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five…year bank loan to cover this； as within a year you will have cash in the
bank and a loan with an early redemption penalty！
However； if your bank account does not get out of the red at any stage
during the year； you will need to re…examine your financing。 All too o。。en
panies utilize an overdra。。 to acquire long…term assets； and that overdra
。。 never seems to disappear； eventually constraining the business。
The a。。raction of overdra。。s is that they are very easy to arrange and take
li。。le time to set up。 That is also their inherent weakness。 The key words in
the arrangement document are ‘repayable on demand’； which leaves the
bank free to make and change the rules as it sees fit。 （This term is under
Finance 57
constant review； and some banks may remove it from the arrangement。）
With other forms of borrowing； as long as you stick to the terms and conditions；
the loan is yours for the duration。 It is not so with overdra。。s。
Term loans
Term loans； as long…term bank borrowings are generally known； are funds
provided by a bank for a number of years。
The interest can either be variable； changing with general interest rates；
or fixed for a number of years ahead。 The proportion of fixed…rate loans
has increased from a third of all term loans to around one in two。 In some
cases it may be possible to move between having a fixed interest rate
and a variable one at certain intervals。 It may even be possible to have a
moratorium on interest payments for a short period； to give the business
some breathing space。 Provided the conditions of the loan are met in such
ma。。ers as repayment； interest and security cover； the money is available
for the period of the loan。 Unlike in the case of an overdra。。； the bank
cannot pull the rug from under you if circumstances （or the local manager）
change。
Just over a third of all term loans are for periods greater than 10 years；
and a quarter are for 3 years or less。
Government Small Firm Loan Guarantee Schemes
These are operated by banks at the instigation of governments in the UK；
and in Australia； the United States and elsewhere。 These schemes guarantee
loans from banks and other financial institutions for small businesses with
viable business proposals that have tried and failed to obtain a conventional
loan because of a lack of security。 Loans are available for periods between 2
and 10 years on sums from ￡5；000 to ￡2；500；000。
The government guarantees 70–90 per cent of the loan。 In return for the
guarantee； the borrower pays a premium of 1–2 per cent per year on the
outstanding amount of the loan。 The mercial aspects of the loan are
ma。。ers between the borrower and the lender。
BONDS； DEBENTURES AND MORTGAGES
Bonds； debentures and mortgages are all kinds of borrowing with different
rights and obligations for the parties concerned。 For a business a mortgage
is much the same as for an individual。 The loan is for a specific event； buying
a particular property asset such as a factory； office or warehouse。 Interest
is payable and the loan itself is secured against the property； so should the
business fail the mortgage can substantially be redeemed。
panies wanting to raise funds for general business purposes； rather
than as with a mortgage where a particular property is being bought； issue
58 The Thirty…Day MBA
debentures or bonds。 These run for a number of years； typically three years
and upwards； with the bond or debenture holder receiving interest over
the life of the loan with the capital returned at the end of the period。
The key difference between debentures and bonds lies in their security
and ranking。 Debentures are unsecured and so in the event of the pany
being unable to pay interest or repay loans they may well get li。。le or
nothing back。 Bonds are secured against specific assets and so rank ahead
of debentures for any payout。
Unlike bank loans； which are usually held by the issuing bank； though
even that assumption is being challenged by the escalation of securitization
of debt being packaged up and sold on； bonds and debentures are sold to
the public in much the same way as shares。 The interest demanded will be
a factor of the prevailing market conditions and the financial strength of the
borrower。
Categories of bond
There are several general categories of bond that panies can tap into：
。 Standard bonds pay interest； a coupon； half…yearly on the principal
amount； known as the face or par value。 At the maturity date the principal
is repaid。 The value of bonds fluctuates dependent on market
conditions； the length of time to maturity and the likelihood of the
borrower defaulting。 None of these ma。。ers are of immediate concern
to the recipient of the funds； as long as they can service the interest。 The
risk is for the bondholder who can see the value of their investment
alter over time。
。 Zero coupon bonds pay no interest over their life but pay a lump sum
at maturity equivalent to the value of the interest such an investment
would normally bear。 The buyer of the bond receives a return by the
gradual appreciation of the bond’s price in the marketplace。 This could
be an a。。ractive financing strategy for a business making an investment
which itself will not bear fruit for a number of years。
。 Junk bonds are bonds usually subordinated to； that is； put below others
in the pecking order of who gets paid in tough times； other regular
bonds。 Such bonds carry a higher interest burden。
。 Callable bonds are used when an issuer wants to retain the option
to buy back their bonds from the public if general interest rates fall
sharply a。。er the issue date。 The issuer notifies bondholders that a。。er
a certain date no further interest will be paid； leaving the holders with
no reason to keep the bond。 The pany issuing the bond can then go
out to the market and launch a new bond at a lower rate of interest and
so lower its cost of capital。 This process is also known as refinancing。
Finance 59
ASSET…BACKED FINANCIERS
The banks are more covert when it es to looking for security for money
lent。 Two other major sources of funds are less circumspect； indeed their
whole prospectus is predicated on a precise relationship between what
a business has or will shortly have by way of assets； and what they are
prepared to advance。 Both groups play an important role in financing
growing businesses。
Leasing panies
Physical assets such as cars； vans； puters； office equipment and the
like can usually be financed by leasing them； rather as a house or flat may
