External Finance (Edexcel A Level Business)

• 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 on very flexible terms

• Relationships may be damaged if the finance is not repaid

• 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
• Small sums may be borrowed from unsecured

• 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 security to be granted a loan

• Loans can usually be made available to businesses very quickly
• Usually has ‘no strings attached (e.g. a share of the business)

• Borrowers are charged a small fee to access finance in this way and 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 compensation

• 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

• Finding the ‘right’ business angel (e.g. with appropriate experience, expertise or interest) can be challenging
  • Networking is vital when entrepreneurs seek this kind of investment
• As business angels own a stake in the business, they may be involved in decision-making and will receive a share of business profits

• 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

• Businesses need to provide a persuasive business plan to convince individuals to invest in their product as they will be competing with many other projects online
• The potential for negative publicity if the project is not successful in attracting enough crowdfunding capital

• May provide access to business processes and market knowledge alongside finance
• Can access large amounts of finance

• Profits need to be shared between businesses
• Decisions will usually need to be agreed by all of the businesses involved

Benefits

Loans

• A sum of money is borrowed and repaid (with interest) over a determined period of time
    
• Bank loans are usually unsecured and are typically repaid over two to ten years  

• Interest rates are fixed for the term of the loan
• Repayments are made in equal instalments, helping budgeting

• Interest rates depend on the businesses credit rating
• Non-current liabilities are increased in the balance sheet

• Mortgages are long-term secured loans
  • They are typically used by a business to purchase buildings, land or large items of capital equipment

• Businesses can purchase expensive equipment or property without the need for large amounts of capital

• Missed payments may lead to property being repossessed
• Repayments are variable, and linked to the current interest rate, making budgeting difficult

• Debentures are long-term agreements between a business and a lender to repay a specified amount (with a fixed rate of interest) by a certain date
  • Debenture holders are creditors rather than owners of a business and do not hold voting rights

• Control over decision-making is retained within the business
• Interest is fixed, aiding budgeting

• Interest is often higher than for other types of loan
• Failure 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 account 
• A limit is agreed and interest is charged only when a business ‘goes overdrawn’

• A short-term source of finance that offers significant flexibility and aids cash flow

• An overdraft may be ‘called in’ if the bank is concerned about a business's ability to repay what it owes

Share Capital

• Share capital is finance raised from the sale of shares in a limited company
• Shareholders are the owners of shares and they are entitled to a share of the company’s profit when dividends are declared

• Large amounts of capital can be raised, especially by public limited companies
• Interest is not payable on finance raised in this way

• Shareholders usually have a vote at a company’s Annual General Meeting (AGM) 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-sized businesses that have significant potential for growth e.g. in the technology sector

• Businesses that may have been refused finance from other sources may be able to attract investment from less risk-averse venture capitalists

• Venture capitalists usually require 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 payments
  
  • E.g. many businesses lease office equipment such as photocopiers and IT equipment

• The business does not own the asset during the period of the lease and so is not responsible for maintenance or repair costs

• Leasing is usually more expensive in the long run than buying an asset

Trade Credit

• An agreement is made with suppliers to buy raw materials, components and stock which are paid for at a later date, typically 30 to 90 days later

• Trade credit is usually interest-free

• Discounts for early payment will not be available

Grants

• Governments and industry trusts may offer grants to businesses that meet specific criteria

• Grants do not need to be repaid

• The business must use the finance for its intended purpose