Question

You are about to buy a business that is worth $200,000, but you do not have enough money to purchase the business entirely. You have a total of $90,000 in savings and you are looking at different financing options. Provide information for the following:  

• Explain the advantages of equity financing and debt financing
• Explain the disadvantages of equity financing and debt financing
• Provide an example of equity financing
• Provide an example of debt financing
• Explain which type of long-term liability financing you would choose to buy the business?

2. Provide a suggestion for future business owners on financing that you have learned from the Unit 7 Learning journal assignment.
3. What did you learn about yourself as a potential business owner while completing this assignment that you did not know about yourself prior?

Answer 1

Equity Financing

With equity money from investors, the owner is relieved of the pressure to meet the deadlines of fixed loan payments. However, he does have to give up some control of his business and often has to consult with the investors when making major decisions.

Advantages of Equity

• Less risk: You have less risk with equity financing because you don't have any fixed monthly loan payments to make. This can be particularly helpful with startup businesses that may not have positive cash flows during the early months.
• Credit problems: If you have credit problems, equity financing may be the only choice for funds to finance growth. Even if debt financing is offered, the interest rate may be too high and the payments too steep to be acceptable.
• Cash flow: Equity financing does not take funds out of the business. Debt loan repayments take funds out of the company's cash flow, reducing the money needed to finance growth.
• Long-term planning: Equity investors do not expect to receive an immediate return on their investment. They have a long-term view and also face the possibility of losing their money if the business fails.

Disadvantages of Equity

• Cost: Equity investors expect to receive a return on their money. The business owner must be willing to share some of the company's profit with his equity partners. The amount of money paid to the partners could be higher than the interest rates on debt financing.
• Loss of Control: The owner has to give up some control of his company when he takes on additional investors. Equity partners want to have a voice in making the decisions of the business, especially the big decisions.
• Potential for Conflict: All the partners will not always agree when making decisions. These conflicts can erupt from different visions for the company and disagreements on management styles. An owner must be willing to deal with these differences of opinions.

Debt Financing

Borrowing money to finance the operations and growth of a business can be the right decision under the proper circumstances. The owner doesn't have to give up control of his business, but too much debt can inhibit the growth of the company.

Advantages of Debt Financing

• Control: Taking out a loan is temporary. The relationship ends when the debt is repaid. The lender does not have any say in how the owner runs his business.
• Taxes: Loan interest is tax deductible, whereas dividends paid to shareholders are not.
• Predictability: Principal and interest payments are stated in advance, so it is easier to work these into the company's cash flow. Loans can be short, medium or long term.

Disadvantages of Debt Financing

• Qualification: The company and the owner must have acceptable credit ratings to qualify.
• Fixed payments: Principal and interest payments must be made on specified dates without fail. Businesses that have unpredictable cash flows might have difficulties making loan payments. Declines in sales can create serious problems in meeting loan payment dates.
• Cash flow: Taking on too much debt makes the business more likely to have problems meeting loan payments if cash flow declines. Investors will also see the company as a higher risk and be reluctant to make additional equity investments.
• Collateral: Lenders will typically demand that certain assets of the company be held as collateral, and the owner is often required to guarantee the loan personally.

When looking for funds to finance the business, an owner has to carefully consider the advantages and disadvantages of taking out loans or seeking additional investors. The decision involves weighing and prioritizing numerous factors to decide which method will be most beneficial in the long-term.

Example of Equity Financing

Shares (Common Stock)

When a company sells shares to other investors, it gives up a piece of itself as a way to raise money to finance growth. Small, privately held companies sell shares to private investors, who then hold equity in the company. Companies that are more ambitious open their shares up to the public. When a company goes public and sells shares , it's selling many pieces of itself to whoever wants to buy. In most cases this is the quickest way to amass large amounts of cash to finance growth.

Venture Capital

Young companies often need money for growth or for research and development, but they're not far enough along to sell stock. In such situations, they often look for help from venture capitalists, or VCs. These are professional investors who identify promising companies and sink money into them in exchange for a share of ownership and, often, a voice in the direction of the business. Venture capitalists are in it for profit. They expect to cash in their ownership stake when the company either goes public by selling stock or gets acquired by another company.

Examples of Debt Financing

• Bank loans
• Debentures
• Personal loans
• Government-backed loans, such as SBA loans
• Lines of credit
• Credit cards
• Equipment loans

Explain which type of long-term liability financing you would choose to buy the business?

Ans : If it is a lump sum Purchase :

Bank Loans (Use the seller's assets) As soon as you buy the business, you'll own the assets--so why not use them to get financing now? Make a list of all the assets you're buying (along with any attached liabilities), and use it to approach banks, finance companies and factors (companies that buy accounts receivable).

If the Seller agrees for an Installment Purchase

The more common form of structuring payments in a business purchase is for you to make a down payment of perhaps 20% or 25% and then sign a promissory note agreeing to pay the balance to the seller over a number of years, in regular installments.

Although down payments are usually made in cash, some buyers have been known to substitute an asset or services for all or part of the down payment

2. Unit 7 data not available in the question

3.A person can either be classified as a risk averse person or a risk bearing one in case of Business.

Risk averse investor is an investor who prefers lower returns with known risks rather than higher returns with unknown risks.

Risk Bearer is a person who is willing to take more risks while investing in order to earn higher returns

I being a potential business owner can be concluded as a risk bearer person because i am trying to take on other business and grow by investing all my savings for it.