ENTREPRENEURSHIP

By: E.N Mbuyisa

MBA 832
Business financing
 Internal and external sources of finance
 Debt vs. equity financing
 Types of financing options
NATURE OF A BUSINESS AND ITS FINANCING SOURCES

Any small business can be financed on the basis of the following four factors:
1. Economic value potential
If the rate of return of a business is envisaged as potentially high, the business
is seen to create value for its investors, and will therefore become an attractive
investment opportunity.
2. Company maturity
During the start-up phase, the business often has extreme difficulty attracting
finance or investment. Investors and/or financial institutions are normally risk
averse because of the high failure rate of the small businesses during this
phase. An older and growing business entity will be in a better position to
attract investment.
3. Types of assets
Financial institutions (e.g. banks) finance two types of assets: tangible
and intangible. Tangible assets include equipment, inventory and land
and buildings. Intangible assets to be financed are research and
development, goodwill and intellectual capital. Business and/or
individuals with a strong tangible asset base will acquire finance more
easily.

4. Owner preferences for debt or equity

According to the textbook (Longenecker) it seems quite easy for
entrepreneurs to acquire financing for starting up a business. The
entrepreneur starting up a new business generally does not have much
of a choice between debt and equity financing. Financial institutions
are low risk takers and normally reluctant to finance a small business
without collateral. The entrepreneur then has to make use of equity
finance and sell shares or membership to external investors.
SOURCES OF FINANCING
Individual Investors
 Personal savings
 Friends and relatives
 Retired people/business angels
Business suppliers and asset-based lenders
 Accounts payable (trade credit)
 Equipment loans and leases
 Asset based lending – sell accounts receivables in exchange for cash
amount
Commercial Banks
 Line of credit
 Term loans (short, medium and long)
 Mortgages (real estate)
Gvt/NGO programmes and agencies
 Ministry of SMEs - SEDCO
 Ministry of Women’s affairs
 Ministry of Youth
SOURCES OF FINANCE
 Asset-based loan
 Business angel
 Equipment loan
 Debt factoring
 Informal capital
 Limited liability
 Line of credit
 Prime rate
 Real estate mortgage
 Term loan
 Trade credit
 Venture capital
OFFERING CREDIT
Factors to consider
 The type of business (durable vs perishable
goods)
 The credit policies of competitors
 Customers’ income levels
 Availability of working capital

Evaluation of Applicants
 Can he/she pay as promised?
 Will the buyer pay?
 When will the buyer pay?
 Can the buyer be forced to pay?
5 Cs OF CREDIT
 Character – (honesty)
 Capability – (financial planning)
 Condition – (business cycles and changes)
 Capital – (cash & assets)
 Collateral - (security)

Credit Information
 Credit histories
 Business financial statements
 Data from outsiders (e.g. other sellers)
 The customer’s banking institution
 Trade-credit agencies
 Credit bureax
DEBT OR EQUITY FINANCING

Every new start-up finds itself in the position where the amount of
financing that will be needed is predetermined. The financial
requirements are usually adapted to the amount acquirable. Which
sources of finance to utilise depends largely on the type of business,
the business’s financial strength and the economic environment (e.g.
interest rates). The decision on debt versus equity financing involves
specific trade-offs for the founding entrepreneur:
 Potential profitability
 Financial risks
 Voting control
Potential Profitability
Using debt increases the owner’s rate of return on his or her investment

Financial Risk

Although debt financing produces a higher rate of return for the owners when
the business is doing well, obligations to service debt yields increased
business risk when the business is doing badly, while equity is less
demanding.

