Chapter 14 - Financing Strategy

Completion
Complete each sentence or statement.

1. Raising money to start a business is called ____________________.

2. An agreement signed by a borrower to repay a loan with regular payments is called a
____________________ note.
3. An investment of money in exchange for a share of ownership in a company is called
____________________.
4. When a company borrows money instead of selling a percentage of ownership to finance itself, the strategy is
called ____________________ financing.
5. Businesses that rely heavily on debt financing are said to be highly ____________________.

Multiple Choice
Identify the letter of the choice that best completes the statement or answers the question.

____ 6. One advantage of incorporating is

a. more risks.
b. freedom from paying taxes.
c. the ability to issue bonds and sell stock.
d. eliminating the need for start-up capital.
____ 7. Business incubators help get new businesses off the ground by
a. providing low-cost space and equipment for start-up businesses to share.
b. loaning money to start-up businesses.
c. encouraging relatives and friends to help start-up businesses.
d. helping entrepreneurs predict monthly costs.
____ 8. Obtaining “bootstrap” financing for a new business means
a. hoping to win the lottery.
b. borrowing money from a bank.
c. starting with very little money.
d. behaving very ethically so a banker will trust you.
____ 9. Which of the following is not an example of “bootstrap” financing?
a. hiring as few employees as possible.
b. using personal saving.
c. borrowing from friends and family.
d. buying new equipment for the business.
____ 10. One disadvantage of debt financing is
a. ownership has to be shared with the lender.
b. the lender can force the entrepreneur into bankruptcy for failure to make payments.
c. the lender can charge as much as he/she wants in interest.
d. the lender must be allowed to help manage the business.

Short Answer

CRITICAL THINKING
11. Is it safer to borrow money from friends or from a bank?
12. How does a debt-to-equity ratio help describe the financial health of a company?
13. Why is incorporating and becoming a legal “entity” an advantage for a corporation?
14. How can debt financing be risky?
15. Is there more or less risk in equity financing than debt financing for the entrepreneur?
Chapter 14 - Financing Strategy
Answer Section

COMPLETION

1. ANS: financing

PTS: 1
2. ANS: promissory

PTS: 1
3. ANS: equity

PTS: 1
4. ANS: debt

PTS: 1
5. ANS: leveraged

PTS: 1

MULTIPLE CHOICE

6. ANS: C PTS: 1
7. ANS: A PTS: 1
8. ANS: C PTS: 1
9. ANS: D PTS: 1
10. ANS: B PTS: 1

SHORT ANSWER

11. ANS:
Both involve risks. An un-repaid loan from a friend could hurt that individual’s finances, result in a lawsuit
between friends, or otherwise ruin the friendship. Friends might also need the money back sooner than
agreed. Banks are less likely to forgive a loan, and may be stricter with the rules for repayment. Failure to
repay a bank loan in a timely fashion could also hurt your credit rating.

PTS: 1
12. ANS:
Comparing the amount of money a company has borrowed to its equity value indicates if the amount of
borrowing has been high, moderate, or low. A high debt-to-equity ratio means that the company has higher
monthly costs to repay loans and therefore lower profits. Higher fixed costs such as loan payments also mean
more risk of bankruptcy.

PTS: 1
13. ANS:
 Incorporating creates a “being” or entity according to the law, so the business has its own legal and financial
status apart from its owner’s, owners’ or stockholders’ status. A corporation becomes a type of “person” and
therefore it assumes from the owners and protects them from any personal legal liability for debt, business
failure, or other mishaps, except breaking the law. Corporations can also sell shares of ownership to investors.

PTS: 1
14. ANS:
If a business does well, the owner can repay the loans on money borrowed but, if sales drop off, the owner
may not have enough money to make regular payments. If payments are not made, lenders can force the
company into bankruptcy or seize its property and assets.

PTS: 1
15. ANS:
There is probably less risk in equity financing because, if the business fails, the owner doesn’t have to pay
back the money: the investors get their investment back only if the company is profitable. However, giving up
equity could allow the investors to take control of the business from the owner someday.

PTS: 1