Insufficient Cash On Hand A Frequent Reason For Needing A Business Loan

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1 Insufficient Cash On Hand A Frequent Reason For Needing A Business Loan 2 Cash flow is cash into or out of a business When cash inflows exceed cash outflows, it is generally indicative of good financial health Ample cash on hand enables the business to pay creditors, employees and the business owner on time Insufficient cash flow is a primary reason for an established business (beyond start-up) to require external financing There are three types of cash flows: Operational Cash Flows: Cash inflows or outflows as a result of business activities Investment Cash Flows: Cash inflows or outflows as a result of investment activities (i.e. the purchasing and selling of assets) Financing Cash Flows: Cash received through debts repaid to the business or cash paid out to repay debts owed by the business Source: Investopedia

2 Your P&L On Paper Is Not Your Actual Cash In The Bank! 3 Example: You need actual cash to operate your business!

3 Leading Causes Of Cash Flow Problems 4 Factor Low Profits or Worse Loses Over-investment In Capacity Too Much Inventory Allowing Customers Too Much Credit Expanding Too Fast Demand Fluctuation Why It Causes A Cash Flow Problem There is a direct link between low profits or losses and cash flow problems Most loss-making businesses eventually run out of cash The business spends too much on fixed assets Production is under-capacity not generating sufficient revenue Ties-up cash and increases the risk of excess and obsolete inventory Extending credit to customers is a good way to build business, but their slow/late payments strain your cash flow If your accounts receivable cycle is regularly a lot longer than your accounts payable cycle, that s an obvious cash flow problem Opening too many stores, outlets, facilities, etc. too quickly before they start generating profits Seasonality in your business should be expected and planned for Inaccurate sales forecasts due to other fluctuations i.e. your customers sales forecasts are inaccurate

4 Steps To Business Financing 5 Identify your financial needs (don t forget the operating cash you need) Know what lenders and investors look for and assess your situation Find assistance in helping you get ready to apply Understand about financing basics and alternatives Identify the most appropriate funding source(s) for your business Verify requirements for the type of financing you re after Prepare and submit documentation

5 Lenders/Investors Expect You To Have Your Act together 6 Business financing is typically in the form of debt, equity or mezzanine Debt lenders will be concerned about protection of their principle investment, as well as a reasonable return (i.e. interest) Equity investors will be concerned about the operations and performance of the business, as they directly affect the value of their equity share; These investors make money when they sell their equity share after the company has increased in value Mezzanine investors will potentially have all of the above expectations Any type of lender or investor will require the following before considering funding your business: Credit report the best possible scores A very thorough, well-thought-out, plausible business plan A track record of sound management and reasonable business results

6 Debt vs. Equity vs. Mezzanine 7 Debt Financing Equity Financing Mezzanine Financing Overview A loan where the principle must be repaid over time, usually with interest The main sources of debt financing are banks and government agencies such as the Small Business Administration Family members, friends and credit cards are sometimes used as sources of debt financing Money obtained from investors, in exchange for an ownership share in the business Such funds may come from friends, family members, angel" investors or venture capital firms A hybrid of debt and equity financing Typically used to finance the expansion of existing businesses Is basically debt capital that gives the lender the right to convert to an ownership or equity share in the business, if the loan is not paid back on-time and in full Advantages The interest paid on loans is generally tax deductible Lender does not receive an ownership share in the business The business is not obligated to repay the money instead, investors hope to reclaim their investment (and a return) out of future profits High-profile investors may also help increase the credibility of a new business The owner rarely loses outright control of the business or its direction provided the business continues to grow and prosper Offers a lot of flexibility in shaping amortization schedules Mezzanine lenders tend to be long-term investors Increases the value of stock held by existing shareholders, although mezzanine equity will dilute the value of the stock Disadvantages New businesses sometimes find it difficult to make regular loan payments when they have irregular cash flow Carrying too much debt increases the perceived risk associated with businesses, making them unattractive to potential lenders and buyers in the future Borrowing from relatives or friends can create serious relationship problems Credit card debt can easily get out of control and be very expensive Investors become part-owners of the business with some sway and can also demand board seats As ownership interests are diluted, managers face a possible loss of autonomy Borrowing from relatives or friends can create serious relationship problems Excessive reliance on equity financing may indicate that a business is not using its capital in the most productive manner May involve loss of control over the business, particularly if projections do not work out as planned May include restrictive covenants on the borrower Subordinate in priority of payment to senior debt, but senior in rank to common stock or equity More expensive than traditional or senior debt arrangements Source:

7 Investors Are Very Choosey 8 A professional investor s decision to pursue a proposed new opportunity will turn on: 1. The thought processes, experiences, knowledge, skills, confidence and character of the people in the business 2. The quality of the business plan and the accompanying materials The business plan is management s first, best and probably only chance to capture the attention of investors Investors need assurance that management has thought about its corporate goals, management team, products, strategies, competition and the need for capital Investors also want to know that management has considered weaknesses, as well as strengths, problems and opportunities Many businesses only write a business plan when they must, i.e. for a outside investors that is a big mistake Failure to plan is planning to fail JPMorgan Chase closes and invests in only 1% of the >4,000 deals presented to it each year. Stage Of Funnel Read 3-Page Executive Summary Number Of Plans Percent Of Plans 4, % Read Full Business Plan 1,200 30% Contact Management, Ask Simple Questions Visit Management One Time Intensive Due Diligence & Research Make Offer; Negotiate Price & Terms Close The Deal; Make The Investment % 320 8% 160 4% 80 2% 40 1% Source: Yale School of Management

