BUSINESS FINANCING

CHAPTER 8
LEARNING OBJECTIVES
 At the end of this chapter, students will be able to:
1. Understanding the importance of capital in the business.
2. Discuss the differences between the form of debt
financing    form of equity financing.
3. Identify types and sources of financing in the form of
loans provided to entrepreneurs.
4. Discusses the methods to be used to obtain bank loans.
5. Identify sources of financing in the form of equity and the
means to obtain it.
INTRODUCTION
 capital is an important element in biz, be it new or old
biz.
 studies: obtaining enough capital at the ‘start-up
phase’ or at the ‘growth phase’ is the most challenging
task for an entrepreneur.
CAPITAL?
 “CAPITAL is the net value of a company that
exists in the form of cash, inventories & facilities
(machines/equipments/vehicles) to be used to
further increase the value of the company”

 “CAPITAL is cash/facilities that are used to

generate income/profit of a biz by way of
investment”
3 TYPES OF CAPITAL
1) Fixed Capital – needed to purchase fixed-
asset(land,building,office, machineries &
equipments etc.)
This capital is stuck in the biz for a long period of
time but it is needed in order for the biz to run
efficiently (to create products or services) thus
generating cash flow & profit for the biz.
 3 TYPES OF CAPITAL
2) Working Capital – short term fund for
financing day-to-day operation of the biz.
Also known as operation capital. Used to
purchase raw materials, pay bills, salaries,
to make credit sales & to be used during
emergencies.
3) Growth Capital – capital needed to finance
the growth of biz (if there is an increase in
demand, the biz must increase its
production, increase the number of staff &
workforce, increase sales; purchase bigger
equipments;develop&design new products).
All these activities needed more fund in the
form of growth capital.
QUESTIONS ON CAPITAL.
Before an entrepreneur tries to raise the
capital for his biz he needs to answer
several important questions.
 How much capital is really needed?
 What form of financing is suitable for his biz? (loan or
equity?)
 How much ownership/control of his biz to be given
away or to let go of?
FORMS OF FINANCING
THERE ARE 2 FORMS OF
FINANCING;
1) DEBT/LOAN FINANCING
2) EQUITY FINANCING
1) DEBT FINANCING
Also known as loan financing, it
involves an instrument called
‘interest’.
The biz has to pay back the
‘principle’ together with the
‘interest’ (it does not matter
whether the biz is running at a loss
or making profit).
TYPES OF DEBT FINANCING
 There are 2 types of debt financing:
 Short Termed Loan – duration of payback
payment is 12 months or less. (Examples of
short term loan: overdrafts, revolving credits,
credit card purchase or cash advance.
 Short Termed Loan is used in daily operations to
pay for supplies, buy raw materials, pay bills,
salaries & allowances.
 Long Termed Loans - payback more than 12
months. Used to purchase fixed assets of which
can be used as collateral for the said loan.
 DEBT FINANCING
ADVANTAGES
 Retain ownership & control of the biz; Freedom
on financial decision; Creditors do not have any
claim on loans after full settlement
DISADVANTAGES
 Payment (payback) must be on-time,regardless
of company’s performance; Upon failure to pay:
entrepreneur can be penalized with higher
interest rate, lower credit rating, creditor might
claim payback payment in full;
 Creditor prefers to give loans to long existing biz
with good payback records rather than giving
loans to new biz with no track-record.
TYPES OF DEBT FINANCING
OVERDRAFT
 Short term facility by a bank to a “current account”
holder: allows of withdrawal more than amount
available in the account to a pre-agreed limit.
 Overdraft is usually used to fund working capital for
inventories, credit sales or operational expenditures.
OVERDRAFT
 Overdraft can be given by a bank either with
collateral or without collateral or with a
guarantee.
 COLLATERAL: in the form of easily
liquidated assets such as share certificates,
bonds etc.
 NO COLLATERAL: does not need any form
of asset if the client is of high integrity,
strong financial support & good biz record
 GUARANTEE: personal guarantor,
corporate guarantor, debentures or lien
(right to an asset until someone who take a
loan from you pays).
TYPES OF DEBT FINANCING
Revolving Credit
Short termed & used for rolling capital
 Does not need a “current account” with a
bank
 Suitable for a company with good financial
status (interest charged is usually lower
than other types of financing)
 Can be continuously used as it is a rolling
facility (once payback is completed
entrepreneurs can reapply revolving credit
again)
TYPES OF DEBT FINANCING
Termed Loan
 Also known as fixed loan – a form of long
termed loan on a fixed duration of which
the maturity is more than a year
 Finance fixed asset purchase or to finance
a project
 Can be dispensed off in full amount
 Also can be dispensed off progressively
(usually for construction projects by the
progress of its completion)
 TYPES OF DEBT FINANCING

