chapter 15 debt financing copyright ©2012 pearson education, inc. publishing as prentice hall 15-1...

Chapter 15 Debt FinancingChapter 15 Debt Financing Copyright Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall©2012 Pearson Education, Inc. publishing as Prentice Hall 15-15-11

Sources of Debt Financing


Debt FinancingDebt Financing Financing that must be repaid with interestFinancing that must be repaid with interest SBA: lenders make $700 billion in loans of SBA: lenders make $700 billion in loans of

less than $1 million to small companies less than $1 million to small companies each yeareach year

Total small business borrowing approaches Total small business borrowing approaches $1 $1 trilliontrillion per year per year

NFIB survey: Crises on Wall Street have NFIB survey: Crises on Wall Street have created a credit crunch for small created a credit crunch for small businessesbusinesses Just 50% of business owners received what Just 50% of business owners received what

they sought they sought


Debt FinancingDebt Financing Is carried as a liability on the company's Is carried as a liability on the company's

balance sheetbalance sheet Can be just as difficult to secure as Can be just as difficult to secure as

equity financing, even though sources equity financing, even though sources of debt financing are more numerousof debt financing are more numerous

Can be expensive, especially for small Can be expensive, especially for small companies, because of the risk/return companies, because of the risk/return tradeoff – “prime-plus…”tradeoff – “prime-plus…”


Consider Borrowing Consider Borrowing Money to…Money to… Increase your work force and/or Increase your work force and/or

inventory to boost salesinventory to boost sales Gain market shareGain market share Purchase new equipmentPurchase new equipment Refinance existing debtRefinance existing debt Take advantage of cash discountsTake advantage of cash discounts


Consider Borrowing Consider Borrowing Money to…Money to… Buy the building in which your Buy the building in which your

business is locatedbusiness is located Establish a relationship with a Establish a relationship with a

lenderlender Retire debt held by a “non-Retire debt held by a “non-

relationship” creditorrelationship” creditor Deal with a downturn in businessDeal with a downturn in business

Source: 2010 Mid-Year Economic Report, National Small Business Association, p 8.

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Small Business Financing Strategies

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Sources of Debt Sources of Debt CapitalCapital

Commercial banksCommercial banks

Source: The Small Business Economy: A Report to the President, 2009, p. 74.

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Commercial Bank Loans to Small Businesses

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Chapter 15 Debt Financing 15-8


Commercial Commercial BanksBanks

Lenders of Lenders of firstfirst resort for small resort for small business ownersbusiness owners

SBA study: Banks provide 50% of all SBA study: Banks provide 50% of all traditional debt to small businesses traditional debt to small businesses

Small banks (<$10 billion in assets) Small banks (<$10 billion in assets) are most likely to lend money to are most likely to lend money to small businessessmall businesses

Focus on a company’s ability to Focus on a company’s ability to generate positive cash flow when generate positive cash flow when evaluating loan proposalsevaluating loan proposals


Commercial Commercial BanksBanks Conservative lendersConservative lenders

Significant owner investmentSignificant owner investment Sufficient cash flow for Sufficient cash flow for

repaymentrepayment Ample collateral as securityAmple collateral as security SBA loan guaranteeSBA loan guarantee Personal guaranteePersonal guarantee


Commercial BanksCommercial Banks

Short-term loans – the Short-term loans – the commercial banks’ commercial banks’ specialtyspecialty Commercial loansCommercial loans Lines of creditLines of credit

...the heart of the financial market for small ...the heart of the financial market for small businesses!businesses!

How large a line of credit?How large a line of credit?Example:Example: Average collection period ratioAverage collection period ratio 49 days 49 days + Average inventory turnover ratio+ Average inventory turnover ratio + 53+ 53

daysdays= Total= Total 102 days 102 days- Average payable period ratio Average payable period ratio - 39 - 39 days days= Cash flow cycle= Cash flow cycle 63 days63 daysAnnual salesAnnual sales $5,800,000 $5,800,000Average daily sales (Annual sales Average daily sales (Annual sales ÷÷ 365 days) 365 days)

$15,890$15,890Cash Flow cycleCash Flow cycle 63 days63 daysx Average daily salesx Average daily sales x $15,890x $15,890EqualsEquals $1,001,096 $1,001,096- Forecasted profit (Annual sales x net profit margin)- Forecasted profit (Annual sales x net profit margin) - -

$377,000$377,000= Line of credit requirement= Line of credit requirement $ $624,096624,096



Commercial BanksCommercial Banks

Short-term loans – the Short-term loans – the commercial banks’ specialtycommercial banks’ specialty Commercial loansCommercial loans Lines of creditLines of credit

...the heart of the financial market for small ...the heart of the financial market for small businesses!businesses!

Floor planningFloor planning


Intermediate and long-Intermediate and long-term loansterm loans Term loansTerm loans Installment loansInstallment loans Character loansCharacter loans

Commercial BanksCommercial Banks...the heart of the financial market for small ...the heart of the financial market for small

businesses!businesses!


