Chapter 13: Other Financing Alternatives 215

Chapter 13

OTHER FINANCING ALTERNATIVES

DISCUSSION QUESTIONS AND ANSWERS

1. What are business incubators and seed accelerators? How do they differ?

A business incubator is an organization that helps startup companies develop by 
providing management, operating, and financial services.

A seed accelerator is an organization that usually provides both an equity investment
and a mentoring and educational fixed­term, cohort program to help startup 
companies succeed.

Business incubators and seed accelerators generally differ in how they are organized, 
the type of funding help they provide to entrepreneurs, and type and length of their 
support and educational programs.  

While most incubator programs do not make equity investments in their client firms, 
they do help entrepreneurs obtain private and public loan funds, and in some cases 
help them meet with angel investors. Business incubators are usually formed as 
nonprofit organizations that are operated by either private firms or public entities 
including government­funded programs, economic development organizations, and 
universities. Entrepreneurs must apply for admittance to a business incubation 
program by providing their business ideas and business plans. The length of time that 
a client (accepted entrepreneur) can stay in an incubator program varies depending on
the complexity of the business model and predetermined revenue or other benchmark 
targets.

Most seed accelerators, also called startup accelerators, make seed investments in 
exchange for equity capital in the startups they accept into their programs. Startups in 
seed incubators must complete their programs in about 3 months, at which time they 
make a pitch to prospective investors. Seed accelerators admit new startups in cohort 
groups or classes to encourage peer support and feedback as an important part of the 
education mission.

2. What is meant by the terms business crowdsourcing and crowdfunding?
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Business crowdsourcing is the process of obtaining business ideas, development

support, and operating services from a large network of nonemployees.

Crowdfunding is the process of financing ideas, ventures, and projects by gathering

funds from a large network of people.

3. Describe the two major types of crowdfunding.

There are two types of crowdfunding: rewards-based crowdfunding and equity

crowdfunding.

Rewards-based crowdfunding involves soliciting non-equity funds to finance

specific business products and services or requesting donations for a specific purpose.

Equity crowdfunding involves soliciting funds from a large number of small

investors in exchange for an equity position in the venture requesting the funding.

4. What are the five C’s of Credit Analysis?

The five C’s of credit analysis are capacity, capital, collateral, conditions, and
character. See Figure 13.1.

5. Name three of the common loan restrictions and explain their relation to new
venturing financing. What are some additional common loan restrictions?

While many different restrictions can be placed on businesses, a few are described
here: (1) Limits on total debt are placed on venture firms to limit the amount of
leverage the firm has; (2) Dividend restrictions are placed on firms to prevent the firm
from paying out the newly issued debt in the form of a dividend; and (3) Maintenance
of financial statements may be required to provide the lending institution with a
current representation of the company’s financial situation.

See Figure 13.2 for some additional common loan restrictions including: (4)
restrictions on additional capital expenditures, (5) restrictions on sale of fixed assets,
(6) performance standards on financial ratios, and (7) current tax and insurance
payments.

6. What is meant by venture banks? How do they differ from traditional commercial
banks?

The term “venture banks” refers to a type of debt investor (lender) that will consider
lending to early stage ventures that do not have proven cash flows. They typically
offer debt to accompany venture equity and will look for compensation in both
interest payments and equity positions (including call options) in the venture.
Commercial banks typically do not consider this type of very risky lending.
 Chapter 13: Other Financing Alternatives 217

7. Why are new ventures at a disadvantage in receiving debt financing?

They are at a disadvantage because they usually do not have large amounts of assets
to provide as collateral, and the risk associated with the loan is not normally in a risk-
averse bank’s goals.

8. Why is credit card financing attractive to entrepreneurs? What are the risks?

It is attractive because it is quite easy to obtain and also provides interest rates lower
than prime for the introductory period, but is also risky due to high interest rates
charged after the teaser period.

9. What is the EB-5 immigrant visas program?

The Immigration and Nationality Act (INA) of 1990 provided an opportunity for
foreign nationals to obtain a “green card” through the EB-5 immigrant visas program.
A foreign national may seek Lawful Permanent Resident (LPR) status by investing $1
million in the U.S. that will preserve or create at least 10 jobs for U.S. workers. The
minimum requirement is reduced to $500,000 if the investment is in a designated
rural or high unemployment area.

10. What is the Small Business Administration (SBA), when was it organized, and
what was its purpose?

The SBA is the Small Business Administration which was created by Congress in
1953 to provide small businesses help in startup and growth.

