3.2 — Sources of Finance

Start-up

Initial capital to launch business

Equipment, premises, inventory, working capital

Working capital

Fund day-to-day operations

Pay suppliers, wages before receiving customer payments

Expansion

Grow the business

New locations, equipment, acquisitions

Survival

Cover cash flow gaps, emergencies

Unexpected costs, slow sales periods

Replacement

Update worn-out or obsolete assets

New machinery, vehicles, technology

R&D

Develop new products/services

Research, prototyping, testing

By source

Internal vs External

By time period

Short-term vs Medium-term vs Long-term

By ownership

Debt (borrowing) vs Equity (ownership)

Definition

Finance generated from within the business

Finance obtained from outside the business

Sources

Retained profit, sale of assets, reduced working capital

Loans, shares, overdrafts, investors, grants

Cost

Often lower/no explicit cost

Interest, dividends, fees

Control

No dilution of ownership

May involve giving up control or meeting conditions

Availability

Limited by business performance

Depends on business creditworthiness, market conditions

Short-term

Repayable within 1 year

Overdraft, trade credit, factoring

Working capital, temporary needs

Medium-term

Repayable 1-5 years

Term loans, hire purchase, leasing

Vehicles, equipment

Long-term

Repayable beyond 5 years

Mortgages, share capital, debentures

Property, major expansion

1. Generate profit

Revenue minus all costs

2. Pay tax

Corporation tax on profits

3. Consider dividends

Decide how much to distribute to owners

4. Retain remainder

Keep remaining profit in business

5. Reinvest

Use for business purposes

No interest cost

Unlike loans, no interest payments

No repayment

Money stays in business permanently

No dilution

Ownership structure unchanged

No approval needed

Don't need bank/investor agreement

Flexible

Use for any purpose

No security required

No collateral needed

Low risk

No debt obligations

Immediate availability

If profits exist, they're accessible

Confidential

No disclosure to external parties

Limited amount

Constrained by profitability

Opportunity cost

Shareholders miss dividends

May not exist

Loss-making businesses have none

Slow accumulation

Takes time to build significant funds

May be insufficient

For large investments

Reduces shareholder returns

Lower dividends may upset shareholders

No external discipline

Easier to misallocate internal funds

Profitable businesses

Startups (no profit history)

Organic growth

Large, immediate investments

Maintaining control

Loss-making businesses

Businesses with patient shareholders

Businesses with dividend-dependent shareholders

Property

Land, buildings no longer needed

Vehicles

Old vehicles being replaced

Equipment

Surplus or obsolete machinery

Inventory

Old stock, slow-moving items (at discount)

Investments

Shares in other companies

Intellectual property

Patents, trademarks not being used

Business units

Divisions, subsidiaries (divestment)

Step 1

Business sells asset (e.g., building) to buyer

Step 2

Business receives cash immediately

Step 3

Business leases asset back from new owner

Step 4

Business continues using asset but pays rent

Large cash injection

Long-term rental costs

Continue using asset

No longer own asset

May improve balance sheet ratios

Lose any future appreciation

Tax-deductible rent

Lease terms may be restrictive

Immediate cash

Quick access to funds

No interest

No borrowing costs

No dilution

Ownership unchanged

Reduces maintenance

No longer responsible for sold asset

Focuses resources

Sell non-core assets

May improve efficiency

Remove underutilised assets

One-off

Can only sell asset once

May get less than value

Quick sale may mean discount

Loss of asset

No longer available for use

May affect operations

If sold asset was needed

Capital gains tax

May be tax on profit from sale

Sign of weakness

May signal financial difficulties

Limited assets

May not have suitable assets to sell

Reduce inventory

Hold less stock; just-in-time; sell slow-moving items

Speed up receivables

Collect from customers faster; shorter credit terms

Delay payables

Take longer to pay suppliers (within terms)

