Deck 9: Small Business Finance

Question 1

When the Bank Cuts the Cord
Kevin Semcken was wandering the aisles and browsing the booths at a technology conference in Denver in 2004. At the time, he was the head of HealthTek Ventures, a venture capital firm in Evergreen, Colorado. Semcken came across a two-person start-up company named Able Planet with a promising idea-headphones embedded with a magnetic coil to enhance sound quality-but a lousy business. Since Semcken only has partial hearing in his left ear, he was intrigued. He was hardly ever able to hear high-frequency sounds like those produced by cymbals. The guys at the Able Planet booth gave him two headsets-one with the coil and one without-while he listened to Dean Martin's "You're Nobody 'Til Somebody Loves You." "When I switched to the Able Planet headphones, I could hear the cymbals," says Semcken. "I was instantly a fan."
Being a venture capitalist, Semcken believed in the product so much he not only invested in Able Planet but also he eventually took over as CEO and chairman. In 2006, Able Planet's LINX headphones won an award for innovation at the Consumer Electronics Show. Soon, the calls began pouring in. By 2008, revenue had jumped more than 1,000 percent, to $2 million.
In the first week of January 2009, Semcken got a call that every small business owner dreads. The loan officer for the bank Able Planet used was changing the terms of the $2.5 million line of credit it provided to Semcken's Wheat Ridge, Colorado-based audio-equipment business.
Under the new terms, the bank would no longer provide funding for the cost of raw materials and manufacturing. Able Planet had been a customer of that bank for almost three years and had never missed a payment. And though Able Planet was not yet generating a positive cash flow, Kevin was understandably stunned. Without those funds, he would have no way to pay for inventory demanded by retailers such as Walmart and Costco. "They waited until the last minute and dropped it on us," Semcken says.
Up until the moment of that phone call, Able Planet's business plan had been fairly simple. The company used the bank line of credit to fund the manufacturing of Linx Audio headphones with a price range of $24 to $299 a pair. For more than a year, Semcken had been using some of the funds generated by the headphones to produce more of them and some of it to develop a promising new technology.
The promising new technology was called Sound Fit, which would expand his product line beyond headphones- like hearing aids and Bluetooth devices. Sound Fit is a listening device designed to fit snugly in the opening of the ear canal, eliminating nearly all ambient noise. Semcken got the idea for Sound Fit from a previous investment in a company developing a balloon-like stent that expanded and contracted to prevent debris from blocking small arteries during heart surgery. Semcken thought something similar could work for the ear. He urged Able Planet's audiologists to create an inflatable disk that could conform to the size of an individual's ear canal. Such a device wouldn't fall out during jogging or other activities like earbuds. They wouldn't rest awkwardly against the ear like Bluetooth devices. And Sound Fit would not require a costly fitting procedure like hearing aids.
Semcken had secured nondisclosure agreements from 30 potential customers for Sound Fit who were interested in seeing more. But before Semcken could move forward with any of these negotiations, he needed funds to create production-quality prototypes, as well as operating cash for the headphone business.
After Semcken finished the phone conversation with his banker, he did what all good business owners facing a problem do: identify all his alternatives. A common funding source for manufacturers is known as a factor. A factor loans against or purchases accounts receivables, but they charge very high interest rates. He could shop for a less risk-averse bank. The company also had more than 20 angel investors who had recently kicked in $1.4 million. But that money was gone. What were the chances those investors would be willing to pitch in more so soon Previously, Sound Fit's potential customers might have been willing to fund the development of prototypes in exchange for a sweeter deal in the event that the technology panned out. Five companies seemed particularly hot on the product, but in a recession, none wanted any extra risk.
The timing of the bad bank news was especially unfortunate. High school and college graduation season was coming soon-one of the busiest times of the year. Following this, there would be back-to-school sales and then Christmas, which account for some 60 percent of annual sales. No money to fund production in January meant no significant revenue for almost the entire year.
Semcken sat down with two of Able Planet's board members, Rob Cascella and Steve Parker, both investors in the business. They advised Semcken to put Sound Fit on hold and redouble his efforts on Linx Audio. "When you're at the point where you're not generating operating cash flow," says Cascella, "you have to worry about today or you're not even going to be there in three years."
But Semcken wanted to continue negotiating with all 30 of Sound Fit's prospects. "The way you get a partner committed is out of fear they're going to lose it," he says. He was open to pushing Linx harder, but if he couldn't finance production of the headphones for existing customers, then expanding the line and finding new accounts would be out of the question. When he told Cascella and Parker that he wanted to ask Able Planet's other angel investors for a loan, they gave him the go-ahead. His offer: For every $100,000 loan they guaranteed, investors would get warrants for 30,000 shares at $3 apiece. Within three days, Semcken had a dozen takers. A representative at U. S. Bank, where Semcken kept his personal account, offered to make the loans, but only up to a certain amount. Semcken was hoping to raise some $1.5 million this way.
Trying to cover all his financial bases, Semcken had been scrambling to find a replacement for the company's $2.5 million line of credit. He traveled around the country to meet with 15 banks-but none were yet stepping up.
Kevin Semcken identified some possible alternative solutions to his financing problem. Did he come up with all possible alternatives, or can you think of more

