2.1.2 External Finance Flashcards
Sources of external finance
- Family and friends.
- Banks.
- peer-to-peer lending
- Business angels.
- Crowd funding.
- Other businesses.
- Family and friends.
- Small business owners approach closer acquaintances to invest or lend money to a business
Advantages:
- Usually a very cheap source of funds
- May have no strings attached (e.g. a share of the business) and can be provided to the business. I’m very flexible terms.
Disadvantages:
- Relationship relationships may be damaged if the finance is not repaid
- Banks.
- Banks provide several different kinds of loans to business businesses e.g. small business loan
Advantages:
- May offer both short-term finance e.g. overdraft and long-term finance e.g. loans or mortgages if a business qualifies
- Thanks often keen to provide free advice and guidance to businesses that use their services
Disadvantages:
- 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. holding a bank account) to access some loans
- For larger amounts, businesses may need to provide security (e.g. sell a building) to be granted a loan
- Peer-to-peer lending
- Individuals with available savings pool it with others in a appear investment scheme such as a funding circle
Advantages:
-Loans can usually be made available to business is very quickly
- Usually has no strings attached (e.g. a share of the business)
Disadvantages:
- Borrow was a charge a small fee to access finance in this way and I have to pay interest in the same way as a bank loan
- The individuals who made the money available in the first place receive some of this interest as a compensation
- Business angels.
- Some individual specialise in making investments in start-up or expanding businesses e.g. Dragons’ Den investors
Advantages:
- 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
Disadvantages:
- Finding the right business Angel (e.g. with appropriate experience, expertise or interest) can be challenging
- As business Angel’s owner mistake in the business, they may be involved in decision-making and will receive a share of business profits
- Crowdfunding
- crowd funding is finance provided by a larger number of small investors on online platforms such as kickstarter
Advantages:
- Create an organic customer based on the platform provide provides a form of free marketing
- A good credit rating is not required so new businesses that lacquer trading record can attract funding
Disadvantages:
- Businesses need to provide a persuasive business plan to convince individual individuals to invest in their product as they will be competing with many other projects online
- The potential for negative publicity of the project is not successful in attracting enough crowd funding capital
- Other businesses.
- It may be possible for a business to access finance via a joint venture with another business, such as a key customer or supplier
- Some large businesses by shares and other companies as an investment or with the intention of a takeover
Advantages:
- May provide access to business processes and market knowledge alongside finance
- Can access large amount of finance
Disadvantages:
- Profits need to be shared between businesses
- Decisions will usually need to be agreed by all businesses
Methods of finance
- Loans
- Overdrafts
- Share capital.
- Venture capital
- Leasing.
- Trade credit.
- Grant.
- Loans
- A sum of money is borrowed and repaid with interest over a determined period of time
Advantages:
- Interest rates are fixed for the term of the loan
- Repayments are made in acorn instalments, helping budgeting
- Businesses can purchase expensive equipment or property without the need for large amounts of capital
- Control over decision-making is retained within the business
- With debentures, interest is fixed, aiding budgeting
Disadvantages:
-interest rate depend depends on the businesses credit rating
- non-current liabilities are increased in the balance sheet
- With a mortgage, missed payment payments may lead to property being repossessed
- Failures to repay debentures may deter investors in the future
- Overdrafts
- An arrangement for business current account holders to spend more money than it has in their bank account
- A limit is agreed and interest is charged only when a business goes overdrawn
Advantages:
- A short-term source of finance that offers significant flexibility and aids cash flow
Disadvantages:
- An overdraft may be called in if the bank is concerned about a business is ability to repay what it owes
- Share capital
- share capital is finance rate from the sale of shares in a limited company
- Shareholders of the owners of shares and they are entitled to a share of the companies profit when dividends are declared
Advantages:
- Large amounts of capital can be raised, especially by public limited companies
- Interest is not payable on finance raised in this way
Disadvantages:
- Shareholders usually have a vote at a company’s annual general meeting where they can have a say in the composition of the board of directors
- Venture capital
- Funds provided by specialist investors in small to medium size businesses have significant potential for growth
Advantages:
- Businesses that may have been refused finance from other sources may be able to attract investment from less risk averse venture capitalist
Disadvantages:
- Venture capitalists usually requires a stake in the business in return for finance and often expect to exert some control over the business
- Leasing
- an asset such as a piece of machinery or a vehicle used by the business in return for regular payment
Advantages:
- The business does not own the asset during the period of the lease and so it does not responsible for maintenance or repair cost
Disadvantages:
- Leasing is usually more expensive in the long run than buying an asset
- Trade credit
- An agreement is made with supplies to buy raw materials, components and stock which are paid for at a later date, typically 30 to 90 days later
Advantages:
- Trade credit is usually interest free
Disadvantages:
- Discount for early repayment will not be available
- Grants.
- Governments and industry trusts may offer grants to businesses that meet specific criteria
Advantages:
- Grants do not need to be repaid
Disadvantages:
- The business must use the finance for its intended purpose
