Important Factors in Business Financing - Coursework Example

 Table of Contents I. Banks i. Advantage/Disadvantage Table II. Investments i. Microsoft Investment Chart ii. Enron Chart iii. Advantage/Disadvantage Table III. Personal Financier i. Advantage/Disadvantage Table IV. Assets i. Advantage/Disadvantage Table V. Customer Financing i. Advantage/Disadvantage Table VI. Franchising i. Advantage/Disadvantage Table VII. Vendor Franchising i. Advantage/Disadvantage Table VIII. Term Loans i. Advantage/Disadvantage Table IX. Interest Only Loans i. Advantage/Disadvantage Table X. Friends and Family i. Advantage/Disadvantage Table XI. Big Business Options XII. Small/Private Business Options XIII. Conclusion XIV. References Business financing can be achieved or arranged in many diverse ways. Due to the vast amount of ways to finance a business, only a limited number will be discussed in this paper. Some of the ways to be discussed will consist of banks, investments, assets, customer financing, franchising, term loans, vendor financing, friends, and family. Some of these business financing methods are for large business, others from small home based businesses. The business needs are the most important factor when choosing financing. Banks Banks are one of the most common ways to finance a business (Downes and Goodman, 2006, 17). No matter the size of the business, big or small, banks can be the solution to financing. A bank can also finance a project based on the business needs. For instance, if a large successful business needed a new warehouse, a bank might advance cash. Big business generally have banks issue stocks or bonds on the market to raise money for their loans. This can generate money, but if the bank or stock fails, the results are disaster. For example, Northern Rocks Share price crashed after credit freezes in the interbank money market. Walayat (2007) explains: Northern Rocks Share price crashed by 30% today as the mortgage bank sought emergency funds from the Bank of England due to the credit freeze in the interbank money market which Northern Rock heavily relies upon. Panic gripped savers forming long lines outside Northern Rock Branches throughout the UK to withdraw funds. Investors dumping the stock on the market open where even unsubstantiated rumors of takeovers and white knights failed to halt the crash in the banks share price. The tick chart for the Northern Rock bank decline is shown below: (Walayat 2007) This can be unfortunate for the bank and the investor trying to raise capital. An example of a small business loan from a prominent bank like HSBC UK would be the following: Small Business Loan Small Business Loan is the right bank finance solution for you: Rates from 6.9% AIR for loan amounts between £15,000 to £25,000. if you want to borrow between £1,000 and £25,000 with fixed monthly repayments. if you want a loan that's quick and easy to arrange. if you want to invest in a longer term project such as buying new equipment. Small Business Loan – key features and benefits Eligible customers can choose to make your first repayment either one month after taking the borrowing or defer your first repayment until three months after drawing down the loan. You choose the repayment term – between 12 months to 10 years. You decide what you use the loan for. Track interest rate and repayments are fixed for the life of the loan. Competitive £100 arrangement fee at opening. As with all business finance, interest can be offset against tax liabilities. Fixed monthly repayments minimises the impact of a large purchase on your day to day cash flow. Option to protect the loan repayments against sickness, accident and death. Track repayments and outstanding balance using Business Internet Banking. (HSBC.com) Another example from HSBC.com is the flexible business loan. This is depicted below: Flexible Business Loan This could be the right solution for you if: you are a limited company who wants to borrow over £10,000 on a variable rate you are a sole trader, partnership or limited company who wants to borrow over £25,001, with a choice of fixed* or variable rates you want a loan that is tailored to your business. Borrowing less than £25,000? Key features and benefits Flexibility – you decide what the loan is used for. Select a fixed* or variable rate - the choice is yours. Interest payable monthly or quarterly. Facilities can be repaid over periods of 12 months to 15 years (10 years for fixed rates). You may be able to take a capital repayment holiday of up to two years**. You may be able to defer up to two loan repayments in any year**. (HSBC.com) Both of these options are available at most banks throughout the UK. The drawbacks for bank loans are two fold. First, most banks require collateral. If a party defaults on a bank loan, the bank will foreclose. Secondly, a business must have good credit. Without almost perfect credit, banks will not even consider giving a business a loan. The upside is most banks have lower interest rates than other means of investment. For example, (Simple Pound, 2007) reports that The Bank of England has a 5.5% interest rate. This is quite low considering credit cards charge up to three times that figure. The chart below shows the highs and lows in interest rate at The Bank of England over the years. (Simple Pound, 2007) Bank