2.1.2 External finance

Bank loan

Money borrowed from a bank and repaid with interest over time.

Benefits of a bank loan

• Large sums of money

• No loss of ownership

• Might offer advisory services

Limitations of a bank loan

• May request a business plan

• May demand collateral security

• Challenging for new businesses

• Must be repaid with interest

Business angels

Individuals who invest in a business in exchange for a share of ownership (equity).

Benefits of business angels

• Access to expertise and guidance

• Willing to take risks

• Flexible financing terms

Limitations of business angels

• Loss of control in decision making

• Finding the right business angel can be challenging

• They will receive a share of business profits, loss of ownership

Crowdfunding

An external source of finance where many individuals fund a business or project, often through websites like Crowdfunder, in return for shares, discounts, or free products.

Benefits of crowdfunding

• Creates an organic customer base

• Platform provides a form of free marketing

• A good credit rating is nit required, so new businesses that lack a trading record can attract funding

Limitations of crowdfunding

• Businesses need to provide a persuasive business plan

• Uncertainty of raising enough start up capital

External finance

Money raised from outside the business.

Grant

A sum of money given by a government or organisation that does not need to be repaid and has no interest.

Benefits of a grant

• Do not need to be repaid

• No loss of ownership

• Available to small businesses

• Encourages innovation

Limitations of a grant

• Business must use the finance for its intended purpose

• Highly competitive and limited availability

• Business needs to meet a certain criteria

• Time consuming to apply for grants

Leasing

A contract that allows a business to use resources such as property or equipment without owning them.

Benefits of leasing

• Not responsible for maintenance or repair costs

• No large upfront payments

Disadvantages of leasing

• Usually more expensive in the long run

• Never own the asset

Loan

An external source of finance; money borrowed and usually repaid after a fixed term of more than 12 months.

Benefits of a loan

• Interest rates are fixed

• repayments are made in equal instalments, helping with budgeting

• Businesses can purchase expensive equipment or property without the need for large amounts of capital

• Control over decision making is retained within the business

Limitations of a loan

• Interest payments

• With a mortgage, missed payments may lead to the property being repossessed

• Failure to repay debentures may deter investors in the future

Overdraft

When a business withdraws more money than is available in its bank account, creating a negative balance.

Benefits of overdrafts

• Provides flexibility for businesses

• Aids cash flow

• Quite easy to obtain

• Provides businesses with emergency funds to finance their operations

Limitations of overdrafts

• Banks usually only lend a small amount of money

• Banks can ask to be repaid on very short notice

Peer-to-peer funding

When individuals lend money directly to other individuals or businesses through online platforms.

Benefits of peer-to-peer funding

• No loss of ownership (no shares of the business taken)

• Usually very quick to access loans

Limitations of peer-to-peer funding

• Borrowers are charged a fee to access finance in this way

• They have to pay interest payments on the money

• If business defaults, reputation damaged across the P2P community

Family and friends

An informal way in which business approach close acquaintances to invest or lend money to a business.

Benefits of family and friends

• Quick to access

• Flexible repayment terms

• Usually very cheap source of funds, no interest payments

Limitations of family and friends

• Relationships may be damaged

• Limited funds (compared to banks)

Other businesses

Funds provided by other businesses, possibly through a joint venture, or by buying shared in their companies as an investment.

Benefits of other businesses

• May get access to large amounts of finance

• May provide chess to business processes and market knowledge

Limitations of other businesses

• Profits need to be shared between businesses

• Decisions will need to be agreed upon by all businesses, loss of control

Share capital

Finance raised by a business through the issuing or selling of new shares.

Benefits of share capital

• Large amounts of capital can be raised

• Does not need to be repaid, no interest payments

Limitations of share capital

• Shareholders need to be paid dividends

• Shareholders usually have a vote at a company’s annual general meeting

Trade credit

When a business receives goods or materials from a supplier and pays for them at a later date.

Benefits of trade credit

• Usually no interest payments

• Access to supplies without immediate payment

Limitations of trade credit

• Short term, must be paid of quickly

• Usually small amounts of funds

Venture capital

External finance from investors who provide capital in exchange for shares in the company, often to help it grow.

Benefits of venture capital

• Potential to raise large amounts of capital

• May offer advice and guidance

• Willing to invest in innovative, high-risk ventures that banks might reject

Limitations of venture capital

• Loss of control, usually require a stake in the business

• Pressure for high returns