External Finances

Question 1

Definition of 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 source of finance

Answer 2

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

Question 3

What is method of finance

Answer 3

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

Question 4

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

Sources:family and friends

Answer 5

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.

Question 6

Advantages of family and friends

Answer 6

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

Question 7

Disadvantages of family and friends finance

Answer 7

Downside is that it may cause tension and problems if the finance is not repaid or the business does not flourish.

Question 8

Banks

Answer 8

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

Question 9

Advantages of banks

Answer 9

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)

Question 10

Disadvantages of banks

Answer 10

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

Question 11

Peer to peer funding

Answer 11

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

Question 12

Advantages to peer funding

Answer 12

Advantages
• 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 13

Disadvantages of peer to peer funding

Answer 13

Peer to peer loans are classified as private business loans, so the money for the loan comes from several investors or small businesses.

Question 14

Business angels

Answer 14

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

Question 15

Advantages of business angels

Answer 15

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

Question 16

Disadvantages of business angels

Answer 16

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

Question 17

Crowd funding

Answer 17

Crowd funding is where a large number of people fund a project over the internet making small investments each, 3 ways to fund:

Question 18

Advantages of crowd funding

Answer 18

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

Question 19

Disadvantages of crowd funding

Answer 19

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 20

Other businesses

Answer 20

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

Question 21

Methods of finance

Answer 21

1. loans
2. share capital
3. venture capital
4. overdrafts
5. leasing
6. trade credit
7. grants

Question 22

Loans

Answer 22

Loaning money from a bank is like “renting” the money
• Banks will lend to small business but may not lend when they first start-up as there is no track record or history of them making money.

Question 23

Advantages of loans

Answer 23

As the loan is fixed for a certain length of time the business owner can plan ahead and knows exactly what the repayments will be and when they will leave the bank account

Question 24

Disadvantages of loans

Answer 24

A bank will charge interest on the loan
• Not very flexible, the business may incur a penalty if they decide to settle the loan early
• A bank will ask for security or collateral on a loan this may be a house or another asset that can be seized if the loan is not paid back

Question 25

Share capital

Answer 25

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

Question 26

Advantages of shared capital

Answer 26

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

Question 27

Disadvantages of share capital

Answer 27

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

Question 28

Venture capital

Answer 28

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.

Question 29

Advantages of venture capital

Answer 29

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

Question 30

Disadvantages of venture capital

Answer 30

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

Question 31

Overdrafts

Answer 31

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

Question 32

Advantages of overdrafts

Answer 32

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

Question 33

Disadvantages of overdrafts

Answer 33

f 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

Question 34

Leasing

Answer 34

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

Question 35

Advantages of leasing

Answer 35

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

Question 36

Disadvantages of leasing

Answer 36

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

Question 37

Trade credit

Answer 37

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

Question 38

Advantages of trade credit

Answer 38

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

Question 39

Disadvantages of train credit

Answer 39

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 40

Grants

Answer 40

The UK government provides financial help to businesses in some areas of the country, in an effort to overcome problems of unemployment.

Question 41

Advantages of grants

Answer 41

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

Question 42

Disadvantages of grants

Answer 42

• 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