Financing a business and capital structure decisions - YouTube

Financing a business and capital structure  decisions. Estimating how much funding we need  

to start and if these funds can become from the  government or where to get funding for a business.  

These decisions could be more complicated than  expected. Moreover, we will analyze what sources  

of finance are available to an entrepreneur and  what are the main sources of finance, with pros  

and cons. Finally, we'll find how to deal with  bad credit history and the optimum debt equity mix  

for business expansion. How is it going everyone?  

it's Matteo and today I want to talk about funding  a business. But before we get into things guys,  

make sure to like my video, subscribe to  my channel and tap the notification bell. 

Looking for the optimal financial structure is a  timeless journey, its arrangement is affected by  

endogenous and exogenous factors that change over  time. Basically, we have to hook the structure to  

the company life cycle and then we have to ask  ourselves whether there are any more convenient  

combination in terms of value creation. In other  words, is this financial structure the best option  

in order to generate a sustainable growth in  this specific stage? If other combinations  

compromise any other agent or any other asset,  then that one is the optimal financial structure,  

achievable in that context. But how to fund a company according to its  

life cycle stage? Obviously there are different  financial solutions for different stages. Stage 1:  

seed or start up. Finance usually comes from  the founders assets, for example taking a 401(k)  

loan along with the government support or  equity crowdfunding. In the launch and growth  

stage (2), bank debt is the main source. In the  maturity phase (3), cash flows should be stable  

so the financial source is mostly internal,  through the retention of profits. Increasing  

the company market share (4), needs massive  investments and an external boost in terms  

of attracting new capital. In the exit stage  (5), harvesting or death, financing results in  

several options, from the sale of existing  assets or provisioning. So much depends on  

whether there is a capital gain or capital loss. If considering only one financial structure  

the best option regardless the context is  a clear error, judging equity as the right  

source and debt ae the ultimate evil is even  worse. Accounting and fiscal consequences can  

be put temporarily aside and concentrate  on the funding as a mere business goal.  

In order to achieve this objective, the  market provides a number of tools to  

the management. A tool is not good or bad in  itself, while its use that makes difference.  

Funding a business is basically a matter of  moving money over time. The tool that moves  

this money is irrelevant, what really counts is  generating value or not. Not today, not tomorrow,  

rather in a going concern perspective or in  general in a sustainable way for stakeholders. 

In this sense, the choice of debt or equity  can be seen in a whole new light. If there  

is a credit opportunity that allows the company  a solid growth, refusing debt would be totally  

ineffective. Similarly, if opening the capital  doors to a new investor can improve the long-term  

performance, why missing that train? In light of this, we can manipulate the  

debt-equity mix assessing the value generated:  the management should prefer that source that  

results in better cash flow, bearing in mind the  investment feasibility and the master roadmap. 

Debt usually come from bank loans. They can  be divided into: asset-baked loans (mortgages,  

equipment loans, inventory loans and  any other loan that is secured by real  

assets) and unsecured business loans (mostly  term loans, where there is no collateral). 

Nevertheless, many economies are incurring  in the so-called "credit crunch" spiral, that  

damages especially small businesses. Although,  there are several forms of government support  

(for example, the SBA loan programs),  entrepreneurs could take into consideration other  

forms of debt financing: Peer-to-Peer  lending (where it's possible to directly deal  

with investors, with reasonable rates and fees  and when a project is funded by the "crowd"  

and they don't desire to be shareholders P2P  can usually assume the form of crowdlending),  

then there is Direct Landing (where non-bank  institutions trade loans over the counter),  

Account Receivable Financing or Invoice  Financing (where the factoring can be  

non-recourse if the financing company became  responsible for the business customers payments  

and recourse if the financing company purchases  accounts receivable from the business, but in the  

case of customers insolvency the business has to  buyback this bad account receivable), then there  

is the Merchant Cash Advance (MCA, useful for  <24 months financing, the MCA consists of a loan  

in exchange for a % share of the business daily  credit card revenue, today it's quite expensive  

in terms of opportunity costs because it's  often adopted by low credit rated businesses),  

the Mezzanine Capital (technically it's an hybrid  solution since it's assimilated to equity in the  

balance sheet, however mezzanine capital includes  even an interest rate in addition to the to  

the equity-based success share percentage). Once an agent brings capital in exchange of  

a company equity's portion, we will move  to the sphere of equity financing. Common  

equity financing includes: Angel Investors (they  are qualified investors that buy stocks from a  

business under private placement exemption),  Venture Capital Firms (private equity firms  

that focus on early stage high potential growth  companies), Small Business Investment Companies  

