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									Start Your Own Business

           Session 7
           Financing the Business

   Campari Revisited
   Requirement for Finance
   Working Capital
   Long Term Finance
   Government Grants
   Venture Capital
   Medium Term Finance – HP & Leasing
   Bank Loans & Overdrafts
   Debtor Financing
   Supplier Credit
   Franchising
More Campari

   Character
   Ability
   Management
   Purpose
   Amount
   Repayment
   Insurance

   Personal track record in business
   personal credit history with the bank.
   Personal impression: physical and mental.
   History of business transactions
   Any county court judgments against you.
   Level of commitment as shown by
     –   your own personal financial investment in the business
     –   what you personally stand to lose.
   Your understanding of your own business proposal,
   Business Proposal - level of sophistication
   Your ability to present a convincing case for your business

   Management ability your capacity to manage the
    resources of the business.
   Financial and business acumen
   Your ability to keep records
   Ability to present and provide information.
   Understanding and ownership of information in the
    Business Plan

   Quality of key personnel.
   Relevant experience of those who will be in a decision-
    making role within the business.
   The level of education and training displayed by key
   Are key positions filled
    –   Sales & Marketing
    –   Production, Research & Development
    –   Finance
    –   Legal

   Why is the banking facility needed?
   Is the purpose to which the facility is to be put against
    any bank policies or government policy?
   Is the requested facility actually in the customer's own
    best interest?
   Will all the facility be used for trading purposes, or will
    some of it be used for other purposes?
   Will the facility be used to purchase fixed assets?
   What will be the customer's stake
   How much money will the customer invest directly in
    the business?

   Is the amount requested correct?
   Have all associated costs been included?
   Is the owners stake too low?
   Ensure that the customer's money is injected before
    the bank lends
   Assumptions in Business Plans
   Justification for Sales Income
   Too Much / Too Little

   Will the business generate enough cash to service the
   Will there be sufficient reserves for contingencies?
   Remember profit may not equal cash!
   What will be the source from which repayment interest
    will be paid?
    –   Will it come from sale of assets, or from profits?
   Are the business proposals realistic?
    –   Question the customer's claims, and test assumptions.
   What is the period of repayment requested?
   Is this realistic?

   Is security necessary?
   Are security values correct in the present climate?
   Is the business adequately insured against all the
    usual risks?
   Are the key personnel adequately insured against
    –   Accidents
    –   sickness
    –   death
Requirement for Finance

   Long Term Finance
          To buy a whole business
          To finance purchase of a long term asset
             –   Land Buildings Machinery
          To finance core working capital
             –   Inventories,
   Medium Term Finance
          To finance medium term assets
             – Computers, cars etc
             – Core working capital which will eventually be financed from retained
   Short Term Finance
          To finance seasonal variations in working capital
          Special arrangements for types of working capital
             – Financing debtors
             – Supplier credit arrangements
Working Capital - The Operating Cycle

   Raw material stocks are obtained from suppliers
    –   Cash with order
    –   COD
    –   Credit
   Raw materials are held in inventories
   Raw materials are issued to production and additional
    costs are added as they are converted (Labour etc,)
   Finished goods are held in stock
   Finished goods are sold on credit / For cash
   Creditors for purchases are paid
   Cash is received from customers (Debtors)
Working Capital Requirement Calculation

   Turnover                       £1,500,000
   Costs as % of sales
           Materials              30%
           Labour                 25%
           Other Variable costs   10%
           Fixed costs (Rent)     15%
           Distribution            5%
   Operating Cycle
           Customers take 2.5 months to pay
           Materials are in stock for 3 months
           Finished goods are 1 months production
           Credit is as follows
              – Materials          2 Months          Variable costs 1 month
              – Fixed Costs        1 month           Distribution   2 weeks
 Working Capital Requirement Calculation
Financing Requirement Example
                    %         £
Turnover          100%    1,500,000
Materials          30%      450,000
Labour             25%      375,000
Variable Cost      10%      150,000
Fixed Cost         15%      225,000
Distribution       5%        75,000

Average Value of Assets         £        Average Value of Liabilities     £
Raw Materials     3 months    112,500    Raw Materials     2 Months      75,000
Finished Goods                           Variable Cost     1 Month       12,500
  Materials        1 Month     37,500    Fixed Costs       1 Month       18,750
  Labour           1 Month     31,250    Distribution      2 Weeks        3,125
  Variable Cost    1 Month     12,500    Total Liabilities              109,375
Customer Debtors 2.5 Months   312,500
Total of Assets               506,250