Better cash management

Reduce unnecessary cash holdings

No external cost

No interest, fees

Immediate effect

Can implement quickly

Internal control

Doesn't involve outsiders

Improves efficiency

Forces better management

Limited scope

Only so much working capital to release

Risks

Too little inventory → stockouts; slow payment → supplier relationships

Short-term

Not sustainable long-term solution

May harm business

Aggressive collection alienates customers

Quick, flexible

Limited by owner's personal wealth

No interest

Owner loses personal liquidity

Shows commitment

Risk to owner's personal finances

No external approval

May not be sufficient

Ordinary shares

Voting rights; dividends variable; last to be paid in liquidation; most common

Preference shares

Fixed dividend; paid before ordinary; usually no voting; lower risk

Buyers

Family, friends, employees, private investors

Process

Private negotiation; no public offer

Restrictions

Cannot sell to general public

Regulation

Less regulated than public issues

Control

Founders can maintain control

Initial Public Offering (IPO)

First sale of shares to public; company "goes public"

Rights issue

Offer new shares to existing shareholders first

Placing

Sell shares to selected institutional investors

Bonus issue

Free shares to existing shareholders (from reserves)

No repayment required

Permanent capital

No interest

Dividends only if profitable and declared

Large sums possible

PLCs can raise substantial amounts

No security

No collateral required

Reduces gearing

Improves debt/equity ratio

Shared risk

Risk spread among shareholders

Credibility

Listed company status

Dilution

Existing shareholders' ownership % reduced

Loss of control

New shareholders may influence decisions

Dividend expectations

Shareholders expect returns

Expensive process

IPO costs significant (lawyers, accountants, underwriters)

Disclosure

Must publish financial information

Takeover risk

Shares can be bought by hostile bidders

Market pressure

Share price creates pressure for short-term results

Stage

Often early-stage or growth businesses

Amount

Typically £250,000 to £10 million+

Equity stake

Usually 20-49% ownership

Involvement

Active role; board seat; advice

Exit

Plan to sell stake in 3-7 years (IPO, trade sale)

