T27- External finance

• Dividends are cash distributions made by companies to their shareholders from current profits or retained earnings.
• Shareholder value maximization (SVM) is an approach that aims to increase the market price per share, which can be achieved through dividend payments or buybacks.
• The cost of equity is the return required by shareholders to compensate them for holding shares.
• What are sources of external finance?

  • family and friends
  • banks
  • peer to peer lending (P2PL)
  • business angels
• what is P2PL?

  • doesn't involve using a bank
  • all loans are unsecured
  • online transactions
  • interest rates are better for both ‘peers’
• what are business angels?

   individuals who look to invest between 10,000 to 100,000 into a business for a share of the ownership in return. E.g. dragons’ den. Owners can use the business angel’s expertise in both business and finance. Can be difficult to attract a business angel m also the business angel may get hold of control of the business which may not be ideal.
• what is crowdfunding?

  This is similar to peer to peer lending, banks are excluded. People lend money to others often for a small reward, often prepare an event and all conducted online
• bank loans - method of finance

  long term finance:

  • loan provided over fixed period
  • rate of interest either fixed or variable
  • timing and amount of repayments are set
  • start up provide some security
  • good for financing investment in fixed assets
  • generally at a lower rate of interest than a bank overdraft
  • doesn't provide flexibility
• bank overdraft - methods of finance

  • short-term finance, widely used by businesses of all sizes
  • an overdraft is really a loan facility – the bank lets the business ‘owe it money’ when the bank balance goes below zero, in return for charging a high rate of interest
  • a flexible source of finance, in the sense that it is only used when needed
  • bank overdrafts are excellent for helping a business handle seasonal fluctuation in cash flow or when the business runs into short term cash flow problems (e.g. a major customer fails to pay on time).
• what is a debenture?

  a debenture is a form of bond or long-term loan which is issued by the company, usually with a fixed rate of interest (over 5 or 10 years often very favourable rates).
• debenture:

  -       Long term: often 10-20 years

  -       Issued by the company (not a bank)

  -       Fixed rate of interest

  -       Usually secured against the assets of the company (provides some protection for debenture holders)

  Can be traded
• What are benefits of a company offering more shares?

  • able to raise substantial funds if the business has goof prospects
  • broader base of shareholders
  • equity rather than debt = lower risk finance structure
• what are drawbacks of a company issuing more shares?

  • can be costly and time consuming
  • existing shareholders holding may be diluted
  • equity has a cost of capital that is higher than debt
• what is venture capital?

  • Specialist investors in private companies
  • Often back management buy-outs (MBOs)
  • They manage investment funds designed to achieve higher rates of returns
  • Tend to focus more on larger investments (>£1m)
  • Will seek a large share of the share capital (equity) + representation on the board
  • Look to sell (‘exit’) their investment in the medium-term (e.g. 5-7 years)
• what is leasing?

  A lease is a contract often over 3 years long. A business will make regular payments for the use of the equipment. The business does not own the equipment/ assets. No large sum of money is needed and after the period of time you can lease a more up to date piece of equipment. This can be an expensive option than the outright purchase of the asset.
• what is a grant?

  Sometimes a government might provide a grant to a business to produce a specific type of product or service. Grants often don’t have to be repaid. E.g. solar panels, electric vehicle charger.
• what is trade credit?


  Trade credit is a form of financing where a supplier allows a customer to purchase goods or services on credit, with payment due at a later date.
• what is a drawback of trade credit?


  sometimes business don't pay their suppliers for a month or two. instead they use it to finance their own business.

  • often most agreements are up to 30days
• what is the appropriate finance for a sole trader(unlimited liability)?

  Source- family & friends

  Method- loan- suitable because cheap and easy, often they do not want a stake in the business, however could fall out with family if not paid back.

  Source- owners capital (personal savings)

  Method- loan. Free, comes from savings, redundancy, inheritance, more committed to business.
• what is the appropriate finance for limited partnerships?

  Source- bank overdrafts

  Method- money can be taken out of the bank when the bank balance is below zero to put into the business.
• what is the appropriate finance for public liminted companies?

  Source- share capital

  Method- provided by owners of the business from their own resources, discounting additional shares to existing shareholders to sell more shares which raises money for the business.
• what is an appropriate finance for private limited companies?

  Source- debentures

  Method- a long term loan (up to 30 years)