                 Financing Requirement       £396,875
 Is it too early to do some individual work?
Financing Requirement Example
                    %         £
Turnover          100%    2,400,000
Materials          15%
Labour             45%
Variable Cost      9%
Fixed Cost         5%
Distribution       5%

Average Value of Assets       £          Average Value of Liabilities   £
Raw Materials     2 months               Raw Materials     3 Months
Finished Goods                           Variable Cost      1 Month
  Materials       2 Months               Fixed Costs        1 Month
  Labour           2 Month               Distribution      2 months
  Variable Cost    2 Month               Total Liabilities

Customer Debtors 0.5 Months
Total of Assets

                 Financing Requirement
 Is it too early to do some individual work
Financing Requirement Example
                    %         £
Turnover          100%    2,400,000
Materials          15%      360,000
Labour             45%    1,080,000
Variable Cost      9%       216,000
Fixed Cost         5%       120,000
Distribution       5%       120,000

Average Value of Assets         £        Average Value of Liabilities     £
Raw Materials     2 months     60,000    Raw Materials     3 Months      90,000
Finished Goods                           Variable Cost      1 Month      18,000
  Materials       2 Months     60,000    Fixed Costs        1 Month      10,000
  Labour           2 Month    180,000    Distribution      2 months       5,000
  Variable Cost    2 Month     18,000    Total Liabilities              123,000
Customer Debtors 0.5 Months   500,000
Total of Assets               818,000

                 Financing Requirement       £695,000
Long Term Finance

   Business Owner‟s Equity
    –   The money you put into the business yourself
    –   The money you keep in the business from the profit you make
    –   Shares you sell to others
            Individuals   Venture Capital Companies
   Long Term Loans
    –   Mortgages          Long Term Bank Loans
   Government Grants
    –   Regional Enterprise Grants
    –   Smart Grants
Government Grants

   Regional Enterprise Grants
    –   Help SME‟s in Assisted Areas expand and diversify
    –   Up to 15% of cost of fixed assets up to £ 500,000
    –   Look At
            Innovation    Training          Environmental Impact
            Research & Development          Supply Chain
            Salary levels                   Regional Benefit
   SMART Innovation Grants
    –   To develop technologically innovative products
            Feasibility Study up to £ 45,000
            Development of Prototypes up to £150,000
            High development cost projects up to £450,000
Other Government Assistance

   Business Links
   Development Agencies
    –   Free factory accommodation
    –   Interest relief grants
    –   Direct Financing – Buy shares
   Small Firms Loan Guarantee Scheme
    –   Will enable up to £ 250,000 to be obtained from bank without
        requiring security of owner‟s personal assets
    –   Must be trading for 2 years
    –   Not “Small Local Businesses” – Retailers etc
    –   85% of loan guaranteed
   New Deal Finance
    –   Salary & Training of Disabled and Long Term Unemployed
   Local Authorities
   DTI Early Growth Funding
    –   Up to £50,000      Innovation        Import Substitution
Other Assistance

   Local Assistance
    –   Chamber of Commerce
    –   Business Link
    –   Learning and Skills Council (LSC)
   Other National Agencies
    –   Department of Trade and Industry (DTI)
    –   The Countryside Agency
    –   Trade Partners UK
    –   Department for Environment, Food and Rural Affairs (DEFRA)
   Grants from organisations
    –   the Prince‟s Trust,
    –   the Crafts Council
    –   The Arts Council.
   EU Funding
    –   Administered Locally
            EU Social Fund   EU Regional Development Fund
Private Equity & Venture Capital

   Private equity provides long-term, committed share capital for
     –   Start up, Expansion, Buy out a business or division
   Differs from raising debt or a loan from a lender, such as a bank.
     –   Lenders have a legal right to interest on a loan and repayment of the
         capital, irrespective of success or failure.
     –   Private equity is invested in exchange for a stake in the company
     –   As shareholders, the investors‟ returns are dependent on the growth
         and profitability of the business.
   Private equity in the UK originated, when entrepreneurs found
    wealthy individuals to back their projects on an ad hoc basis.
   This informal method of financing became an industry in the late
    1970s and early 1980s when a number of private equity firms
    were founded.
   There are over 170 active UK private equity firms, which provide
    several billion pounds each year to unquoted companies, around
    80% of which are located in the UK.
Medium Term Finance - HP & Leasing

