External Finance Flashcards

External Sources of Finance

• Family & Friends:

  • Often low/zero interest, making it an attractive option for startups or small businesses.

  • Informal terms can lead to disputes, especially if the business struggles.

  • Advantages:

  • Flexible repayment terms.

  • Quick access to funds.

  • Disadvantages:

  • Limited capital.

  • Potential strain on relationships.

• Banks:

  • Provide loans, overdrafts, and mortgages to help businesses manage cash flow or invest in assets.

  • Offer advice and support, leveraging their financial expertise.

  • High risk may result in high interest rates or denial of loan, particularly for young or unstable businesses.

  • Advantages:

  • Large sums available.

  • Structured financial planning.

  • Disadvantages:

  • Strict eligibility criteria.

  • Repayment obligations.

• Peer-to-Peer Lending:

  • Loans from groups via P2P websites, providing an alternative to traditional bank loans.

  • Quick online applications streamline the borrowing process.

  • Lower interest rates than banks can make it an appealing choice.

  • Less regulation = higher risk for lenders and potentially borrowers.

  • Advantages:

  • Competitive interest rates.

  • Accessible online platform.

  • Disadvantages:

  • Risk of default.

  • Limited investor protection.

• Business Angels:

  • Individuals investing £10,000-£100,000 for shares, looking for high-growth potential.

  • Long-term investment with advice and support can be invaluable for startups.

  • Finding angels with a common vision can be difficult, requiring careful networking.

  • Advantages:

  • Mentorship and guidance.

  • Network of contacts.

  • Disadvantages:

  • Equity dilution.

  • Potential loss of control.

• Crowdfunding:

  • Large groups invest small amounts via crowdfunding websites, often pre-ordering products.

  • Can raise large sums quickly, especially for innovative or socially beneficial projects.

  • Extra marketing and exposure can significantly boost a company’s profile.

  • May need to offer shares, reducing the original owner's control.

  • Advantages:

  • Marketing boost.

  • Community engagement.

  • Disadvantages:

  • Public scrutiny.

  • Project failure risk.

• Other Businesses:

  • Finance to buy shares for control/takeover, potentially integrating resources and expertise.

  • Large sums and expertise provided can accelerate growth.

  • Risk of takeover, changing the direction of the company.

  • Advantages:

  • Access to resources and expertise.

  • Synergistic growth opportunities.

  • Disadvantages:

  • Loss of autonomy.

  • Potential conflicts of interest.

External Methods of Finance

• Bank Loans:

  • Borrow money for a set period with agreed repayment, suitable for significant investments.

  • Low-interest rates (compared to other bank finances) make it cost-effective.

  • Quick to arrange, providing timely access to funds.

  • Inflexible repayment schedule can strain cash flow.

  • Advantages:

  • Predictable repayment schedule.

  • Retained ownership.

  • Disadvantages:

  • Collateral requirements.

  • Impact on credit rating.

• Mortgages:

  • Loans secured on an asset, reducing risk for the lender.

  • Lower interest rate compared to unsecured loans.

  • Risk losing asset if not repaid, requiring careful financial management.

  • Advantages:

  • Long-term financing option.

  • Lower interest rates.

  • Disadvantages:

  • Risk of foreclosure.

  • Stringent approval process.

• Issue Share Capital:

  • Selling shares to investors (Ltd/PLC), bringing in new capital.

  • No interest payments reduce the financial burden.

  • Potential loss of ownership and control, requiring shareholder management.

  • Need to pay dividends might affect profitability.

  • Advantages:

  • Source of permanent capital.

  • No repayment obligations.

  • Disadvantages:

  • Dilution of ownership.

  • Shareholder expectations.

• Venture Capital:

  • VCs invest in part ownership to help businesses grow, often targeting high-growth sectors.

  • Significant finance and expertise can drive expansion.

  • Diluted ownership; VCs want a say in the business, potentially leading to conflicts.

  • Advantages:

  • Access to expertise and networks.

  • Catalytic growth potential.

  • Disadvantages:

  • High expectations for returns.

  • Loss of strategic control.

• Overdrafts:

  • Spending beyond available balance, providing a financial cushion.

  • Extra cash for short-term issues, like managing uneven cash flow.

  • High interest rates can make it an expensive option if used long-term.

  • Advantages:

  • Immediate access to funds.

  • Flexibility in usage.

  • Disadvantages:

  • High interest charges.

  • Potential for overspending.

• Leasing:

  • Leasing equipment instead of buying, preserving capital.

  • No large upfront costs, making it accessible for startups.

  • Maintenance covered reduces operational headaches.

  • More expensive long term, increasing overall costs.

  • Advantages:

  • Predictable monthly payments.

  • Access to up-to-date equipment.

  • Disadvantages:

  • No asset ownership.

  • Potential for early termination fees.

• Trade Credit:

  • Buying goods/services and paying later (e.g., 30-60 days), improving liquidity.

  • Aids cash flow by delaying payments.

  • Some suppliers may not offer it, limiting flexibility.

  • Advantages:

  • Improved cash flow management.

  • Short-term liquidity.

  • Disadvantages:

  • Potential for late payment fees.

  • Dependence on supplier terms.

• Grants:

  • ‘Free’ money from the government/charities to support small businesses to meet certain targets

  • Doesn’t have to be paid back

  • Only given to businesses that meet a certain criteria and requires a good business plan

  • Advantages:

  • Does not need to be paid back

  • Boost credibility

  • Disadvantages:

  • Competitive

  • Strict Conditions

• Debt factoring

  • Business sells their invoices (money customers owe) to a debt factoring company at a discounted price

  • Quickly