External finance

• External finance: is obtained from sources outside of and separate from the business.
• Issue of shares:

  Advantages:

  • This is a permanent source of capital which would not have to be repaid to shareholders.
  • No interest has to be paid.

  Disadvantages:

  • Dividends are paid after tax, whereas interest on loans is paid before tax is deducted.
  • Dividends will be expected by the shareholders.
  • The ownership of the company could change hands if many shares are sold,which the original owners might object to.
• Bank loans: A bank loan is a sum of money obtained from a bank which must be repaid and on which interest is payable.

  Advantages:

  • These are usually quick to arrange.
  • They can be for varying lengths of time.
  • Large companies are often offered low rates of interest by banks if they borrow large sums.

  1. Disadvantages:

  • A bank loan will have to be repaid eventually and interest must be paid.
  • Security or collateral is usually required.
• Selling debentures: These are long-term loan certificates issued by limited companies.

  Advantages

  • Debentures can be used to raise very long-term finance, for example, 25 years.

  Disadvantages:

  • As with loans, these must be repaid and interest must be paid.
• Factoring of debts: A debtor is a customer who owes a business money for goods bought. Debt factors are specialist agencies that ‘buy’ the claims on debtors of businesses for immediate cash.

  Advantages:

  • Immediate cash is made available to the business.
  • The risk of collecting the debt becomes the factor’s and not the business’s.

  Disadvantages:

  • The business does not receive 100% of the value of its debts.
• Grants and subsidies from outside agencies: Outside agencies include, for example, the government.

  Advantages:

  • These grants and subsidies usually do not have to be repaid.

  Disadvantages:

  • They are often given with ‘strings attached’, for example, the firm must locate in a particular area.
• Micro-finance is providing financial services – including small loans – to poor people not served by traditional banks.

  Why do the banks refuse to lend?

  • The size of the loans required by poor customers – perhaps a few dollars – meant that the bank could not make a profit from the loans
  • The poorer groups in society often have no asset to act as ‘security’ for loans– banks are usually not prepared to take risks by lending without some form of security (assets they can sell if the borrower cannot repay).
• Crowdfunding is funding a project or venture by raising money from a large number of people who each contribute a relatively small amount, typically via the internet.

  Advantages:

  • Allows the public’s reaction to the new business venture to be tested.
  • Can be a fast way to raise substantial sums.

  Disadvantages:

  • Crowdfunding platforms may reject an entrepreneur’s proposal if it is not well thought out.
  • Media interest and publicity need to be generated to increase the chance of success.
  • Competitors can "steal" the idea