🌍 What Are External Sources of Finance?
Definition: External sources of finance come from outside the business — from lenders, investors, or other third parties.
External finance allows businesses to raise larger amounts than internal sources typically provide. However, there is usually a cost — either interest payments or sharing ownership.
External sources can be split into two types: debt finance (borrowing — you pay it back with interest) and equity finance (selling shares — you give up some ownership).
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🏦 Loan Capital & Bank Overdrafts
Bank loans
A bank loan provides a fixed sum of money that is repaid over a set period with interest.
- Fixed repayment schedule — easy to plan for
- Can borrow large amounts for major investments
- Interest increases the total cost of the asset
- May require collateral (security) such as property
Bank overdrafts
An overdraft allows a business to spend more than it has in its bank account, up to an agreed limit.
- Very flexible — only borrow what you need
- Good for short-term cash flow gaps
- Interest rates are usually HIGHER than loans
- Bank can withdraw the facility at any time
Loan = long-term, planned borrowing 📅 | Overdraft = short-term, flexible borrowing 🔄
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📈 Share Capital & Venture Capital
Share capital
Limited companies can raise finance by selling shares to investors. Public companies sell on the stock exchange; private companies sell to selected individuals.
- Can raise very large amounts of money
- No repayment required — shares are permanent capital
- Shareholders expect dividends and a say in decisions
- Original owners lose some control and share of profits
Venture capital
Venture capitalists invest large sums in businesses with high growth potential, often start-ups or businesses in early stages.
- Provides large investment plus expert advice and contacts
- Ideal for high-risk, high-reward businesses
- Venture capitalists demand a significant share of ownership
- They often want involvement in strategic decisions
Example: Many tech start-ups like early-stage Uber and Airbnb relied on venture capital to fund rapid growth before becoming profitable.
🤝 Trade Credit, Crowdfunding & Grants
Trade credit
Suppliers allow the business to buy now and pay later — typically within 30, 60 or 90 days.
- Improves short-term cash flow
- No interest charged (if paid on time)
- Very common in business-to-business transactions
- Late payment can damage supplier relationships
Crowdfunding
Raising small amounts of money from many people, usually through online platforms like Kickstarter or Indiegogo.
- Great for start-ups and creative projects
- Also acts as free marketing and market research
- No guarantee of reaching the funding target
- May require giving rewards, products or equity to backers
Government grants and subsidies
Money provided by the government that does not need to be repaid. Usually given to support specific goals like job creation or innovation.
- Free money — no repayment or interest
- Competitive — not all businesses qualify
- Often comes with strict conditions on how it's spent
- Application process can be long and complex
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💡 Microfinance & Business Angels
Microfinance
Small loans provided to entrepreneurs in developing countries or those who cannot access traditional banking. Pioneered by organizations like Grameen Bank.
- Helps people start businesses who otherwise couldn't
- Loans are small — typically a few hundred dollars
- Supports poverty reduction and community development
- Interest rates can be relatively high
Business angels
Wealthy individuals who invest their own money in start-ups in exchange for equity (ownership share). They often bring business experience and mentoring.
- Invest smaller amounts than venture capitalists
- Provide valuable mentoring and industry contacts
- Expect equity and possibly involvement in decisions
- Finding the right angel investor takes time and effort
Business angel = individual investor with own money 🧑💼 | Venture capitalist = professional investment firm with pooled funds 🏢