External Sources of Finance (DP IB Business Management)

Share capital is finance raised from the sale of shares in a limited company through flotation or a rights issue

Shareholders are the owners of shares and they are entitled to a share of the company’s profit when dividends are declared

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

Secured loans are more likely to be available to larger businesses and are typically repaid over five to twenty years

• Interest rates may vary over the term of the loan and terms may be renegotiated if needed

• Failure to make repayments can mean a business has to convert non-current assets into cash (sell them)

Mortgages are long-term secured loans

• They are typically used by a business to purchase buildings, land or large items of capital equipment

• Interest is payable and assets are at risk if the business does not make repayments as planned 

This is an arrangement between the business and their bank to spend more money than it has in its account 

• A limit is agreed upon, and interest is charged only when a business ‘goes overdrawn’

• It is 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

Some large businesses rely heavily on overdrafts to manage working capital

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

• Trade credit is usually interest-free

• Although trade credit may also be available for small businesses, larger businesses tend to be able to request more generous trade credit terms from suppliers

Assets such as machinery or a fleet of vehicles are made available to the business in return for regular payments (a form of rental)

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

• E.g. many businesses lease office equipment such as photocopiers and IT equipment

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

Crowdfunding allows businesses to access finance provided by a large number of small investors on online platforms such as Kickstarter

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

• Investors are often attracted by incentives such as a sample 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

Micro-finance providers are small lenders who make finance directly available to individuals or businesses who would be unable to access finance from anywhere else (they are considered to be risky)

• These are a useful source of funds for businesses that may not qualify for other sources of funds

• There are usually few formalities involved in applying for finance, though the amount available is usually very limited

• Many providers operate on a crowdfunding basis

• Examples may include credit unions and some charities, such as Kiva

Some individuals specialise in making investments in start-up or expanding businesses e.g. Dragons Den investors

These business angels tend to be more willing to take a risk than banks

Finding the ‘right’ business angel (e.g. with appropriate experience, expertise or interest) can be challenging

• In most cases getting the support of a business angel relies on knowing the ‘right people so 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