2.1.2 - External finance

• Define external finance:

  • is investment for the business that is obtained from; banks, investors and lenders outside of the business.
• Source of finance:

  • this is where the finance has come from, e.g. a bank.
• Method of finance:

  • this is the use of finance - or what use it would be suitable for, e.g. loan to buy computer equipment for the business.
• family and friends:

  • Plt companies are able to raise finance by selling shares to family/friends.
  • sole trader/partnership may also find that their family want to contribute. may be interest, a share of the profits, or interest free loan.
• Family and friends adv:

  • offered without the need for security and at low rates, over longer terms.
  • unlikely to need a business plan.
• Family and friends dis:

  • may cause tension and problems if the finance is not repaid or doesn’t flourish.
  • may also demand money back at short notice.
• Banks:

  • May lend a loan to a start-up business or when a business wants to grow and expand.
  • provide an overdraft to help with cash flow problems.
• Banks adv:

  • lend to businesses without asking for a % of the ownership.
  • will allow business to continue running the business their own way, and not interfere, so the owner retains control of the business.
• Banks dis:

  • Can be expensive compared to other sources and interest must be paid back on time.
  • hard for new business to obtain loan as have no historical sales data.
  • owner may need to use own assets for security.
• Peer to peer funding:

  • funding circle have gained trust of consumers by offering lower rates than banks to business owners who want to borrow money.
  • matches businesses that need finance with investors who are looking for a good return on their investment.
• Peer to peer funding adv:

  • Businesses can get access to funding within a week once approved.
  • owners can apply online.
  • investors can expect return of 6-7% whereas savings accounts might only give 3%.
• Peer to peer funding dis:

  • Are classified as private business loans, so the money for the loan comes from several investors or small businesses.
  • if not enough interested individuals or willing to invest in your loans, cant acquire entire amount.
• Business angels:

  • angel investors offer to lend their personal disposable finance.
  • angle will normally take shares in the business in return for providing finance.
  • normally, seek to not only provide the business with money to grow, but also brings their experience and knowledge to help the company achieve success.
• Business angel adv:

  • angels are free to make investment decisions quickly.
  • owner gets access to your investors sector knowledge and contacts.
  • angles mentoring or management skills.
• Business angels dis:

  • not suitable for investment below £10,000 or more than £500,000.
  • owner needs to give up shares of the business.
• Crowd funding:

  • Is where a large number of people fund a project over the interest making a small investment each -
  • Donate - no money back, but rewards like tickets or newsletters.
  • Lend - get money back with interest and satisfaction of contributing to success of a small business.
  • invest - invest in a business in Exchange for equity or shares which may increase value.
• Crowd funding adv:

  • good alternative to loans for small businesses.
  • finance can be obtained without paying upfront fees.
  • business can generate funds and also promote the business at the same time.
• Crowd funding dis:

  • will need to showcase their ideas to investors and may need to put together a video and other promotional material to attract investors.
• Other businesses:

  • Other businesses may wish to invest in start-ups.
  • may have surplus profit and view this as a way to get a good return on their investment.
  • usually, IT or disruptive technology businesses will attract funding as they are likely to offer a large % return on investment.
• sources of external finance:

  • family and friends
  • banks
  • peer to peer funding
  • business angels
  • crowd funding
  • other businesses
• Methods of external finance:

  • bank loans
  • share capital
  • venture capital
  • overdrafts
  • leasing
  • trade credit
  • grants
• Bank loans:

  • an amount of money loaned at interest by a bank for a certain period of time.
• Bank loan adv:

  • loan is not repayable on demand.
  • you don’t give % of the business.
• Bank loan dis:

  • loans aren’t flexible
  • interest rates may change after term is up.
• Share capital:

  • companies raise finance to expand by selling their shares.
• Share capital adv:

  • funding flexibility (raise finance without taking on debt).
  • permanent capital (don’t expect capital to be repaid).
  • no obligation to pay dividends.
• Share capital dis:

  • ownership dilution
  • loss of privacy
  • reduced control
  • admin costs
• venture capital:

  • invest large sums of other people money in a business in return for shares in the company.
• Venture capital adv:

  • lacks monthly payments.
  • assists future finance.
  • provide expert business management.
• Venture capital dis:

  • expensive
  • difficult to obtain
  • relatively scarce
  • requires setting up a board of directors.
• Overdrafts:

  • an overdraft may be organised by the bank which is short term lending of smaller amounts of money.
• Overdraft adv:

  • are flexible (borrow when needed).
  • cheaper than loans.
  • quick to arrange.
• Overdraft dis:

  • charged interest for borrowing
  • going over arranged overdraft limit may affect credit score.
  • temptation to overspend.
• Leasing:

  • one party agrees to rent property owned by another party.
• Leasing adv:

  • this is a lower monthly cost than loans.
  • can be arranged without and advanced fees being paid.
• Leasing dis:

  • pleasing often fixed term, if business changes mind and lease from another business, difficult to get out.
• Trade credit:

  • one business trades with another, the seller gives the buyer 30,60,90 days to pay.
• Trade credit adv:

  • improved cashflow management
  • opportunity for discounts
  • flexibility in payment terms.
• Trade credit dis:

  • interest costs
  • reduced negotiating
  • late penalty payments.
• Grants:

  • the government provides financial help to businesses in some areas of the country.