Running head: FUNDING PROPOSAL 1 Funding Proposal Desmond Fulton Rasmussen College Author Note This paper is being submitted on October 26, 2019 for Latricia Roundtree Principles of Finance FUNDING PROPOSAL 2 Funding Proposal The client, SmartClean Inc., provides cleaning services to industrial and office locations. During the five years that the company has been in business, it has attained stable revenue growth every year. The business was initially established using a loan. The remaining loan balance is $10,000 after making regular repayments; hence the owner has built an excellent personal and business credit history. The client, SmartClean Inc., has a couple of different options for raising the necessary capital to expand the business operations in the desired manner. The available choices of financing are either debt financing or equity financing. Debt Financing Debt financing is basically borrowing money to expand business or acquire an asset, hence increasing profit. Debt financing is a financial leveraging; the existing business owners retain their percentage of ownership because no new shares are issued. Money borrowed through debt financing is repaid with interest. Debt financing has both advantages and disadvantages (Scarborough and Cornwall, 2015). Advantages The main advantage of debt financing is the retention of full control over the business by the owner. The lender gains interest from amount loaned to the business, but the financier has no right to determine how it will conduct its operations. The business ownership remains utterly independent from the control of its shareholders and corporate directors. It implies that the lender lacks entitlement to profits made by the business using the borrowed money. The business FUNDING PROPOSAL 3 obligation is to repay the borrowed money plus accrued interest within the agreed fixed time period (Coyle, 2002). Debt financing is entirely appropriate for a business that is pursuing an aggressive growth strategy, mainly if the debt is accessible on a low-interest-rate basis. Even though the risk of losing assets used as security for the debt is real, in case a business fails to repay the borrowed money, at least the corporate control is not lost to outsiders. Company seeking debt financing should get professional advice from lawyers and accounts on the best way to protect from asset forfeiture in case of defaulted repayment. Another advantage of debt financing arises from the interest on principal amount borrowed. Interest paid on borrowed loan is considered a business expense. The interest in loan repayment is deductable from a business’s tax obligation. Debt financing provides cover for business income from taxation, hence reducing business tax liability. Debt financing helps a business to build credit record. Continued use of debt financing coupled with timely repayment promotes business creditworthiness. A favorable credit record benefits a company when seeking large bank loans, purchasing assets on credit, and negotiating competitive insurance terms with banks. Debt financing provides a business with greater freedom and flexibility when compared to equity financing. The business obligation to the lender is limited to the loan repayment period. Once all the borrowed money is repaid, the business completely free from the lender’s commitment. The repayment of principal and interest is planned for on monthly basis; thus easing budgeting and financing planning. Moreso, the paperwork and the legal procedures for obtaining debt financing are less complicated and cheaper in comparison to equity financing. The disadvantage of Debt Financing FUNDING PROPOSAL 4 The main problem of debt financing is the obligation to repay the principal amount plus interest. The interest is an extra financial burden for the business. The financial commitment of repaying borrowed money is treated as liability on a business financial statement. The obligation to repay debt sometimes forces company to forego pressing business needs, hence causing loss of business opportunities. The company with substantial financial obligations resulting from debt financing sometimes ends up transferring the ownership rights to other entities to remain afloat (Coyle, 2002). The procedures and regulations governing the acquisition of debt financing expose the business assets to the risks of forfeiture. To acquire debt financing, business must provide collateral in form of business assets as security for the loan. Failure by the business to meet the repayment obligation at any point during the fixed time; gives the lender the right to dispose the collateral to recover the outstanding debt. Businesses that fail to pay creditors lose important assets, which hinder optimal business operations or sometimes lead to bankruptcy. Debt financing is limited to businesses with good credit rating and track record in repaying loans. Businesses with poor credit rating face very difficult terms to obtain debt financing. Besides, a company with a large number of loans is considered a credit risk by potential lenders and investors. Therefore, it is faced