Chapter 25B: External finance

Methods of external finance

• Bank loans

• Leasing

• Share capital

• Trade credit

• Venture capital

• Grants

• Overdrafts

Bank loans

Sum of money ➡ borrowed and repaid with interest ➡ over period of time ➡ usually unsecured ➡ repaid over years

Advantages of bank loans

• Interest rates fixed for term of the loan

• Repayments made in equal instalments ➡ helps budgeting

Disadvantages of bank loans

• Interest rates depend on business’ credit rating

• Higher costs for business ➡ added a debt

Overdrafts

Allows business to spend more money ➡ than they have on their accounts ➡ limit is agreed ➡ interest only charge when a business overdraws

Business has negative balance on their account ➡ amount withdrawn greater than current balance

Advantages of overdrafts

• Offers flexibility

• Aids cash flow

Disadvantages of overdrafts

• Bank may be concerned ➡ business’ ability to repay what it owes

Share capital

Finance raised by business ➡ issuing/selling new shares

Advantages of share capital

• Large amounts of capital can be raised

• No interest paid

Disadvantages of share capital

• Shareholders have an annual voting ➡ time consuming

• Loss of control ➡ owners may be compromised

Venture capital

External source of finance ➡ business issues shares to small number of investors ➡ in return for capital injection into company

Advantage of venture capital

• Businesses refused by other sources ➡ may attract investment from venture capitalists

Disadvantage of venture capital

• VCs usually require stake in the business ➡ in return for finance

• Often expect to exert some control over business

Leasing

Contract to acquire ➡ use of resources ➡ machinery/vehicles

Advantage of leasing

• Maintenance/repair costs are with leasing company

Disadvantage of leasing

• More expensive in the long run ➡ than buying an asset

Trade credit

Firm receives stock/inventory/raw materials from supplier ➡ which it does not need to pay for until later

Advantage of trade credit

• Usually interest-free

Disadvantage of trade credit

• Discounts for early payment ➡ not available

Grants

Sum of money given by government ➡ usually given to new businesses

Advantage of grants

• No need to be repaid

Disadvantage of grants

• Business must use finance for intended purpose