(they provide funds to a small company as SBA  but buying stocks), Crowdfunding (when the crowd  

finances a project in exchange of a portion  of the company equity), Private Equity Markets  

(when the company is taken to public a massive  flow of equity financing will be obtained, today  

this process is more accessible than  past, thanks to digitalization and new  

markets expressly dedicated to private  equity financing, small caps and so on). 

Small and medium-sized enterprises are a major  concern for European policymakers, as the fixed  

costs required to access the financial market  may be too high for those companies. So their  

financing relies mainly on bank credit. However,  when bank credit impedes SMEs from accessing to  

bank credit, the entrepreneur - or simply the  sole trader - is forced to follow different paths. 

For instance e-platforms. E-platforms  represent quite new solution.  

Clearly if on one side, quicker procedures are  available, on the other we have to deal with  

new money systems. A few years ago we used to  talk about "shadow banking", where loan to values,  

fees, warranty and so on could be differ so much  than the traditional banking system. Moreover,  

it's not only a matter of disintermediation,  rather, today the decentralization paradigma  

is literally changing game rules. It's not  empirically (or better econometrically),  

proven that supply creates its own demand, but  Keynes would smile in the case of Initial Coin  

Offerings created a trend and hype in  2017 in Europe and ICOs can be seen  

as a crowdfunding endeavor. Regardless  of these innovations, if a company shows  

a bad credit history and if it's endemic, in  those cases solvency's concerns will be brought  

even to the different paths mentioned  above. There are no easy markets for loans  

(were easy means with reasonable interest rates).  Before talking about e-platforms or crowdfunding,  

it's fundamental to investigate why the company's  credit is still bad. Looking at my company from  

an external perspective, through a fundamental  analysis with a focus on performance and solvency  

analysis it's crucial. Obviously, the bank  performs advanced due diligence on the borrower,  

but a financial statements and  book analysis are the fundamentals. 

Debt is acceptable when its comprehensive cost  rate is less than the return of the investment(s)  

made with that loan. Once scores have been  fixed it's possible to negotiate better loans  

conditions, in terms of interest rates, credit  limits, repayments and so on. In order to be as  

fast as possible removed from the blacklist  a guarantor support could help. Moreover,  

there are a number of lenders specialized in  creditworthy borrower and businesses without an  

established credit history. In connection with these new businesses,  

it's important to remark that a strong business  model is essential to grow. Think about if  

a startup is living only thanks to government  grants, it's likely to go bankrupt. In other  

words: health. Once a business health is  restored (at least in a good part), it will be  

possible to explore new loan opportunities. Late 50s, Modigliani & Miller found out  

the irrelevance of the founding source choice  - through debt or equity - in terms of capital  

structure and investment theory. We can surely  affirm that there is not a one-way right source  

for every expansion path. The "right"  source depends on the specific moment  

related to the company lifecycle: are there any  government support available? Has that source  

some indirect or hidden benefits? Is the current  capital structure more suitable for new equity?  

Does the income statement need to use the tax  shield originated from the finance charges?  

Just some questions, some crucial questions  about the right funding source for a company  

expansion. Obtaining funds is usually a matter of  indicators: when your KPIs are good - or in a good  

range - financial institution is allowed to give  you money, because it's in their interest. Check  

my article about financial statements analysis and  interpretation, take a look of your balance sheet,  

of your dashboards and fix your scores about  debt solidity, equity, cash flow, .. A robust,  

a solid documentation provided to the bank, in  this way it's pretty sure that they give you  

the money you you are looking for (or a  good part of it). It's fundamental to shift  

focus on sustainability over time and opportunity  cost and reduce resources on the traditional debt  

or equity choice. Regardless of the source, if  one is supported by economic robustness and that  

support is clearly explained by management,  shareholders will certainly appreciate.