External Sources of Finance

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External Sources of Finance

External sources of finance raise finance (money) from a third party. The finance can be used to fund large, long-term investments. However, external finance can be more costly, because loans usually charge interest (which isn't paid if a company funds growth with retained earnings). Some sources of external finance are:

Bank loans or mortgages

Bank loans and mortgages are very important for many businesses. A business borrows money from a bank and then pays interest on the money borrowed.
It is often harder for new businesses to get bank loans because banks see them as riskier.

Loans from family and friends

Start-ups often use loans from family and friends. This is usually because the entrepreneur doesn’t have enough personal savings to finance the investment.
If the entrepreneur gives up equity (a share of the business) then this is not a loan.

Hire purchases

This is when a business buys something and instead of paying for it upfront pays for it in installments.
When PSG bought Kylian Mbappe from Monaco, they didn’t pay the whole amount at the time and instead completed the purchase in different stages.
This lets businesses buy things (like machinery) for the business that they otherwise wouldn’t be able to afford.

Trade credit

Trade credit describes when businesses pay suppliers at a later date. It involves buying something now and paying for it later.
Supermarkets use trade credit and trade creditors a lot, taking delivery of food and then paying the suppliers at a later date.

Government grants

A government may give grants (money) to businesses to research things that the government is interested in.
The Horizon 2020 fund is a set of grants given out by the countries in the European Union.

External Sources of Finance

External sources of finance raise finance (money) from a third party. The finance can be used to fund large, long-term investments. However, external finance is often more expensive because businesses pay interest on loans. There are several sources of external finance:

Debt factoring

Debt factoring involves businesses selling their debt to a third party business.
The business selling its debt will gain cash immediately rather than wait for debts to be settled although the business will sell its debt for less than its original value.
The third party that buys this debt will then arrange and organise invoices and ensure that the debt money is collected. The third party business will retain a fee to cover the costs of its debt collection service.

Overdraft

An overdraft is a service offered by banks allowing businesses to borrow an amount of money up to a limit which has been agreed in advance.
Overdrafts are flexible as they allow a business to borrow as much as it wishes provided that the amount stays within an agreed limit.
Businesses often pay for this flexibility through higher interest rates.

Venture capital

Venture capital involves investors, or venture capitalists, providing a business with loans and share capital which is usually to support business growth.
Venture capitalists will often ask for some control of the business they are investing in and this can be through the issue of shares or through the appointment of venture capitalists as non-executive directors of the business.