2.1.2 External finance

• What is external finance?

  Funding obtained from sources outside of a company or organization.
• What are the six sources of external finance?

  Family and friends, banks, peer-to-peer funding, business angels, crowdfunding and other businesses
• Shareholders are entitled to dividends, which can be paid out as cash or reinvested into the company.
• The cost of equity is the return that shareholders expect to receive on their investment.
• What makes friends and family a source of finance?

  Small business owners approach close acquaintances to invest in or lend money to a business.
• What are the advantages and disadvantages of using friends and family as a source of finance?

  Advantages: Trust, flexibility, and potentially lower interest rates

  Disadvantages: Relationships may be damaged and there is a lack of professionalism
• What makes a bank a source of finance?

  Lending/providing several different kinds of loans to a business.
• What are the advantages and disadvantages of using banks as a source of finance?

  Advantages: Capital injection, expertise, credibility, and free advice

  Disadvantages: Interest payments, collateral requirements, potential rejection, and a business plan is usually required
• What makes peer-to-peer funding a source of finance?

  Financial technology that allows people to lend or borrow money from one another without going through a bank.
• What are the advantages and disadvantages of using peer-to-peer funding as a source of finance?

  Advantages: Access to funding, lower interest rates, flexibility, and loans can be made available quickly

  Disadvantages: Risk of default, lack of investor protection, and potential for fraud
• What makes business angels a source of finance?

  Private investors, who provide financial backing in return for ownership equity (invest in start-up or expanding businesses e.g Dragon Den investors).
• What are the advantages and disadvantages of using business angels as a source of finance?

  Advantages: expertise, flexibility, networking, and they offer you free advice/guidance once you invest

  Disadvantages: limited funding, loss of control as they own a stake in the business, and its challenging/expensive to find the 'right' angel
• What makes crowdfunding a source of finance?

  Raising money or funding by a business by getting small amounts of capital from a large number of people e.g donations.

  When a business donates, lends, or invests money via online for you to raise money or funds e.g donations.
• What are the advantages and disadvantages of using crowdfunding as a source of finance?

  Advantages: Access to capital, the platform provides free marketing , and community engagement

  Disadvantages: Lack of control, competition for attention, and potential for failure to meet funding goals/negative publicity if the project is not successful in attracting enough crowdfunding capital
• What are investors usually attracted by?


  Incentives, such as a sample or early access to a product
• What makes other businesses a source of finance?

  Investment
• What are the advantages and disadvantages of using other businesses as a source of finance?

  Advantages: Access to expertise, shared risk

  Disadvantages: Loss of control as decisions need to be agreed upon by all businesses, potential conflicts of interest, and profits need to be shared
• What are the seven methods of finance?

  Loans, overdrafts, share capital, venture capital, leasing, trade credit and grants
• What makes a loan a method of finance?

  Debt/a sum of money borrowed and repaid with interest over a determined period of time.
• What are bank loans, mortgages and debentures?

  Bank loans: Borrowed money from a bank that must be repaid with interest.

  Mortgages: Loans specifically for purchasing real estate, with the property serving as collateral.

  Debentures: Long-term debt instruments issued by companies to raise capital, typically with a fixed interest rate and repayment date.
• What are the advantages and disadvantages of using loans as a method of finance?

  Advantages: Access to immediate funds, ability to leverage for growth, banks do not ask for a % of the business, and control

  Disadvantages: Interest payments and risk of debt accumulation (build up)
• What makes an overdraft a method of finance?

  Short-term borrowing, allows you to spend money even if you run out of money in your bank account. It occurs when you don't have enough money in your account to cover a transaction, but the bank pays the transaction anyway.
• What are the advantages and disadvantages of using overdrafts as a method of finance?

  Advantages: Flexible, aids cash flow, short-term borrowing, and it allows you to carry on purchasing assets

  Disadvantages: High interest rates, have to pay to have an overdraft facility, and can be expensive
• What makes share capital a method of finance?

  Bringing in new owners, in return they get a stake of the business or share business ownership.
• What are the advantages and disadvantages of using share capital as a method of finance?

  Advantages: Permanent capital, no repayment required, they have expertise knowledge and experience

  Disadvantages: Ownership dilution, dividend payments, and loss of control
• What makes venture capital a method of finance?

  Inviting entrepreneurs to invest in your business essentially using their money in return they get shares of ownership.
• What are the advantages and disadvantages of using venture capital as a method of finance?

  Advantages: Funding for growth, expertise and networking

  Disadvantages: Loss of control as venture capital firms require a stake in the business, high expectations such as a strong business plan, and potential conflicts
• What makes leasing a method of finance?

  Rental/an asset used by a business in return for payment.
• What are the advantages and disadvantages of using leasing as a method of finance?

  Advantages: Lower initial costs, flexibility, access to newer equipment, and not responsible for maintenance or repair costs

  Disadvantages: Higher overall costs, no ownership, potential restrictions, and more expensive in the long run rather than buying an asset
• What makes trade credit a method of finance?

  A business-to-business agreement in which a customer can purchase goods without paying cash up front, and paying the supplier at a later scheduled date, it's short term.
• What are the advantages and disadvantages of using trade credit as a method of finance?

  Advantages: Easy to obtain, no interest, and can improve cash flow

  Disadvantages: Potential strain on supplier relationships, limited amount available, and may lead to dependency
• What makes grants a method of finance?

  Non-repayable funding, government and industry trusts may offer grants to businesses that meet specific criteria. Essentially an award given to a small business that does not need to be paid back
• What are the advantages and disadvantages of using grants as a method of finance?

  Advantages: Non-repayable

  Disadvantages: Competitive, limited funding, and the business must use the finance for it's intended purpose