External Finance (Edexcel A Level Business)
Revision Note
Written by: Lisa Eades
Reviewed by: Steve Vorster
Sources of External Finance
External finance is sourced from outside of the business
The external sources of finance available to a business
Sources of external finance include family and friends, banks, peer-to-peer funding, business angels, crowdfunding, and other businesses
1. Family and friends
Small business owners approach close acquaintances to invest in or lend money to a business
The Advantages & Disadvantages of Family and Friends as a Source of Finance
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2. Banks
Banks provide several different kinds of loans to businesses, e.g. a small business loan
The Advantages & Disadvantages of Bank Loans
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3. Peer-to-peer funding
Individuals with available savings pool it with others in a peer investment scheme such as Funding Circle
The Advantages & Disadvantages of Peer-to-Peer Funding
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4. Business angels
Some individuals specialise in making investments in start-up or expanding businesses e.g. Dragons Den investors
The Advantages & Disadvantages of Business Angels
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5. Crowdfunding
Crowdfunding is finance provided by a large number of small investors on online platforms such as Kickstarter
The Advantages & Disadvantages of Crowdfunding
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Investors are often attracted by incentives
Examples of incentives include samples or early access to a product
E.g. In November 2022, well-known Twitter commentator Russ Jones published his long-awaited book funded via Unbound, a crowdfunding publisher
6. 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 buy shares in other companies as an investment or with the intention of a takeover
E.g in 2018, Mike Ashley, owner of Sports Direct, acquired a stake of just under 30% of Debenhams, a troubled British high street retailer, to eventually take over the company
The Advantages & Disadvantages of Finance from Other Businesses
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Examiner Tips and Tricks
Recently, some sources of finance have been trickier to access. When assessing external sources of finance in your answers, acknowledge that businesses may find accessing these sources more challenging and expensive than in previous years. Many small to medium-sized businesses are often undercapitalised in their early stages. This has restricted their ability to grow.
Peer-to-peer lending, Crowdfunding and sources such as Business Angels have been able to fill some of the gaps left by changes in the banking industry.
Recognising that a business may not be able to achieve its objectives due to an inability to borrow can be a useful evaluative point.
Methods of Finance
Businesses have many different methods of finance available to help them
Several methods of finance are available to businesses, including loans, share capital, venture capital, overdrafts, leasing, trade credit and grants
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
Mortgages are long-term secured loans
They are typically used by a business to purchase buildings, land or large items of capital equipment
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
Benefits and Drawbacks of Loans
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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’
Benefits and Drawbacks of Overdrafts
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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
Benefits and Drawbacks of Overdrafts
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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
Benefits and Drawbacks of Venture Capital
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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
Benefits and Drawbacks of Leasing
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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
Benefits and Drawbacks of Trade Credit
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Grants
Governments and industry trusts may offer grants to businesses that meet specific criteria
E.g. grants may be available for businesses that create jobs or improve infrastructure in a region
Benefits and Drawbacks of Grants
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