Risk tolerance

Accepts high risk for high return

Large amounts

More than banks typically lend to startups

Expertise

Investors bring experience, contacts, advice

No repayment

Equity investment, not loan

Credibility

VC backing signals quality to others

Aligned interests

VC succeeds when business succeeds

Support growth

Often provide follow-on funding

Equity dilution

Give up significant ownership

Loss of control

VCs influence strategic decisions

Pressure

Expectation of rapid growth

Exit focus

VCs want exit; may not align with founder goals

Difficult to obtain

Very selective; most applications rejected

Due diligence

Intensive process; time-consuming

May lose business

If targets not met, VC may push for changes

Amount

Typically £10,000 to £500,000

Stage

Often seed/startup stage

Involvement

Mentor-like; less formal than VC

Background

Often successful entrepreneurs

Motivation

Returns + enjoyment of helping businesses

Risk

Accept very high risk

Fill funding gap

Between friends/family and VC

Expertise

Practical business experience

Networks

Introduce to contacts

Flexible

Less formal than VC

Patient

Often longer time horizon

Early stage

Willing to fund startups

Equity dilution

Give up ownership

Involvement

May want more say than desired

Limited follow-on

May not have funds for later rounds

Finding angels

Can be difficult to locate

Variable quality

Not all angels helpful

Term loan

Fixed amount, fixed term, regular repayments

Secured loan

Asset pledged as collateral

Unsecured loan

No collateral; higher interest rate

Fixed rate

Interest rate stays same throughout

Variable rate

Interest rate changes with market rates

No ownership dilution

Bank has no ownership or control

Predictable

Fixed repayment schedule

Interest tax-deductible

Reduces corporation tax

Various terms

Can match loan to asset life

Builds relationship

Good repayment history helps future borrowing

Keep all profits

After interest, profits belong to owners

Interest cost

Must pay interest regardless of profit

Repayment obligation

Must repay regardless of business performance

Security required

Often need collateral

Reduces cash flow

Regular repayments reduce available cash

May be refused

Banks assess creditworthiness

Covenants

May restrict business activities

Increases gearing

Higher debt ratio increases risk

Limit

Maximum amount that can be overdrawn

Flexibility

Use as much or little as needed

Interest

Charged only on amount used

Repayable on demand

Bank can ask for repayment at any time

Review

Usually reviewed annually

Fees

Arrangement fee; possibly unused facility fee

Flexibility

Draw down as needed

Pay for what you use

Interest only on amount borrowed

Quick to arrange

Faster than formal loan

Short-term solution

Ideal for temporary cash flow gaps

No fixed repayment

Reduce when cash available

Maintains relationship

Regular bank contact

Repayable on demand

Bank can withdraw facility

Variable interest

Rate can increase

Higher interest

Usually more expensive than term loan

Not for long-term

Expensive if used continuously

Security may be required

For larger facilities

Charges

Fees for arrangement, exceeding limit

Uncertainty

Renewal not guaranteed

Repayment

Flexible; on demand

Fixed schedule

Interest

On amount used

On full amount

Best for

Short-term, variable needs

Specific, planned investment

Security

Bank can withdraw anytime

Fixed term commitment

Cost

Higher rate but flexible

Lower rate but less flexible

Terms

Common terms: 30, 60, or 90 days

Cost

Usually no explicit interest if paid on time

Discounts

Often discount for early payment (e.g., 2% for payment within 10 days)

Relationship

Based on trust and trading history

Interest-free

No cost if paid within terms

Widely available

Standard business practice

Eases cash flow

Time to sell goods before paying

No formal application

Part of normal trading

Flexible

Negotiate different terms

Preserves other credit

Doesn't use up bank facilities

Limited amount

Only for purchase value

Short-term

Must pay within terms

May be withdrawn

If late payment, supplier may stop credit

Opportunity cost

Miss early payment discounts

Relationship risk

Late payment damages supplier relationship

Not for all purchases

Some require immediate payment

Reward-based

Backers receive product or reward

Early access, products, experiences

Equity

Backers receive shares

Ownership stake; potential dividends/capital gain

Debt (peer-to-peer)

Backers lend money

Interest payments

Donation

Backers give without expectation

Nothing; goodwill

Kickstarter

Reward-based (creative projects)

Indiegogo

Reward-based (various)

Crowdcube

Equity crowdfunding (UK)

Seedrs

Equity crowdfunding (UK)

GoFundMe

Donation-based

Funding Circle

Peer-to-peer lending (debt)

Access for startups

Don't need track record

Market validation

Tests demand before production

Marketing

Raises awareness alongside money

Community

Builds engaged supporters

No collateral

Usually not required

Flexible terms

Set own targets, rewards

Retains control

Reward-based keeps full ownership

Not guaranteed

Campaign may not reach target

Time-consuming

Running campaign takes effort

Public

Business idea exposed; competitors can see

Platform fees

Typically 5-10% of funds raised

Delivery pressure

Must deliver rewards/products

Equity dilution

If equity crowdfunding

Investor management

Many small shareholders to communicate with

Reputation risk

Failed campaign or delivery harms reputation

Operating lease

Short-term; lessor retains ownership; asset returned at end

Finance lease

Long-term; lessee has most risks/rewards of ownership; may transfer ownership at end

No large upfront cost

Spread payments over time

Preserves capital

Cash available for other uses

Fixed payments

Easier budgeting

Up-to-date assets

Easier to upgrade

Maintenance included

Often lessor maintains asset

Tax benefits

Lease payments often tax-deductible

Off-balance sheet

Operating leases may not appear as liability

No obsolescence risk

Lessor bears risk of asset becoming outdated

No ownership

Don't own asset at end (operating lease)

Total cost

May pay more than buying outright

Commitment

Locked into payments for term

Restrictions

Limitations on use, modifications

End-of-lease costs

May be charges for wear and tear

No asset value

Don't benefit from appreciation

1

Business selects asset

2

Finance company buys asset

3

Business pays deposit (typically 10-20%)

4

Business makes regular payments over term

5

Ownership transfers to business at end

Eventual ownership

Own asset after final payment

Spread cost

Payments over time, not upfront

Use while paying

Asset available immediately

Fixed payments

Predictable budgeting

Easier than bank loan

Often easier to obtain

Asset as security

Finance company holds title until paid

Interest cost

Pay more than cash price

Committed

Must continue payments

No ownership until end

Can't sell asset during term

Deposit required

Upfront payment needed

Asset may depreciate

Still paying for depreciating asset

Repossession risk

Miss payments, lose asset

Amount

Very small loans (often under $1,000)

