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Producedby:Agricultureand
ConsumerProtection
Title:Basicfinanceformarketers....

Moredetails

Chapter7Sourcesoffinance
Chapterobjectives
Structureofthechapter
Sourcesoffunds
Ordinary(equity)shares
Loanstock
Retainedearnings
Banklending
Leasing
Hirepurchase
Governmentassistance
Venturecapital
Franchising
Keyterms
Sourcingmoneymaybedoneforavarietyofreasons.Traditionalareasofneedmaybe
forcapitalassetacquirementnewmachineryortheconstructionofanewbuildingor
depot.Thedevelopmentofnewproductscanbeenormouslycostlyandhereagaincapital
mayberequired.Normally,suchdevelopmentsarefinancedinternally,whereascapitalfor
theacquisitionofmachinerymaycomefromexternalsources.Inthisdayandageoftight
liquidity,manyorganisationshavetolookforshorttermcapitalinthewayofoverdraftor
loansinordertoprovideacashflowcushion.Interestratescanvaryfromorganisationto
organisationandalsoaccordingtopurpose.

Chapterobjectives
Thischapterisintendedtoprovide:
Anintroductiontothedifferentsourcesoffinanceavailabletomanagement,
bothinternalandexternal
Anoverviewoftheadvantagesanddisadvantagesofthedifferentsources
offunds
Anunderstandingofthefactorsgoverningthechoicebetweendifferent
sourcesoffunds.

Structureofthechapter
Thisfinalchapterstartsbylookingatthevariousformsof"shares"asameanstoraise
newcapitalandretainedearningsasanothersource.However,whilstthesemaybe
"traditional"waysofraisingfunds,theyarebynomeanstheonlyones.Therearemany
moresourcesavailabletocompanieswhodonotwishtobecome"public"bymeansof
shareissues.Thesealternativesincludebankborrowing,governmentassistance,venture
capitalandfranchising.Allhavetheirownadvantagesanddisadvantagesanddegreesof
riskattached.

Sourcesoffunds
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Acompanymightraisenewfundsfromthefollowingsources:
Thecapitalmarkets:
i)newshareissues,forexample,bycompaniesacquiringastock
marketlistingforthefirsttime
ii)rightsissues
Loanstock
Retainedearnings
Bankborrowing
Governmentsources
Businessexpansionschemefunds
Venturecapital
Franchising.

