Chapter 25A: External finance

External finance

Money raised from outside the business

Sources of external finance

• Family and friends

• Banks

• Peer-to-peer lending

• Business angels

• Crowdfunding

• Other businesses

Family and friends

Small business owners approach ➡ close acquaintances ➡ invest in/lend money to a business

Advantages/disadvantages of family and friends

Advantages	Disadvantages
Cheap source of funds	Relationships may be damaged ➡ if finance is not repaid
‘No strings attached’ ➡ provided to the business on flexible terms

Banks/bank loans

External method of finance➡ money borrowed from a bank ➡ paid back with interest

Advantages/disadvantages of bank loans

Advantages	Disadvantages
Offers both short-term and long-term finance ➡ depending on what business needs	Business plan usually required to access bank finance
Large amounts can be loaned	Interest needs to be paid back to bank
Might offer free advisory services to businesses	Business may need to provide security to be granted large loans

Peer-to-peer lending

When a person lends money ➡ to other individuals/business ➡ via online transactions

Advantages/disadvantages of P2P lending

Advantages	Disadvantages
Loans usually made available very quickly	Borrowers charged a small fee
‘No strings attached’ ➡ no need for shares of business	Interest needs to be paid back

Business angels

Individuals who invest in a business ➡ in exchange for a stake (shares) in the business

Advantages/disadvantages of business angels

Advantages	Disadvantages
BAs tend to be more willing to take risks	Finding the ‘right’ business angel can be challenging
Free advice and guidance to business	May be involved in decision making ➡ owners feel their freedom is compromised
Investment usually for a determined period of time

Crowdfunding

Where a large number of individuals ➡ provide funding for a business/project ➡ in return for shares/free discounts ➡ via the internet/crowdfunding platform

Advantages/disadvantages of crowdfunding

Advantages	Disadvantages
Creates organic customer base ➡ platform provides free marketing	Businesses need to provide ➡ persuasive business plan ➡ to convince individuals to invest in their product
Credit rating not required ➡ new business that lack trading record can attract funding	Potential of negative publicity if project is not successful ➡ in attracting crowdfunding capital

Advantages/disadvantages of other businesses

Advantages	Disadvantages
May provide access to business processes + market knowledge	Profits need to be shared between business
Can access large amounts of finance	Long decision making process ➡ conflict of interests