2.1.2 External Finance Flashcards
External finance
Capital raised from outside the business
Sources of finance
Where the finance is coming from
Methods of finance
How the finance is provided
Examples of sources of finance
Family and friends, banks, peer to peer funding, business angles, crows finding, other businesses
Different methods of finance
Loans, share capital, venture capital, overdrafts, leasing, trade credit, grants
Family and friends
Investment from people known to the entrepreneur who want to support business
Advantages of family and friends
May be flexible repayment terms and conditions, may provide interest free of low rate finance
Disadvantages of family and friends
Amount may be limited, may place pressure on relationships, lenders may lose money
What type of business is friends and family best for
Small businesses running as sole traders or possibly a partner
Peer to peer funding
The practice of an individual lending to other individuals with whom there is no relationship
Advantages of peer to peer funding
Gives borrowers access to funds at advantageous rates compared to some other forms of finance
Disadvantages of peer to peer funding
Finance is restricted to small amounts and small established businesses
Business angels
Usually high net worth individuals who invest into a start up business in return for equity
What do business angles offer other than capital
Support and expertise
Advantages of business angles
Very knowledgable and experienced, act as mentor for business, provides guidance and advice
Disadvantages of business angels
May require some for of equity which gives them a measure of control
Crowdfunding
Raises money by inviting lots of people to lend small sums of money via websites
Advantages of crowd funding
Millions of potential founders globally
Disadvantages of crowdfunding
Sufficient finance may not be raised
Crowdfunding is best for what type of businesses
Unusual ideas and projects that might to attract other forms of finance
Other businesses
Funds can be provided to other businesses known as B2B funding, businesses with healthy cash balance look to invest into other business
Advantages of other businesses
Includes trade credit, hire Prichard and leasing and corporate venture capital
Disadvantages of other businesses
Trade credit is usually short term, factoring reduces profitability, hire purchasing and leasing can be expensive, venture capital may involve loss of control
Loans
A set amount of money provided for a specific purpose to be repaid with interest over a period of time
Advantages of loans
Quick and easy to secure, fixed interest rates allow firm to budget, improved cash flow, borrower retains ownership of company
Disadvantages of loans
Interest must be paid regardless of financial performance, a firm usually has to provide security known as collateral, can be charged a penalty for early repayments
Share capital
Finance raised through the sales of shares by only private and public limited companies.
How will shareholders be rewarded for their investment
Shareholder becomes part owner of the business, repayment of dividends and the increasing value of their share rises
Advantages of share capital
Only need to pay dividend if a profit is being made and the amount of dividend is not fixed, possible to raise large amounts of finance, no interest repayments
Disadvantages of share capital
Loss of ownership, potential risk of loss of control - threat of hostile takeover, complex and costly process of issuing shares
Venture capital
Investment from an established business into another business in return for a percentage
What type of businesses use venture capital
High risk businesses with potential for rapid growth or high returns usually associated with high risk start ups
Advantages of venture capital
Potential for large sums of money, expertise to help business, makes it easier to attract other sources of finance, provides required capital from expansion
Disadvantages of venture capital
Long and complex process because venture capitalist hard to find, partial loss of ownership, initially expensive for firm - legal and accounting fees, venture capitalist require high rate of return
Overdrafts
The facility to overspend on a current account up to an agreed sum temporarily
Advantages of overdraft
Only borrowed when required allowing flexibility, only pay for the money borrowed, quick and easy to arrange, no charges for paying of the overdraft
Disadvantages of overdrafts
The bank can call it in at any time, only available from current bank account, interest payments tend to be variable making it hard to get a budget, banks may secure the overdraft against the businesses assets
Leasing
Allows a business to benefit from the use of an asset without owning or buying it outright
Advantages of leasing
Avoids need to finance asset, lease company responsible for any repairs or maintenance
Disadvantages of leasing
More costly in long run, if business cash flow is unreliable, regular repayments can be a problem
Trade credit
Paying suppliers a period of time after the goods or services have been received eg stock
Advantages of trade credit
It helps with cash flow problems, gives businesses time to sell the output before paying invoices
Disadvantages of trade credit
Business may loose out on discounts offered for the immediate or quick repayment increasing costs, not suitable for long term or large purchases
Grants
Fixed amounts of capital provided to business by the government to fund specific projects
What type of business are grants especially useful for
Large businesses, or businesses needing large sum of capital injected into their business
Advantages of grants
Located in high area of deprivation, provide employment, reduce negative environmental impacts, support a good cause