Target

Low-income individuals, micro-enterprises

Common in

Developing countries; underserved communities

Providers

Microfinance institutions (MFIs), NGOs, some banks

Terms

Often short-term; small repayments

Security

Often none; or group lending (peers guarantee each other)

Grameen Bank

Pioneer of microfinance; Bangladesh

Kiva

Online platform connecting lenders with borrowers

BRAC

Large MFI based in Bangladesh

Opportunity International

Global microfinance provider

Access

Available to those excluded from traditional banks

Empowerment

Enables entrepreneurship, income generation

No collateral

Often doesn't require security

Small amounts

Appropriate scale for micro-enterprises

Social impact

Reduces poverty; empowers women

Financial inclusion

Brings people into financial system

High interest rates

Often higher than traditional banks

Small amounts

May be insufficient for growth

Debt risk

Borrowers may over-extend

Limited services

May not offer full banking

Sustainability

Some MFIs financially weak

Not suitable for all

Not for larger businesses

R&D grants

Support for innovation, research

Regional grants

Encourage investment in specific areas

Export support

Help businesses enter foreign markets

Training grants

Subsidise workforce development

Environmental grants

Support sustainable practices

Startup grants

Help new businesses launch

Free money; no repayment

Competitive; not guaranteed

No dilution

Specific purposes; conditions

Supports specific activities

Application process complex

Reporting requirements

May be delayed

1

Business sells goods on credit; issues invoice

2

Business sells invoice to factor (typically 80-90% of value immediately)

3

Factor collects from customer

4

Factor pays remaining balance minus fee

Immediate cash

Expensive (fees reduce margin)

Outsource credit control

Loss of customer relationship

Predictable cash flow

May signal financial weakness

No debt on balance sheet

Not suitable for all businesses

Scales with sales

Customer may prefer dealing with you

Collection

Factor collects

Business collects

Customer awareness

Customers know

Customers usually don't know

Control

Factor manages receivables

Business manages

Confidentiality

Less confidential

More confidential

Purpose

Match source to use (long-term asset → long-term finance)

Amount needed

Some sources limited in scale

Cost

Interest rates, fees, dividend expectations

Control

Equity dilutes ownership; debt doesn't

Risk

Debt must be repaid regardless of performance

Availability

What sources can the business actually access?

Security

What assets can be offered as collateral?

Time

How quickly is finance needed?

Stage of business

Startups have fewer options than established firms

Gearing

Current debt levels affect capacity

Tax

Interest is tax-deductible; dividends are not

Flexibility

Some sources more flexible than others

Startup

Personal savings, friends/family, angels, crowdfunding, microfinance, grants

Early growth

Venture capital, bank loans, leasing

Established

Retained profit, bank loans, share issues

Mature

All options; bonds, stock market

Sole trader

Personal savings, bank loan/overdraft, trade credit, friends/family

Partnership

Partners' capital, bank loans, trade credit

Private Ltd

Retained profit, share issues (private), bank loans, leasing, VC, angels

Public Ltd (PLC)

All above + public share issues, bonds, extensive bank facilities

Internal finance

Finance generated from within the business

External finance

Finance obtained from outside the business

Retained profit

Profits kept in the business rather than distributed as dividends

Share capital

Finance raised by selling ownership shares in the company

Venture capital

Investment from specialists in exchange for equity in high-growth businesses

Business angel

Wealthy individual investing in early-stage businesses

Bank loan

Fixed sum borrowed from a bank, repaid with interest over an agreed period

Overdraft

Facility allowing spending more than the bank account balance, up to a limit

Trade credit

Supplier allows payment later (typically 30-90 days)

Crowdfunding

Raising small amounts from many people, usually online

Leasing

Using an asset owned by another in exchange for payments

Hire purchase

Paying to use an asset with ownership transferring at the end

Microfinance

Small-scale financial services for those excluded from traditional banking

Factoring

Selling invoices to a third party for immediate cash