Voting Control
Equity financing requires some loss of owner control. As an entrepreneur it is
important to decide whether it is worth losing control over something that might
have initially required a lot of hard work, time and passion!
Financing a Small Business:
Debt vs. Equity Investment
• Choosing between Loans and Equity
• While there are no hard and fast rules, if you are in the
formation stage of setting up your business, it makes sense to
strongly consider selling an equity stake in your business in
order to secure financing to get it off the ground. Equity sales
are advantageous because they don't require any repayment,
and most businesses don't turn a profit for a significant time
period, which makes paying back loans extremely difficult.
• If you are an established business and have ongoing financing
needs, then loans may make a lot more sense. Loans are
easier to deal with when a company has enough cash flow to
make repayment realistic, and an established company likely
has more collateral to offer to secure the loans. Finally, it's
worth noting that loans and equity are treated differently for tax
purposes, so consult with a business tax advisor to see if one
course of action makes more sense than the other.
• Loans
• Whether you should choose loans or not depends
largely on the maturity of your business, cash flow
and whether you're simply unwilling to give up any
more control in your company.
• Advantages: The biggest advantage for choosing
loans is that you maintain control over your
business. Unlike equity investors, lenders have no
say in your business and are not entitled to your
business profits. The only obligation you owe to
your lender is to repay the loan as agreed upon.
Finally, one last advantage that can be very helpful
is that loan payments that go towards paying off the
interest on the loan can be deducted as a business
expense for tax purposes.
• Disadvantages: The biggest disadvantage of
loans is that you have to pay back a steady
amount on a consistent schedule, and, as anyone
who runs a business knows, profits can be
anything but steady. You may have to make a
large loan payment precisely when you need the
cash for your business the most. Another
disadvantage is that many small business owners
have to use personal property as collateral to
secure the loan, which puts them personally at
risk if business goes bad. Finally, if you are
unable to pay the loan back, you may be
personally sued by the bank, regardless of
whether the loan is secured or unsecured.
 Equity
 Equity is a mixed bag of benefit and cost,
and the factors that influence whether you
choose to use equity sales to fund your
business include whether your business is
still young or expanding and your willingness
to give control over the business to people
other than yourself.
• Advantages: Although many may see giving
other people an interest in their business as
losing control, this doesn't have to be the case. If
you choose the right investors, they can be
extremely helpful in terms of running the
business, establishing business connections and
offering valuable advice and assistance. Another
advantage of equity investments over loans is
that they tend to be far more creative and
flexible, which many businesses may prefer. The
single biggest advantage of selling equity stakes
to investors is that if your business loses money
or goes broke, you likely won't have to pay
investors a dime.
• Disadvantages: The loss of control in your
business is probably the biggest disadvantage
involved in selling equity stakes to fund your
business. There are many instances where the
founders of a business, who put years of their life
into the company, are voted out of the company by
investors. Be very careful to really consider
whether the financing gain is worth the loss of
control. The other main disadvantage is that equity
investors will want to receive a portion of the
business profits, taking away valuable company
profits that could otherwise be reinvested into the
company. Finally, because equity investors are now
co-owners, you have a duty to inform them of all
significant business events, and they can now sue
you if they feel their rights are being infringed upon.
Getting Money from Family and Friends for a Business

