The nature of external sources of finance

External sources of finance involve obtaining funds from outside the business itself.

Informal sources such as family, friends, and crowd funding

Informal external finance often comes from personal networks or public contributions, making it accessible for small or new businesses.

Finance from family and friends

Business owners approach relatives or close contacts for loans or gifts to support startup or expansion.

Advantages:

• Funds may be provided without interest, with flexible repayment terms, or even as outright gifts.

Disadvantages:

• The amounts available are usually limited.
• Repayment issues could damage personal relationships if the lender needs the money urgently.

Finance through crowd funding

Businesses raise small contributions from a large number of people, typically via online platforms, to reach a funding target. Details of the business idea are shared publicly to attract donors.

Advantages:

• Suitable for startups or established firms launching new ideas.
• Increases brand awareness and potential sales by exposing the concept to a wide audience.
• Donors may receive rewards like discounted products or early access.

Disadvantages:

• Public sharing risks the idea being copied by competitors before launch.
• If the project fails, it could harm the business's reputation among many people.

Formal lending from banks and peer-to-peer lenders

Formal lending provides structured finance through established channels, often with clear terms but requiring approval based on the business's credibility.

Finance from banks

Banks offer products like loans, overdrafts, and mortgages to fund business activities.

Advantages:

• As trusted institutions, they provide transparent terms and additional services, such as financial advice or help with documentation.

Disadvantages:

• Strict criteria must be met for approval, which can be challenging for new or high-risk businesses, potentially leading to rejection.

Finance from peer-to-peer lenders

Online platforms connect borrowers with individual lenders. Borrowers provide details on loan needs and duration, while lenders specify amounts and desired interest rates. The platform assesses risk and matches parties, charging higher rates for riskier borrowers.

Advantages:

• Often offers lower interest rates than traditional banks.
• Useful for businesses denied bank loans.

Disadvantages:

• Interest rates can still be high for those seen as risky.
• The process relies on finding suitable matches.

Investment from business angels and other businesses

Investment-based external finance involves exchanging funds for ownership or influence, often bringing expertise alongside capital.

Finance from business angels

Wealthy individuals invest in promising new or innovative businesses, often providing guidance and contacts in return for a share of ownership.

Advantages:

• Investors bring valuable business knowledge and networks, which can help the company succeed.

Disadvantages:

• Finding a suitable investor can be time-consuming and difficult.
• Giving up shares may reduce the original owner's control over decisions.

Finance from other businesses

Companies with surplus retained profits may invest in another firm, especially if it supports their own operations, such as funding a key supplier to strengthen supply chains.

Advantages:

• Can improve business relationships and efficiency, particularly when interest rates on savings are low.

Disadvantages:

• The investing business typically demands shares, which could lead to them influencing or controlling decisions in the recipient firm.