` Repayment ability from cash flow of business.

    ` Five Cs

    ` Owners of 20 percent or more are required to

    personally guarantee SBA loans.

    ` Eligibility:

    ` Size.

    ` Type of business.

    ` Use of proceeds.

    ` And the availability of funds from other sources.

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    11-14

    SBA 7(a) Loan Program

    ` Maximum loan amount of $2 million.

    ` SBAs maximum exposure of $1 million.

    ` Maximum guarantee by the SBA is 50 percent.

    ` Interest rates are negotiated.` Subject to SBA maximums.

    ` Pegged to the prime rate.

    ` Guarantee 85 percent of loans of $150,000 or less.` Guarantee 75 percent of loans above $150,000 to a

    maximum of $1 million.

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    11-15

    Other SBA Programs

    ` 504 loan program:

    ` Provides fixed-rate financing.

    `Acquire machinery, equipment, or even real estate.

    `For expansion or modernization.

    ` Maximum of the program is usually $1 million.

    ` SBA Microloan 7(m) loan program:

    ` Short-term loans of up to $35,000.` Working capital, purchase of inventory, supplies,

    furniture, fixtures, machinery, or equipment.

    ` Cannot be used to pay existing debts.

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    11-16

    Research and Development

    Limited Partnerships

    ` Money given to a firm for developing a technology thatinvolves a tax shelter.

    ` Major elements:

    `Contract` Liability for loss incurred is borne by the limited partners.

    ` Tax advantages to the limited partnership and sponsoringcompany.

    ` Sponsoring company

    ` Performs the work on a best-effort basis.

    ` Acts as a general partner.

    ` Limited partnership`A party in a partnership agreement that usually supplies money

    and has a few responsibilities.

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    11-17

    R&D Limited Partnership: Procedure (1 of 2)

    ` Funding stage

    ` Establishment of contract between sponsoring companyand limited partners.

    ` Investment of money.

    ` Documentation of terms and conditions of ownership,and scope of the research.

    ` Development stage

    `

    Sponsoring company performs actual research.` Technology successfully developed: exit stage

    commences.

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    11-18

    R&D Limited Partnership: Procedure (2 of 2)

    ` Exit stage

    ` Sponsoring company and the limited partnerscommercially reap the benefits of the effort.

    ` Three basic types of arrangements for doing this:

    ` Equity partnerships.

    ` Royalty partnerships.

    ` Joint ventures.

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    11-19

    Benefits and Costs

    ` Benefits:

    ` Provides funds with minimum amount of equity dilution.

    ` Reduces the risks involved.

    `Strengthens sponsoring companys financial statements.

    ` Costs

    ` More expensive to establish than conventional financing.

    ` Expending of time and money.` Restrictions placed on technology can be substantial.

    ` Exit from the partnership may be too complex.

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    11-20

    Government (SBIR) Grants

    ` Phase I

    `Awards up to $100,000 for six months.

    ` Successful projects considered in Phase II.

    ` Phase II`Awards are up to $750,000 for 24 months.

    ` Money to be used to develop prototype products orservices.

    ` Phase III` Does not involve direct funding from the SBIR program.

    ` Commercialization of technology through private sectoror regular government procurement contracts.

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    11-21

    SBIR Grant: Procedure

    ` Solicitations describing areas for funding are published.

    ` Proposal is submitted by a company or individual.

    ` Screening of received proposals.

    ` Evaluation of proposal on a technological basis.` Granting of awards based on potential for

    commercialization.

    ` Ownership of research findings is by the company or

    individual, not by the government.

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    11-22

    Small Business Technology Transfer (STTR)

    ` Grant program avalable to entrepreneurs.

    ` Agencies that participate in the STTR program:

    ` Department of Defense (DOD).` Department of Energy (DOE).

    ` Department of Health and Human Services (DHHS).

    ` National Aeronautics and Space Administration (NASA).

    ` National Science Foundation (NSF).

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    11-23

    Private Placement

    ` Funding from private investors, also called angels(family or friends or wealthy individuals).

    ` Types of investors

    `

    Investor can influence nature and direction of thebusiness to some extent.

    ` May be involved in the business operation.

    ` Entrepreneur needs to consider degree of involvement.

    ` Private offerings`A formalized method for obtaining funds from private

    investors.

    ` Faster and less costly.

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    11-24

    Regulation D

    ` Contains:

    ` Broad provisions designed to simplify private offerings.

    ` General definitions of what constitutes a private offering

    `

    Specific operating rules (Rule 504, 505, and 506).` Accredited investors

    ` Institutional investors.

    ` Purchasing over $150,000 of issuers securities.

    ` Net worth of $1 million or more at time of sale.` Incomes in excess of $200,000 in each of the last 2

    years.

    ` Directors, executive officers, and general partners of

    issuing company.

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    11-25

    Rules 504, 505, and 506 (1 of 2)

    ` Rule 504:

    ` Sale of upto $500,000 of securities to any number ofinvestors in any 12-month period.

    ` No general advertising/ solicitation through public media.

    ` Rule 505:

    ` Sale of $5 million of unregistered securities in the private

    offering in any 12-month period.` No general advertising/ solicitation through public media.

    `Additional information must be disclosed if issuanceinvolves unaccredited investors.

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    11-26

    Rules 504, 505, and 506 (2 of 2)

    ` Rule 506:

    ` Sale of unlimited number of securities to 35 investorsand an unlimited number of accredited investors andrelatives of issuers.

    ` No general advertising/ solicitation through public media.

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    11-27

    Disadvantages of Outside Capital

    ` Takes 3 and 6 months to raise/ check on availability.

    ` Decreases firms drive for sales and profits.

    ` Availability of capital increases impulse to spend.

    ` May cause disruption and problems in venture.

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    11-28

    Bootstrap Financing

    ` Using any possible method for conserving cash.

    ` Use of discounts for volume.

    `

    Frequent customer discounts.` Promotional discounts.

    `Obsolescence money".

    ` Savings through bulk packaging.

    ` Consignment financing.


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