Ordinary(equity)shares
Ordinarysharesareissuedtotheownersofacompany.Theyhaveanominalor'face'
value,typicallyof$1or50cents.Themarketvalueofaquotedcompany'ssharesbears
norelationshiptotheirnominalvalue,exceptthatwhenordinarysharesareissuedfor
cash,theissuepricemustbeequaltoorbemorethanthenominalvalueoftheshares.
Deferredordinaryshares
areaformofordinaryshares,whichareentitledtoadividendonlyafteracertaindateorif
profitsriseaboveacertainamount.Votingrightsmightalsodifferfromthoseattachedto
otherordinaryshares.
Ordinaryshareholdersputfundsintotheircompany:
a)bypayingforanewissueofshares
b)throughretainedprofits.
Simplyretainingprofits,insteadofpayingthemoutintheformofdividends,offersan
important,simplelowcostsourceoffinance,althoughthismethodmaynotprovide
enoughfunds,forexample,ifthefirmisseekingtogrow.
Anewissueofsharesmightbemadeinavarietyofdifferentcircumstances:
a)Thecompanymightwanttoraisemorecash.Ifitissuesordinaryshares
forcash,shouldthesharesbeissuedproratatoexistingshareholders,so
thatcontrolorownershipofthecompanyisnotaffected?If,forexample,a
companywith200,000ordinarysharesinissuedecidestoissue50,000new
sharestoraisecash,shoulditofferthenewsharestoexistingshareholders,
orshoulditsellthemtonewshareholdersinstead?
i)Ifacompanysellsthenewsharestoexistingshareholdersin
proportiontotheirexistingshareholdinginthecompany,wehave
arightsissue.Intheexampleabove,the50,000shareswouldbe
issuedasaoneinfourrightsissue,byofferingshareholdersone
newshareforeveryfoursharestheycurrentlyhold.
ii)Ifthenumberofnewsharesbeingissuedissmallcomparedto
thenumberofsharesalreadyinissue,itmightbedecided
insteadtosellthemtonewshareholders,sinceownershipofthe
companywouldonlybeminimallyaffected.
b)Thecompanymightwanttoissuesharespartlytoraisecash,butmore
importantlytofloat'itssharesonastickexchange.
c)Thecompanymightissuenewsharestotheshareholdersofanother
company,inordertotakeitover.
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Newsharesissues
Acompanyseekingtoobtainadditionalequityfundsmaybe:
a)anunquotedcompanywishingtoobtainaStockExchangequotation
b)anunquotedcompanywishingtoissuenewshares,butwithoutobtaininga
StockExchangequotation
c)acompanywhichisalreadylistedontheStockExchangewishingtoissue
additionalnewshares.
Themethodsbywhichanunquotedcompanycanobtainaquotationonthestockmarket
are:
a)anofferforsale
b)aprospectusissue
c)aplacing
d)anintroduction.
Offersforsale:
Anofferforsaleisameansofsellingthesharesofacompanytothepublic.
a)Anunquotedcompanymayissueshares,andthensellthemontheStock
Exchange,toraisecashforthecompany.Allthesharesinthecompany,not
justthenewones,wouldthenbecomemarketable.
b)Shareholdersinanunquotedcompanymaysellsomeoftheirexisting
sharestothegeneralpublic.Whenthisoccurs,thecompanyisnotraising
anynewfunds,butjustprovidingawidermarketforitsexistingshares(allof
whichwouldbecomemarketable),andgivingexistingshareholdersthe
chancetocashinsomeoralloftheirinvestmentintheircompany.
Whencompanies'gopublic'forthefirsttime,a'large'issuewillprobablytaketheformof
anofferforsale.Asmallerissueismorelikelytobeaplacing,sincetheamounttobe
raisedcanbeobtainedmorecheaplyiftheissuinghouseorothersponsoringfirm
approachesselectedinstitutionalinvestorsprivately.
Rightsissues
Arightsissueprovidesawayofraisingnewsharecapitalbymeansofanoffertoexisting
shareholders,invitingthemtosubscribecashfornewsharesinproportiontotheirexisting
holdings.
Forexample,arightsissueonaoneforfourbasisat280cpersharewouldmeanthata
companyisinvitingitsexistingshareholderstosubscribeforonenewshareforeveryfour
sharestheyhold,atapriceof280cpernewshare.
Acompanymakingarightsissuemustsetapricewhichislowenoughtosecurethe
acceptanceofshareholders,whoarebeingaskedtoprovideextrafunds,butnottoolow,
soastoavoidexcessivedilutionoftheearningspershare.
Preferenceshares
Preferenceshareshaveafixedpercentagedividendbeforeanydividendispaidtothe
ordinaryshareholders.Aswithordinarysharesapreferencedividendcanonlybepaidif
sufficientdistributableprofitsareavailable,althoughwith'cumulative'preferenceshares
therighttoanunpaiddividendiscarriedforwardtolateryears.Thearrearsofdividendon
cumulativepreferencesharesmustbepaidbeforeanydividendispaidtotheordinary
shareholders.
Fromthecompany'spointofview,preferencesharesareadvantageousinthat:
Dividendsdonothavetobepaidinayearinwhichprofitsarepoor,while
thisisnotthecasewithinterestpaymentsonlongtermdebt(loansor
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debentures).
Sincetheydonotcarryvotingrights,preferencesharesavoiddilutingthe
controlofexistingshareholderswhileanissueofequityshareswouldnot.
Unlesstheyareredeemable,issuingpreferenceshareswilllowerthe
company'sgearing.Redeemablepreferencesharesarenormallytreatedas
debtwhengearingiscalculated.
Theissueofpreferencesharesdoesnotrestrictthecompany'sborrowing
power,atleastinthesensethatpreferencesharecapitalisnotsecured
againstassetsinthebusiness.
Thenonpaymentofdividenddoesnotgivethepreferenceshareholdersthe
righttoappointareceiver,arightwhichisnormallygiventodebenture
holders.
However,dividendpaymentsonpreferencesharesarenottaxdeductibleinthewaythat
interestpaymentsondebtare.Furthermore,forpreferencesharestobeattractiveto
investors,thelevelofpaymentneedstobehigherthanforinterestondebttocompensate
fortheadditionalrisks.
Fortheinvestor,preferencesharesarelessattractivethanloanstockbecause:
theycannotbesecuredonthecompany'sassets
thedividendyieldtraditionallyofferedonpreferencedividendshasbeen
muchtoolowtoprovideanattractiveinvestmentcomparedwiththeinterest
yieldsonloanstockinviewoftheadditionalriskinvolved.

