Obtaining Debt Capital

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Obtaining Debt Capital

• Venture Planning
• Chapter 15
• Dowling
• Fall 2006

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Sources of Debt Capital

• Sources of debt capital
• Trade credit
• Commercial banks
• Finance companies
• Factors
• Leasing companies

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Exhibit 15.1
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Exhibit 15.2
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Trade Credit

• Trade credit
• 30-40 percent of current liabilities of
  non-financial companies
• The smaller the firm, the higher this percentage
• Suppliers offer trade credit to attract new
  customers
• Bad debt risk is built into prices
• Costs of trade credit include lost discounts for
  prompt payment

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Commercial Banks

• Common types of financing involving the use of a
  bank
• Line of credit loans
• Time-sales finance
• Term loans
• Chattel mortgages and equipment loans
• Conditional sales contracts
• Plant improvement loans

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Commercial Bank Financing

• Commercial Bank Financing
• Generally more readily available to existing
  businesses with a track record of sales, profits,
  satisfied customers and a current backlog
• Positive cash flow and collateral
• Great importance placed on quality of management
  team

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Line of Credit Loans

• Line of credit loans
• Agreement setting out maximum loan balance a bank
  will allow the borrower for a one-year period
• Used for such seasonal financings as inventory
  buildup and receivables financing
• For prime risk (financially sound) companies,
  lines of credit generally available at 1 to 2
  percent over Feds rediscount rate

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Accounts Receivable Financing

• Accounts receivable financing
• Short-term financing involving either pledge of
  receivables as collateral for a loan or the sale
  of receivables
• Made on a discounted value of the receivables
  pledged

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Time Sales Financing

• Time-sales finance
• Way of obtaining short-term financing from
  long-term installment accounts receivable
• Bank purchases installment contracts at discount
  rate from their full value and takes as security
  an assignment of the manufacturer/dealers
  interest in the conditional sales contract

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Unsecured Term Loans

• Unsecured term loans
• Provide needed growth capital to those that cant
  obtain the capital from the sale of stock
• Substitute for a series of short-term loans made
  with the anticipation of renewal by both the
  borrower and the lender

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Chattel Mortgages and Equipment Loans

• Chattel Mortgages and Equipment Loans
• Chattel is any machinery, equipment, or business
  property that is made the collateral of a loan in
  the same way as a mortgage on real estate

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Obtaining Debt Capital

• Conditional sales contracts
• Effective rate of interest on a conditional sales
  contract is high, running to as high as 15-18
  percent if the effect of installment features is
  considered
• Plant improvement loans
• Can be intermediate- and long-term, and are
  generally secured by first mortgage on that part
  of the property that is being improved

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Sources of Debt Capital

• Commercial finance companies
• Factoring
• Leasing companies

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Commercial Finance Companies

• Frequently lend money to companies that do not
  have positive cash flow
• Will not make loans to companies unless they
  consider them viable risks usually more
  accepting of risk than are banks

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Factoring

• Factoringa form of accounts receivable financing
  where the receivables are sold, at a discounted
  value, to a factor
• The factor buys the clients receivables
  outright, without recourse, as soon as the client
  creates them, by shipment of goods to customers
• Cash is made available to the client as soon
  as proof is provided (old-line factoring) or on
  the average due date of the invoices (maturity
  factoring)

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Leasing Companies

• Leasing companiesleases common and readily
  resalable items such as automobiles, trucks,
  computer equipment, and office furniture to both
  new and existing businesses
• Up front payment required of about 150 percent of
  the value of the item being leased
• Interest may be more or less than other forms of
  financing, depending on the equipment leased, the
  credit of the lessee, and the time of year

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What to Look for in a Bank

• Knowledge
• Sense of urgency
• Teaching talent
• Industry knowledge
• Financial stability
• Manager (Loan Officer) with backbone

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Exhibit 15.3
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Managing the Banking Relationship

• Managing and orchestrating the banking
  relationship
• The lending decision
• Need more today than a good relationship with a
  loan officer to secure funding.
• Analysis and documentation are generally
  required.

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Managing the Banking Relationship

• The TLC of a banker or other lender
• Your banker is your partner, not a difficult
  minority shareholder
• Be honest and straightforward in sharing info
• Invite the banker to see your business in
  operation
• Always avoid overdrafts, late payments and late
  financial statements
• Answer questions frankly and honestly. Tell the
  truth. Lying is illegal and undoubtedly violates
  covenants.

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Bank Lending Criteria

• Lending criteria
• Quality and track record of management team
• Historical financial statements show 3-5 years of
  profitability
• Well-developed business plan
• Analysis of debt capacity
• Ability of company to repay both principal and
  interest on time

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Bank Loans

• After the loan decision
• Loan restrictions
• Negative covenants
• Positive covenants

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Personal Loan Guarantees

• Personal guarantees and the loan
• When to expect them
• Youre under-collateralized
• Youve had poor or erratic performance
• Youve had management problems
• Your relationship with your banker is strained
• You have a new loan officer
• There is turbulence in credit markets
• Wave of bad loans made by lending institutions

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Personal Loan Guarantees

• Personal guarantees and the loan
• How to avoid them
• Good to spectacular performance
• Conservative financial management
• Adequate collateral
• Careful management of the balance sheet

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Obtaining Debt Capital

• Beware of leverage the ROE mirage
• Leverage creates an unforgiving capital structure
  and the potential additional ROI often is not
  worth the risk

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Exhibit 15.4
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Exhibit 15.5
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Exhibit 15.6
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Exhibit 15.8