• There are many different ways you can finance

your new business: a bank loan, venture capital
funding, or even crowdfunding. But if you've tapped
out the traditional methods, including your savings,
retirement accounts, and the equity in your home,
obtaining money from family and friends is a great
way to get or keep a business going.
• It is common for small business owners to start up
a business by using funds from family and friends.
Borrowing money from family and friends or giving
them an equity interest in the business is much
easier than obtaining funding from a bank.
• Benefits of Borrowing Money from Family and Friends
• Unlike a bank loan, acquiring private money does not
require filling out paperwork or waiting for the loan to go
through. Obtaining financing from friends and family offers
several advantages.
• Flexibility of a private loan: Unlike a standardized bank
loan with inflexible terms, it is possible to work out a
customized repayment plan. For example, a generous
family member or friend may allow for interest-only
payments for a short time or may delay initial payments
for several months.
• Credit history is not relevant: It may be nearly
impossible to acquire a loan when the borrower has a
history of credit problems or a bankruptcy. Many banks
will shy away from lending to a borrower that poses a
financial risk.
• Lower interest rate: Banks establish interest rates
on business loans by using the prime interest rate
as a base and then add a few percentage points.
The interest rate on a loan depends on the
creditworthiness of the borrower and the economy.
In most cases, the interest rate on money from
family or friends will be much less than a standard
bank loan.
• Collateral is unnecessary: Because of the risk
involved in lending money for a business,
commercial lenders will often require security for
the loan, such as a mortgage on a property. Most
friends and family will not usually require collateral
to secure a private loan.
• Asking for Money
• Asking friends and family for money for a business endeavor
can be uncomfortable. Money is a touchy subject, but if you
believe strongly in the business and the possibility of its
success, it will be a lot easier to sell friends and family on the
idea.
• Depending on how well you know the potential private lender
will determine the appropriate environment for making your
sales pitch. In the living room or at the kitchen table in a home,
in a coffee shop, or at a restaurant are all appropriate places.
Take these steps when planning to obtain financing:
• Schedule a meeting;
• Provide information about the business;
• Offer a product sample or a brochure;
• Provide a business plan;
• Thoroughly explain the risk;
• Allow the friend or family member time to think;
• Formalize the arrangement in writing.
• Put the Terms of the Loan in Writing
• The terms of the lending arrangement should be in
writing. An arrangement should include the terms
regarding the interest rate, late fees, repayment terms,
and the length of the loan. A written agreement
establishes the legal obligations of each party and
defines the important terms of the arrangement.
• Offer an Equity Interest
• Some friends and family might prefer an equity interest in
the business. An equity investment will give the investor
a share of the business. This means that the investor will
share the profits and losses as a co-owner of the
business. Unlike a loan, if the business fails there is no
obligation to pay the investor back. The investor,
therefore, bears all risk, unless there is a guarantee on
the investment.
Equity Investors
 If you decide to forgo traditional investment,
such as taking out a loan from a financial
institution, you may find yourself in the world
of equity investors. An equity investor
actually buys a portion of your business and,
for better or worse, is a part owner in your
enterprise. This can be a very good thing or
a very bad thing, so it's important to know
what you're getting yourself into.
Equity Investors Expect a Return
• An equity investor is prepared to lose all of his or
her investment into your company. If the
business fails, the equity investor knows that
there is little chance of getting any of their money
back. As a result, equity investors often ask for a
fairly high percentage of a company's profits or
other benefits to make up for the substantial
chance of loss. There's also a good chance that
the investor will want salaries capped, especially
in the beginning, so always consider how much
of your company's hard earned profits you're
willing to give away and whether you can afford
to have your salary capped.
 Although equity investors usually demand a
significant portion of the business profits and
they have considerable leverage, there's
always room to negotiate. Before seriously
negotiating, determine for yourself just how
much you're willing to give away to investors
before equity investing no longer seems
attractive compared to traditional financing
options for your business.
• Equity Investors Have Substantial Rights
• One of the most contentious points between business
owners and equity investors is how much control equity
investors will have in the company. Don't think of these
rights as simply ceremonial or there to appease. Equity
investors often exercise their rights, including voting the
company's founder right out of the company. Rights
that equity investors may end up with include:
• The right to vote to elect a board of directors;
• The right to vote on all major business decisions;
• The right to be informed about all significant business
decisions;
• The right to sue you or the company if they feel their
rights aren't be respected.
Venture Capital FAQ

• Q: What is a venture capitalist?