Loanstock
Loanstockislongtermdebtcapitalraisedbyacompanyforwhichinterestispaid,usually
halfyearlyandatafixedrate.Holdersofloanstockarethereforelongtermcreditorsof
thecompany.
Loanstockhasanominalvalue,whichisthedebtowedbythecompany,andinterestis
paidatastated"couponyield"onthisamount.Forexample,ifacompanyissues10%
loanstockythecouponyieldwillbe10%ofthenominalvalueofthestock,sothat$100of
stockwillreceive$10interesteachyear.Theratequotedisthegrossrate,beforetax.
Debenturesareaformofloanstock,legallydefinedasthewrittenacknowledgementofa
debtincurredbyacompany,normallycontainingprovisionsaboutthepaymentofinterest
andtheeventualrepaymentofcapital.
Debentureswithafloatingrateofinterest
Thesearedebenturesforwhichthecouponrateofinterestcanbechangedbytheissuer,
inaccordancewithchangesinmarketratesofinterest.Theymaybeattractivetoboth
lendersandborrowerswheninterestratesarevolatile.
Security
Loanstockanddebentureswilloftenbesecured.Securitymaytaketheformofeithera
fixedchargeorafloatingcharge.
a)FixedchargeSecuritywouldberelatedtoaspecificassetorgroupof
assets,typicallylandandbuildings.Thecompanywouldbeunabletodispose
oftheassetwithoutprovidingasubstituteassetforsecurity,orwithoutthe
lender'sconsent.
b)FloatingchargeWithafloatingchargeoncertainassetsofthecompany
(forexample,stocksanddebtors),thelender'ssecurityintheeventofa
defaultpaymentiswhateverassetsoftheappropriateclassthecompany
thenowns(providedthatanotherlenderdoesnothaveapriorchargeonthe
assets).Thecompanywouldbeable,however,todisposeofitsassetsasit
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choseuntiladefaulttookplace.Intheeventofadefault,thelenderwould
probablyappointareceivertorunthecompanyratherthanlayclaimtoa
particularasset.
Theredemptionofloanstock
Loanstockanddebenturesareusuallyredeemable.Theyareissuedforatermoften
yearsormore,andperhaps25to30years.Attheendofthisperiod,theywill"mature"
andbecomeredeemable(atparorpossiblyatavalueabovepar).
Mostredeemablestockshaveanearliestandlatestredemptiondate.Forexample,18%
DebentureStock2007/09isredeemable,atanytimebetweentheearliestspecifieddate
(in2007)andthelatestdate(in2009).Theissuingcompanycanchoosethedate.The
decisionbyacompanywhentoredeemadebtwilldependon:
a)howmuchcashisavailabletothecompanytorepaythedebt
b)thenominalrateofinterestonthedebt.Ifthedebenturespay18%nominal
interestandthecurrentrateofinterestislower,say10%,thecompanymay
trytoraiseanewloanat10%toredeemthedebtwhichcosts18%.Onthe
otherhand,ifcurrentinterestratesare20%,thecompanyisunlikelyto
redeemthedebtuntilthelatestdatepossible,becausethedebentureswould
beacheapsourceoffunds.
Thereisnoguaranteethatacompanywillbeabletoraiseanewloantopayoffa
maturingdebt,andoneitemtolookforinacompany'sbalancesheetistheredemption
dateofcurrentloans,toestablishhowmuchnewfinanceislikelytobeneededbythe
company,andwhen.
Mortgagesareaspecifictypeofsecuredloan.Companiesplacethetitledeedsoffreehold
orlongleaseholdpropertyassecuritywithaninsurancecompanyormortgagebrokerand
receivecashonloan,usuallyrepayableoveraspecifiedperiod.Mostorganisations
owningpropertywhichisunencumberedbyanychargeshouldbeabletoobtaina
mortgageuptotwothirdsofthevalueoftheproperty.
Asfarascompaniesareconcerned,debtcapitalisapotentiallyattractivesourceof
financebecauseinterestchargesreducetheprofitschargeabletocorporationtax.