11. Identify and briefly describe four basic SBA credit programs.

Refer to Figure 13.3. The four basic SBA credit programs:

1) 7(a) Loan: can be used for most business purposes including the financing of
working capital.
2) 504 Loan: can be used to purchase fixed assets, as well as for other business
needs.
3) Microloan: intended for very small businesses with a maximum amount of
$35,000 to be used for general purposes.
4) Venture Capital: this credit program works through Small Business Investment
Companies (SBICs) which are private for-profit investment firms.

12. Compare the characteristics in terms of loan amounts, lenders, and SBA role in 7(a)
loans versus 504 loans.

Refer to Figure 13.3.

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7(a) Loan: Lenders include commercial bank, credit union, or financial services firm.
Loans are up to $2 million with 7- to 10-year maturities and can be used for most
business purposes including the financing of working capital needs. The SBA role
approves loan and guarantees up to 85% of loan value.

504 Loan: Lenders include commercial bank jointly with not-for-profit Certified
Development Company. Loans are up to $4 million for fixed assets and up to $2
million for other business needs. The SBA role approves and guarantees the
development company’s portion of debt.

13. What is a Small Business Investment Company (SBIC)?

SBIC stands for Small Business Investment Company and is a private financing
company which provides capital of diverse types.

14. What types of advisory services are available from the SBA?

The SBA provides advisory services (including technical, financial, and contracting)
to many small and disadvantaged businesses. They also provide assistance to
exporters and those involved in technology transfer. See section 13.6.

15. What is a debt guarantee and how does the SBA back a small business loan?

A debt guarantee is an assurance that a certain portion of the debt principal (and/or
interest) will be repaid even in the event of default. The SBA guarantees part of the
loan that a local SBA-participating lender makes through an SBA program.

16. In which research areas does the SBA provide supplemental programs?

Refer to Section 13.6. The SBA provides technical assistance, financial assistance,
contracting assistance, disaster assistance recovery, supports special interests,
provides advocacy, laws & regulations assistance, and works to provide civil rights
compliance. Technical assistance is provided for entrepreneurial development,
management assistance to small business owners, efforts to help small businesses to
export, etc. Financial assistance includes loan programs, provides venture capital
through Small Business Investment Companies (SBICs), manages surety bond
guarantees, etc. Contracting assistance includes working to create an environment for
maximum participation by small, disadvantaged, and woman-owned business in
federal government contract awards.

17. What are some characteristics of a Community Development Financial Institutions

(CDFI) loan?

In 1994, Congress created the Treasury Department’s Community Development

Financial Institutions (CDFI) Fund. Most CDFIs currently still focus on promoting
affordable housing and homeownership. However, CDFIs are increasing their
 Chapter 13: Other Financing Alternatives 219

financing of small businesses through the making of microloans as well as larger

loans. The SVA makes direct loans to CDFIs, which, in turn, make microloans to
small businesses. See Figure 13.4 for factors to review when considering a CDFI
loan.

18. What are factoring and receivables lending?

Factoring is selling receivables to a third party at a discount from their face value in
order to have an immediate cash flow instead of a deferred cash flow when the
receivable is collected.

Receivables lending involves pledging receivables as collateral against a loan.

19. Describe examples of customer funding used to reduce financing needs.

Depending on the type of business venture, funds from customers may be used to 
help finance startups. Several models or approaches may be considered by 
entrepreneurs. 

“Pay­in­advance” is a very common model. For example, many service businesses 
require at least a partial payment in advance before the service is provided. Home 
remodeling projects usually require partial up­front payments, while tickets for 
sporting and entertainment events are usually paid in full prior to the actual event.

Subscription models are another way customer funds can be used to help finance 
startup ventures. Subscriptions to purchase wine or computer services on a monthly 
basis are examples of obtaining financing from customers. 

Acting as a matchmaker to bring together buyers and sellers is another way to make 
use of customer funding. One example is the matching of the demand for hotel rooms 
with the supply of available hotel rooms, for which transaction fees are charged.  
Another example is the matching of available short­term apartment or house rentals 
with people wanting short­term non­hotel lodging. 
 
20. What is venture leasing? How does it differ from traditional leasing?

Venture leasing involves leasing assets to high-growth ventures typically backed by

venture investors. The return to the lessor involves lease payments and a portion of
the venture’s equity.