• A: Venture capitalists are individuals or
companies who provide investment capital
and management expertise to new
businesses. In return, they will ask for an
equity position in the company, usually in
proportion to their risk and the amount of
their investment. They have a stake in
your company because their future returns
are tied to its performance.
• Q: How does a venture capitalist get involved
with my business?
• A: Venture capitalists effectively buy their way
into the company with their investment. That
means that the company will not have to repay
the capital; rather, venture capitalists expect to
take their return in capital gains. The company
will have a sizeable amount of money to work
with, while the venture capitalist takes an active
role in managing the company to ensure it
success. After all, the venture capitalist has just
bet a great deal of money that your company will
be a winner.
• Q: What role will the venture capitalist
play?
• A: A venture capitalist must be seen as a
partner. His or her active management
participation may occur through membership
on the board of directors, or through input into
other management decisions. The venture
capitalist's goal is a high (30-40 percent per
year) return on the investment over the period
of his or her involvement, which is typically
four to seven years. This means that the
company must follow an aggressive growth
strategy.
• Q: How can a venture capitalist benefit my
business?
• A: The resources and expertise of a venture
capitalist not only bring money without the
requirement of regular repayment by the
company, but also provide several other less
tangible benefits. The venture capitalist
shares a common desire for success with you,
and should not be thought of as a lender. He
or she contributes expertise, experience,
contacts, and discipline. The presence of a
venture capitalist also lends credibility to the
company.
• venture capitalist looking for?
• A: The strength of a company's management team can
be more important to a venture capitalist than the
company's product. This year's most promising product
may be eclipsed by next year's new technology, but a
good management team can foresee and work through
such difficulties. A venture capitalist wants to see a
capable, committed set of managers who are adaptable
and comfortable with growth and change. A venture
capitalist is always looking for a high rate of return. The
earlier your company is in its business cycle, the higher
that rate will have to be to compensate the venture
capitalist for his or her risk. This means that the
company must be positioned for rapid growth, in terms
of both management and product.
• A venture capitalist also wants to see a realistic set of
financial projections and requirements. He or she will take
a conservative view of your company's chances for profit
and success. It is helpful to emphasize financial
requirements for this stage in your company's growth.
Showing a realistic reflection of the company's financial
state shows discipline and the ability to plan for the future.
• The owners' commitments to the business through personal
financial stakes are also key. A venture capitalist will be
leery of investing money in any enterprise in which the
principals are unwilling to invest their own.
• Finally, the venture capitalist will want a clear exit strategy --
how to get his or her investment and return back out of the
company. Some preferable exits are through an IPO or the
sale of the company. However, other methods include
management buyout, corporate redemption, forced
receivership, sale of shares to principals, or sales of shares
to other equity partners.
• Q: What should I do to find a venture capitalist?
• A: Before seeking a venture capitalist, you will need
to tailor your business plan into a venture capital
plan. A venture capital plan differs in the following
ways:
• It is a strategic document in that it not only sells a
financial plan to investors, but the company's vision,
future goals, and potential.
• It must clearly demonstrate how the company intends
to repay the venture capitalist's investment, and what
the exit strategy will be.
• It must describe exactly how much money the
company wants, and what it will use it for.
• Additional detail is required because venture capital
is riskier than traditional financing.
• Q: When should I approach a venture capitalist?
• A: Timing well your approach to a venture capitalist is
important. As in any type of financing, you can get
venture capital most easily when you need it least.
Courting a venture capitalist takes a great deal of time
and effort, so it should be done when you and other key
members of the management team do not need full
attention on the company. Some good times to look for
a venture capitalist may be
• At year-end, when you have an audited financial
statement to show;
• When a major contract which could substantially
increase revenue is pending; or
• When your company's financial performance is good or
improving, rather than in a downturn.
• Q: What can I expect in my first meeting with
a venture capitalist?
• A: Ideally, your first meeting with a venture
capitalist should occur after you have been
introduced by a mutual contact that can vouch
for you and your company. This referral can
enhance your company's credibility, and your
chances. You will need to make your proposal at
this meeting, so you should consider carefully
what you will say, and rehearse it. You will need
to impress the venture capitalist that he or she
can help your company grow, and that it can
make money for him or her as well as for itself.
What Is Equity Crowdfunding?
• Raising the capital necessary to successfully launch
a small business is perhaps the most difficult hurdle
for most entrepreneurs. Common options include
maxing out multiple credit cards or taking out bank
loans, both of which present personal financial risks.
Venture capitalists and angel investors, meanwhile,
are focused on multimillion-dollar investments in
companies poised for rapid growth.
• With the advent of equity crowdfunding, however,
even individuals with just a few hundred dollars to
invest can get in on the game and take an
ownership stake (however small) in the company.
The Basics of Equity Crowdfunding
• At its essence, "crowdfunding" is a form of
fundraising in which a startup (or even just an
individual) raises small amounts of capital from a
large pool of investors, typically through an online
intermediary.
• Equity crowdfunding, on the other hand, involves
an exchange of capital for equity. As with
traditional equity investors, those investing through
an equity crowdfunding intermediary risk losing
their money entirely but also may see exponential
returns. What's different is the platform, which
allows direct interaction between the company and
the investors, and the size of the investments.