Retainedearnings
Foranycompany,theamountofearningsretainedwithinthebusinesshasadirectimpact
ontheamountofdividends.Profitreinvestedasretainedearningsisprofitthatcouldhave
beenpaidasadividend.Themajorreasonsforusingretainedearningstofinancenew
investments,ratherthantopayhigherdividendsandthenraisenewequityforthenew
investments,areasfollows:
a)Themanagementofmanycompaniesbelievesthatretainedearningsare
fundswhichdonotcostanything,althoughthisisnottrue.However,itistrue
thattheuseofretainedearningsasasourceoffundsdoesnotleadtoa
paymentofcash.
b)Thedividendpolicyofthecompanyisinpracticedeterminedbythe
directors.Fromtheirstandpoint,retainedearningsareanattractivesourceof
financebecauseinvestmentprojectscanbeundertakenwithoutinvolving
eithertheshareholdersoranyoutsiders.
c)Theuseofretainedearningsasopposedtonewsharesordebentures
avoidsissuecosts.
d)Theuseofretainedearningsavoidsthepossibilityofachangeincontrol
resultingfromanissueofnewshares.
Anotherfactorthatmaybeofimportanceisthefinancialandtaxationpositionofthe
company'sshareholders.If,forexample,becauseoftaxationconsiderations,theywould
rathermakeacapitalprofit(whichwillonlybetaxedwhensharesaresold)thanreceive
currentincome,thenfinancethroughretainedearningswouldbepreferredtoother
methods.
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Acompanymustrestrictitsselffinancingthroughretainedprofitsbecauseshareholders
shouldbepaidareasonabledividend,inlinewithrealisticexpectations,evenifthe
directorswouldratherkeepthefundsforreinvesting.Atthesametime,acompanythatis
lookingforextrafundswillnotbeexpectedbyinvestors(suchasbanks)topaygenerous
dividends,norovergeneroussalariestoownerdirectors.

Banklending
Borrowingsfrombanksareanimportantsourceoffinancetocompanies.Banklendingis
stillmainlyshortterm,althoughmediumtermlendingisquitecommonthesedays.
Shorttermlendingmaybeintheformof:
a)anoverdraft,whichacompanyshouldkeepwithinalimitsetbythebank.
Interestischarged(atavariablerate)ontheamountbywhichthecompany
isoverdrawnfromdaytoday
b)ashorttermloan,foruptothreeyears.
Mediumtermloansareloansforaperiodoffromthreetotenyears.Therateofinterest
chargedonmediumtermbanklendingtolargecompanieswillbeasetmargin,withthe
sizeofthemargindependingonthecreditstandingandriskinessoftheborrower.Aloan
mayhaveafixedrateofinterestoravariableinterestrate,sothattherateofinterest
chargedwillbeadjustedeverythree,six,nineortwelvemonthsinlinewithrecent
movementsintheBaseLendingRate.
Lendingtosmallercompanieswillbeatamarginabovethebank'sbaserateandateither
avariableorfixedrateofinterest.Lendingonoverdraftisalwaysatavariablerate.Aloan
atavariablerateofinterestissometimesreferredtoasafloatingrateloan.Longerterm
bankloanswillsometimesbeavailable,usuallyforthepurchaseofproperty,wherethe
loantakestheformofamortgage.Whenabankerisaskedbyabusinesscustomerfora
loanoroverdraftfacility,hewillconsiderseveralfactors,knowncommonlybythe
mnemonicPARTS.
Purpose
Amount
Repayment
Term
Security
P ThepurposeoftheloanAloanrequestwillberefusedifthepurposeoftheloanisnot
acceptabletothebank.
A Theamountoftheloan.Thecustomermuststateexactlyhowmuchhewantstoborrow.The
bankermustverify,asfarasheisabletodoso,thattheamountrequiredtomakethe
proposedinvestmenthasbeenestimatedcorrectly.
R Howwilltheloanberepaid?Willthecustomerbeabletoobtainsufficientincometomakethe
necessaryrepayments?
T Whatwouldbethedurationoftheloan?Traditionally,bankshaveofferedshorttermloansand
overdrafts,althoughmediumtermloansarenowquitecommon.
S Doestheloanrequiresecurity?Ifso,istheproposedsecurityadequate?

