2.1.2 - External Finance Flashcards
1
Q
What is external finance
A
- External finance is investment for the business that is obtained from; banks, investors and lenders outside of the business
2
Q
What is a source of finance
A
This is where the finance has come from e.g. a bank
3
Q
What is a method of finance
A
This is the use of a finance – or what use it would be suitable for e.g. loan to buy computer equipment for the business
4
Q
What are the different sources of finance
A
- family and friends
- banks
- peer-to-peer funding
- business angels
- crowd funding
- other businesses
5
Q
What are family and friends (sources of finance)
A
- Private limited companies are able to raise finance by selling shares to friends and family.
- A sole trader or partnership may also find that their family may want to contribute to the business. This may be for interest, a share of the profits or maybe even an interest free loan amongst family
6
Q
What are the advantages of friends and family (sources of finance)
A
- 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
7
Q
What are the disadvantages of friends and family(sources of finance)
A
- 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
8
Q
What are banks (sources of finance)
A
- Banks may lend a loan to a business to start-up or when a business wants to grow and expand
- Banks may also provide a business with an overdraft to help when they have cash flow problems
- All the high street banks have business departments that will deal with commercial loans
9
Q
What are the advantages of banks (sources of finance)
A
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 (unlike business angels)
10
Q
What are the disadvantages of banks (sources of finance)
A
- 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
11
Q
What is peer to peer funding (sources of finance)
A
- Lending marketplaces such as Funding Circle have gained the trust of consumers by offering lower rates than banks to business owners who want to borrow money
- Peer-to-peer funding matches businesses that need finance with investors who are looking for a good return on their investment
12
Q
What are the advantages of peer to peer funding (sources of finance)
A
- 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%
13
Q
What are the disadvantages of peer to peer funding (sources of finance)
A
- 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
14
Q
What is a business angel (sources of finance)
A
- An angel investor offers to lend their personal disposable finance
- The angel would normally take shares in the business in return for providing finance
- Angels normally seek to not only provide the business with money to grow, but also bring their experience and knowledge to help the company achieve success
- Angel Investors seek to have a return on their investment over a period of 3-8 years
- Usually smaller loan amounts than a venture capitalist
15
Q
What are the advantages of a business angel (sources of finance)
A
- 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
16
Q
What are the disadvantages of a business angel (sources of finance)
A
- Not suitable for investments below £10,000 or more than £500,000
- Owner needs to give up a share of the business
17
Q
What is crowd funding (sources of finance)
A
Crowd funding is where a large number of people fund a project over the internet making small investments each, 3 ways to fund:
- Donate: no money back, but rewards like tickets or a newsletter
- Lend: get money back with interest and satisfaction of contributing to success of a small business
- Invest: Invest in a business in exchange for equity or shares which may increase in value
18
Q
What are the advantages of crowd funding (sources of finance)
A
- Good alternative to loans for small business owners
- Finance can be obtained without paying upfront fees
- The business can generate funds and also promote the business at the same time
19
Q
What are the disadvantages of crowd funding (sources of finance)
A
- 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
20
Q
What are other businesses (sources of finance)
A
- Other businesses may wish to invest in start-ups
- A business may have surplus profit and view this as a way to get a good return on their investment
- Usually IT or disruptive technology businesses will attract funding as they are likely to offer a larger % return on investment
21
Q
What are the methods of financing
A
- loans
- share capital
- venture capital
- overdrafts
- leasing
- trade credit
- grants
22
Q
What is share capital
A
- In a public limited company – plc - one that has been floated on the stock market - they can raise more finance to expand by having an ordinary share issue
- This is an external and long term method of finance but would only apply to a large business with a plc after its name
23
Q
What are the advantages of share capital
A
- Investors are often prepared to provide extra funding as the business grows
- More cost effective way to raise finance than a loan – no interest to pay back
- Finance is based on acquiring more equity rather getting further into debt
24
Q
What are the disadvantages of share capital
A
- Potential investors may require a great deal of background information before they buy the shares
- The more shares that are sold, the more the profits have to be divided up and paid out to investors as dividends
- Can be expensive and slow process to organise
25
What is venture capital
- Venture capitalists (VCs) will invest large sums of other people’s money in a business in return for shares in the company.
- Typically, VCs will invest at least £50 000 in a small regional business although this can rise into millions of pounds.
- The VC will look for a high rate of return in a specific time period e.g. 5 years
26
What are the advantages of venture capital
* Useful if the business is looking to raise a large amount of money in a short space of time e.g. £1 million
* The business gets all the skills of the venture capital business, their network and links may increase revenue streams
* Great for owners who have been refused a loan from a bank
27
What are the disadvantages of venture capital
* Venture capital firms look for a strong business plan, sound management and a proven track record, making it difficult for start-up firms
* Venture capital firms typically want 20-30% stake in the business
28
What is an overdraft
* Some months a business may need extra cash to tide it over until a better month. A loan is over many years so is not suitable.
* An overdraft may be organised by the bank which is short term lending of smaller amounts of money
* Once its arranged (say £2,000) on an account a business can dip into it or pay it back as they see fit
29
What are the advantages of an overdraft
* For a business owner this would idea as a quick fix method to tide the business over a difficult month of trading
* An overdraft can be arranged on the phone
* or online with an instant decision from the bank
* The business will only pay interest on the amount of money that they are overdrawn
* As soon as the business improves trading they can easily pay back the overdraft to the bank and the interest charges will stop
30
What are the disadvantages of an overdraft
* If the business goes over this amount the overdraft will be “unauthorised” and the business will be charged heavily
* Very expensive source of finance, very high charges and interest rates
* Not suitable for large amounts over a long period of time
31
What is leasing
* As a business grows it may decide that it needs some more vehicles or equipment
* They may decide to lease so that the equipment can be updated regularly and spread the cost
* They will never own the equipment but will get the option to change it when it wears out
* Examples are photocopiers and vans
32
What are the advantages of leasing
* This is a lower monthly costs for a business owner than a loan
* Often business leases can be arranged without any advanced fees being paid
* The leasing firm maintain the equipment, vans, cars etc. so the business will always have reliable working equipment
33
What are the disadvantages of leasing
* Leasing is often over a fixed term, if the business changes its mind and wants to lease from a different company, contracts may be difficult to get out of
34
What is trade credit
* When one business trades with another they will sometimes need to “buy” goods with trade credit
* The seller gives the buyer 30, 60, 90 days to pay
* The buyer then has time to sell the goods in their own shop before they have to pay for them
* The wholesaler may give the buyer a discount when they use cash instead
35
What are the advantages of trade credit
* Business can sell the goods before the stock needs to be paid for, so can make a profit before the costs have to be paid
* No interest has to be paid on trade credit
* Businesses that pay regularly on time can build relationships with their suppliers and secure better deals
36
What are the disadvantages of trade credit
* 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
37
What is a grant
* The business usually will not have to pay the grant back
* Unlike a loan there will be no interest to pay
* The business owner will get funds without any loss of control of the business
38
What are the advantages of a grant
▪ The UK government provides financial help to businesses in some areas of the country, in an effort to overcome problems of unemployment.
▪ Government grants do not normally have to be repaid and owners keep full control of their business.
39
What are the disadvantages of a grant
* A business will have to find a grant that suits their specific project, which can be difficult
* There’s a lot of competition for grants
* The business may be expected to match the funds they are awarded, eg a grant might cover part of the cost of a project
* Grants are usually awarded for proposed projects, not ones that have already started
* The application process can be very complex and time-consuming
