2.1.2 External Finance Flashcards
(41 cards)
External finance
Investment for the business that is obtained from; banks investors and lender outside of the business
Source of finance
This is where the finance has come from - a bank (external or internal)
Method of finance
This is the use of a finance or what it would be suitable for - loan to buy computer equipment for a firm
What are the external sources of finance for a business?
Family and friends Banks Peer-to-peer funding Business angels Crowd funding other businesses
Family and friends
Private limited companies are able to raise finance by selling shares to friends or family
-may find that family want to contribute to the business for interest, a share of the profits or maybe an interest free loan amongst family
Family and friend advantages
- Loans from family and friends will probably be offered without the need for security and at lower rates and over longer terms than traditional lenders
- Unlikely to need a business plan which means the owner may not need to write one
- this can be quicker and cheaper to arrange -flexible
Family and friends disadvantages
- May cause tension and problems if the finance is not repaid or the business does not flourish
- may also demand their money back at short notice
Bank
Banks may lend a loan to a business to start-up or when a business wants to grow and expand
-may also provide a business with an overdraft to help when they have cash flow problems
Bank advantages
- Banks will lend to a business without asking for a % of the ownership
- Banks will allow the business owner to continue running the business their own way and not intruders, owner retains control of business
Banks disadvantages
- 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 loam as they have no historical sales data to show the bank
- The owner may need use their own assets as security for their loan - their house
Peer to peer funding
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
-matches businesses that need finance with investors who are looking for a good return on their investment
Peer to peer funding 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%
Peer to peer funding disadvantages
- 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
Business angels
- An Angel investor offers to lend their personal disposable finance, 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
- Usually smaller loan amounts than a venture capitalist
Business angels advantages
- 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
Business angels disadvantages
- Not suitable for investments below £10,000 or more than £500,000
- Owner needs to give up a share of the business - dilution of ownership
Crowdfunding - what is it and the 3 different ways?
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
Crowdfunding advantages
- 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
Crowdfunding disadvantages
- 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
- may take a long time
- ideas could be stolen
Other businesses
Some large Multi-national businesses are willing to invest in innovative start up
Methods of finance examples
loans share capital venture capital overdrafts leasing trade credit grants
Loans
-provides a long term finance for a start up with the bank stating the fixed period the loan is provided , the rate of interest and amount of repayments, money that is borrows from the bank
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.
Loans advantages
- 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
- Banks will not ask for a % of the business or get involved in the running of the business
- Getting into a high street bank to apply for a business loan is a straightforward process
Loans disadvantages
- 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