financing can be a short term or long term solution to financing a business. Bank loans can range from months to decades, depending on the business and financing. Bank Advantages Bank Disadvantages Unlimited amount of financing. Good credit is required. Stocks and bonds can be issued by the bank. Collateral is normally required. Low interest rates Payments are due on time. Investments Another form of business finance is through investments. These investments can be through the stock markets, personal financiers, or company retirement plans. Investments can be used in various ways to finance a business (Loeb, 2007, 10). An international corporation, such as Microsoft, can sell stocks to generate financing for their business. Big companies can also offer stock options as a retirement plan. The advantage of stocks and retirement plans can be seen in Microsoft. Microsoft stocks started low, then gradually rose. Early employees with stock options became millionaires overnight. For example, NASDAQ quoted the following beginning prices and today prices for Microsoft. The disadvantage to stocks and retirement plans is large companies like Enron. This company inflated stocks, making investors and employees bankrupt. NASDAQ shows the difference between Enron's price shares in 2000 versus 2002. The reason 2002 does not show up is the stock was worth American pennies. Investments can be good, if the company invested in is successful. However, investments can be a gamble that bankrupts investors and businesses. Investments through stocks and retirement/pensions plans can also be short or long term. High risk stocks can be short term investments, low risk stocks can be long term investments. For example, .com companies were real popular stocks, but then the market fell out causing the .com long term investors to lose out. However, short term .com investors made good money. High risk companies like the .com, Enron, or newer companies not proven over time need to be short term investments. Normally a broker or bank can advise. Long term investments are in companies that have stood the test of time, like Coca Cola, Siemens AG, Sainsbury Ltd., and other companies that have survived more than a few years. Long term investments can also consist of mutual funds. Mutual funds are a group of stable stocks like the one mentioned above. For example a small percentage is invested in Coca Cola, and then another small percentage is invested in another, and so forth. This is a long term investment, because these stocks will grow over time, but do not have great fluctuations in their stocks day to day. Retirement/pensions plans are normally long term. Companies take a percentage, normally chosen by the employee, and invest along with company matching funds into mutual funds or other long term plans. If the company is on the stock market, the company will invest in itself. These plans grow gradually over the years. If retirement plans are cashed out early, normally penalties and fines are accrued. Investment Advantages Investment Disadvantages A good way to raise a massive amount of money. A business belongs to the shareholders. Companies can grow unrestrained with enough investment. The market can be fickle, gaining or losing money per share in one day. Personal Financier The personal financier usually invests in small businesses (Dreiser, 2005, 63). Personal financiers set strict guidelines for businesses to follow. The financiers tend to govern how a business is directed, making the owner's dream or plan fall by the wayside. If not setting a strict contract, then personal financiers become partners. This means that the profits are cut in half, even if the profits exceed the initial investment a thousand fold. Personal Financiers can be good or bad, depending on the situation. Personal Financier Advantages Personal Financier Disadvantages A benefactor for a business can get a business started The personal financier has too much power. Assets Assets can be a good way to arrange business financing. The first way assets can be used to finance a business is by being collateral. Good collateral can make banks or personal financiers loan large amounts of money. The drawback is if the principal of the loan does not get paid back, the asset or assets go to the loaner. Other way assets can help finance a business is liquidation. Assets can be sold to raise capital. This is a final solution, once sold an asset is gone, unless bought once again. However, assets give business money that does not need to be paid back. This type of asset use gives an owner or company money with no strings attached. Finally, assets can be used to make money. For example, a factory that makes X helps its company produce income by making X's to sell. A small business that cuts grass would make money with their asset of a lawnmowers. Assets can raise business financing in several ways. The following chart from EVCA (2007) shows the percentages of groups that own private equity or assets in the European Union: Assets are a great investment. They can also help raise the capital needed to start a business. Asset Advantages Asset Disadvantages Can garner financing for a business. If payments are not made, assets can be forfeited. Can help make money for a business, which does not have to be paid back. Taxes are assessed on assets. Customer