CAPITAL FUNDING

• Sources of capital

• Debt financing- financing method involving an interest bearing instrument, usually loan, the payment of which is only indirectly related to the sales and profits of the venture. Typically debt financing [also called asset based financing] requires that some asset such as a car, house, plant, machine or land, can be used as collateral.

• Equity financing- does not require collateral and offers the investor some form of ownership position in the venture. The investor shares in the profits of the venture as well as disposition of its assets on a pro rata basis based on the percentage of the business owned.

• Internal or external funds- the type of funds most frequently employed is internally generated funds. Internally generated funds can come from several sources within the company; profits, sale of assets, reduction in working capital, extended payment terms and accounts receivables.

• Personal funds- few, if any, new ventures are started without the personal funds of the entrepreneur. Not only are these the least expensive funds in terms of cost and control, but they are absolutely essential in attracting outside funding, particularly from banks, private investors and venture capitalists.

• Family and friends- these are common source of capital for a new venture. They are most likely to invest due to their relationship with entrepreneur. This helps overcome one portion of uncertainty felt by impersonal investors- knowledge of entrepreneur.

• Commercial banks- are by far the source of short term funds most frequently used by the entrepreneur when collateral is available. The funds are provided in the form of debt financing such as require some tangible guaranty or collateral- some asset with value.

• Types of bank loans

• These loans are based on the assets or the cash flow of the venture. The asset base for loans is usually;

1. Accounts receivable loans- provide a good basis for a loan, especially if the customer base is well known and creditworthy. For those creditworthy customers, a bank may finance up to 80% of the value of their accounts receivable.

2. Inventory loans- is another of the firms assets that is often basis for a loan, particularly when the inventory is liquid and can be easily sold. The finish goods inventory can be financed for up to 50% of its value.

3. Equipment loans- can be used to secure longer term financing usually on a 3 to 10 year basis. Equipment financing can fall into any of several categories; financing the purchase of new equipment, financing used equipment already owned by the company. When new equipment is being purchased or presently owned equipment is used as collateral, usually 50 to 80 percent of the value of the equipment.

4.Real estate loans- is also frequently used in asset based financing., the mortgage financing is usually easily obtained to finance a company’s land, plant or another building, often up to 75 percent of its value.

5.Cash flow financing- lines of credit financing is perhaps the form of cash flow financing most frequently used by the entrepreneurs. In arranging for a line of credit to be used as needed, the company’s pays a commitment fee to ensure the commercial bank will make the loan when requested and then pays interest on any outstanding funds borrowed from the bank.

• Instalment loans- can also be obtained by a venture with track of sales and profits. This short term funds are frequently used to cover working capital needs for a period of time. These loans are usually 30 to 40 days.

• Straight commercial loans- a hybrid of instalment loan is the straight commercial loan, by which funds are advanced to the company for 30 to 90 days. This self liquidating loans are frequently used for seasonal financing and for building up inventories.

• Long term loans- when longer time period of the money is required, long term loans are used. These loans usually available only to strong, mature companies, can make funds available for up to 10 years.

• Character loans- when the business itself does not have the assets to support a loan, the entrepreneur may need a character [personal] loan.

• Bank lending decisions

• the bank lending decisions are made according to the five C’s of lending;

1. Character

2. Capacity

3. Capital

4. Collateral

5. Conditions

• Financing the business

• Early stage financing- is usually the most difficult and costly to obtain;

• Seed capital- the most difficult financing to obtain through outside funds, is usually a relatively small amount of funds needed to prove concepts and finance feasibility studies.

• Start up capital- is involved in developing and selling some initial products to determine if commercial sales are feasible.

• Expansion or development financing [the second basic financing type] is easier to obtain than early stage financing. Venture capitalists play an active role in providing funds.

• Acquisition financing or leveraged buyout financing [third type]- is more specific in nature. It is issued for such activities as traditional acquisitions, leveraged buyouts [management buying out the present owners] and going private [a publicly held firm buying out existing stockholders, thereby becoming a private company].

• Venture capital

• one of the least understood areas in entrepreneurship. Some of think that venture capitalists do the early stage financing of relatively small, rapidly growing technology companies. It is more accurate to view venture capital broadly as a professionally managed pool of equity capital.

• The objective of a venture capital firm is to generate long term capital appreciation through debt and equity investments.

• Venture capital process into four primary stages;

• Preliminary screening- begins with the receipt of the business plan. A good business plan is essential in the venture capital process.

• Agreement on principal terms- the second stage is the agreement on principal terms between the entrepreneur and the venture capitalist.

• Due diligence- detailed review and due diligence, is the longest stage, involving anywhere from one to three months.

• Final approval- a comprehensive internal investment memorandum is prepared. This documents reviews the venture capitalists findings and details the investment terms and conditions of the investment transaction.

• Ratio analysis

• calculations of financial ratios can also be extremely valuable as an analytical and control mechanism to test financial well being of a new venture during its early stage.

• Liquidity ratios;

• Current ratio

• -This ratio commonly used to measure the short term solvency of the venture meet its short term debts.

• - Current asset/ current liabilities

• Acid test ratio

• This is a more rigorous test of the short term liquidity of the venture because it eliminates inventory, which is the least liquid current asset.

• [current assets- inventory]/ current liabilities

• Activity ratios;

• Average collection period

• The ratio indicates the average number of days it take to convert accounts receivable into cash. This ratio helps the entrepreneur to gauge the liquidity of accounts receivable or the ability of the venture to collect form its customers.

• Accounts receivable/ average daily sales

• Inventory turnover

• This ratio measures the efficiency of the venture in managing and selling its inventory. A high turn over is a favourable sign indicating that the venture is able to sell its inventory quickly.

• Cost of good sold/ inventory

• Leverage ratios;

• Debt ratio

• Many new ventures will incur debts as a means of financing the start up. The debt ratio helps the entrepreneur to asses the firm’s ability to meet all its obligations [short and long term].

• Total assets/ total liabilities

• Debt to equity• This ratio assesses the firm’s capital structure. It provides a measure of risk to creditors by

considering the funds invested by creditors [debt] and investors [equity]. The higher the percentage of debt, the greater the degree of risk to any of the creditors.

• Total liabilities/ stockholders equity

• Profitability ratios;

• Net profit margin

• This ratio represents the venture’s ability to translate sales into profits.

• Net profit/ net sales

• Return on investment

• Measures the ability of the venture to manage its total investment in assets.

• Net profit/ total assets