2.1.2 External Finance

Question 1

What is external finance?

Answer 1

External finance is investment for the business that is obtained from; banks, investors and lenders outside of the business

Question 2

What is a source of finance?

Answer 2

This is where the finance has come from e.g. a bank.

Question 3

What is a method of finance?

Answer 3

This is the use of a finance - or what it would be suitable for e.g. loan to buy computer equipment for the business.

Question 4

What are the 6 sources of finance?

Answer 4

1. ) Family and friends
2. ) Banks
3. ) Peer-to-Peer funding
4. ) Business angels
5. ) Crowd funding
6. ) Other businesses

Question 5

What are the advantages of using family and friends?

Answer 5

• Loans from friends and family will probably be offered without the need for security and at lower rates and over longer terms than traditional lenders.
• They are also unlikely to need a business plan which means the owner may not need to write one

Question 6

What are the disadvantages of using family and friends?

Answer 6

• Downside is that it may cause tension and problems if the finance is not repaid or the business does not flourish.
• They may also demand their money back at short notice.

Question 7

What are the advantages of using banks?

Answer 7

• Banks will lend to businesses without asking for a % of the ownership.
• Banks will allow the business owner to continue running the business their own way, and not interfere, so the owner retains control of the business.

Question 8

What are the disadvantages of using banks?

Answer 8

• Bank loans can be expensive compared to other sources of finance and interest must be paid back on time.
• It may be hard for a new business owner to obtain a loan as they have no historical sales data to show the bank.
• The owner may need to use their own assets as security for the loan e.g. their own house.

Question 9

What are the advantages of using peer to peer funding?

Answer 9

• Businesses can get access to funding within a week once approved.
• Business owners can apply online.
• Investors can expect returns of 6-7% whereas a savings account might only give them 3%.

Question 10

What are the disadvantages of using peer to peer funding?

Answer 10

• Peer to peer loans are classified as private business loans, so the money for the loan comes from several investors or small businesses.
• If there are not enough individuals interested or willing to invest in your loan, you may not be able to acquire the entire amount that the business needs.

Question 11

What are the advantages of using business angels?

Answer 11

• Angels are free to make investment decisions quickly.
• The owner gets access to your investor’s sector knowledge and contacts.
• The owner gets access to angels mentoring or management skills.
• The owner will have no repayments or interest on the money lent.

Question 12

What are the disadvantages of using business angels?

Answer 12

• Not suitable for investments below £10,000 or more than £500,000.
• Owner needs to give up a share of the business.

Question 13

What are the advantages of crowd funding?

Answer 13

• Good alternative to loans for small business owners.

- Finance can be obtained without paying upfront fees.

Question 14

What are the disadvantages of crowd funding?

Answer 14

-The business will need to show case their idea to investors and may need to put together a video and other promotional material to attract investors.

Question 15

What are the 7 methods of finance?

Answer 15

1. ) Loans
2. ) Share capital
3. ) Venture capital
4. ) Overdrafts
5. ) Leasing
6. ) Trade credit
7. ) Grants

Question 16

What are the advantages of using loans?

Answer 16

-Banks will not ask for a % or involvement in the business
-As the loan is fixed for a certain length of time the business owner can plan ahead

Question 17

What are the advantages of using share capital?

Answer 17

-Investors are often prepared to provide extra funding as the business grows
-No interest

Question 18

What are the disadvantages of using share capital?

Answer 18

-Potential investors may require a great deal of background info. before they buy the shares.
-increased profits sent to investors (dividends).

Question 19

What are the advantages of venture capital?

Answer 19

-Useful if the business is looking to raise a large amt. of money in a short space of time.
-The business gets all the skills of the VC business, their network and links may ^ revenue streams.

Question 20

What are the disadvantages of using venture capital?

Answer 20

-VC capital firms look for a strong business plan, sound management + a proven track record, making it difficult for start-up firms.
-VC firms typically want 20-30% stake in the business.

Question 21

What are the advantages of overdrafts?

Answer 21

-Quick fix method to tide the business over a difficult month of trading.
-As soon as the business improves trading they can easily pay back the overdraft to the bank and the interest charges will stop.

Question 22

What are the disadvantages of overdrafts?

Answer 22

-Very expensive sources of finance, very high charges + interest rates.
-Not suitable for large amts. over a long period of time.

Question 23

What are the advantages of leasing?

Answer 23

-This is a lower monthly costs for a business owner than a loan.
-The leasing firms maintain the equipment, so the business will always have reliable working equipment.

Question 24

What are the disadvantages of leasing?

Answer 24

-Leasing is often over a fixed term, if the business changes it’s mind and wants to lease from a different company, contracts may be difficult to get out of.

Question 25

What are the advantages of trade credit?

Answer 25

-Business can sell the goods before the stock needs to paid for, so can make a profit before the costs have to be paid.
-No interest.
-Businesses that pay regularly on time can build relationships with their suppliers + secure better deals.

Question 26

What are the disadvantages of using trade credit?

Answer 26

-Not all stock is available to buy using the trade credit method, so only applies to certain industries.
-If the business does not pay in time they risk being refused further credit by the supplier in the future.

Question 27

What are the advantages of using grants?

Answer 27

-Usually does not have to be paid back.
-No interest

Question 28

What are the disadvantages of using grants?

Answer 28

-Difficult to find a grant that suits their specific project, which can be difficult.
-Lots of competition for grants.
-The business may be expected to match the funds they are awarded.