Financing Customer financing can be accomplished in multiple ways. One way is selling a problem and then offering a solution. Flyers, magazines, books, or newspapers can be sold informing the public of a problem. For example, obesity or memory loss can be explained. After the customer buys the publication, the business can develop a weight pill or vitamin with the proceeds. The advantage of this method of financing a business is the customer is paying for the product before the product is even made. The drawback to this plan is consumers might not buy into the problem. If the consumers do not buy into the problem, then the solution is not paid for. This is a short term plan, depending on which way the consumer goes. Another source of customer financing is viral equity. A business would sell equity to customers. This makes each customer a shareholder. This is good in providing market research and capital. It also helps with advertising, since all of the shareholders will promote the product. This is a short term way to finance a business, because only so many shares of a company can be sold. If too many shares are sold, they become less in value. It is like a pie. A pie can be cut in ten pieces or one hundred, but the more pieces cut the littler each piece becomes. Customer Financing Advantages Customer Financing Disadvantages Customers pay for the product before the product is produced. Not all product ideas produce enough financing. Franchising Franchising has its advantages and disadvantages when financing a business. A franchise is a business sold outright or sold with percentages of profits being given back to the original company (Hoy, 2002, 116). For instance Coca Cola is a franchising business. Coca Cola sells the syrup, for a residual price, to franchises. These franchises make, bottle, and sell the Coca Cola, giving the corporation a percentage of the profits. Another type of franchise is the chain restaurants. A franchise restaurant is built, and then sold. The good thing about franchises is the original company does not do all the work. In the UK, another major franchise is Dominoes. Not only does Dominoes Pizza qualify as a franchise, but as an investment as well. Dominoes is: Domino’s Pizza Group (DPG) is what’s known as a ‘Master Franchisee’. This means that Domino’s Pizza Inc. (the brand owner, based in Ann Arbor, Michigan, USA) has granted DPG exclusive rights to own, operate and franchise Domino’s Pizza stores in the UK and Ireland. DPG is a wholly-owned subsidiary of Domino's Pizza UK & IRL plc, whose stock is traded on the Alternative Investment Market (AIM) of the London Stock Exchange. (Dominoes, 2007) The financing of Dominoes has grown very profitable. It also demonstrates that financing can come from more than one source. The bad thing about franchises is individuals going against the company's policies, making the company look bad. An example would be if drugs, rodents, or anything else was bottle in a Coca Cola, the corporation would look bad, not the franchise producing the bad product. This type of business financing is a long term solution. Franchising Advantages Franchising Disadvantages The original business does not do all the work, but receives profits. Bad franchises make the original business look bad. Vendor Financing Vendor financing is a form of deferred loans or shares subscribed by the vendor. A vendor takes shares along with the parent company in the new venture. The finance of this type of business venture is usually when the vendor expects their return to be the value of business that is higher than management or company financing them. An example of vendor financing can also use Coca Cola as an example. Vendors buy or rent Coca Cola machines, stocking the product and servicing the machine themselves. All of the money goes to the vendor, but the outright purchase or rental of the machine and purchase of the colas is the vendor's expense. This type of business financing is long term. Whether the rental of the machine, or outright buying of the machine, the colas must still be purchased for as long as the vendor owns or rents the machine. Vendor financing is like franchising financing on a different level. Vendor Franchising Advantages Vendor Franchising Disadvantages Original company does little or no work, allowing the vendors to complete the tasks. The vending business is only as good as the vendor makes it. Term Loans Term loans are types of bank loans for a specific amount that has a fixed repayment schedule, with a floating interest rate. Term loans mature between one and ten years (Wesson, 2006, 26). Banks can offer small businesses cash to purchase assets. These loans normally have a monthly or quarterly repayment schedules. The terms of the loans vary, depending on the loan agreement drawn up. The drawback to this financing is the scheduled payments must be paid, or the bank can sue the company for assets. The advantage to this type of business financing is this gives small business a chance to succeed without the initial investment. This type of financing can be short or long term financing, depending on the individual business' needs. Term Loan Advantages Term Loan Disadvantages Gives small businesses initial investment. Can lose collateral assets. Interest Only Loans Another way to finance a business is