Back To CourseCreating a Business Plan
2 chapters | 13 lessons
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Tammy teaches business courses at the post-secondary and secondary level and has a master's of business administration in finance.
Mr. Wesley, a science teacher, accidentally created a widget that enables electronic cars to travel more miles than the current technology. As a result, he's received orders from every United States car manufacturer. But before he can fulfill the orders, he needs sufficient capital or financing to rent a manufacturing warehouse, buy supplies, and pay for labor and other expenses. Mr. Wesley creates a corporation (a legal business entity), then starts working on a business plan to submit to the bank along with his application.
A business plan is a roadmap of the company's products or services and goals, and the methods for achieving this plan. A business plan also includes a financial component outlining the corporation's prospective sales, expenses, and financing. Banks require that new companies show sufficient start-up capital and income cash flow to maintain ongoing operations. Mr. Wesley contacts his brother, Fernando, an accountant, to assist him with this part of the business plan. Fernando explains two financing options exist: debt and equity. Debt includes obtaining a loan or issuing bonds, while equity focuses on issuing stock. Let's take a closer look at their discussion on equity.
An initial public offering (or IPO) represents the first offering of stock to investors. Stock is a share or percentage owned in a corporation. When investors purchase stock, the corporation receives cash to fund or finance operations. Common stock represents one type of stock ownership. In return for the investment, common stockholders receive voting rights. For each share owned by a common stockholder, he or she receives one vote on major corporate decisions. However, explains Fernando, corporations give up 100% decision making to these stockholders. Mr. Wesley asks that as chief financial officer, can't he make a final decision? Fernando says, 'No, the common stockholders have the authority if they own the majority of the shares.'
There is a solution, though, to ensure a certain class of stockholders (the more business savvy investors) retain the majority vote by offering two different classes of common stock: class A and class B. For example, class A investors may receive 10 votes per share, while class B investors receive 1 vote per share.
Another benefit of issuing common stock is that shareholders are not guaranteed dividends. Dividends are monies paid to the investors from profits. In summary, the common stockholders' main benefits are voting rights and a hopeful increase in the stock price when they sell the stock, also called capital gains. Now let's move on to the preferred stockholders.
Fernando shares with Mr. Wesley that while dividends are not guaranteed with common stockholders, they are with preferred stockholders. Preferred stockholders also receive priority over common stockholders in the event the business becomes insolvent and liquidates. However, one main advantage exists for the corporation with preferred stockholders - they have no voting rights, meaning the corporate executives maintain 100% control. Mr. Wesley smiles at this news since he really wants to personally drive the success of his business.
He then asks, 'What if the IPO takes off? We fulfill the current manufacturer's orders, anticipate an influx of international orders, and then need more funding?' Fernando explains the corporation can issue stock warrants, which allow investors to purchase the stock on a specific day for a specific price. This allows the corporation to receive cash to meet the international order demand. Investors are eager to purchase stock warrants because they know the price per share will likely increase with new international orders. Mr. Wesley thanks Fernando for explaining stock warrants because he confuses them with stock options. Stock options are similar, they are sold for a specific price on a specific day but by another investor, not directly from the corporation. Mr. Wesley asks one more question, 'Which agency regulates stock?'
The Securities and Exchange Commission (or SEC for short) regulates stock offerings. While it doesn't guarantee the profitability of an investment, it requires corporations to register their stock offerings by submitting financial documents to ensure public confidence. Registration and the cost of producing those financial documents can be quite hefty, which is why the government instituted Regulation D. Regulation D allows small companies to remain private and offer stock to a few accredited investors, significantly reducing costs and time. Accredited investors must have a minimum net worth of $1 million dollars and be able to withstand the risk of financial loss. Mr. Wesley recaps by saying, 'If I can remain private and issue stock to a few wealthy investors who can help the widget corporation make solid financial decisions, that's the route I'm taking.'
A business plan is a roadmap of a company's offerings, goals, and methods for achieving those goals. Additionally, investors and financial institutions want to ensure the business has sufficient capital to implement and maintain those goals. Therefore, the business plan should include one or both types of financing: debt and equity.
Debt represents business loans and issuing bonds, while equity focuses on stock. There are two types of stock, common and preferred, and with each type, stock warrants or options can be issued. While each type has its advantages and disadvantages, both must be registered with the SEC unless an accredited investor purchases stock from a private company through Regulation D legislation.
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Back To CourseCreating a Business Plan
2 chapters | 13 lessons