Sources of Finance

Potential Sources

Long-term

• Finances the whole business over many years

• Share capital

• Retained profits

• Venture capital

• Mortgages

• Long-term bank loans

Medium-term

• Finances major projects or assets with a long life

• Bank loans

• Leasing

• Hire purchase

• Government grants

Short-term

• Finance day to day trading of the business

• Bank overdraft

• Trade creditors

• Short-term bank loans

• Factoring

Types of sources

Internal

• Founder finance
• Retained profits
• Friends and family

Founder Finance

• Cash and investments
• Redundancy payments
• Inheritances
• Personal credit cards
• Re-mortgaging
• Putting time into the business for free

Importance of personal sources to startups

• Cheap (comparatively)
• Entrepreneur keeps more control over the business
• The more the founder puts in, the more others will invest
• Little red tape or delay
• Skin in the game

External sources

• Bank loan
• Bank overdraft
• Business angels
• Loans and grants

Internal Sources—Detail

Retained Profits

• An internal source of long-term finance

• A good indicator of the firm’s success

• Allows surplus profit to be used for future activities

• If used properly, can cause share prices to rise, appeasing shareholders

• Advantages

  • Cheap
  • No security required
  • Independent and confidential
  • Shareholder goodwill
  • Management of dividend payments

• Disadvantages

  • Impact on dividends to shareholders
  • Misuse of funds
  • Possibility of overcapitalisation and ineffective use of funds
  • Opportunity cost

Ordinary Share Capital

• Advantages
  • Limited liability encourages shareholders to invest
  • It is not necessary to pay a dividend
  • Bringing new shareholders into a small business can add further expertise
  • Increasing ordinary share capital can make it easier to borrow more funds from the bank
  • Ordinary share capital is permanent
• Disadvantages
  • Possible high dividend payments
  • Conflict of objectives
  • Loss of control of original owners

Asset Disposal

• Selling an asset that is not vital to the core business to raise capital quickly

• Advantages

  • Quickly reduce the responsibility of the business
  • Quickly gain working capital

• Disadvantages

  • Sacrifices part of the business
  • May reduce ability to compete in future
  • May reduce the size of your portfolio

Working Capital

• Money that already exists within the business

• Advantages

  • The money is already available
  • No agreements or repayments needed
  • Quick

• Disadvantages

  • Requires the cash to already exist within the business
  • Isn’t guaranteed

External Sources—Detail

Bank overdraft

• Widely used and flexible

• Useful for businesses with seasonal sales

• Rate of interest is always variable

• Security typically not required

• Banks can demand immediate repayment, but this is rare

• Overdraft agreements can be revised and are typically treated as a reliable source of finance

• Advantages

  • Extremely flexible
  • Interest is only paid on the amount of the overdraft being used
  • Particularly useful to seasonal businesses
  • Security is not usually required

• Disadvantages

  • Level of interest rate charged
  • Flexible interest rates
  • Banks can demand immediate repayment
  • Paperwork demands

Loans

• Bank agrees to lend a sum of money to the firm or individual for an agreed, specific purpose.

• Creditors are providers of loan capital

• They charge interest and must be paid before any dividends are received by shareholders

• If a business goes into liquidation, creditors must be paid in full before anyone else

• Advantages

  • Easy for budgeting
  • Lower interest rates
  • Designed to meet the company’s needs

• Disadvantages

  • Limitations on amount available
  • Inflexibility
  • Potential expense

Venture Capital

• Typically, between £50,000 and £150,000

• Provided by individuals, usually known as business angels

• High risks but frequently has very good returns

• Advantages

  • Suited to high-risk companies
  • Venture capitalists may allow interest or dividends to be delayed
  • Source of advice and contacts

• Disadvantages

  • Giving up some ownership of the business
  • Possible high finance costs
  • Excessive influence

Debentures

• Long term loans made to a business

• Fixed interest rate (%)

• Repayable on a selected date

• Advantages

  • Very explicit, guidelines and times need meeting
  • Fixed repayments

• Disadvantages

  • Finance must be returned by a certain date

Debt Factoring

• Selling debts to a debt factoring company for a percentage of the full amount

• Advantages

  • Quick return
  • Works with potential bad customers, not repaying their debts to you

• Disadvantages

  • You don’t get the full amount back
  • Might damage reputation with customers

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