8 Before anyone will hand you this money, you ve got a lot of work to do! 9

9 This Is What You Need To Think Through & Do To Go After Financing Outline Of Thought Process & Work Flow 10 Overview What are our products, services, features and benefits? What is unique? Market: Nature and size, segments, growth rate, special factors Who are the customers? (Demand) What do they think about our product? Who are the competitors? (Supply) What is our comparative advantage? Production How do we make our product/ service? What does it cost? Sales & Marketing How do we get customers? Sales force? Advertising? Devise a Strategy Comparative strengths and weaknesses, scope, timing Business model How do we make money? Volume pricing costs? Legal, accounting, tax and finance, insurance and administrative support needs Technical Patents, licenses, other Personnel Plan Management skills required, versus skills already on hand. Fill the gaps? Who, how many, job duties, when, where do we get them? Compensation, stock incentives, costs, fringe benefits (health care, etc.) Financial Plan Base Case (Main focus); Upside/downside cases How much money do we need? Now versus later Identify sources of capital Founders, friends & family, angels, VC firms Investor exit: IPO, sell to strategic buyer, buyback? Equity Valuation Comparable companies Research, Bloomberg, Yahoo Valuation -- Trading multiple model, VC method Deal Structure Articles of Incorporation, By-Laws, Shareholders Agreement, etc. Negotiate initial equity (Founders, other investors); incentive stock option plan Structure terms of the financing offer to investors Write Your Business Plan Cover Page & Disclaimer Summary (1,400 words or less) Write this first! Main Text (20-25 pages); Edit and re-edit for reading ease Financial statements and financial projections Shareholders list, management résumés, contracts, other appendices, pictures Mail proposal to Target Investors Practice and deliver oral presentation Source: Yale School of Management

10 To Obtain Outside Investment Outline Of A Standard Business Plan 11 Cover Page & Disclaimer Including who to contact information Executive Summary 1,400 Words or less, 3-4 pages Terms of the Financing Amount of financing needed Price, key terms and conditions Company Summary History Ownership Location and facilities Product / Services Product or service description Features and benefits Competitive comparisons Production or other sourcing Technology & patents Future products & services Market Analysis Summary Market segmentation Industry analysis size and growth Industry participants Distribution patterns Competition and buying patterns Main Competitors Market analysis, size and expected growth Strategy and Implementation Marketing strategy Pricing Promotion Sales strategy Sales forecasts Sales programs and techniques Costs, services and support Milestones Management Summary Management team, plans to fill gaps Organizational structure Board of Directors Personnel plan and philosophy, incentives Financial Plan Key assumptions Projected financial statements Projected cash flows & break-even analysis Key financial indicators and ratios Source: Yale School of Management

11 A Long-Term, Strategic Relationship Venture Capital As A Source Of Equity Investment 12 Venture capital (VC) investing is a strategic, long-term source of equity investment It applies to startups, sustained businesses and growth businesses, because it is staged through a sequence of financing rounds During each round of financing, the VC firm provides new financing to the business, in exchange for an equity share in the business Financing rounds are staged throughout the life of a private company

12 Source: MBA Knowledge Base 13

13 Risk Perception & Timing For Stages Of Venture Capital Financing 14 Financing Stage Period (Funds Locked in Years) Risk Perception Activities To Be Financed Early stage finance - Seed 7-10 Extreme For supporting a concept or idea or R & D for product development Start up 5-9 Very high Initializing operations or developing prototypes First stage 3-7 High Second stage 3-5 Sufficiently high Later stage finance 1-3 Medium Start commercial production and marketing Expand market & growing working capital need Market expansion, acquisition & product development for profit making company Buy out-in 1-3 Medium Acquisition financing Turnaround 3-5 Medium to high Turning around a sick company Mezzanine 1-3 Low Facilitating public issue Source: MBA Knowledge Base

14 Summary 15

15 Key Take-Aways (1/2) 16 Cash flow is cash into or out of a business When cash inflows exceed cash outflows, it is generally indicative of good financial health Ample cash on hand enables the business to pay creditors, employees and the business owner on time Don t be fooled your P&L on paper is not your actual cash in the bank! Insufficient cash on hand is one of the main reasons businesses (not just start-ups) require external investment (i.e. a cash influx) Investment comes in the form of debt, equity or mezzanine each have advantages and disadvantages Sources of investment can be the business owner s own resources (including credit cards), friends, relatives, angel investors, banks, government agencies and venture capitalists (VCs) each have advantages and disadvantages Investment from a VC entails a long-term, strategic relationship, over the life of the business while it is a private entity

16 Key Take-Aways (2/2) 17 Any outside investor will require a credit report, a business plan and a track record Investors need assurance that management has thought about its corporate goals, management team, products, strategies, competition and the need for capital Investors also want to know that management has considered weaknesses, as well as strengths, problems and opportunities Investors are very choosey VCs, in particular, eventually close and fund only a very small percentage of the deals that are presented to them The bottom line is that professional investor s decision to pursue a proposed new opportunity will turn on: 1. The thought processes, experiences, knowledge, skills, confidence and character of the people in the business 2. The quality of the business plan and the accompanying materials

17 Sources Of Additional Information/Help 18 While connected to the internet click on a link below to see web pages. Cash Flow Funding A Business Business Plans To Secure Outside Investment

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