Answer 1

Synopsis of the case study:
K found that two persons started a company called AB with a hopeful idea of 'headphones surrounded with magnetic coil' for enhancing the quality of sound. K became a fan of the product once he used it; later, he invested and eventually took over the company as a chief executive officer and chairman. The company became more reputed with good revenue; but it had to face an adverse effect when its bank terms of credit changed. The banks were no longer providing funds for cost of raw materials and manufacturing. This affected the business a lot. They were about to introduce a new technology with the 30 new customers called 'sound fit' but they refused to take risks as the company was in short of operating cash. Later, K identified alternatives to the problem. The partners of the business recommended generating the present cash flows. K covered the financial bases to scramble the replacement for the company but no bank supported him.
Common alternative solutions to recover the company:
• Plan to achieve the list of objectives
• Proper resource management techniques to be implemented
• Focus on cash management techniques and long term goals.
• Remove poor procedures to reduce wastage and manage time effectively.
• Appoint a mentor for assisting in planning and assigning of responsibility.
• Risk assessment of alternatives and opportunities
• Implement process of key performance indicators to enable the management to react on the challenging situations.

Question 2

According to Inc. magazine, of the approximately 600,000 companies that started in the year 2000, only about 5,000 received funding from venture capitalists. If just this small percentage actually received venture capital, why do small business magazines print such a disproportionately large number of articles about venture capital

Question 3

Define "initial capital requirements." How can you determine these

Answer 3

Initial capital:
The initial capital refers to the cash or investment used in establishing a new business.
The following are the ways in which investors can collect the initial capital:
• Personal savings of the proprietors
• Loan from bank
• Government grant
• Third parties' investment
Factors involved in determining the initial capital:
Nature of the business:
The nature of the business is the main factor to determine the initial capital. The businesses which are producing the basic goods or luxury goods are the main base of the initial capital requirement.
Place of the business:
Place of the business (rural or urban) will also determine the initial capital of the business.
• For the businesses which are started in rural areas, initial capital is more focused on road facility, power, and infrastructure facilities.
• For the businesses which are started in urban areas, the initial capital will be focused on the rent, pollution control certificate, and plant infrastructure.
Scale of the business
The scale of business is classified into three types:
• Small scale
• Medium scale
• Large scale
Small scale needs low initial capital, medium scale needs normal initial capital, and large scale needs maximum capital.
Expenses
The preliminary expenses such as certificate of incorporation, stamp duties, and expense of share issue are also the factors which increase the initial capital requirement.

Question 4

Finding money to finance your small business can be a real challenge. You might look to the traditional avenues such as using personal funds, tapping the resources of family and friends, or even relying on partners for financial backing. In the mid-1990s, however, a new approach to finding financing emerged- one that utilizes the networking capability of the Internet. That's what Pam Marrone of AgraQuest, Inc., tapped into when she needed additional financing.
Marrone's Davis, California, company develops and manufactures all-natural pesticides. She needed $2.5 million to pay the research, development, and production costs of two pest-control products. Marrone knew how to find money the old-fashioned way. After all, she had raised $300,000 in start-up financing to launch her company. But when she began looking to expand her business's product line, she decided to experiment with a more direct link to potential investors via the Internet.
Marrone chose to list her business idea (at a minimal charge) with Venture Connect, a Web site designed to match investors and entrepreneurs. She also developed her own company home page, which included an extensive business summary and job postings, and promoted it through Yahoo!'s business directory. "This is a potential way to get directly to investors," Marrone said. "The responses have been fast." Marrone was confident that her unique search for financing would pay off, yet she was being just as cautious in her search for financing in this high-tech approach as if she had taken a more traditional approach. After all, we're still talking about money.
What are the advantages and disadvantages of financing via the Internet, as Marrone did