   Leasing and hire purchase are financial facilities that allow a
    business to use an asset over a fixed period, in return for regular
   Business chooses the equipment it requires and the finance
    company buys it on behalf of the business.
   Hire purchase and leasing agreements are legal commitments
    and so cannot be withdrawn providing the payments are made.
     –   may not be possible, or may be costly to terminate agreements early.
   Regular payments allow businesses
     –   To budget their expenditure
     –   To compare profit generated from an asset with its long-term cost.
   Agreements are at fixed rates of interest,
Hire Purchase & Leasing
   Hire Purchase
    –   After all the payments have been made, the business becomes the
        owner of the equipment
    –   For tax purposes the business customer is treated as the owner of the
        equipment from the start of the agreement and so can claim capital
    –   The business will normally be responsible for the maintenance of the
   Long Term or Finance Leases
    –   Ownership never passes to the business.
    –   Leasing company claims the capital allowances and passes the
        benefit on by way of reduced rental charges.
    –   Business can generally deduct the full cost of lease rentals from
        taxable income, as a trading expense.
    –   Business will normally be responsible for the maintenance and
        insurance of the equipment.
    –   Term of three years or more
    –   secondary lease period at a considerably reduced or nominal rent.
Hire Purchase & Leasing

   Short Term or Operating Leases
    –   Equipment can also be leased for shorter periods of time.
    –   Leasing company will expect to re-lease or sell the asset second
        hand at the end of the lease period
    –   No need to recover the full cost of the equipment through a single
        lease rentals.
    –   Common where there is an established second hand market, such as
        cars and small items of plant and equipment.
   Contract-Hire
    –   Contract-hire is a form of operating lease where the leasing contract
        also includes management and maintenance of the asset.
   Finding Lease/Hire Purchase Finance
    –   The Finance and Leasing Association provide a list of members, who
        operate to an agreed Code of Practice.
    –   A Guide to Hire Purchase and Leasing, a booklet providing
        information on leasing facilities as alternative sources of finance, can
        be downloaded from the DTI's website
Bank Loans

   A loan is for a fixed amount with a fixed repayment schedule.
   Will generally secure their loans
     –   Against the assets of the business
     –   Against personal assets of Owner
   The banks offer a number of ways to manage cash flow and the
    costs associated with loans
     –   fixed interest rates interest caps.
   Most suitable for funding fixed assets and core working capital
   Interest rate may be slightly less than on overdraft
   No opportunity to flex the amount of financing.
   Term of the loan should not exceed the expected life of the asset it
    is financing.
   Advantages of a term loan
     –   Repayments are and can budget accordingly
     –   APR may be lower.
   Banks generally attach various terms and conditions (covenants)

   Overdrafts are a flexible form of bank lending
   Used to finance the short-term working capital
    requirements of your business.
   Not appropriate as a source of long-term finance as
    they are repayable upon demand.
   The key advantage of an overdraft is that you only pay
    for the funds you use.
   Typically the rate of interest will be between 3% and
    7% over the bank‟s base rate, depending on the level
    of risk.
Factoring and Invoice Discounting

   Financial services companies that provide businesses with debtor
    finance, secured against unpaid invoices are known as Factors
    and Invoice Discounters.
   Factors buy trade debts
    –   Typically will pay 80% to 85% when they receive a valid copy invoice.
    –   The balance, less charges, is paid when the customer pays.
    –   The Factor collects the debt from your customer directly
    –   Some Factors provide bad debt insurance.
   Invoice discounting
    –   Responsibility for collection of debts remains with Business
    –   Service is normally undisclosed to customers.
    –   Payments received are paid into a bank account of the Invoice
    –   Business then credited with the balance less charges.
    –   Invoice discounting is only available if business can do credit control.
    –   Invoice Discounters will typically pay 80% to 85% against valid
Factoring and Invoice Discounting - Cost

   For both factoring and invoice discounting there is a service
   Normally a proportion of turnover, and a discount charge, based
    on the amount of finance provided.
   Charges are agreed in advance and form part of the factoring or
    invoice discounting agreement.
   For factoring the service charge is normally between 0.75% and
    2.5% of turnover, depending on the workload to be undertaken.
   The charge for invoice discounting will usually be less, as less
    work is required.
   The discount charge is calculated on day-to-day usage of funds.
   Likely to be comparable with normal secured bank overdraft rates.
Factoring and Invoice Discounting - Suitability

