Raising Money From Outside the Business

There are nine external sources on the syllabus and students try to memorise nine separate lists. Do not. They fall into three groups, and once you see the groups you can work out the advantages of any of them from first principles.

Three groups, not nine lists

Borrowing

Bank loans and mortgages

A fixed sum, repaid in instalments over an agreed period with interest. Secured loans are backed by an asset, so the rate is lower — but the lender can take that asset if repayments stop. A mortgage is simply a long-term secured loan used to buy land or property, usually over many years.

• Interest may be fixed (same rate all the way through, easier to plan) or variable (moves with the market, so repayments can rise).
• Repayments are a fixed cost that must be met whether sales are good or bad.
• The owner keeps full control, because a lender has no vote in the business.

Overdrafts

An agreement with the bank to spend more than is in the account, up to an agreed limit. Interest is charged only on the amount actually overdrawn, and only while overdrawn. That makes it the natural tool for short gaps in cash flow — and a very expensive way to fund anything long term.

Selling a share of the business

Share capital

A limited company raises money by selling shares — through a flotation (first sale to the public) or a rights issue (offering new shares to existing shareholders, usually at a discount). Shareholders own part of the company, receive dividends when they are declared, and vote at the Annual General Meeting.

• Good: huge sums can be raised, and none of it has to be repaid.
• Bad: ownership is diluted, profits are shared forever, flotation costs are high, and the original owners can lose control of decisions.

Business angels

Wealthy individuals who invest their own money in start-ups and growing firms in exchange for a stake. They accept more risk than a bank and often bring experience and contacts with them. The hard part is finding the right one, which usually depends on networking, and they will expect a say in decisions.

Crowdfunding

Many small investors back a project through an online platform. It needs a persuasive plan because thousands of projects compete for attention, and backers are often attracted by early access or a sample of the product. It doubles as free marketing, but a failed campaign is public.

Delaying and renting

Trade credit

The supplier delivers stock now and is paid 30 to 90 days later. It is normally interest-free, which makes it one of the cheapest sources there is. Large firms can negotiate longer terms; new businesses with no trading record often cannot get it at all.

Leasing

Renting the asset instead of buying it. Regular payments, no large sum up front, and the leasing company usually handles maintenance and repairs. The business never owns the asset, and over many years leasing costs more than buying would have done.

Microfinance

Small lenders providing finance to people and businesses that no bank would touch. Few formalities, but the amounts available are very limited. It matters most in low-income economies and for very small enterprises.

Worked examples