Question 5

When the Bank Cuts the Cord
Kevin Semcken was wandering the aisles and browsing the booths at a technology conference in Denver in 2004. At the time, he was the head of HealthTek Ventures, a venture capital firm in Evergreen, Colorado. Semcken came across a two-person start-up company named Able Planet with a promising idea-headphones embedded with a magnetic coil to enhance sound quality-but a lousy business. Since Semcken only has partial hearing in his left ear, he was intrigued. He was hardly ever able to hear high-frequency sounds like those produced by cymbals. The guys at the Able Planet booth gave him two headsets-one with the coil and one without-while he listened to Dean Martin's "You're Nobody 'Til Somebody Loves You." "When I switched to the Able Planet headphones, I could hear the cymbals," says Semcken. "I was instantly a fan."
Being a venture capitalist, Semcken believed in the product so much he not only invested in Able Planet but also he eventually took over as CEO and chairman. In 2006, Able Planet's LINX headphones won an award for innovation at the Consumer Electronics Show. Soon, the calls began pouring in. By 2008, revenue had jumped more than 1,000 percent, to $2 million.
In the first week of January 2009, Semcken got a call that every small business owner dreads. The loan officer for the bank Able Planet used was changing the terms of the $2.5 million line of credit it provided to Semcken's Wheat Ridge, Colorado-based audio-equipment business.
Under the new terms, the bank would no longer provide funding for the cost of raw materials and manufacturing. Able Planet had been a customer of that bank for almost three years and had never missed a payment. And though Able Planet was not yet generating a positive cash flow, Kevin was understandably stunned. Without those funds, he would have no way to pay for inventory demanded by retailers such as Walmart and Costco. "They waited until the last minute and dropped it on us," Semcken says.
Up until the moment of that phone call, Able Planet's business plan had been fairly simple. The company used the bank line of credit to fund the manufacturing of Linx Audio headphones with a price range of $24 to $299 a pair. For more than a year, Semcken had been using some of the funds generated by the headphones to produce more of them and some of it to develop a promising new technology.
The promising new technology was called Sound Fit, which would expand his product line beyond headphones- like hearing aids and Bluetooth devices. Sound Fit is a listening device designed to fit snugly in the opening of the ear canal, eliminating nearly all ambient noise. Semcken got the idea for Sound Fit from a previous investment in a company developing a balloon-like stent that expanded and contracted to prevent debris from blocking small arteries during heart surgery. Semcken thought something similar could work for the ear. He urged Able Planet's audiologists to create an inflatable disk that could conform to the size of an individual's ear canal. Such a device wouldn't fall out during jogging or other activities like earbuds. They wouldn't rest awkwardly against the ear like Bluetooth devices. And Sound Fit would not require a costly fitting procedure like hearing aids.
Semcken had secured nondisclosure agreements from 30 potential customers for Sound Fit who were interested in seeing more. But before Semcken could move forward with any of these negotiations, he needed funds to create production-quality prototypes, as well as operating cash for the headphone business.
After Semcken finished the phone conversation with his banker, he did what all good business owners facing a problem do: identify all his alternatives. A common funding source for manufacturers is known as a factor. A factor loans against or purchases accounts receivables, but they charge very high interest rates. He could shop for a less risk-averse bank. The company also had more than 20 angel investors who had recently kicked in $1.4 million. But that money was gone. What were the chances those investors would be willing to pitch in more so soon Previously, Sound Fit's potential customers might have been willing to fund the development of prototypes in exchange for a sweeter deal in the event that the technology panned out. Five companies seemed particularly hot on the product, but in a recession, none wanted any extra risk.
The timing of the bad bank news was especially unfortunate. High school and college graduation season was coming soon-one of the busiest times of the year. Following this, there would be back-to-school sales and then Christmas, which account for some 60 percent of annual sales. No money to fund production in January meant no significant revenue for almost the entire year.
Semcken sat down with two of Able Planet's board members, Rob Cascella and Steve Parker, both investors in the business. They advised Semcken to put Sound Fit on hold and redouble his efforts on Linx Audio. "When you're at the point where you're not generating operating cash flow," says Cascella, "you have to worry about today or you're not even going to be there in three years."
But Semcken wanted to continue negotiating with all 30 of Sound Fit's prospects. "The way you get a partner committed is out of fear they're going to lose it," he says. He was open to pushing Linx harder, but if he couldn't finance production of the headphones for existing customers, then expanding the line and finding new accounts would be out of the question. When he told Cascella and Parker that he wanted to ask Able Planet's other angel investors for a loan, they gave him the go-ahead. His offer: For every $100,000 loan they guaranteed, investors would get warrants for 30,000 shares at $3 apiece. Within three days, Semcken had a dozen takers. A representative at U. S. Bank, where Semcken kept his personal account, offered to make the loans, but only up to a certain amount. Semcken was hoping to raise some $1.5 million this way.
Trying to cover all his financial bases, Semcken had been scrambling to find a replacement for the company's $2.5 million line of credit. He traveled around the country to meet with 15 banks-but none were yet stepping up.
Do you agree with board member Rob Cascella, who told Kevin to concentrate on producing headphones and put off the Sound Fit for later … or do you agree with Kevin, who sees Sound Fit as the future of Able Planet Defend your choice.

