11/11/2013. Lecture 10 Debt capital. Prof. Maged Attia 11/11/2013. Idea or opportunity. Entrepreneur and team. Resources & Financing

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1 Lecture 10 Debt capital Prof. Maged Attia 11/11/ Entrepreneur and team Idea or opportunity Lectures 1,5 Lectures 2, 3,4 Resources & Financing Lectures 6-10 Other topics: - Exit options - Family Business Lectures 12,13,14 3 1

2 Debt capital 4 Commercial banks Trade credit Finance companies Factors Leasing companies 16-5 Common types of financing involving the use of a bank Line of credit loans Term loans Mortgages and equipment loans Plant improvement loans Time-sales finance Conditional sales contracts

3 Maturity > 12 months Types of long-term debt: Loans from financial institutions Corporate bonds Contract: Debt contract where borrower promises to pay future cash flows to lender. Debt contract specifies the size and timing of interest payments and how they are calculated. May specify if there are assets pledged as security, if debt is transferable, any other restrictions on and rights of the parties Secured Lender has claims against the borrower and against assets of the borrower. Unsecured Lender has a claim against the borrower, but no claim to any particular property owned by the borrower. Source: McGraw-Hill - Business Finance 9E by Pierson, Brown, Easton, Howard and Pinder Marketable Securities such as notes, bonds or debentures that are issued direct to investors and can then be traded in a secondary market. Non-marketable Loans arranged privately between two parties. Source: McGraw-Hill - Business Finance 9E by Pierson, Brown, Easton, Howard and Pinder 3

4 Interest cost of debt Fixed versus variable if variable, typically some benchmark rate (cash rate) plus a premium dependent on risk of borrower. Higher for subordinated debt lowest ranking debt in event of company being wound up. Effect of debt on risk Financial risk risk attributable to the use of debt as a source of finance. Source: McGraw-Hill - Business Finance 9E by Pierson, Brown, Easton, Howard and Pinder Effect of debt on control Lenders have no voting rights. However, lenders have a large degree of potential control if the company breaches the loan agreement. To protect their assets, creditors can take control of loan security, appoint administrators, move for receivership or liquidation. Source: McGraw-Hill - Business Finance 9E by Pierson, Brown, Easton, Howard and Pinder Commercial banks Trade credit Finance companies Factors Leasing companies

5 Trade credit the ability to buy goods and services and have 30, 60, or 90 days to pay for them Major source of short-term funds for small businesses Represents 30 to 40 percent of the current liabilities of non-financial companies, with generally higher percentages in smaller companies Frequently lend money to companies that do not have positive cash flow Will not make loans to companies unless they consider them viable risks; usually more accepting of risk than are banks Factoring a form of accounts receivable financing where the receivables are sold, at a discounted value, to a factor The factor buys the client s receivables outright, without recourse, as soon as the client creates them, by shipment of goods to customers Cash is made available to the client as soon as proof is provided (old-line factoring) or on the average due date of the invoices (maturity factoring)

6 Leasing companies leases common and readily resalable items such as automobiles, trucks, typewriters, and office furniture to both new and existing businesses Up front payment required of about 160 percent of the value of the item being leased Interest may be more or less than other forms of financing, depending on the equipment leased, the credit of the lessee, and the time of year

7

8 Your banker is your partner, not a difficult minority shareholder Be honest and straightforward in sharing information Invite the banker to see your business in operation Always avoid overdrafts, late payments, and late financial statements Task Deadline Submit group name and members 9/16/2013 Submit topic and introduction to business plan for approval 9/30/2013 Submit business plan outline 10/14/2013 Submit preliminary business plan and Power Point for 1-1 review with professor Submit final business plan and present it in class to all students 20min business plan presentation All team members should present 11/18/ /13/ /16/ Debt capital Case: Bank Documents: The Devil Is in the Details (Due week after next) 24 8

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