Sources of Funds

1
Sources of Funds

• How much start-up funds are needed
• Sources of financing

2
How Much Money?

• More, more, more!
• Insufficient capital an important factor in
  business failure
• Reasons for insufficient capital
• Shoestring financing
• Underestimation of costs
• Failure to consider initial operating losses
• Need to know amount to request financing

3
Elements of Start-up Cost

• Furniture, Fixtures and Equipment
• Useful to obtain price quotes and contact vendors
  well in advance
• Used equipment will often be available
• Include additional amounts for
• cost overruns
• unforeseen equipment needs
• Rent deposit - 1-2 months advance

4
Start-up Costs

• Advertising and promotion
• Initial advertising will be critical to the
  success of the business
• Yellow pages and similar ads are expensive
• Quality web site can be expensive to set up and
  maintain

5
Start-up Costs - Inventory

• Initial inventory stock constitutes one of the
  major initial outlays of the business
• Amount depends on product lines, turnover
• Some may be financed by supplier
• Estimating Requirements
• 1. Annual COS/Inv. Turnover
• or monthly COS x months sales
• in inventory
• 2. Estimate based on similar firms
• (note potential for seasonal fluctuations)

6
Estimating Inventory

• Example
• Estimate annual sales 100,000
• Estimated annual COS 60,000
• Estimated turnover ?
  4
• Estimated required inv. 15,000
• (60,000 / 4)
• Or Monthly COS (60,000/12) 5,000
• Number of months in inv. (12/4) x 3
• Estimate required inv. 15,000
  

7
Start-up Costs - Accounts Receivable

• Accounts receivable is another asset which must
  be financed.
• Applies if business sells on credit
• Initial sales wont become a cash inflow until
  collected
• Current accounts receivable generally makes very
  good collateral for bank loans

8
Start-up Costs - Working Capital

• Business will need an additional 1-3 months
  operating cost
• Cushions against losses and unforeseen expenses
• Contingency
• Additional reserve for unexpected costs

9

• Cost Amount Source
• Equipment
• Remodeling
• Rent deposit
• Utility deposits
• Legal, etc.
• Advertising
• Inventory
• Accts. Rec.
• Work. cap
• Contingency
• Total

10
Sources of Funds

• Many businesses start with relatively modest
  investments
• Once established, it is easier to borrow
• You will be a primary source of funds
• Allows you to maintain complete control over
  business
• Difficult to borrow
• Lenders expect to see some of your money on the
  line

11
Family and Friends

• May be the only source available
• Relatively easy to obtain
• Structuring the arrangement
• Debt preferred
• No loss of control
• Interest deductible
• Equity
• Need to find a way to
• provide compensation

12
Venture Capital and Angels

• Unless your venture is sufficiently large, and
  promising, venture capital not likely to be
  interested
• Some individual investors (angels) may be
  interested
• For either type of financing, a formal business
  plan, with well-developed projections, will be
  necessary

13
Bank Financing

• In general, the bank wont be a significant
  source of start-up financing
• May finance portion of receivables and inventory
• Necessary to first seek bank financing for SBA
  loans

14
Working Capital Financing

• Line-of-credit
• Most businesses will want to establish a credit
  arrangement for seasonal needs
• Will normally finance 70-80 of current accounts
  receivable
• Factoring - Sale of accounts receivable
• Common in clothing industry
• Factor may provide credit function
• May be with or without recourse (your responsible
  if not paid)
• Suppliers for inventory

15
Debt Versus Equity

• If return on assets exceeds cost of debt, owner
  return on equity will increase as the firm uses
  more debt
• (p. 238 of text)
• Debt is also preferred because it does not
  involve loss of ownership control
• Debt is risky - it also increases downside risk

16
Debt vs. Equity Example

• 
  Equity Debt
• Operating income 28,000
  28,000
• Interest (100,000 x 10) 0
  10,000
• Net income 28,000
  18,000
• ROI (NI/Equity) 14
  18
• 
  (28k/200k) (18/100k)
• Original owners share 19,600
  18,000
• of income (70)
  (100)

17
Preparing for Financing

• How much do you need?
• Cash flow projections
• Adequate to meet debt service
• Evidence of a market
• Dont hide the negatives

18
The Five Cs of Credit

• 1. The borrowers character
• 2. The borrowers capacity to repay the loan
• 3. The capital being invested in the venture
• by the borrower
• 4. The conditions of the industry and economy
• 5. The collateral available to secure the loan

19
Walker Machine Works

• Prop 1 Prop 2
  Prop 3
• Person Williams Thomas
  Davis
• Relation None Friend
  Prof
• 
  Father
• Background Hydraulics Real est. Mktg.
• Involvement Active Advice
  Advice
• Equity split 50-50 40-60
  33.3
• Financing 9,000 9,000
  9,000