2.1 Raising finance Flashcards
Define Internal source of finance
When the finance comes from inside the business
Internal finance comes from the owner’s capital, retained profit, or the sale of assets
Define External source of finance
When the finance comes from outside the business
Define Working capital
Money used in day to day operations in a business
Benefits of using internal finance
Internal finance is often free (e.g. it does not involve the payment of interest or charges)
It does not involve third parties who may want to influence business decisions
Internal finance can usually be organised very quickly and without significant paperwork
Businesses that may fail credit checks (necessary for a bank loan) can access internal finance sources more easily
Drawback of using internal finance
There is a significant opportunity cost involved in the use of internal finance, e.g. once retained profit has been used, it is not available for other purposes
Internal finance may not be sufficient to meet the needs of the business
Using an internal finance method is rarely as tax-efficient as many external methods, e.g. loan repayments may be treated as a business cost and offset against tax
Sources of external finance
- Family & friends
- Banks
- Peer-to-peer lending
- Business angels
- Crowdfunding
- Other businesses
Adv. of Family & Friends as a Source of Finance
Usually a very cheap source of funds
May have ‘no strings attached (e.g. a share of the business) and can be provided to the business on very flexible terms
Disadv. of Family and Friends as a Source of Finance
Relationships may be damaged if the finance is not repaid
Adv. of bank loans
May offer both short term finance (e.g. overdrafts) and long term finance (e.g. loans or mortgages) if a business qualifies
Banks are often keen to provide free advice and guidance to businesses that use their services
Small sums may be borrowed from unsecured
Disadv. of bank loans
A business plan is usually required to access bank finance
Banks can be cautious about lending to new, untested businesses
Interest (and often an arrangement fee) is payable
Businesses must be customers of the bank (i.e. hold a banking account) to access some loans
For larger amounts, businesses may need to provide security to be granted a loan
Adv. of P2P funding
Loans can usually be made available to businesses very quickly
Usually has ‘no strings attached (e.g. a share of the business)
What is Peer to peer funding?
Works by matching borrowers with lenders via online platforms or offline brokers
Disadv. of P2P lending
Borrowers are charged a small fee to access finance in this way and have to pay interest in the same way as a bank loan
The individuals who made the money available in the first place receive some of this interest as compensation
What is a Business angel?
Business angels are wealthy, entrepreneurial individuals who provide capital in return for a proportion of your company’s shares.
Advantages of Business Angels
Business angels tend to be more willing to take a risk than banks
Angels often offer advice and guidance to the businesses in which they invest
Investment is usually for a determined period of time so owners regain shares in the future
Disadvantages of Business Angels
Finding the ‘right’ business angel (e.g. with appropriate experience, expertise or interest) can be challenging
Networking is vital when entrepreneurs seek this kind of investment
As business angels own a stake in the business, they may be involved in decision-making and will receive a share of business profits
What is Crowdfunding?
Crowdfunding is finance provided by a large number of small investors on online platforms such as Kickstarter
Adv. of Crowdfunding
Creates an organic customer base and the platform provides a form of free marketing
A good credit rating is not required so new businesses that lack a trading record can attract funding
Disadv. of Crowdfunding
Businesses need to provide a persuasive business plan to convince individuals to invest in their product as they will be competing with many other projects online
The potential for negative publicity if the project is not successful in attracting enough crowdfunding capital
Advantages of Finance from Other Businesses
May provide access to business processes and market knowledge alongside finance
Can access large amounts of finance
Disadvantages of Finance from Other Businesses
Profits need to be shared between businesses
Decisions will usually need to be agreed by all businesses
