2.1.2 External finance Flashcards
Sources of external finance
Family and friends, Bank loans, peer to peer funding, Business angels, crowd funding, other businesses
Advantages of family and friends
Usually a very cheap source of funds
Usually don’t want a share of the business
Disadvantage of family and friends
May not provide large sum of finance
Relationships may be damaged if the finance is not repaid
Advantage 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
Low Interest Rates: Generally, bank loans have the cheapest interest rates.
Disadvantage 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 collateral to be granted a loan
Advantage of peer to peer funding
Loans can usually be made available to businesses very quickly
Usually has ‘no strings attached (e.g. a share of the business)
Disadvantage of peer to peer funding
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
Advantage 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
Disadvantage of business angels
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
Advantage of crowd funding
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
Disadvantage of crowd funding
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
Advantage of other businesses
May provide access to business processes and market knowledge alongside finance
Can access large amounts of finance
Disadvantage of other businesses
Profits need to be shared between businesses
Decisions will usually need to be agreed by all of the businesses involved
You’re doing a great job Krish
Keep going!
Examples of methods of finance
Leasing, share capital, trade credit, Venture capital, grants, overdrafts
Advantage of overdrafts
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.
Disadvantage of overdrafts
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.
Advantage of share capital
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.
Disadvantage of share capitals
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
Advantage of venture capitalists
Provide advice
Offer a large sum of money
Networking opportunities and quicker growth
Disadvantage of venture capitalists
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
Advantage of leasing
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
Disadvantage of leasing
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.
Advantage of trade credits
Trade credit is usually interest-free
improved cash flow management
Builds relationship
Disadvantage of trade credits
Charges and fines occur if they cannot pay
short term, must be paid off quickly
Discounts for early payment will not be available
Advantage of grants
does not need to be paid back
available to small businesses
free
Disadvantage of grants
business needs to meet certain criteria
only offer a percentage of your costs
time consuming