Sources of Debt Sources of Debt CapitalCapital Commercial banksCommercial banks Asset-based lendersAsset-based lenders


Asset-Based Asset-Based BorrowingBorrowing

Two common methods:Two common methods: Discounting accounts Discounting accounts

receivablereceivable

AccountsReceivable

Inventory financingInventory financing

Source: Commercial Finance Association

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Asset-Based Loans



Sources of Debt Sources of Debt CapitalCapital Commercial banksCommercial banks

Trade creditTrade credit Equipment suppliersEquipment suppliers Commercial finance companiesCommercial finance companies Savings and loan associationsSavings and loan associations

Asset-based lendersAsset-based lenders


Sources of Debt Sources of Debt CapitalCapital Stock brokerage housesStock brokerage houses Insurance companiesInsurance companies Credit unionsCredit unions BondsBonds Private placementsPrivate placements Small Business Investment Small Business Investment

Companies (SBICs)Companies (SBICs)

(Continued)(Continued)


Small Business Small Business Investment Companies Investment Companies (SBICs)(SBICs) About 307 SBICs operate in the U.S.About 307 SBICs operate in the U.S. Use a combination of private capital Use a combination of private capital

and federally guaranteed debt to and federally guaranteed debt to provide long-term capital to small provide long-term capital to small companiescompanies

Since 1958, SBICs have provided Since 1958, SBICs have provided more than $57.2 billion in financing more than $57.2 billion in financing to 107,000 small companies to 107,000 small companies

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SBIC Financing Paterns

Debt, 24.50%

Debt and Equity, 29.80%

Equity, 45.70%




Stock brokerage housesStock brokerage houses Insurance companiesInsurance companies Credit unionsCredit unions BondsBonds Private placementsPrivate placements Small Business Investment Small Business Investment

Companies (SBICs)Companies (SBICs)


Small Business Lending Companies Small Business Lending Companies (SBLCs)(SBLCs)



Economic Development Economic Development Administration (EDA)Administration (EDA)

Department of Housing and Urban Department of Housing and Urban Development (HUD)Development (HUD)

U.S. Department of Agriculture’s U.S. Department of Agriculture’s Rural Business-Cooperative Rural Business-Cooperative ServiceService

Federally Sponsored Programs:Federally Sponsored Programs:



Small Business Innovation Research Small Business Innovation Research (SBIR) (SBIR)

Small Business Technology Transfer Small Business Technology Transfer programsprograms

Small Business Administration (SBA) Small Business Administration (SBA) – largest single backer of small – largest single backer of small businesses in the nationbusinesses in the nation


Federally Sponsored Programs:Federally Sponsored Programs:(Continued)(Continued)


Small Business Small Business Administration Loan Administration Loan ProgramsPrograms

SBA has helped 20 million small SBA has helped 20 million small companies acquire the capital companies acquire the capital they need for start-up and they need for start-up and growth growth

SBASBAExpressExpress Program – loan Program – loan guarantees of up to 50% on guarantees of up to 50% on loans up to $350,000loans up to $350,000


7(A) Loan Guaranty Program7(A) Loan Guaranty Program


Source: U.S. Small Business Administration

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SBA 7(A) Guaranteed Loans



7(A) Loan Guaranty Program7(A) Loan Guaranty Program CAPLine ProgramCAPLine Program Section 504 Certified Section 504 Certified

Development Company ProgramDevelopment Company Program



Microloan ProgramMicroloan Program Average loan is $13,550 with a Average loan is $13,550 with a

maturity of 3 years (Maximum is 6 maturity of 3 years (Maximum is 6 years) years)

37% go to business start-ups37% go to business start-ups International Trade LoansInternational Trade Loans

Export Working Capital ProgramExport Working Capital Program International Trade Loan ProgramInternational Trade Loan Program

Disaster Assistance LoansDisaster Assistance Loans



State and Local Loan State and Local Loan ProgramsPrograms Capital Access Programs (CAPs) – Capital Access Programs (CAPs) –

now offered in 22 states and are now offered in 22 states and are designed to encourage lenders to designed to encourage lenders to make loans to businesses that do make loans to businesses that do not qualify for traditional financing not qualify for traditional financing

Revolving Loan Fund (RLFs) – Revolving Loan Fund (RLFs) – combine private and public funds combine private and public funds to make small business loans to make small business loans


Internal Methods of Internal Methods of FinancingFinancing Factoring - selling accounts Factoring - selling accounts

receivable outrightreceivable outright

Source: "Annual Asset-Based Lending and Factoring Surveys 2006," Commercial Finance Association, July 2, 2007, p. 15.

$-

$20,000

$40,000

$60,000

$80,000

$100,000

$120,000

$140,000

Mill

ions

of $

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006

Factoring Volume(in Millions of $)

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Chapter 15 Debt Financing 15-32


Factoring - selling accounts Factoring - selling accounts receivable outrightreceivable outright

Leasing assets rather than Leasing assets rather than buying thembuying them

Credit cardsCredit cards

Internal Methods of Internal Methods of FinancingFinancing


Web SitesWeb Sites American Bankers AssociationAmerican Bankers Association

http://www.aba.com/default.htm National Association of Small National Association of Small

Business Investment CompaniesBusiness Investment Companieshttp://www.nasbic.org/http://www.nasbic.org/

U.S. Small Business AdministrationU.S. Small Business Administrationhttp://www.sba.gov/

http://www.aba.com/default.htm

http://www.sba.gov/


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