interest only loans. A company buys an asset, like a building or anything that is unlikely to depreciate with money borrowed from a bank. Then the company pays back the interest only, selling the property at the end of the loan repaying the capital. Properties in neighbourhoods where properties are increasing in value can make this method profitable. Another good interest only loan is when a company buys property to fix up and then sell above the worth of the property. Under these circumstances interest only loans can be extremely profitable to finance a business. This is a risky way to finance a business. The property can depreciate, leaving a considerable amount of debt for the company to repay. This could lead to bankruptcy for a business, or the loss of property and a large debt still to be paid back. This type of business financing is short term. It cannot be sustained for long. Interest Only Loans Advantages Interest Only Loans Disadvantages Gives businesses financing for a short period of time. Property depreciation can make a business go bankrupt. Friends and Family Friends and family can invest in business financing several ways. Many large corporation have friends and family invest in company plans or stocks. For example, Microsoft has family and friends invest in the company. The second way family and friends can invest is into a small business. Parents can give children retirement, on hopes of a return on their investment. Friends can invest for a partnership in a small business. The advantage to having friends and family invest in a business is the trust between the business owner or CEO and the investors. However, the disadvantage is if the business fails, families can be torn apart over money. Friends and Family Advantages Friends and Family Disadvantages Loans are easier to be forgiven by friends or family. Money can make irreparable rifts between friends and family. Parents can increase retirement if financing their children's businesses. Parents can lose their entire retirement when financing their children's businesses. Big Businesses' Financial Options Businesses that are large corporations like Microsoft, Tesco, Wilshire Farm Foods, and others have many business financing options. Big businesses have assets, cash flow, and other means of garnering cash flow. This makes financing more available. Below are some of the likely means of financing for big businesses. Big Businesses' Financial Options Small/Personal Businesses' Financial Options Small/Personal Businesses can only be approved for limited financing. The following options are the most likely for small businesses. Conclusion No matter what kind of financing a business chooses, the most important factor is the business itself. A small business will not have the same needs as a large corporation. These needs include what financing will be used for, the ability to live up to the conditions of the financing, and what is best for the company as a whole. Businesses need to do an inventory of their needs, before even trying to finance their business. Business financing should help businesses succeed, not fail. The key to financing a business, big or small, is risk management. Risk management is the process of accessing risks, then creating a counter plan. Financial risk management needs to be concentrated on risks that can be managed. A firm exposed to business risk can determine risks by the direct result of previous investment and financing decisions. This causes the business to create goals to raise their businesses value. Without risk management, business financing can fall through, or bankrupt a business. Business financing can be arranged in various manners. Due to the vast amount of ways to finance a business, only a few options were shown above. Banks, investments, assets, customer financing, franchising, term loans, vendor financing, friends, and family are all good means to finance businesses. One type of financing might be better than others depending on if the business is a large business, small businesses, or from small home based businesses. The businesses' needs are the most important factor when choosing financing. References Dominoes (2007) Accessed 12 December 2007 from http://www.dominos.uk.com/franchising/ Downes, J. and J.E. Goodman. (2006) Dictionary of Finance and Investment Terms. UK: Barron Dreiser, T. (2005) The Financier. UK: Kessinger. EVCA (2007) Investors. Accessed 8 December 2007 from http://www.evca.com/html/investors/inv_why_01.asp HSBC.com (2007) Accessed 12 December 2007 from http://www.hsbc.co.uk/1/2/business/home Hoy, F. (2002) Franchising: An International Perspective. UK: Routledge. Loeb, G.M. (2007) The Battle for Investment Survival. UK: Wiley. NASDAQ (nd) Accessed 20 November 2007 from http://finance.aol.com/quotes/microsoft-corporation/msft/nas Simple Pound (2007) Accessed 3 December 2007 from http://simplepound.meewella.com/interest-rates-and-inflation.php Smith, J.K. And R. Smith. (2000) Entrepreneurial Finance. New York: Wiley. Walayat, Nadeem. (2007) Northern Rock 30% Share Price Crash. Accessed 8 December 2007 from http:www.marketoracle.co.uk%2FArticle2127. html&moduleId=image_details.jsp.M&clickedItemDescription=Image Host URL Wesson, P.H. (2006) Secrets Lenders never told you: Get your Business Loan Approved. UK: BookSurge Publishing. Read More