Leasing
Aleaseisanagreementbetweentwoparties,the"lessor"andthe"lessee".Thelessor
ownsacapitalasset,butallowsthelesseetouseit.Thelesseemakespaymentsunder
thetermsoftheleasetothelessor,foraspecifiedperiodoftime.
Leasingis,therefore,aformofrental.Leasedassetshaveusuallybeenplantand
machinery,carsandcommercialvehicles,butmightalsobecomputersandoffice
equipment.Therearetwobasicformsoflease:"operatingleases"and"financeleases".
Operatingleases
Operatingleasesarerentalagreementsbetweenthelessorandthelesseewhereby:
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a)thelessorsuppliestheequipmenttothelessee
b)thelessorisresponsibleforservicingandmaintainingtheleased
equipment
c)theperiodoftheleaseisfairlyshort,lessthantheeconomiclifeofthe
asset,sothatattheendoftheleaseagreement,thelessorcaneither
i)leasetheequipmenttosomeoneelse,andobtainagoodrent
forit,or
ii)selltheequipmentsecondhand.
Financeleases
Financeleasesareleaseagreementsbetweentheuseroftheleasedasset(thelessee)
andaprovideroffinance(thelessor)formost,orall,oftheasset'sexpectedusefullife.
Supposethatacompanydecidestoobtainacompanycarandfinancetheacquisitionby
meansofafinancelease.Acardealerwillsupplythecar.Afinancehousewillagreeto
actaslessorinafinanceleasingarrangement,andsowillpurchasethecarfromthe
dealerandleaseittothecompany.Thecompanywilltakepossessionofthecarfromthe
cardealer,andmakeregularpayments(monthly,quarterly,sixmonthlyorannually)tothe
financehouseunderthetermsofthelease.
Otherimportantcharacteristicsofafinancelease:
a)Thelesseeisresponsiblefortheupkeep,servicingandmaintenanceofthe
asset.Thelessorisnotinvolvedinthisatall.
b)Theleasehasaprimaryperiod,whichcoversallormostoftheeconomic
lifeoftheasset.Attheendofthelease,thelessorwouldnotbeabletolease
theassettosomeoneelse,astheassetwouldbewornout.Thelessormust,
therefore,ensurethattheleasepaymentsduringtheprimaryperiodpayfor
thefullcostoftheassetaswellasprovidingthelessorwithasuitablereturn
onhisinvestment.
c)Itisusualattheendoftheprimaryleaseperiodtoallowthelesseeto
continuetoleasetheassetforanindefinitesecondaryperiod,inreturnfora
verylownominalrent.Alternatively,thelesseemightbeallowedtosellthe
assetonthelessor'sbehalf(sincethelessoristheowner)andtokeepmost
ofthesaleproceeds,payingonlyasmallpercentage(perhaps10%)tothe
lessor.
Whymightleasingbepopular
Theattractionsofleasestothesupplieroftheequipment,thelesseeandthelessorareas
follows:
Thesupplieroftheequipmentispaidinfullatthebeginning.Theequipment
issoldtothelessor,andapartfromobligationsunderguaranteesor
warranties,thesupplierhasnofurtherfinancialconcernabouttheasset.
Thelessorinvestsfinancebypurchasingassetsfromsuppliersandmakesa
returnoutoftheleasepaymentsfromthelessee.Providedthatalessorcan
findlesseeswillingtopaytheamountshewantstomakehisreturn,the
lessorcanmakegoodprofits.Hewillalsogetcapitalallowancesonhis
purchaseoftheequipment.
Leasingmightbeattractivetothelessee:
i)ifthelesseedoesnothaveenoughcashtopayfortheasset,
andwouldhavedifficultyobtainingabankloantobuyit,andso
hastorentitinonewayoranotherifheistohavetheuseofitat
allor

