2.1.3: External finance

external finance

• finance from sources outside the business

• usually unavailable initially as new business have no trading record and present risk

• realistic option once business has survived initial stages

sources of finance

• family and friends

• banks

• peer-to-peer funding

• business angels

• crowd funding

• other businesses

family and friends

• common for small business

• cheap source - low interest on loan

• no need to share ownership

• could lead to loss of friendship/breakdown of family

banks

• loans, overdrafts, mortgages

• banks involved as businessed need a bank account to facilitate financial transactions

• might offer free advisory services

peer-to-peer lending (P2PL)

• people lending money to unrelated individuals avoiding use of a bank

• not exclusive to businesses

• features:

  • secured loans - no protection for lenders

  • for profit

  • take place online

  • no previous knowledge or relationship needed between lender and borrower

  • lenders can choose which borrower to lend to

  • websites have a 1% charge

• better interest rates for borrowers and lenders

• convenient and can be completed quickly online

• lack of government protection for lenders

• no instant access to cash for lenders

business angels

• individuals who invest between 10k-100k+

• exchange for a stake in a business

• 1-2 investments in 3 years - individually or together with someone else

• invest in start-ups or expansions

• people because business angels because:

  • they like excitement of risk

  • like being part of a new or developing business

  • attracted by tax relief offered

  • investment opportunities for surplus income

• problem: finding a suitable angel

  • must have shared interest and common vision

  • owners may want angels with business experience hoping they can provide input

  • owners may want angels to keep their distance while keeping financial interest

  • angels may be demanding with time pressure

• angels may be overwhelmed by business propositions and spend time selecting targets for investment

• business must present clear, compelling proposition and highlight positives as well as risk

• owners must be comfortable with sharing profits with angel

crowd funding

• banks are excluded

• individuals lend money to others with no previous knowledge

• fundraisers are businesses

• lenders or investors are a large number of people collectively representing the crowd

• online transactions administered by crowd funding specialist

• allow those seeking finance to publish details of business project

• some sites carry out checks on fundraisers

• investors offered shares in the business

other businesses

• setting up a fully funded subsidiary - setting up a manufacturing company to supply business with components

• joint ventures - sharing finance, cost and profit

• PLCs may buy shares in other companies - earn income, control stakes, takeover

methods of finance

• loans

• share capital

• venture capital

• overdrafts

• leasing

• trade credit

• grants

loan

arrangement where the amount borrowed must be returned over a fixed period of time in regular payments (inflexible, interest added)

• bank loans: unsecured, high risk for banks

• mortages: secured, assrts as collateral, long-term, 25+ years, fund premises or buy a large capital equipment, cheaper than unsecured loans, less risk for lender

• debentures: specialised financing, debenture holder = creditor of a company (someone business owes money), fixed rate of return, no voting rights, repaid on set date, used by public limited for long term financing

share capital

• important for limited companies

• selling shares

• issues share capital - money raised from selling shares

• authorised share capital - maximum amount shareholders want to raise

• share capital - permanent capital

  • not normally redeemed (not repaid)

  • buyer entitled to dividend

    • amount not always declared

• capital gain - shareholder selling share at higher price than it was bought for

• not normally sold back to business

• public limited companies - shares sold in stock market or stock exchange

• private limited company - shares transferred privately

• shareholders entitled to vote - 1 vote per share

  • takes place annually

  • vote to re-elect or replace board of directors

types of shares:

1. ordinary shares

   • equities

   • common

   • riskiest

   • no guaranteed dividend

   • size of divident depends on profit made and profit retained

   • have voting rights

   • share prices change as bought

2. preference shares

   • owners recieve fixed rate of return when declaring dividend

   • less risk

   • shareholders aren’t strictly owners

   • company sold = rights to dividend and late payment limited to fixed amounts

   • sometimes allow holders to recieve late payments that were missed when dividend wasn’t declared

   • some are redeemable - can be bought back by company

3. deferred shares

   • rare

   • held by founders

   • only recieve dividend after ordinary shareholders have been paid

venture capital

• specialists in provision of funds

• small and medium sized business

• invest after start-up

• prefer technology companies with growth potential

• prefer stake in company for control and profit shares

• raises funds from institutional investors

• likely to exit after 5 years

bank overdraft

• business can spend more money than it has

• ‘overdrawn’

• bank and business agree on overdraft limit and interest charged when account is overdrawn

• amount of overdrawn depends on business needs

• flexible source of funding

• bank has legal right to call in the money owed anytime

leasing