To raise capital for Nanda Home, Nanda decides to borrow money from bank. Borrowing money from bank Nanda not only can raise fund for her business. The initial legal form of Nanda Home also doesn’t change. That is sole trader. With this legal form, even though Nanda gets money from bank, but it doesn’t mean Bank get involved in business of Nanda Home. Nanda totally is independent to others. Nanda owns everything, all profit go to her. In addition, a sole trader like Nanda, is directly involved in running business. Nanda is entitled to make decision, and participate in management.
In other words, the business is under her control. So what is Bank involved with Nanda Home? As mentioned before, banks always pay much attention to the characteristic of borrower (Nanda Home), history of borrowing, the ability to pay back loan, and security. With this form, Nanda has to be responsible for her loans, liability for business debts usually unlimited. That means the bank can seize not only the facilities of Nanda business, but also Nanda’s personal property; it can be house, cars of Nanda as security if Nanda fail in pay back loan or interest.
Another thing we have to take notice when borrowing from bank is interest. Now, Nanda is borrower and Bank is creditor. Thus, Nanda has to pay interest for monthly or annually depending on the term of contract. In here, bank interest rates on loans stay on an average of 5. 5% per annum. With that rate, Nanda has to consider whether it can payback loan or pay with that interest rate or not, because if Nanda can’t afford to pay interest, they also lead company to deadlock. To know that Nanda has to forecast their revenue, cost and expense for whole process, tax as well to know how much profit they earn.
In addition, to bank, interest rate is considered as a cost for loans, but before getting loans, Nanda Home also has to In sum up, the advantage of using Bank as a source of finances is Bank is very popular, it is a traditional source of finance when company borrow money. The disadvantage is Nanda Home has to prove the purpose of its business and historical of payment as well as suffer the supervision of bank. And the most disadvantage is Nanda Home has to pay interest annually 5. 5%, which means the profit of Nanda Home will be decrease.
After paying loan, Nanda Home doesn’t have much money to run business as well as expanse their business. In addition, because the interest rate is quite low, thus they can decide to pay back loan in long term to have abundant cash in their business. On other hand, if the interest rate doesn’t change, Nanda Home will pay less interest for bank. However, even though Nanda Home can pay loan in long term, but it shouldn’t be too long. The best way is Nanda Home should pay back all loan in suitable time. Thus Nanda Home can follow suggestion below.
However, it’s difficult to borrow a big money ($920,000) while Nanda Home is a new enterprise and they just have 80,000 when starting business. The capability of Bank to lend money is very low, because it’s too risky. Thus Nanda Home can focus on other method to raise capital is to issue share then sell it. Selling share is considered as one of method to raising fund. However to apply this method, the legal form of company will change. It is not sole trader anymore; it will become company or cooperation.
With this new legal form, Nanda Home will have more owners who buy shares. Therefore, the power to influent company will be shared among main owners. And owners who get the most share will be most powerful, and have important position in company, because she/ or he contributes capital most for company. Thus Nanda will share her ownership to other, and it’s obviously, Nanda power will decrease, or she must to share ideas or make meeting before making any important decision. This is a disadvantage of this legal form in comparison with sole trader.
Thus the important thing when selling share is Nanda has to hold the biggest amount of preference shares to be the main owners. As mentioned before, there are two kind of share: common share and preference share. Preference share benefit more for shareholder. Shareholders of preference share are paid dividends first, and dividends they get from company are stable. In addition, return rate investment of preference share when the company go bankrupt is also very high, it means that when the company go bankrupt, shareholder of preference share still can get money back, while shareholder of common share cannot do that.
Thus to attract investor, the people buy Nanda Home share, Nanda can issue some preference shares, while Nanda Home has to hold the a big mount of preference share as well as common shares make sure that Nanda still have influence on Nanda Home. However, by selling share, Nanda Home can have permanent capital (the shareholder expect to be paid dividend income quarterly or yearly) instead of borrowing money from bank (Nanda has to be pay back all). In addition, advantage is Nanda Home still can retain profit to re-investment to expand the business and don’t pay dividend to shareholder.
Assume that Nanda Home will retain 40% profit to expand business, 60% of profit for shareholders in 2008, and price per share is about $ 1. $1 for each share is suitable, because the Nanda Home is new enterprise and not many investors know about its capability in term of making profit. Thus with that price, Nanda Home can attract investors to buy its share. By receiving money from investors, Nanda Home can raise fund for their business. In addition, Nanda Home hold 60% value of share they issue is necessary to maintain their ownership, and have heavy voice in making important decision in running business.
Therefore, to raise $1,000,000 to carry out project in 2008, Nanda Home have issue 1,000,000 shares. In those 1,000,000 shares, there should be 20% preference shares, and 80% common shares. This ratio is reasonable, because Nanda Home have to pay dividend for preference shareholders based on fixed percentage even though company gets into trouble and has not much profit, while company can calculate a suitable dividend for common shareholders. Thus, Nanda Home just has to pay a certain amount for their preference shareholders and even they’re in hard situation they still may be able to handle with it.
And Nanda Home can issue a large amount of common share to mobilize capital. Common shareholders can receive their dividends but the money they receive changes over time. It depends on whether company can make profit or not. Thus to common shareholder, Nanda Home are not under much pressure to pay dividends while they still can retain profit for business. Because of those reasons, I think that ratio is reasonable. However, Nanda Home must notice that they have to hold a big amount of common share (about 60%) to be main shareholders, and have heavy voice in making important decision for business.