Termed Loan
 Payback by installment – 3 or 6 months or
annually
 Termed Loan is given depending on reason
of loan, payback capability & duration of
payback
 Termed loan is normally given to clients that
will receive a sum of money in the future e.g.
after securing a government contract
 TYPES OF DEBT FINANCING
Hire Purchase
 Offered by financial institution to purchase
tools, facilities, machineries & vehicles via
installments payment
 Minimun 10% deposit on product cost,
remaining balance to be borne by the bank
 Installment to the bank till the end of
duration agreed
 Ownership is with the bank till full
settlement (then only title of ownership is
shifted to the clients)
FORM OF ISLAMIC SHARIAH BASED
FUNDING
 Al Mudharabah
 an agreement between a financier and entrepreneur
 Financier as investors agreed to fully fund the business, while the
entrepreneur as a businessman working on it.
 Distributed profits while losses borne by the financier

 Al Musyarakah
 partnership agreement in an arbitration of two or more parties to
undertake a business project.
 financiers with entrepreneurs to jointly contribute to capital funding.
 Gains and losses in accordance with the agreed ratio.
 Al Murabahah
 certain goods sale and purchase agreement between the owner of
goods to the buyer.
 entrepreneurs will first identify a product
 Financier will buy the goods and then sell it to entrepreneurs with a
higher price
 FORM OF ISLAMIC SHARIAH BASED
FUNDING
 Bai' Bithaman Ajil
 more or less the same concept mentioned but entrepreneurs as customers
 defer payments on purchases of goods from the financier.

 Bai' Al Dayn
 form of debt financing the provision of financial resources needed for production,
business and services through commercial paper and document
 short term to maturity not exceeding one year.

 AI Ijarah
 the concept of lease financing in accordance with sharia.
 financiers will purchase the first property required by the entrepreneur, and then
leased assets

 Al Wakalah
 Under the agreement, a person will appoint an institution or organization as its
agent, and is authorized to perform a task or job on his behalf.
FORM OF ISLAMIC SHARIAH BASED
FUNDING
 ArRahn
 agreement in which a property or valuable asset is placed in the
custody of a person or institution as security for a loan at au debt
 Al Kafalah
 the loan guarantee agreement or the performance of work
provided by a person to another.
 Parties will be responsible for providing security to a third party

 Al Qardhul Hasan
 credit welfare state that one party agrees to lend to a certain sum
for a specified period.
 The borrower is only required to repay only the amount borrowed
 TYPES OF DEBT FINANCING
Mortgage
 A contract of which the bank buy the fixed
asset & rent it to the client
 Client will pay the rent for a certain period of
time.
 Client has full right to use the asset during
the term (but ownership of the asset is of the
bank)
 Advantageous: 1)Usage of asset without
purchasing.
 2)Increased of cash flow without spending
money on asset.
 3)Tax deductible on rental of
equipment/asset.
 TYPES OF MORTGAGE
1) Operational Mortgage
 BANK will provide asset to the client &
maintenance of asset.
 CLIENT agrees on a rental rate & the
duration of the renting.
 Upon the duration of mortgage is
completed, asset will be returned to the
bank & mortgaged to another party, or to the
same client or sold of as a used asset.
 E.g: computers & photocopy machines
 TYPES OF MORTGAGE
2) Financial Mortgage
 Clients determine what is needed & apply to
bank to buy it. Maintenance & insurance of
asset to be borne by client.
 Mortgage contract is for the duration of
economic lifespan of asset & cannot be
ended before the term of mortgage expired.
 Upon mortgage completion, asset can be
returned to the bank, bought at market price
or sold off as a used asset to another party.
 TYPES OF DEBT FINANCING
Factoring
 A type of financing to a biz which offers 30 -
120 days credit sales to customers. Bank buys
over invoice/debts & manage the collection
(biz got cash through invoice sales to the
bank)
 Helps cash flow & reduce difficulties &
expenses in managing credit sales account.
 1) Recourse Factoring – client must also do
the collection.
 2) Non-Recourse Factoring – client sell off
rights to debt & uncollected accounts. Client
has no obligation to the bank should the
collection fail.
 APPLYING FOR A LOAN
Questions before applying for a loan.
 Is the capital really needed? Can the biz manage
the existing cash flow effectively? What is the
loan for? How soon is the loan needed?
 Does he has a good personal credit record? Is
the biz capable to pay back? Does the biz has a
positive net returns?
 Does the biz has any outstanding loans or debts?
Does the entrepreneur has enough personal
capital injection? Does the entrepreneur has any
collateral? Is the entrepreneur willing to give
personal guarantee to the loan?
 Does the biz has a good mgt team?
APPLYING FOR A LOAN
 Having answered those questions, (knowing what to do
with the needed money, how much is needed etc.),
entrepreneur is ready to apply his loan to any financial
institutions or banks.
 He has to prepare a written “ Loan Proposal” to be given
to bank officer for evaluation.
LOAN PROPOSAL MUST INCLUDE
THE FOLLOWING ELEMENTS:-

1) Summary
 It should be clear, compact & accurate.