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ii)iffinanceleasingischeaperthanabankloan.Thecostof
paymentsunderaloanmightexceedthecostofalease.
Operatingleaseshavefurtheradvantages:
Theleasedequipmentdoesnotneedtobeshowninthelessee'spublished
balancesheet,andsothelessee'sbalancesheetshowsnoincreaseinits
gearingratio.
Theequipmentisleasedforashorterperiodthanitsexpectedusefullife.In
thecaseofhightechnologyequipment,iftheequipmentbecomesoutofdate
beforetheendofitsexpectedlife,thelesseedoesnothavetokeeponusing
it,anditisthelessorwhomustbeartheriskofhavingtosellobsolete
equipmentsecondhand.
Thelesseewillbeabletodeducttheleasepaymentsincomputinghistaxableprofits.

Hirepurchase
Hirepurchaseisaformofinstalmentcredit.Hirepurchaseissimilartoleasing,withthe
exceptionthatownershipofthegoodspassestothehirepurchasecustomeronpayment
ofthefinalcreditinstalment,whereasalesseeneverbecomestheownerofthegoods.
Hirepurchaseagreementsusuallyinvolveafinancehouse.
i)Thesuppliersellsthegoodstothefinancehouse.
ii)Thesupplierdeliversthegoodstothecustomerwhowilleventually
purchasethem.
iii)Thehirepurchasearrangementexistsbetweenthefinancehouseandthe
customer.
Thefinancehousewillalwaysinsistthatthehirershouldpayadeposittowardsthe
purchaseprice.Thesizeofthedepositwilldependonthefinancecompany'spolicyandits
assessmentofthehirer.Thisisincontrasttoafinancelease,wherethelesseemightnot
berequiredtomakeanylargeinitialpayment.
Anindustrialorcommercialbusinesscanusehirepurchaseasasourceoffinance.With
industrialhirepurchase,abusinesscustomerobtainshirepurchasefinancefromafinance
houseinordertopurchasethefixedasset.Goodsboughtbybusinessesonhirepurchase
includecompanyvehicles,plantandmachinery,officeequipmentandfarmingmachinery.

Governmentassistance
Thegovernmentprovidesfinancetocompaniesincashgrantsandotherformsofdirect
assistance,aspartofitspolicyofhelpingtodevelopthenationaleconomy,especiallyin
hightechnologyindustriesandinareasofhighunemployment.Forexample,the
IndigenousBusinessDevelopmentCorporationofZimbabwe(IBDC)wassetupbythe
governmenttoassistsmallindigenousbusinessesinthatcountry.

Venturecapital
Venturecapitalismoneyputintoanenterprisewhichmayallbelostiftheenterprisefails.
Abusinessmanstartingupanewbusinesswillinvestventurecapitalofhisown,buthe
willprobablyneedextrafundingfromasourceotherthanhisownpocket.However,the
term'venturecapital'ismorespecificallyassociatedwithputtingmoney,usuallyinreturn
foranequitystake,intoanewbusiness,amanagementbuyoutoramajorexpansion
scheme.
Theinstitutionthatputsinthemoneyrecognisesthegambleinherentinthefunding.There
isaseriousriskoflosingtheentireinvestment,anditmighttakealongtimebeforeany
profitsandreturnsmaterialise.Butthereisalsotheprospectofveryhighprofitsanda
substantialreturnontheinvestment.Aventurecapitalistwillrequireahighexpectedrate
ofreturnoninvestments,tocompensateforthehighrisk.
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Aventurecapitalorganisationwillnotwanttoretainitsinvestmentinabusiness
indefinitely,andwhenitconsidersputtingmoneyintoabusinessventure,itwillalso
considerits"exit",thatis,howitwillbeabletopulloutofthebusinesseventually(afterfive
tosevenyears,say)andrealiseitsprofits.Examplesofventurecapitalorganisationsare:
MerchantBankofCentralAfricaLtdandAngloAmericanCorporationServicesLtd.
Whenacompany'sdirectorslookforhelpfromaventurecapitalinstitution,theymust
recognisethat:
theinstitutionwillwantanequitystakeinthecompany
itwillneedconvincingthatthecompanycanbesuccessful
itmaywanttohavearepresentativeappointedtothecompany'sboard,to
lookafteritsinterests.
Thedirectorsofthecompanymustthencontactventurecapitalorganisations,totryand
findoneormorewhichwouldbewillingtoofferfinance.Aventurecapitalorganisationwill
onlygivefundstoacompanythatitbelievescansucceed,andbeforeitwillmakeany
definiteoffer,itwillwantfromthecompanymanagement:
a)abusinessplan
b)detailsofhowmuchfinanceisneededandhowitwillbeused
c)themostrecenttradingfiguresofthecompany,abalancesheet,acash
flowforecastandaprofitforecast
d)detailsofthemanagementteam,withevidenceofawiderangeof
managementskills
e)detailsofmajorshareholders
f)detailsofthecompany'scurrentbankingarrangementsandanyother
sourcesoffinance
g)anysalesliteratureorpublicitymaterialthatthecompanyhasissued.
Ahighpercentageofrequestsforventurecapitalarerejectedonaninitialscreening,and
onlyasmallpercentageofallrequestssurviveboththisscreeningandfurtherinvestigation
andresultinactualinvestments.

