Business & ManagementIB

External sources of finance

External sources of finance...Share capital the money raised from selling shares of the company. The main sources of finance for a limited liability company...
External sources of finance

Share capital the money raised from selling shares of the company. The main sources of finance for a limited liability company. This can provide lots of finance.

Selling Shares: private limited companies cannot sell their shares to the general public. If they want to they can ‘go public’ by floating their shares on the stock exchange. This is known as initial public offering (IPO). Existing companies can raise further finance by selling more shares in a share issue. However by issuing shares, ownership and control of the business becomes diluted.

Loan capital

Overdrafts: allows a business to temporarily overdraw on its bank account, i.e., to take out more money than it has in its account.

Debentures: the holder of a debenture is a creditor of the company, not an owner. This means that holders are entitled to an agreed fixed rate of return, but have no voting rights and the amount borrowed must be repaid by the expiry date.

Mortgages: only limited companies can raise funds from the sale of shares and debentures. Smaller firms need long-term finances to purchase the premises, a purpose which mortgages are designed for. It is usually a long-term loan from a financial institution (like a bank) and the lender must use land or property as security on the loan. (Note: Mortgages are specialised long-term loans only for the purchase of premises, not machinery for example)

Grants: governmental financial gifts to support business activities. These tend to be offered to eligible business in one-off payments.

Subsidies: governmental grant to reduce costs of production, generally to provide benefit to society. This tends to be done for essential products and services such as agricultural goods, public transport etc. Subsidies do not cut into profit margins of the producer.

Debt factoring: when a firm sells its products, it issues an invoice stating the amount due. Debt factoring involves a specialist company (called a factor) providing finance against these unpaid invoices. So, when a debtor fails to pay its bill in time, the company turns to the factor and asks for the return of these funds, which the factor does immediately. However, when a customer pays the bill in full, the factor would usually keep 20% of the value of the invoice.

Venture capital: high risk capital invested by venture capital firms usually at the beginning of a business idea. They find small businesses with high growth potential. These firms seek businesses with convincing and coherent plans to make the risk of investment worthwhile. They then receive profit in return from their investment.

Business angels: usually wealthy individuals who invest their money in businesses with high growth potential. They provide funding and in return tend to take a proactive role in the business and receive profits until the business can buy out the stake owned by the business angel.

Advantages Disadvantages
Hire purchase ✔ Quick and easy to acquire equipment. ✔ Interest rates are higher.
✔ The good can be taken away from the buyer if their payment is late.
Trade credit ✔ An interest free source of finance. ✔ The cost of goods can be higher if paid for at a later date.
✔ Delaying the payment can result in a poor relationship between the firm and its suppliers.
Leasing ✔ No large sums of money need to be allocated for the purchase of the equipment.
✔ Useful when equipment is used occasionally.
✔ Maintenance is not the responsibility of the user.
✔ In the long term, it is more expensive than the outright purchase.
✔ Interest rates are higher.
✔ Not able to secure any loans with another institution on assets that are leased.

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