Traditional leasing targets returns only from the lease payments and the sale of
salvaged assets.
 220 Chapter 13: Other Financing Alternatives

21. What is a direct public offering?

A direct public offering is a security offering made directly to a large number of

investors. It is often done over the internet but the success rate is still debatable.

22. From the Headlines – Solix: Describe the alternative financing Solix arranged for
the launch of its biofuels production facility. Comment on your impressions of what
attracted the investors.

Answers will vary: Solix’s technology and development were initially subsidized by
Colorado State University and government grants. Then, to produce its large-scale
algal oil production facility, it partnered with the Southern Ute Alternative Energy
fund for a plant location and contributed capital. It also secured funding from
private investors and government-funded entities. Among other things, the attraction
to investors appears to have been a combination of affinity for the new technology
and its promise, public policy and funding for related initiatives, and the possibility
of investment returns.

EXERCISES/PROBLEMS AND ANSWERS

1. [Bank Loan Considerations] Assume you started a new business last year with
$50,000 of your own money that was used to purchase equipment. Now you are
seeking a $25,000 loan to finance the inventory needed to reach this year’s sales
target. You have agreed to pledge your venture’s delivery truck and your personal
automobile as support for the loan. Your sister also has agreed to cosign the loan.
During your initial year of operation, you paid your suppliers in a timely fashion.

A. Analyze the loan request from the viewpoint of a lender who uses the “five Cs” of
credit analysis as an aid in deciding whether to make loans.

Capacity to pay: depend on the venture’s ability to generate profits and cash flow
from the business activities

Capital: $50,000 personal capital has been invested in the venture.

Collateral: The delivery truck and the entrepreneur’s personal automobile have
been pledged as collateral. A sister has agreed to cosign the loan.

Conditions: The loan is to finance the inventory. Consequently the conditions

would relate to this inventory use.

Character: The venture has a history of paying creditors in a timely fashion.

 Chapter 13: Other Financing Alternatives 221

B. Assume you are currently carrying an accounts receivable balance of $10,000. How
might you use accounts receivables to obtain an additional bank loan?

You could approach a bank with the receivables and your track record of
collections and ask if they could be collateral for a loan. You could also contact a
factor and see if you could “sell” the receivables for cash.

C. Assume at the end of next year, you will have an accounts

receivable balance of $15,000 and an inventories balance of
$30,000. If a bank normally lends an amount equal to 80 percent of
accounts receivable and 50 percent of inventories pledged as
collateral, what would be the amount of a bank loan a year from
now?

$15,000  .80 = $12,000

$30,000  .50 = $15,000
Total = $27,000

2. [Factor Financing] Assume the operation of your business resulted in sales of $730,000
last year. Year-end receivables are $100,000. You are considering factoring the receivables
to raise cash to help finance your venture’s growth. The factor imposes a 7 percent
discount and charges an additional 1 percent for each expected ten-day average collection
period over thirty 30 days.

A. Estimate the dollar amount you would receive from the factor for your receivables if the
collection period was thirty 30 days or less.

If the collection period is 30 days or less, the factor will pay .93 x $100,000 =
$93,000.

B. Estimate the dollar amount you would receive from the factor for your receivables if the
average collection period was sixty days.

If the collection period is 60 days, the factor will pay 90% of the value (i.e., .07 for 30
days plus an additional .01 for 31-40 days, plus an additional .01 for 41-50 days, and
an additional .01 for 51-60 days. Thus, the dollar amount paid would be: .90 x
$100,000 = $90,000.

C. Show how your answer in Part B would change if the factor charges an 8 percent
discount and charges an additional .5 percent for each expected fifteen-day average
collection period over thirty days.

.08 + .005 +.005 = .09

1.00  .09 = .91
.91  $100,000 = $91,000
Or, (1(.08 + (.005  2)))  $100,000 = $91,000
 222 Chapter 13: Other Financing Alternatives

D. If the $730,000 in sales last year were evenly distributed throughout the year, an
average $100,000 in receivables outstanding would imply what average collection
period? Given the original terms stated in the problem, what dollar amount would you
expect to receive for your receivables?

Recall from Chapter 5 that the average collection period is also referred to as the days
of sales outstanding; and in Chapter 6, the “sale-to-cash conversion period.”
$100,000 / ($730,000 / 365) = $100,000/$2,000 = 50.0 days average collection period
Original terms: for 50 days, the discount would be .07 + .01 +.01 = .09
1.00  .09 = .91
.91  $100,000 = $91,000
Or, (1(.07 + (.01  2)))  100,000 = 91,000