2.1.2 External Finance Methods of finance

Advantages of loans

• Banks will not ask for a % of the business

• Interest rates are fixed for the term of the loan so the business owner can plan ahead

  
  

Disadvantages of loans

• Not very flexible, the business may incur a penalty if they decide to settle the loan early

• A bank will charge interest on the loan

  
  

Advantages of share capital

• Large amounts of capital can be raised, especially by public limited companies

• The company is not committed to fixed interest payments

Disadvantages of share capital

• Existing owners may lose control

• may have to offer a monthly or quarterly dividend to investors

Advantages of venture capital

• Can bring expertise into the business as part of the deal 

• Avoids having to pay interest on the entire amount of finance 

Disadvantages of venture capital

• Venture capitalists usually require a stake in the business in return for finance and often expect to exert some control over the business

• Usually only able to raise small amounts of finance 

Advantages of overdrafts

• A short-term source of finance that offers significant flexibility and aids cash flow

• Interest is only payable on the actual amount borrowed 

Disadvantages of overdrafts

• Interest rates are high 

• An overdraft may be ‘called in’ if the bank is concerned about a business's ability to repay what it owes

Advantages of leasing

• The business does not own the asset during the period of the lease and so is not responsible for maintenance or repair costs

• This is a lower monthly cost for a business owner than a loan

Disadvantages of leasing

• Leasing is often over a fixed term, if the business changes its mind and wants to lease from a different company, contracts may be difficult to get out of

• Leasing is usually more expensive in the long run than buying an asset

Advantages of trade credit

• Business can sell the goods before the stock needs to be paid for, so can make a profit before the costs have to be paid

• usually interest-free

Trade credit disadvantages

• If the business does not pay in time they risk being refused further credit by the supplier in the future

• Discounts for early payment will not be available

Advantages of grants

• Unlike a loan there will be no interest to pay

• The business owner will get funds without any loss of control of the business

Disadvantages of grants

• The business must use the finance for its intended purpose

• Difficult to find a grant that suits their specific project