Question 6

How and why does a small business's capital structure change over time

Question 7

What are the five "Cs" of credit, and how do lenders use them

Question 8

Finding money to finance your small business can be a real challenge. You might look to the traditional avenues such as using personal funds, tapping the resources of family and friends, or even relying on partners for financial backing. In the mid-1990s, however, a new approach to finding financing emerged- one that utilizes the networking capability of the Internet. That's what Pam Marrone of AgraQuest, Inc., tapped into when she needed additional financing.
Marrone's Davis, California, company develops and manufactures all-natural pesticides. She needed $2.5 million to pay the research, development, and production costs of two pest-control products. Marrone knew how to find money the old-fashioned way. After all, she had raised $300,000 in start-up financing to launch her company. But when she began looking to expand her business's product line, she decided to experiment with a more direct link to potential investors via the Internet.
Marrone chose to list her business idea (at a minimal charge) with Venture Connect, a Web site designed to match investors and entrepreneurs. She also developed her own company home page, which included an extensive business summary and job postings, and promoted it through Yahoo!'s business directory. "This is a potential way to get directly to investors," Marrone said. "The responses have been fast." Marrone was confident that her unique search for financing would pay off, yet she was being just as cautious in her search for financing in this high-tech approach as if she had taken a more traditional approach. After all, we're still talking about money.
Should Marrone use her Internet financing source exclusively, or should she maintain a relationship with her local bank commercial loan officer Why or why not

