2.1.2 External Finance

• External finance is sourced from outside of the business
• Family & Friends (ESF)

  • Small business owners approach close acquaintances to invest in or lend money to a business
  • used by Sole trader, Partnership & Ltd
• Advantages of friends & family

  • cheap source of funds
  • hold no shares in business
  • can be on flexible terms
• Disadvantages of friends & family

  • Relationship may be damaged if finance is not repaid
• Banks ( ESF)

  • Banks provide several different kinds of loans to businesses e.g. a small business loan
• Advantages of Bank

  • offer both short & long term finance
  • provide free advice & guidance to business
  • small sums may be borrowed from unsecured
• Disadvantages of Bank

  • business plan required
  • can be cautious about lending to new, untested business
  • Interest
  • Business must be customers of the bank
  • for larger amounts, business may need to provide security to be granted a loan
• Peer to peer funding is Individuals with available savings pool it with others in a peer investment scheme such as Funding Circle
• Advantages of Peer to Peer funding

  • Loans can be made to business' quicker
  • usually has no shares attached
• Disadvantages of Peer to Peer funding

  Unsecured loans without going through bank

  higher risk for the lender as the loan may not be paid back

  Borrowers are charged a small fee to access finance and have to pay interest
• Business angels


  • Some individuals specialise in making investments in start-up or expanding businesses e.g. Dragons Den investors
• Advantages of Business Angels

  more willing to take risks than a bank

  Angels offer guidance & support, money to grow & experience and knowledge

  Investment is usually for a determined period of time so owners regain shares in the future
• Disadvantages of Business Angels

  Usually holds stake in business - influence decision making & receive shares

  Finding the appropriate angel with the right kind of expertise can be hard
• • Crowdfunding allows businesses to access finance provided by a large number of small investors on online platforms such as Kickstarter
• 'Donate' crowdfunding

  Contributors don't get their money back, but rewards like tickets or newsletters are given in return
• 'Lend' crowdfunding

  Contributors get money back with interest & satisfaction of contributing to a small business
• 'Invest' crowdfunding


  Contributors invest in the business in exchange for equity shares
• Advantages of Crowd funding

  • Platform provides free marketing
  • Creates an organic customer base
  • good credit rating is not required so new business can also attract funding
• Disadvantages of Crowd funding

  need a persuasive business plan

  competition - needs high differentiation

  potential of negative publicity if project is not as successful
• • It may be possible for a business to access finance via a joint venture with another business, such as a key customer or supplier
• Advantages of investing in other business

  Provide access to business knowledge & processes along side finance

  Can access large amounts of finance
• Disadvantages of investing in other business

  Profits need to be shared between business

  Decisions will have to be agreed by all business' involved
• (MEF) Loans are a sum of money is borrowed and repaid with interest over a determined period of time
• Advantages of Loans

  • Interest rates are fixed for the term of the loan
  • Repayments are made in equal instalments, helping budgeting
  • Quicker to get
  • Unsecured - no collateral is needed
• Disadvantages of Loans

  • Interest rates depend on the businesses credit rating
  • Non-current liabilities are increased in the balance sheet
• Overdrafts are an arrangement whereby a bank allows a business to spend more than it has in its account up to a certain limit.
• Advantages of Over draft

  •  short-term source of finance that offers significant flexibility and aids cash flow
  • interest is charged only when a business ‘goes overdrawn’
• Disadvantages of Overdraft

  • An overdraft may be ‘called in’ if the bank is concerned about a business's ability to repay what it owes
• • Share capital is finance raised from the sale of shares in a limited company
• Advantages of Share Capital

  • Large amounts of capital can be raised, especially by plc
  • No Interest
  • Long term method
• Disadvantages of Share Capital

  • Shareholders are entitled to a share of the company’s profit when dividends are declared
  • only apply to large business
  • Shareholders influence decision making
• Venture Capital


  Funds provided by specialist investors in small to medium-sized businesses that have significant potential for growth
• Advantages of Venture Capital

  • Businesses that may have been refused finance from other sources may be able to attract investment from less risk-averse venture capitalists
• Disadvantages of Venture Capital

  Look for a high rate of return, strong business plan, sound management & a proven track record

  Only invest money, no experience/knowledge
• Leasing is when an asset such as a piece of machinery or a vehicle used by a business in return for regular payments
• Advantages of leasing

  Business doesn't own equipment so not responsible for maintenance & repair
• Disadvantage of leasing


  More expensive in the long run than buying an asset
• • Trade Credit is when an agreement is made with suppliers to buy raw materials, components and stock which are paid for at a later date, typically 30 to 90 days later
• Advantages of Trade Credit

  interest free
• Disadvantages of Trade credit

  • Discounts for early payment will not be available