Sources of Debt Financing

Chapter 15 Debt Financing Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall 1

Debt Financing

   Financing that must be repaid with interest SBA: lenders make $600 billion in loans of less than $1 million to small companies each year Total small business borrowing approaches $1 trillion per year Chapter 15 Debt Financing Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall 2

Debt Financing

   Is carried as a liability on the company's balance sheet Can be just as difficult to secure as equity financing, even though sources of debt financing are more numerous Can be expensive, especially for small companies, because of the risk/return tradeoff – “prime-plus…” Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall Chapter 15 Debt Financing 3

Consider Borrowing Money to…

     Increase your work force and/or inventory to boost sales Gain market share Purchase new equipment Refinance existing debt Take advantage of cash discounts Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall Chapter 15 Debt Financing 4

Consider Borrowing Money to…

    Buy the building in which your business is located Establish a relationship with a lender Retire debt held by a “non relationship” creditor Deal with a downturn in business Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall Chapter 15 Debt Financing 5

Sources of Debt Capital

 Commercial banks Chapter 15 Debt Financing Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall 6

Source: Source SBA: Banking and SME Financing in the United States, June 2006, http://www.sba.gov/advo/research/rs277tot.pdf.

Commercial Banks

    Lenders of owners first resort for small business SBA study: Banks provide 64.7% of all traditional debt to small businesses Small banks (<$500 million in assets) are most likely to lend money to small businesses Focus on a company’s ability to generate positive cash flow when evaluating loan proposals Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall Chapter 15 Debt Financing 8

Commercial Banks

 Conservative lenders  Significant owner investment  Sufficient cash flow for repayment  Ample collateral as security  SBA loan guarantee  Personal guarantee Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall Chapter 15 Debt Financing 9

Commercial Banks

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

 Short-term loans – the commercial banks’ specialty  Commercial loans  Lines of credit Chapter 15 Debt Financing Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall 10

How large a line of credit?

Example: Average collection period ratio + Average inventory turnover ratio = Total Average payable period ratio = Cash flow cycle 49 days + 53 days 102 days - 39 days 63 days Annual sales Average daily sales (Annual sales ÷ 365 days) $5,800,000 $15,890 Cash Flow cycle x Average daily sales Equals - Forecasted profit (Annual sales x net profit margin) = Line of credit requirement 63 days x $15,890 $1,001,096 - $377,000 $ 624,096 Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall

Commercial Banks

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

 Short-term loans – the commercial banks’ specialty  Commercial loans  Lines of credit  Floor planning Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall Chapter 15 Debt Financing 12

Commercial Banks

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

 Intermediate and long-term loans  Term loans  Installment loans  Discounted installment contracts  Character loans Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall Chapter 15 Debt Financing 13

Sources of Debt Capital

  Commercial banks Asset-based lenders Chapter 15 Debt Financing Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall 14

Asset-Based Borrowing

Accounts Receivable

Two common methods:

 

Discounting accounts receivable Inventory financing

Chapter 15 Debt Financing Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall 15

Asset-Based Loans (in Millions of $) $500,000 $450,000 $400,000 $350,000 $300,000 $250,000 $200,000 $150,000 $100,000 $50,000 $ 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006

Source: Commercial Finance Association

Sources of Debt Capital

      Commercial banks Asset-based lenders Trade credit Equipment suppliers Commercial finance companies Saving and loan associations Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall Chapter 15 Debt Financing 17

Sources of Debt Capital

      Stock brokerage houses Insurance companies Credit unions Bonds Private placements Small Business Investment Companies (SBICs) (Continued) Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall Chapter 15 Debt Financing 18

Small Business Investment Companies (SBICs)

   About 400 SBICs operate in the U.S.

Use a combination of private capital and federally guaranteed debt to provide long-term capital to small companies Since 1958, SBICs have provided more than $48 billion in financing to 100,000 small companies Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall Chapter 15 Debt Financing 19

Equity 51.0% SBIC Financing Patterns Debt 20.5% Debt and Equity 28.5%

Source: SBIC Program Overview , National Association of Small Business Investment Companies, 2007.

Sources of Debt Capital

(Continued)       Stock brokerage houses Insurance companies Credit unions Bonds Private placements Small Business Investment Companies (SBICs)  Small Business Lending Companies (SBLCs) Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall Chapter 15 Debt Financing 21

Sources of Debt Capital

(Continued)

Federally Sponsored Programs:

   Economic Development Administration (EDA) Department of Housing and Urban Development (HUD) U.S. Department of Agriculture’s Rural Business-Cooperative Service Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall Chapter 15 Debt Financing 22

Sources of Debt Capital

(Continued)

Federally Sponsored Programs:

   Small Business Innovation Research (SBIR) Small Business Technology Transfer programs Small Business Administration (SBA) – largest single backer of small businesses in the nation Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall Chapter 15 Debt Financing 23

Small Business Administration Loan Programs

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

Express

Program – loan guarantees of up to 50% on loans up to $350,000 7(A) Loan Guaranty Program – the most popular SBA loan program Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall Chapter 15 Debt Financing 24

SBA 7(A) Guaranteed Loans $18.0

$16.0

$14.0

$12.0

$10.0

$8.0

$6.0

$4.0

$2.0

$0.0

1976 1980 1984 1988 1992 1996 2000 2004

Source: U.S. Small Business Administration

Small Business Administration Loan Programs

  SBA

Express

Program 7(A) Loan Guaranty Program   CAPLine Program International Trade Programs  Export Working Capital Program  International Trade Program Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall Chapter 15 Debt Financing 26

Small Business Administration Loan Programs

  Section 504 Certified Development Company Program Microloan Program  Average loan is $13,000 with a maturity of 3 years (Maximum is 6 years)  37% go to business start-ups Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall Chapter 15 Debt Financing 27

Small Business Administration Loan Programs

   Prequalification Loan Program Disaster Loans 8(A) Loan Program Chapter 15 Debt Financing Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall 28

State and Local Loan Programs

  Capital Access Programs (CAPs) – now offered in 22 states and are designed to encourage lenders to make loans to businesses that do not qualify for traditional financing Revolving Loan Fund (RLFs) – combine private and public funds to make small business loans Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall Chapter 15 Debt Financing 29

Internal Methods of Financing

 Factoring - selling accounts receivable outright Chapter 15 Debt Financing Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall 30

Factoring Volume (in M illions of $ ) $140,000 $120,000 $100,000 $80,000 $60,000 $40,000 $20,000 $ 19 8 0 19 8 2 19 8 4 19 8 6 19 8 8 19 9 0 19 9 2 19 9 4 19 9 6 19 9 8 2 0 0 0 2 0 0 2 2 0 0 4 2 0 0 6

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

Internal Methods of Financing

   Factoring - selling accounts receivable outright Leasing assets rather than buying them Credit cards Chapter 15 Debt Financing Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall 32

Web Sites

   American Bankers Association http://www.aba.com/default.htm

National Association of Small Business Investment Companies http://www.nasbic.com/ U.S. Small Business Administration http://www.sba.gov/ Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall Chapter 15 Debt Financing 33

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Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall Chapter 15 Debt Financing Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall 34