   Debtor finance is most suitable for growing businesses
   Finance will grow in line with the growth in turnover.
   Conversely, where turnover is falling the level of finance will fall.
    The cost of the service needs to be weighed against
     –   the costs of in-house debt collection
     –   having sufficient cash to benefit from early payment discounts from
   Debt finance providers are looking for „clean‟ invoices
     –   There is clear evidence of delivery of the goods or service
     –   Low level of disputes or credit notes.
   May not be available for some industries, for example contracting,
    where there is a high level of retentions and variation orders
   Providers of debt finance usually acquire debts with recourse if the
    debtor does not pay.
   Take out insurance against non-payment by your debtors.
   Many also provide bad debt insurance
Factoring and Invoice Discounting

   Finding a factor or invoice discounters
     –   Factors & Discounters Association
   Questions to ask when selecting a Factor
     –   What will the service cost?
     –   How long will the agreement take to set up?
     –   How quickly will money be available against invoices?
     –   How quickly will you collect from customers?
     –   Who will be my day-to-day contact?
     –   Who will speak to my customers?
     –   How much notice must I give to terminate the agreement?
     –   Can you give references with similar businesses to mine?
     –   Can I factor export invoices?
     –   Are debts bought with or without recourse to me?
     –   Do I have to take out insurance against bad debts and, if so, can I
         choose who to buy the insurance from?
Supplier Credit

   After initial relationship is set up suppliers may offer
    credit terms
   This can be cheapest form of finance, but prices may
    be adjusted to allow for credit
   Some specialist suppliers may offer extended credit
    –   Newly developed products
    –   New product introductions to market
    –   New Imports
Exercise Time

   What type or types of finance would you consider getting if you
            Acquiring a factory building
            Buying a machine tool to manufacture components
            Buying a car for use by a salesman
            Fitting out your new office or restaurant
            Buying a computer for use in your office
            Buying the initial stock of furniture for your furniture shop
            Buying the stock of Xmas Novelties for your retail shop
            Starting to Export your products to Europe
            Your business was growing rapidly and your customers were paying you
             after 3 months
            You were taking over the spare parts supply division of your current
            Introducing a new product line based on a new type of microchip.
            Opening a Pizza Hut

   Franchising is the means by which a large number of
    chains have grown very rapidly in the last decade.
   The franchisor has a successful business (selling
    hamburgers, pizzas or printing,)
   Instead of establishing branches under its own name it
    licenses franchisees to use its name, corporate identity
   It will often tie supplies
   The franchisees actually run the business, employing
    staff as necessary
Franchising – Benefits for Franchisee

   In return for what can be a substantial licence fee, the franchisees
     –   Training before starting.
     –   Premises are fitted out with the appropriate equipment and decor
             cost of doing this is likely to be loaned to the franchisee by the franchisor
     –   Must usually buy most or all of their trading stock and other supplies
         from the franchisor.
     –   Franchisee benefits considerably from the marketing and advertising
         of the franchisor.
   Franchisee does not have to make pricing or marketing decisions
   Franchisor is usually willing to put a lot of effort into helping the
    franchisees because the public perceives the chain as a chain and
    not as a collection of disparate outlets all using the same name.
   The franchisee will get the 'handholding' of the franchisor if
    franchisee has not been self-employed before.
   Frees franchisee to concentrate on the business without having to
    think about marketing, choosing suppliers, bookkeeping systems
Franchising – Benefits for Franchisor

   Franchisees are the legal owners of the outlets
   Franchisor is freed from
    –   Administrative burden of maintaining a branch network
    –   Employing large numbers of staff.
   Franchisors income comes from
    –   Licence fees
    –   Collecting an agreed percentage of profits made by the
    –   Profits on supplies
Find out about franchising

   Franchising is a relatively quick way to set up in business if you
     –   Are interested in selling a well-known brand or product
     –   Are prepared to work hard
     –   Have the right amount of money to invest (both for the initial cost and
         ongoing costs)
   Do your homework because you will be tying yourself into a
    partnership arrangement for a definite period of time.
   Test out the viability of the franchised product or service in the
    area you intend to work.
     –   In-depth research to ensure there is a market for the product or
     –   there is not too much local competition.
   You must be sure that you will be suited to this type of work.
   Talk to other franchisees
   Websites to visit
     –   The British Franchise Association

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