2.1.2 External Finance Flashcards
What is external finance
Capital raised from outside the business
Types of external finance
Family / friends Bank Peer to peer Business angles Crowd funding Other businesses
Why businesses need finance
Bills Wagers Furniture Machinery Stock Advertising Suppliers Invest / expand Rent / buy
7 ways finance is provided
Loans Share capital Venture capital Over draft Leasing Trade credit Grant
Describe family and friends
Ads and disads
- Investment from people known to the entrepreneur
- Amount may be limited
- Repayment terms and conditions may be flexible
- May place pressure on relationships
Describe banks
- Financial institutions that are licenced to take deposits, pay interest, make loans and act as an intermediary in financial transactions, as well as provide other financial services to their customers
- Banks will have departments and employees who specialise in business banking including offering advice on topics such as methods of finance and business planning
Describe peer to peer
- The practise of an individual lending to other individuals (peers) with whom there is no relationship or contact
- Borrowers are given a credit rating
- Normally an unsecured personal loan although on some occasions collateral may be offered
- Cuts out the use of traditional intermediaries e.g. banks
- Lending is done online
- Lenders decide who they want to lend to then compete to win the lending opportunity in a reverse auction i.e. the lender willing to offer the lowest interest rate wins
Describe business angels
- Wealthy individuals make personal investments into start-up businesses in return for a share of the business i.e. percentage equity
- Can be seen as high risk as the business is not established but angels will assess the potential for reward
- The entrepreneur will need to demonstrate a good understanding of their business model and present a detailed business plan in order to secure the investment
- Business angels may also offer support and expertise
- Some business angels form groups to share research and make joint investments
Describe crowd funding
- Crowdfunding involves raising finance from a large number of people each investing different, often small, amounts of money
- The business uses the internet to explain how much money is required, how it will be used and the exit strategy stating predicted return on the investment
- The investor is only tied into their promised contribution if the total amount is raised
Describe other businesses
- Businesses with healthy cash balances may look to invest in other businesses
- This may be with a view to higher potential returns than the business is receiving with cash sat in the bank
- This is particularly true at present with low interest rates
- Alternatively this may be to support another business
- Set up a subsidiary business
- Support a supplier
- Support a customer
Describe loans
●A set amount of money provided for a specific purpose, to be repaid with interest, over a set period of time
●May be secured against an asset and if there is a default on repayments the asset can be taken
●Financial institutions can vary interest rates depending upon the amount of risk placed on the loan
●An external source of finance generally considered to be more suitable for longer-term projects
Loan advantages
●Quick and easy to secure
●Fixed interest rates allow firms to budget
●Improved cash flow
●The borrower retains ownership of the company
Loans disadvantages
●Interest must be paid regardless of financial performance
●A firm that is highly geared i.e. has a high proportion of capital raised through debt, may be seen as high risk
●A firm normally provides security known as collateral
●Often more expensive than other forms of finance
●Can be charged a penalty for early payment
Describe share capital
●Finance raised from the sale of shares
●This is a form of equity capital i.e. the shareholder becomes a part owner of the business
●Shareholders will be rewarded for their investment by the payment of dividends but may also benefit from an increase in share price increasing the value of their shares
●Only an option for incorporated businesses i.e. Ltds and Plcs
●Issuing shares is a complex and costly process so only really an option for raising large amounts of finance to fund long term projects
Share capital advantages
●Only need to pay dividends if a profit is being made and the amount of dividend is not fixed
●Possible to raise large amounts of finance
●No interest repayments