 Explain briefly how loan will be utilized, how it will be

repaid & how the loan will benefit the company.
 Also includes the interesting & unique characteristics of
the products of the biz.
ELEMENTS IN LOAN PROPOSAL
2) Management Profile
 Who plays the vital role in the management?

 Should include background of the top management

team of the company (important to list down their
academic qualifications, special skills & experience)
ELEMENTS IN LOAN PROPOSAL
3) Business detail (Company)
 Explain line of business.

 Includes summary of history; past & current activities.

 Show clearly that the entrepreneur fully understand the

nature of biz, its market trend, risks & its environment.
 Explain briefly about the product offered.
ELEMENTS IN LOAN PROPOSAL
4) Forecast
 Show a 3-year revenue (sales) & cash flow forecast.

 The forecast has to be clear & realistic.

 Contingencies must be included IF the assumptions

made are not met.
ELEMENTS IN LOAN PROPOSAL
5) Financial Statement
 Includes biz & personal financial statement.(forecast
of P&L, Cash flow & Balance sheet.)
 Ensure that the entrepreneur fully understand the
implications of what was being presented in the
financial statement.
ELEMENTS IN LOAN PROPOSAL
6) Loan Motive/purpose
 Prepare a detail statement on how the loan will be used.

 Make sure the entrepreneur understand the type of loan

applied for.
 Include loan payback method (amount & time of
repayment including interest rates) in the forecasted
cash flow & income statement.
ELEMENTS IN LOAN PROPOSAL
7) Amount of Loan
 Explain how much loan is needed & how much is the
personal capital input.
 Amount needed is based on the usage of loan & the
entrepreneurs capacity to payback/repay.
ELEMENTS IN LOAN PROPOSAL
8) Payback Plan
 Should highlight entrepreneur’s capacity & capability to
payback.
 Explain how the payback will be made; installments by
monthly, quarterly, half yearly or annually.
WHAT BANKERS LOOK FOR IN AN
ENTREPRENEUR
When an entrepreneur presents his “Loan
Proposal” , bankers will use 5Cs to
evaluate the loan application:
 CHARACTER (PERSONALITY) is often
related to ethics such as honesty, integrity,
trustworthy & accepted morality in a society.
 CAPACITY (CAPABILITY) is the
entrepreneur’s & his business capacity or
ability to payback the loan given.
WHAT BANKERS LOOK FOR IN AN
ENTREPRENEUR
 CAPITAL is the financial strength of an entrepreneur.
Financial capacity is determined by the entrepreneur’s
equity share in the biz (how much he has injected
money into his biz)
 COLLATERAL is used as a security or insurance
should entrepreneur fails in loan repayment
(house,land,building etc.)
WHAT BANKERS LOOK FOR IN AN
ENTREPRENEUR
 CONDITION refers to the environment of the biz.
Environment includes all factors that affect capability of
entrepreneur to repay the loan which sometimes
cannot be controlled by both banker & entrepreneur.
(external & internal environments; eg. economic
conditions)
* EQUITY FINANCING
Apart from loan(debt) financing,
entrepreneurs can also raise
the capital needed through
Equity Financing.
 EQUITY FINANCING (EF)
Through EF, entrepreneur offers an investor
a form of ownership in his biz (Selling his
percentage of his stake, usually 20 to 40%
equity). In return equity financers get yearly
bonus & dividend.
Through EF, entrepreneur is not required to
payback any form of funds forwarded by the
equity investors.
To recover their money, Equity Investor will
leave/exit from entrepreneur’s biz through
selling off their shares in the future (usually
stay in entrepreneur’s co. for a period of 5-10
years)
EQUITY FINANCING
ADVANTAGES
 Entrepreneur does not have to repay the
money invested/injected into the co.
 Any biz capable of attracting outside
investors shows that the biz itself has a
good growth potential & profitable future
 Investors (equity financers) are more
dedicated to the success of the co.
They are a good source of consultation,
advisory & networking to the biz.
EQUITY FINANCING
DISADVANTAGES
 Entrepreneur does not have total control of
the co. It might be more difficult to manage
(decision-making: has to consult & discuss
with other shareholders/owners).
 Equity Investors do not always agree to the
plans of the biz. (sometimes their views
might be against the views of the owner-
entrepreneur/founder)
 Arranging equity financing is much more
complex & sometimes requires a third
party (that could include lawyers &
accountants).
SOURCES OF EQUITY
FINANCING
 1) Owner’s Capital:
 The most common source of fund for new
businesses. The fund could either be from a
personal saving or sale of personal asset.
SOURCES OF EQUITY
FINANCING
 2) Family & Friends are also considered an
important source of equity financing. Normally a
source for financing new biz & easily available for
small time entrepreneurs.
SOURCES OF EQUITY
FINANCING
 3) Informal Investor also known as “angels” -
financially strong individuals or rich individuals who
invest their money for newly start-up projects or new
biz ventures.
SOURCES OF EQUITY
FINANCING
 4) Venture Capital : Funds by companies or
professional bodies to invest with new growing
business.
 Example of Venture Capital Companies in
Malaysia (Malaysia Venture Capital
Management Bhd, PUNB Ventures Bhd, MSC
Venture Corporation Sdn Bhd, OSK Venture
International Bhd. (BNM – there are more
than 20 VC Companies in Malaysia)
WHAT KIND OF BUSINESS WILL
ATTRACT VENTURE CAPITALIST?

