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 companys 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 companys 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 Cs 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 firms ability to meet all its obligations [short and long term].
Total assets/ total liabilities

Debt to equity
This ratio assesses the firms 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 ventures 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