be rented。 Alternatively； they can be bought on hire purchase。 This leaves
other funds free to cover the less tangible elements in your cash flow。
Leasing is a way of ge。。ing the use of vehicles； plant and equipment
without paying the full cost all at once。 Operating leases are taken out
where you will use the equipment （for example a car； photocopier； vending
machine or kitchen equipment） for less than its full economic life。 The
lessor takes the risk of the equipment being obsolete； and assumes
responsibility for repairs； maintenance and insurance。 As you； the lessee；
are paying for this service； it is more expensive than a finance lease； where
you lease the equipment for most of its economic life and maintain and
insure it yourself。 Leases can normally be extended； o。。en for fairly nominal
sums； in the la。。er years。
Hire purchase differs from leasing in that you have the option to eventually
bee the owner of the asset； a。。er a series of payments。 You can find
a leasing pany via The Finance and Leasing Association （fla 》
For Businesses 》 Business Finance Directory）； which gives details of all UKbased
businesses offering this type of finance。 The website also has general
information on terms of trade and code of conduct。
Discounting and factoring
Customers o。。en take time to pay up。 In the meantime you have to pay those
who work for you and your less patient suppliers。 So； the more you grow；
the more funds you need。 It is o。。en possible to ‘factor’ your creditworthy
customers’ bills to a financial institution； receiving some of the funds as
your goods leave the door； hence speeding up cash flow。
Factoring is generally only available to a business that invoices other
business customers； either in its home market or internationally； for its
services。 Factoring can be made available to new businesses； although its
services are usually of most value during the early stages of growth。 It is
60 The Thirty…Day MBA
an arrangement that allows you to receive up to 80 per cent of the cash
due from your customers more quickly than they would normally pay。 The
factoring pany in effect buys your trade debts； and can also provide a
debtor accounting and administration service。 You will； of course； have to
pay for factoring services。 Having the cash before your customers pay will
cost you a li。。le more than normal overdra。。 rates。 The factoring service will
cost between 0。5 and 3。5 per cent of the turnover； depending on volume of
work； the number of debtors； average invoice amount and other related
factors。 You can get up to 80 per cent of the value of your invoice in advance；
with the remainder paid when your customer se。。les up； less the various
charges just mentioned。
If you sell direct to the public； sell plex and expensive capital equipment；
or expect progress payments on long…term projects； then factoring
is not for you。 If you are expanding more rapidly than other sources of
finance will allow； this may be a useful service that is worth exploring。
Invoice discounting is a variation on the same theme where you are
responsible for collecting the money from debtors； this is not a service
available to new or very small businesses。 You can find an invoice discounter
or factor through The Asset Based Finance Association （
thefda。uk/public/membersList。asp）； the association representing the
UK’s 41 factoring and invoice discounting businesses。
EQUITY
Businesses operating as a limited pany or limited partnership have a
potentially valuable opportunity to raise relatively risk…free money。 It is riskfree
to the business but risky； sometimes extremely so； to anyone investing。
Essentially this type of capital； known collectively as equity； consists of the
issued share capital and reserves of various kinds。 It represents the amount
of money that shareholders have invested directly into the pany by
buying shares； together with retained profits that belong to shareholders
but which the pany uses as additional capital。 As with debt； equity
es in a number of different forms with differing rights and privileges。
Ordinary shares form the bulk of the shares issued by most panies
and are the shares that carry the ordinary risks associated with being in
business。 All the profits of the business； including past retained profits；
belong to the ordinary shareholders once any preference share dividends
have been deducted。 Ordinary shares have no fixed rate of dividend； indeed
over half the panies listed on US stock markets pay no or virtually
no dividend。 These include high…growth panies such as Google and
Microso。。； which argue that by retaining and reinvesting all their profits
they can create be。。er value for shareholders than by distributing dividends。
A pany does not have to issue all its share capital at once。 The total
Finance 61
amount it is authorized to issue must be shown somewhere in the accounts；
but only the issued share capital is counted in the balance sheet。 Although
shares can be partly paid； this is a rare occurrence。
Preference shares get their name for two reasons。 First； they receive their
fixed rate of dividend before ordinary shareholders。 Second； in the event of
a winding up of the pany； any funds remaining go to repay preference
share capital before any ordinary share capital。 In a forced liquidation this
may be of li。。le fort； as shareholders of any type e last in the queue
a。。er all other claims from creditors have been met。
Class A and Class B shares are cases where categories of shareholder
are singled out for more or less favourable treatment。 For example； class
A shares are o。。en given up to five votes per share； while class B gets one。
In extreme cases class B shareholders can get no votes at all。 panies
will o。。en try to disguise the disadvantages associated with owning shares
with fewer voting rights by naming those shares。 One of the most famous
examples was their use by the Savoy Hotel Group to ward off an unwanted
takeover by Trusthouse Forte。 While Trusthouse was able to buy 70 per cent
of Savoy shares on the open market； they could secure only 42 per cent of
the voting rights as they were only able to buy class B shares； the A shares
being in the hands of the Savoy family and allies。
Reserves； a typically misleading term in all accounting； means profits
of various kinds that have been retained in the pany as extra capital。
Also important is what the term reserves does not mean。 It does not mean
actual money held back in reserve in bank accounts or elsewhere。 Reserves
e from retained profits over man