Financing and Credit: In the beginning of a business, and over time, you may nee

Question

Financing and Credit:

In the beginning of a business, and over time, you may need to borrow money for a short time (revolving credit or short term loans), or a long time (a mortgage, or an equipment loan, for example).

Given your profit and loss projection from last week, do you anticipate needing to borrow money for any reason? Keep in mind the seasonality of your company. You might make a lot of money in the winter, and have essentially no business in the summer — think of how that is true for a ski resort, for example.

If you foresee having to use someone else’s money, how do you anticipate getting that? Discuss using both debt and equity financing. Also think about how you can use other people’s money (like suppliers). Be sure to address any bootstrapping measures you might take.

Even if you plan to keep your business small, imagine what you would need to do if you wanted to grow. This exercise requires you to use your imagination. The only wrong answer for these discussion purposes will be if you state you do not need money now and never will. Even if that is true, imagine what you would do if you needed it.

Can anyone help me with this dicussion board post

Explanation / Answer

Financing is needed to start a business and ramp it up to protability. There are several sources to consider when looking for start-up nancing. But rst you need to consider how much money you need and when you will need it.

In case of seasonal business there may be a high profitable period as well as a slump in off season. We need to borrow money in a seasonal business to maintain the cash flow in the business. Also there may be financial obligation to be met, to cater to that we need to indulge in borrowing. But we should also consider that facts that we should negotiate a better payment terms and avoid costly credits as credit cards and bank overdrafts.

The nancial needs of a business will vary according to the type and size of the business. For example, processing businesses are usually capital intensive, requiring large amounts of capital. Retail businesses usually require less capital.

Debt and equity are the two major sources of nancing.

Equity Financing

Equity nancing means exchanging a portion of the ownership of the business for a financial investment in the business. The ownership stake resulting from an equity investment allows the investor to share in the company’s prots. Equity involves a permanent investment in a company and is not repaid by the company at a later date.

Personal Savings
The rst place to look for money is your own savings or equity. Personal resources can include prot-sharing or early retirement funds, real estate equity loans, or cash value insurance policies.

Life insurance policies - A standard feature of many life insurance policies is the owner’s ability to borrow against the cash value of the policy. This does not include term insurance because it has no cash value. The money can be used for business needs. It takes about two years for a policy to accumulate sufcient cash value for borrowing. You may borrow most of the cash value of the policy. The loan will reduce the face value of the policy and, in the case of death, the loan has to be repaid before the beneciaries of the policy receive any payment.

Home equity loans - A home equity loan is a loan backed by the value of the equity in your home. If your home is paid for, it can be used to generate funds from the entire value of your home. If your home has an existing mortgage, it can provide funds on the difference between the value of the house and the unpaid mortgage amount. Some home equity loans are set up as a revolving credit line from which you can draw the amount needed at any time. The interest on a home equity loan is tax deductible.

Friends and Relatives
Founders of a start-up business may look to private nancing sources such as parents or friends. It may be in the form of equity nancing in which the friend or relative receives an ownership interest in the business. However, these investments should be made with the same formality that would be used with outside investors.

Venture Capital
Venture capital refers to nancing that comes from companies or individuals in the business of investing in young, privately held businesses. They provide capital to young businesses in exchange for an ownership share of the business. Venture capital rms usually don’t want to participate in the initial nancing of a business unless the company has management with a proven track record. Generally, they prefer to invest in companies that have received signicant equity investments from the founders and are already protable.

They also prefer businesses that have a competitive advantage or a strong value proposition in the form of a patent, a proven demand for the product, or a very special (and protectable) idea. Venture capital investors often take a hands-on approach to their investments, requiring representation on the board of directors and sometimes the hiring of managers. Venture capital investors can provide valuable guid­ance and business advice. However, they are looking for substantial returns on their investments and their objectives may be at cross purposes with those of the founders. They are often focused on short-term gain.

Angel Investors
Angel investors are individuals and businesses that are interested in helping small businesses survive and grow. So their objective may be more than just focusing on economic returns. Although angel inves­tors often have somewhat of a mission focus, they are still interested in protability and security for their investment. So they may still make many of the same demands as a venture capitalist.

Angel investors may be interested in the economic development of a specic geographic area in which they are located. Angel investors may focus on earlier stage nancing and smaller financing amounts than venture capitalists.

Government Grants
Federal and state governments often have nancial assistance in the form of grants and/or tax credits for start-up or expanding businesses.

Equity Offerings
In this situation, the business sells stock directly to the public. Depending on the circumstances, equity offerings can raise substantial amounts of funds. The structure of the offering can take many forms and requires careful oversight by the company’s legal representative.

Initial Public Offerings
Initial Public Offerings (IPOs) are used when companies have protable operations, management stability, and strong demand for their products or services. This generally doesn’t happen until compa­nies have been in business for several years. To get to this point, they usually will raise funds privately one or more times.

Warrants
Warrants are a special type of instrument used for long-term nancing. They are useful for start-up companies to encourage investment by minimizing downside risk while providing upside potential. For example, warrants can be issued to management in a start-up company as part of the reimbursement package.

Debt Financing

Debt nancing involves borrowing funds from creditors with the stipulation of repaying the borrowed funds plus interest at a specied future time. For the creditors (those lending the funds to the business), the reward for providing the debt nancing is the interest on the amount lent to the borrower.

Debt nancing may be secured or unsecured. Secured debt has collateral (a valuable asset which the lender can attach to satisfy the loan in case of default by the borrower). Conversely, unsecured debt does not have collateral and places the lender in a less secure position relative to repayment in case of default.

Debt nancing (loans) may be short term or long term in their repayment schedules. Generally, short-term debt is used to nance current activities such as operations while long-term debt is used to nance assets such as buildings and equipment.

Friends and Relatives
Founders of start-up businesses may look to private sources such as family and friends when starting a business. This may be in the form of debt capital at a low interest rate. However, if you borrow from relatives or friends, it should be done with the same formality as if it were borrowed from a commercial lender. This means creating and executing a formal loan document that includes the amount borrowed, the interest rate, specic repayment terms (based on the projected cash ow of the start-up business), and collateral in case of default.

Banks and Other Commercial Lenders
Banks and other commercial lenders are popular sources of business nancing. Most lenders require a solid business plan, positive track record, and plenty of collateral. These are usually hard to come by for a start- up business. Once the business is underway and prot and loss statements, cash ows budgets, and net worth statements are provided, the company may be able to borrow additional funds.

Commercial Finance Companies
Commercial nance companies may be considered when the business is unable to secure financing from other commercial sources. These companies may be more willing to rely on the quality of the collateral to repay the loan than the track record or profit projections of your business. If the business does not have substantial personal assets or collateral, a commercial nance company may not be the best place to secure nancing. Also, the cost of finance company money is usually higher than other commercial lenders.

Government Programs
Federal, state, and local governments have programs designed to assist the nancing of new ventures and small businesses. The assistance is often in the form of a government guarantee of the repayment of a loan from a conventional lender. The guarantee provides the lender repayment assurance for a loan to a business that may have limited assets available for collateral. The best known sources are the Small Business Administration and the USDA Rural Development programs.

Bonds
Bonds may be used to raise nancing for a specic activity. They are a special type of debt nancing because the debt instrument is issued by the company. Bonds are different from other debt nancing instruments because the company species the inter­est rate and when the company will pay back the principal (maturity date).

If we want to grow we need to focus on the below strategies:

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