3.

2 Sources of Finance

Sources of Finance are the ways a business gets its money in order to run the business

EXTERNAL SOURCES come from outside the organization, usually with the help of a
third party provider. Due to higher costs, it is only used when unable to get enough
internal funds.
Share capital (equity capital) - funds raised through share issue/ share placement
(issuing more stock)
+ Large sums of money (especially IPO’s and publicly held companies)
+ No interest
- Limited liability → bureaucracy
- Potential loss of control (for publicly held) if too much ownership is shared
- Must pay dividends to shareholders so they hold on to their shares
● Works well for limited liability companies (publicly and privately held)

Loan capital (debt capital) - borrowed funds from financial lenders such as banks
➢ Long-term → usually for the purchase of fixed assets (mortgages, business
development loans, debentures)
+ No loss of control
- Interest payments
- Collateral (property or person/organization that agrees to pay back loan)
- Usually a bad sign except for start-ups—still risky
● Works well when large sum is needed that you are sure to pay back (over
a long term)

Examples of loan capital

- Bank loans are where individuals/businesses borrow money from banks
at an agreed interest rate and repayment schedule, typically more than
one year after borrowing. These are used for big investments or improving
cash flow.
- Mortgages are long-term secured loans used to purchase property. The
lender of money uses the property as collateral for the loan. Borrowers
make monthly payments + interest (typically 15-30 years), allowing them
to own property without paying all at once.
- Debentures are long-term loans issued by a business. Debenture holders
receive interest payments even if the business makes a loss and before
shareholders receive dividends. Holders do not have ownership or voting
rights. Increases gearing ratio, so firms are more vulnerable to risk.
- Corporate Bonds
 - Business development loans

Overdraft - banking service that allows to withdraw more money than in account
+ Helps businesses to meet short-term liquidity needs/ emergencies
+ Easy to acquire
- VERY high interest rate → don’t want overdue payments
- Must be pre-approved
● Works well with minor cash flow problems when you are certain you can
pay back in a short time

Trade credit - customers can purchase using credit cards but pay at a later date
➢ Credit period is the time period within which you’re supposed to pay back creditor
+ No payments made at time of purchase
- Higher price
● Works well when the relationship with your creditor/supplier is good

Crowdfunding - raising small amounts of money from a large number of people to fund
a business project or venture
➢ Typically done via online crowdfunding platforms
+ Free & available to everyone
+ Community of donors
+ Direct feedback
- Fees
- Compliance
- Competition
● Works for small businesses with outstanding ideas

Leasing - lessee draws up a contract with the leasing company (lessor) to use
particular fixed assets for an agreed fee
+ No maintenance
+ Cheap
+ Leasing is registered as an expense, thus not taxed
- No ownership
- Expensive in the long term
● Works for businesses that need an asset but cannot afford its purchase
● When the business only needs to use the asset for a short period of time
Microfinance providers - for-profit social enterprises that offer financial services to
those without a job or on very low incomes
+ Easy to obtain (no collateral)
+ Helps to alleviate poverty
- High interest rates
● Works well in less developed economies when businesses need small
sums of money to kickstart

Business angels - wealthy, successful private individuals

➢ Risk their own money in a business venture with high growth potential
➢ Their own personal investment with high degree of risk
➢ Ownership OR pay back with interest
- Loss of control
● Works for businesses with high growth potential and appeal to business
angels