 High Returns: Venture capitalist takes high risk in

investing in a new biz, thus they require a high return
to compensate the risks involved; (usually 30%-40%
rate of return).
WHAT KIND OF BUSINESS WILL
ATTRACT VENTURE CAPITALIST?
 Ease of Exit: Venture Capitalist will only invest in
projects/businesses that enables them to leave easily
through profitable sale of their share or equity in the
future.
STAGES OF EQUITY
FINANCING
1) Seed financing
 Financing for a “biz concept” as well as for cost of R&D
of a product. Normally, a small fund is needed for
research to prove the viability of the concept/idea.
 Hard to get seed-financing as biz must prove that the
product has great market potential or a highly
demanded product.
STAGES OF EQUITY
FINANCING
2) Start-up financing
 Funds for companies to develop & market the product.

 Usually given to co. which is at the start-up phase in the

midst of organizing its opening, very new & did not
make any form of sales yet.
 Hard to obtain start-up funds.
STAGES OF EQUITY
FINANCING
3) Development/Growth Financing
Funds for development & growth of co. with previous
track records. Venture capitalist plays most important
role at this stage which can be divided into:
 First Stage: Funds needed to increase production
capacity
 Second Stage: Funds needed to increase marketing
capability (bigger promotion drives)
STAGES OF EQUITY
FINANCING
4) Mezzanine financing
Funds needed for public offering (IPO). The co. is
already making profits but needed extra money to
increase production capacity; size of factory. Fund is
also needed to help financing the cost to attract the
general public to invest in the company (from private
limited co. to public limited co.)
STAGES OF EQUITY
FINANCING
5) Management Buy Out
 Comes in forms of loan or equity investment that
enables an existing management to buy over an
existing business or part of it from an existing owner.
Majlis Amanah Rakyat (MARA) (www.mara.gov.my)
Tabung Ekonomi Usaha Niaga (TEKUN) (www.tekun.gov.my)
Bank Pembangunan Malaysia Berhad (BPMB) (www.bpmb.com.my)
SME Bank (www.smebank.eom.my)
Perbadanan Jaminan Kredit (CGC) (www.iguarantee.com.my)
Bank Pertanian Malaysia/Agrobank (www.agrobank.eom.my)
Kementerian Sains, Teknologi dan Inovasi (MOSTI) (www.mosti.gov.my)
Kementerian Belia dan Sukan (KBS) (www.kbs.gov.my)
Perbadanan Pembangunan Industri Kecil dan Sederhana (SMIDEC)
(www.smidec.gov.my)
Multimedia Development Corporation Sdn. Bhd. (MDeC) (
www.mdec.com.my)
MIMOS Bhd. (www.mimos.com.my)
Amanah Ikhtiar Malaysia (AIM) (www.aim.gov.my)
Perbadanan Usahawan Nasional Berhad (PUNB)
(www.punb.com.my)
Bank Negara Malaysia (BNM) (www.bnm.gov.my)
 CONCLUSION
An entrepreneur must understand the form, type
and sources for business financing. He/she
must understand the evaluation criteria to get a
fund.
 Loan Financing
 Equity Financing
 a seached for by a venture capitalist is a strong
management team, product uniqueness,
market opportunity and growth potential.
 Stages to Equity Financing starts with seed,
start-up, development, mezzanine and
management buy out.