2.1.2 External finance

Question 1

Sources of external finance

Answer 1

Family and friends, Bank loans, peer to peer funding, Business angels, crowd funding, other businesses

Question 2

Advantages of family and friends

Answer 2

Usually a very cheap source of funds

Usually don’t want a share of the business

Question 3

Disadvantage of family and friends

Answer 3

May not provide large sum of finance

Relationships may be damaged if the finance is not repaid

Question 4

Advantage of bank loans

Answer 4

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

Low Interest Rates: Generally, bank loans have the cheapest interest rates.

Question 5

Disadvantage of bank loans

Answer 5

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 collateral to be granted a loan

Question 6

Advantage of peer to peer funding

Answer 6

Loans can usually be made available to businesses very quickly

Usually has ‘no strings attached (e.g. a share of the business)

Question 7

Disadvantage of peer to peer funding

Answer 7

Borrowers are charged a small fee to access finance in this way

The individuals who made the money available in the first place receive some of this interest as compensation

Question 8

Advantage of business angels

Answer 8

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

Question 9

Disadvantage of business angels

Answer 9

Finding the ‘right’ business angel (e.g. with appropriate experience, expertise or interest) can be challenging

As business angels own a stake in the business, they may be involved in decision-making and will receive a share of business profits

May be useless

Question 10

Advantage of crowd funding

Answer 10

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

Question 11

Disadvantage of crowd funding

Answer 11

A good credit rating is not required so new businesses that lack a trading record can attract funding

The potential for negative publicity if the project is not successful in attracting enough crowdfunding capital

Can get stolen

Question 12

Advantage of other businesses

Answer 12

May provide access to business processes and market knowledge alongside finance

Can access large amounts of finance

Question 13

Disadvantage of other businesses

Answer 13

Profits need to be shared between businesses

Decisions will usually need to be agreed by all of the businesses involved

Question 14

You’re doing a great job Krish

Answer 14

Keep going!

Question 15

Examples of methods of finance

Answer 15

Leasing, share capital, trade credit, Venture capital, grants, overdrafts

Question 16

Advantage of overdrafts

Answer 16

A short-term source of finance that offers significant flexibility and aids cash flow

It’s quick to arrange.

There is not normally a charge for paying off the overdraft earlier than expected.

Question 17

Disadvantage of overdrafts

Answer 17

An overdraft may be ‘called in’ if the bank is concerned about a business’s ability to repay what it owes

A business overdraft isn’t free and you’ll pay an annual interest rate on the amount by which you’re overdrawn.

Question 18

Advantage of share capital

Answer 18

Large amounts of capital can be raised, especially by public limited companies

Interest is not payable on finance raised in this way

lower risk of bankruptcy.

Question 19

Disadvantage of share capitals

Answer 19

Take a percentage of the business and result to loss of profit

The business is vulnerable to takeover – As a business grows and sells more shares, it becomes vulnerable to the threat of a takeover.

Complex and costly process

Question 20

Advantage of venture capitalists

Answer 20

Provide advice

Offer a large sum of money

Networking opportunities and quicker growth

Question 21

Disadvantage of venture capitalists

Answer 21

Venture capitalists usually require a stake in the business in return for finance

Can lose control

Cannot go back on the deal

Hard To Get The Right Deal and person

Question 22

Advantage of leasing

Answer 22

The business does not own the asset during the period of the lease and so is not responsible for maintenance or repair costs

You don’t have to pay the full cost of the asset up front, so you don’t use up your cash or have to borrow money.

no long-term commitments

Question 23

Disadvantage of leasing

Answer 23

Leasing is usually more expensive in the long run than buying an asset

Restrictions on Use

No Ownership Equity. When you lease, you are not building asset ownership.

Question 24

Advantage of trade credits

Answer 24

Trade credit is usually interest-free

improved cash flow management

Builds relationship

Question 25

Disadvantage of trade credits

Answer 25

Charges and fines occur if they cannot pay

short term, must be paid off quickly

Discounts for early payment will not be available

Question 26

Advantage of grants

Answer 26

does not need to be paid back

available to small businesses

free

Question 27

Disadvantage of grants

Answer 27

business needs to meet certain criteria

only offer a percentage of your costs

time consuming