Sources of Debt Financing Chapter 15 Debt Financing

Debt Financing n n Must be repaid with interest. Is carried as a liability on the company's balance sheet. Can be just as difficult to secure as equity financing, even though sources of debt financing are more numerous. Can be expensive, especially for small companies, because of the risk/return tradeoff – “prime-plus…. ” Chapter 15 Debt Financing Copyright 2006 Prentice Hall Publishing Company 2

Consider Borrowing Money to… Increase your work force and/or inventory to boost sales n Gain market share n Purchase new equipment n Refinance existing debt n Take advantage of cash discounts n Chapter 15 Debt Financing Copyright 2006 Prentice Hall Publishing Company 3

Consider Borrowing Money to… Buy the building in which your business is located n Establish a relationship with a lender n Retire debt held by a “nonrelationship” creditor n Deal with a downturn in business n Chapter 15 Debt Financing Copyright 2006 Prentice Hall Publishing Company 4

Sources of Debt Capital n Commercial banks Chapter 15 Debt Financing Copyright 2006 Prentice

Copyright Prentice Hall Administration Publishing Company Source: Small Business and Micro Business Lending in the United States, 2006 U. S. Small Business 6

Commercial Banks Lenders of first resort for small business owners n 80% of all loans to existing businesses come from banks n Focus on a company’s ability to generate positive cash flow when evaluating loan proposals n Chapter 15 Debt Financing Copyright 2006 Prentice Hall Publishing Company 7

Commercial Banks n Conservative lenders Ø Significant owner investment Ø Sufficient cash flow for repayment Ø Ample collateral as security Ø SBA loan guarantee Ø Personal guarantee Chapter 15 Debt Financing Copyright 2006 Prentice Hall Publishing Company 8

Commercial Banks. . . the heart of the financial market for small businesses! n Short-term loans – the commercial banks’ specialty Ø Commercial loans Ø Lines of credit Chapter 15 Debt Financing Copyright 2006 Prentice Hall Publishing Company 9

How large a line of credit? Example: Average collection period ratio + Average inventory turnover ratio = Total - Average payable period ratio = Cash flow cycle 49 days + 53 days 102 days - 39 days 63 days Annual sales Average daily sales (Annual sales ÷ 365 days) $5, 800, 000 $15, 890 Cash Flow cycle x Average daily sales Equals - Forecasted profit (Annual sales x net profit margin) = Line of credit requirement 63 days x $15, 890 $1, 001, 096 - $377, 000 $624, 096 Copyright 2006 Prentice Hall Publishing Company 10

Commercial Banks. . . the heart of the financial market for small businesses! n Short-term loans – the commercial banks’ specialty Ø Commercial loans Ø Lines of credit Ø Floor planning Chapter 15 Debt Financing Copyright 2006 Prentice Hall Publishing Company 11

Commercial Banks. . . the heart of the financial market for small businesses! n Intermediate and long term loans Ø Term loans Ø Installment loans Ø Discounted installment contracts Ø Character loans Chapter 15 Debt Financing Copyright 2006 Prentice Hall Publishing Company 12

Sources of Debt Capital Commercial banks n Asset-based lenders n Chapter 15 Debt Financing

Asset-Based Borrowing n Discounting accounts Accounts Receivable receivable n Inventory financing Chapter 15 Debt

Source: Commercial Finance Association Copyright 2006 Prentice Hall Publishing Company 15

Sources of Debt Capital Commercial banks n Asset-based lenders n Trade credit n Equipment suppliers n Commercial finance companies n Saving and loan associations n Chapter 15 Debt Financing Copyright 2006 Prentice Hall Publishing Company 16

Sources of Debt Capital (Continued) Stock brokerage houses n Insurance companies n Credit unions n Bonds n Private placements n Small Business Investment Companies (SBICs) n Chapter 15 Debt Financing Copyright 2006 Prentice Hall Publishing Company 17

Small Business Investment Companies (SBICs) 400+ SBICs operate in the U. S. n Use a combination of private capital and federally guaranteed debt to provide long-term capital to small companies. n Since 1960, SBICs have provided more than $36. 5 billion in financing to some 109, 000 small companies. n Chapter 15 Debt Financing Copyright 2006 Prentice Hall Publishing Company 18

Source: SBIC Program Statistical Package, US Small Business Copyright Administration. 2006 Prentice Hall Publishing Company 19

Sources of Debt Capital (Continued) n n n n Stock brokerage houses Insurance companies Credit unions Bonds Private placements Small Business Investment Companies (SBICs) Small Business Lending Companies (SBLCs) Chapter 15 Debt Financing Copyright 2006 Prentice Hall Publishing Company 20

Sources of Debt Capital (Continued) Federally Sponsored Programs: Economic Development Administration (EDA) n Department of Housing and Urban Development (HUD) n U. S. Department of Agriculture’s Rural Business-Cooperative Service n Chapter 15 Debt Financing Copyright 2006 Prentice Hall Publishing Company 21

Sources of Debt Capital (Continued) Federally Sponsored Programs: Small Business Innovation Research (SBIR) n Small Business Technology Transfer programs n Small Business Administration (SBA) – largest single backer of small businesses in the nation n Chapter 15 Debt Financing Copyright 2006 Prentice Hall Publishing Company 22

Small Business Administration Loan Programs Low Doc Loan Program n SBAExpress Program n 7(A) Loan Guaranty Program – the most popular SBA loan program n Chapter 15 Debt Financing Copyright 2006 Prentice Hall Publishing Company 23

Source: U. S. Small Business Administration Copyright 2006 Prentice Hall Publishing Company 24

Small Business Administration Loan Programs Low Doc Loan Program n SBAExpress Program n 7(A) Loan Guaranty Program – the most popular SBA loan program n CAPLine Program n International Trade Programs n Ø Export Working Capital Program Ø International Trade Program Chapter 15 Debt Financing Copyright 2006 Prentice Hall Publishing Company 25

Small Business Administration Loan Programs Section 504 Certified Development Company Program n Microloan Program n Prequalification Loan Program n Disaster Loans n 8(A) Loan Program n Chapter 15 Debt Financing Copyright 2006 Prentice Hall Publishing Company 26

State and Local Loan Programs Capital Access Programs (CAPs) – now offered in 22 states and are designed to encourage lenders to make loans to businesses that do not qualify for traditional financing. n Revolving Loan Fund (RLFs) – combine private and public funds to make small business loans. n Chapter 15 Debt Financing Copyright 2006 Prentice Hall Publishing Company 27

Internal Methods of Financing n Factoring - selling accounts receivable outright. Chapter 15 Debt

Source: Commercial Finance Association Copyright 2006 Prentice Hall Publishing Company 29

Internal Methods of Financing Factoring - selling accounts receivable outright n Leasing assets rather than buying them n Credit cards n Chapter 15 Debt Financing Copyright 2006 Prentice Hall Publishing Company 30

Web Sites American Bankers Association http: //www. aba. com/default. htm n National Association of Small Business Investment Companies http: //www. nasbic. com/ n U. S. Small Business Administration http: //www. sba. gov/ n Chapter 15 Debt Financing Copyright 2006 Prentice Hall Publishing Company 31