Question 9

When the Bank Cuts the Cord
Kevin Semcken was wandering the aisles and browsing the booths at a technology conference in Denver in 2004. At the time, he was the head of HealthTek Ventures, a venture capital firm in Evergreen, Colorado. Semcken came across a two-person start-up company named Able Planet with a promising idea-headphones embedded with a magnetic coil to enhance sound quality-but a lousy business. Since Semcken only has partial hearing in his left ear, he was intrigued. He was hardly ever able to hear high-frequency sounds like those produced by cymbals. The guys at the Able Planet booth gave him two headsets-one with the coil and one without-while he listened to Dean Martin's "You're Nobody 'Til Somebody Loves You." "When I switched to the Able Planet headphones, I could hear the cymbals," says Semcken. "I was instantly a fan."
Being a venture capitalist, Semcken believed in the product so much he not only invested in Able Planet but also he eventually took over as CEO and chairman. In 2006, Able Planet's LINX headphones won an award for innovation at the Consumer Electronics Show. Soon, the calls began pouring in. By 2008, revenue had jumped more than 1,000 percent, to $2 million.
In the first week of January 2009, Semcken got a call that every small business owner dreads. The loan officer for the bank Able Planet used was changing the terms of the $2.5 million line of credit it provided to Semcken's Wheat Ridge, Colorado-based audio-equipment business.
Under the new terms, the bank would no longer provide funding for the cost of raw materials and manufacturing. Able Planet had been a customer of that bank for almost three years and had never missed a payment. And though Able Planet was not yet generating a positive cash flow, Kevin was understandably stunned. Without those funds, he would have no way to pay for inventory demanded by retailers such as Walmart and Costco. "They waited until the last minute and dropped it on us," Semcken says.
Up until the moment of that phone call, Able Planet's business plan had been fairly simple. The company used the bank line of credit to fund the manufacturing of Linx Audio headphones with a price range of $24 to $299 a pair. For more than a year, Semcken had been using some of the funds generated by the headphones to produce more of them and some of it to develop a promising new technology.
The promising new technology was called Sound Fit, which would expand his product line beyond headphones- like hearing aids and Bluetooth devices. Sound Fit is a listening device designed to fit snugly in the opening of the ear canal, eliminating nearly all ambient noise. Semcken got the idea for Sound Fit from a previous investment in a company developing a balloon-like stent that expanded and contracted to prevent debris from blocking small arteries during heart surgery. Semcken thought something similar could work for the ear. He urged Able Planet's audiologists to create an inflatable disk that could conform to the size of an individual's ear canal. Such a device wouldn't fall out during jogging or other activities like earbuds. They wouldn't rest awkwardly against the ear like Bluetooth devices. And Sound Fit would not require a costly fitting procedure like hearing aids.
Semcken had secured nondisclosure agreements from 30 potential customers for Sound Fit who were interested in seeing more. But before Semcken could move forward with any of these negotiations, he needed funds to create production-quality prototypes, as well as operating cash for the headphone business.
After Semcken finished the phone conversation with his banker, he did what all good business owners facing a problem do: identify all his alternatives. A common funding source for manufacturers is known as a factor. A factor loans against or purchases accounts receivables, but they charge very high interest rates. He could shop for a less risk-averse bank. The company also had more than 20 angel investors who had recently kicked in $1.4 million. But that money was gone. What were the chances those investors would be willing to pitch in more so soon Previously, Sound Fit's potential customers might have been willing to fund the development of prototypes in exchange for a sweeter deal in the event that the technology panned out. Five companies seemed particularly hot on the product, but in a recession, none wanted any extra risk.
The timing of the bad bank news was especially unfortunate. High school and college graduation season was coming soon-one of the busiest times of the year. Following this, there would be back-to-school sales and then Christmas, which account for some 60 percent of annual sales. No money to fund production in January meant no significant revenue for almost the entire year.
Semcken sat down with two of Able Planet's board members, Rob Cascella and Steve Parker, both investors in the business. They advised Semcken to put Sound Fit on hold and redouble his efforts on Linx Audio. "When you're at the point where you're not generating operating cash flow," says Cascella, "you have to worry about today or you're not even going to be there in three years."
But Semcken wanted to continue negotiating with all 30 of Sound Fit's prospects. "The way you get a partner committed is out of fear they're going to lose it," he says. He was open to pushing Linx harder, but if he couldn't finance production of the headphones for existing customers, then expanding the line and finding new accounts would be out of the question. When he told Cascella and Parker that he wanted to ask Able Planet's other angel investors for a loan, they gave him the go-ahead. His offer: For every $100,000 loan they guaranteed, investors would get warrants for 30,000 shares at $3 apiece. Within three days, Semcken had a dozen takers. A representative at U. S. Bank, where Semcken kept his personal account, offered to make the loans, but only up to a certain amount. Semcken was hoping to raise some $1.5 million this way.
Trying to cover all his financial bases, Semcken had been scrambling to find a replacement for the company's $2.5 million line of credit. He traveled around the country to meet with 15 banks-but none were yet stepping up.
As a small business consultant, what would you advise Kevin Semcken do to guide Able Planet through its financial storm

Question 10

What are the differences between debt funds and equity funds

Question 11

What kinds of businesses would depend on floor planning

Question 12

What does "pledging accounts receivable" mean

Question 13

What are the advantages of borrowing through the SBA

Question 14

Why do suppliers extend trade credit to other businesses What are the advantages and disadvantages of using trade credit

Question 15

How do private placements and public offerings differ

Question 16

Discuss the types of interest rates that may apply to a loan.

Question 17

What is the difference between a secured loan and an unsecured loan