Franchising
Franchisingisamethodofexpandingbusinessonlesscapitalthanwouldotherwisebe
needed.Forsuitablebusinesses,itisanalternativetoraisingextracapitalforgrowth.
FranchisorsincludeBudgetRentaCar,Wimpy,Nando'sChickenandChickenInn.
Underafranchisingarrangement,afranchiseepaysafranchisorfortherighttooperatea
localbusiness,underthefranchisor'stradename.Thefranchisormustbearcertaincosts
(possiblyforarchitect'swork,establishmentcosts,legalcosts,marketingcostsandthe
costofothersupportservices)andwillchargethefranchiseeaninitialfranchisefeeto
coversetupcosts,relyingonthesubsequentregularpaymentsbythefranchiseeforan
operatingprofit.Theseregularpaymentswillusuallybeapercentageofthefranchisee's
turnover.
Althoughthefranchisorwillprobablypayalargepartoftheinitialinvestmentcostofa
franchisee'soutlet,thefranchiseewillbeexpectedtocontributeashareoftheinvestment
himself.Thefranchisormaywellhelpthefranchiseetoobtainloancapitaltoprovidehis
shareoftheinvestmentcost.
Theadvantagesoffranchisestothefranchisorareasfollows:
Thecapitaloutlayneededtoexpandthebusinessisreducedsubstantially.
Theimageofthebusinessisimprovedbecausethefranchiseeswillbe
motivatedtoachievegoodresultsandwillhavetheauthoritytotakewhatever
actiontheythinkfittoimprovetheresults.
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Theadvantageofafranchisetoafranchiseeisthatheobtainsownershipofabusiness
foranagreednumberofyears(includingstockandpremises,althoughpremisesmightbe
leasedfromthefranchisor)togetherwiththebackingofalargeorganisation'smarketing
effortandexperience.Thefranchiseeisabletoavoidsomeofthemistakesofmanysmall
businesses,becausethefranchisorhasalreadylearnedfromitsownpastmistakesand
developedaschemethatworks.
Nowattemptexercise7.1.
Exercise7.1Sourcesoffinance
OutdoorLivingLtd.,anownermanagedcompany,hasdevelopedanewtypeofheating
usingsolarpower,andhasfinancedthedevelopmentstagesfromitsownresources.
Marketresearchindicatesthepossibilityofalargevolumeofdemandandasignificant
amountofadditionalcapitalwillbeneededtofinanceproduction.
AdviseOutdoorLivingLtd.on:
a)theadvantagesanddisadvantagesofloanorequitycapital
b)thevarioustypesofcapitallikelytobeavailableandthesourcesfrom
whichtheymightbeobtained
c)themethod(s)offinancelikelytobemostsatisfactorytobothOutdoor
LivingLtd.andtheprovideroffunds.

Keyterms
Banklending
Capitalmarkets
Debentures
Deferredordinaryshares
Franchising
Governmentassistance
Hirepurchase
Loanstocks
Newshareissue
Ordinaryshares
PARTS
Preferenceshares
Retainedearnings
Rightsissue
Sourcesoffunds
Venturecapital

http://www.fao.org/docrep/w4343e/w4343e08.htm

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