Lecture 9

Question 1

What are some longer term sources of finance and their uses?

Answer 1

• equity
• leasing
• medium to long term loans
• used to buy fixed or permanent assets such as land, building, plant, equipment, vehicles etc

Question 2

What are some short term sources of finance and their uses?

Answer 2

• factoring
• invoice discounting
• stock finance
• overdraft and short-term loans
• used to finance working capital, debtors, stocks

Question 3

What are 3 key differences between finance for large and small businesses?

Answer 3

1) personal characteristics of entrepreneur
2) downside risks associated with business
3) opaque market place (not transparent)

Question 4

What are information asymmetries within small businesses?

Answer 4

• small businesses have more information than the bank
• moral hazard occurs where there is imperfect information
• bank uses credit scoring and collects information about small businesses
• the riskier the business, the greater the cost of borrowing
• Evans and Jonanovic: access to finance is a function of wealth, not talent, so starting a business is largely a function of wealth.

Question 5

What is the pecking order? (small businesses do this)

Answer 5

Companies prioritize their sources of financing, first preferring internal financing, and then debt, lastly raising equity as a “last resort”.

Question 6

What is bootstrapping?

Answer 6

Bootstrapping is building a company from the ground up with nothing but personal savings and, with luck, the cash coming in from the first sales.

Question 7

What are the problems related to lending to a small business?

Answer 7

• High default rate (the percentage of all outstanding loans that a lender has written off after a prolonged period of missed payments)
• difficult to distinguish good borrowers from bad borrowers
• expensive to realise collateral
• high interest rates will encourage high risk businesses

Question 8

How can lenders reduce the risk of lending to small businesses?

Answer 8

• collect information about business and similar businesses
• charge higher interest rates
• provide a ‘bonus’ to good borrowers
• collateral

Question 9

What is venture capital?

Answer 9

a type of financing that is provided by firms to fund small, early stage emerging gaits that are deemed to have high growth potential

Question 10

What are business angels?

Answer 10

an individual who provides capital for a business start-up, usually in exchange for convertible debt or ownership equity.

Question 11

Reasons for the demand for equity?

Answer 11

• no interest payments
• difficulty getting other methods of funds
• VC provides support
• money is patient (unless VC then within 3 years)

Question 12

What are the disadvantages of equity in general?

Answer 12

• dilutes ownership
• dividends may be expected
• outsiders may want to interfere
• requires growth (particularly with VC’s)

Question 13

What are the differences between business angels and venture capitalists?

Answer 13

Venture capital:
- from corporations
- generally more mature projects
- 3-6 years (closer to 3)
- months to make decision
- appoint key people
- invest several million
Business angels:
- (rich) individuals 
- start-ups/ early stage
- 4-6 years
- weeks to decide
- personal involvement in project
- commercial but also interesting projects
- $0.02-$0.3 million invested