with difficulties while raising capital either through further borrowing or equity finance; it severely constrains a business cash flow. Debt financing stifles business growth due to the exorbitant cost of compounded interest repayments. The stifling of business growth increases the risk of bankruptcy. Combined with high debt level, slowing business growth rate is considered high risk by banks, hence limiting borrowing volume. A business faced by a combination of such factors may result in equity financing to balance business financial sourcing. FUNDING PROPOSAL 5 Equity Financing Equity financing means the process through which business mobilizes finance by issuing shares to potential investors to sustain business operations. This method of business financing is commonly used at business start-up-stage and during business expansion stage. The equity financers gain through the rise in business share prices and from dividends. The main attribute of equity financing is that the investor gains stake in business ownership (Scarborough and Cornwall, 2015). Advantages The main advantage of equity financing is the provision of funds from alternative sources besides bank and other money lending institutions which charge interest on the amount borrowed. Equity financing provides business with cash flow for funding operations and expansion. Unlike debt finance, equity finance is not paid back to the investor, but it is rather a long-term investment. Investors providing equity financing have long-term perspective; hence, interest in short-term returns. The business use equity financing to utilize cash at hand to fund expansion and diversification rather than spending profits offset loans. It is for this reason that equity financing is less risky than debt in financing business expansion; because shareholders are not paid back immediately like in case of loan. Equity financing is appropriate in situation where a business is unable to take any more debt (Coyle, 2002). Equity financing allows a business to gain legitimacy and credibility among the network of investors. Equity financers are knowledgeable on wide range of issues on managing businesses. Such investors bring valuable management ideas into a business when they purchase equity and become active participants in its operations. They also connect the business with other FUNDING PROPOSAL 6 opportunities within their business networks, thus opening new prospects for expansion and diversification. Disadvantages of Equity Financing • The amount of cash paid to stakeholders could be bigger than in debt financing. Stakeholders usually expect to receive profits on their invested money. • The owner loses control since investors assume some control of the firm. • Partners usually find it difficult to agree on a given decision, thus derailing the firm’s activities. Recommendations The firm should consider going taking Debt Financing as opposed to Equity Financing because of the following positive characteristics of debt financing: • The lender does not assume control of the business • The business owner decides on their own without involving the financier • Interest rates can be subtracted from the tax returns of the company • The firm is not required to update the investors about its progress • Raising capital (debt) is less complex Breakeven Analysis The formula for determining the breakeven analysis is as shown below: 𝐵𝑟𝑒𝑎𝑘 𝑒𝑣𝑒𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 = 𝐹𝑖𝑥𝑒𝑑 𝑐𝑜𝑠𝑡𝑠 / (𝑝𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 − 𝑢𝑛𝑖𝑡 – 𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑐𝑜𝑠𝑡 𝑝𝑒𝑟 − 𝑢𝑛𝑖𝑡) (Coyle, 2002). 𝐵𝑟𝑒𝑎𝑘 𝑒𝑣𝑒𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 = $75,000 / (250 – 35) = 349 FUNDING PROPOSAL 7 𝑩𝒓𝒆𝒂𝒌 − 𝑬𝒗𝒆𝒏 𝑷𝒐𝒊𝒏𝒕 (𝒖𝒏𝒊𝒕𝒔) (349) = 𝑩𝒓𝒆𝒂𝒌 ($12,209) − 𝑬𝒗𝒆𝒏 𝑷𝒐𝒊𝒏𝒕 ($′𝒔) = 𝑇𝑜𝑡𝑎𝑙 𝐹𝑖𝑥𝑒𝑑 𝐶𝑜𝑠𝑡𝑠 (𝑇𝐹𝐶) $75,000 𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝐶𝑜𝑠𝑡 𝑝𝑒𝑟 𝑈𝑛𝑖𝑡 (𝑉𝐶𝑈) $250.00 Formulas: 𝐵𝐸𝑃 (𝑢𝑛𝑖𝑡𝑠) = 𝑇𝐹𝐶/(𝑆𝑃𝑈 − 𝑉𝐶𝑈) 𝑆𝑎𝑙𝑒𝑠 𝑃𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑈𝑛𝑖𝑡 (𝑆𝑃𝑈) $35.00 𝐵𝐸𝑃 ($′𝑠) = 𝐵𝐸𝑃 (𝑢𝑛𝑖𝑡𝑠) ∗ 𝑆𝑃𝑈 Therefore, given the variable costs, selling price, and the fixed costs of the services offered, the company would have to sell 349 of their services to break even. The total revenue raised would approximately be $12,209. This will help the company to offset/clear its loan of $10,000 completely. Due to increased competition, the firm can also opt to continue selling its services at $250 and seek debt financing to offset its loan. The Breakeven Graph $1,500,000 $1,000,000 $500,000 TF C $0 0 ($500,000) ($1,000,000) ($1,500,000) 400 800 1,200 1,600 2,000 2,400 2,800 3,200 3,600 4,000 TV C FUNDING PROPOSAL 8 References Coyle, B. (2002). Equity Finance: Debt Equity Markets. Global Professional Publishers. Holland, R. (1998). Break-Even Analysis. The University of Tennessee. Norman M. Scarborough and Jeffrey R. Cornwall. (2015). Chapter 13: Sources of Financing: Debt and Equity Pearson Education. In Essentials of Entrepreneurship and Small Business Management, Global Edition. Pearson.
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