A-Level Business Lesson: How to Raise Finance
Even after the initial business capital is secured, a business needs to continually have the finance to carry out its day-to-day activities.
These sources of finance are from:
- Share capital
- Venture capital
- Personal sources
The type of business, the state of the economy and the stage of the development of the business affects the sources of finance that are available to the business.
There are sources of finance available for all types of business; the actual route chosen will depend on a number of factors.
With established companies, it is easier to secure funding from multiple sources at a low risk for the financiers and lenders. However, smaller businesses are seen as a greater risk and can find it more difficult to obtain credit.
Activity 22 – Do some quick research on venture capital. What is it?
8.1 Venture Capital
This is a source of finance that is provided to the business that guarantees long-term share capital.
Venture capital is provided by private investors both to start up and to expanding businesses.
In exchange for the capital, a private investor receives a share of the business. In addition, the investor receives a return on the investment (ROI) that depends on profit from the growth of the business.
Venture capitalists tend to have a major influence in any business in which they invest. They can be very demanding in terms of the control they wish to exert.
The business owner needs to weigh this potential interference when bringing venture capitalists on board. It also needs to be considered, of course, that the venture capitalists might bring expertise that the business does not possess.
Another factor which the owner should consider is the percentage of profit demanded by the venture capitalist. The greater the venture capital invested, the higher the expectations on return on investment. They can ultimately control the company.
8.2 Bank Loans and Overdrafts
A bank loan can be taken out by a business to finance its activities. The business can borrow a specified sum of money from a bank with regular and set repayments for a specified period of time.
The bank charges an interest on this loan and will often require collateral to secure the loan, in the event of failure to repay the loan. Longer term loans have higher interests on them.
Bank overdrafts are another option, but these tend to be smaller in scale and designed to get over short term cash flow issues.
The overdraft is a set limit and that is the maximum the business can withdraw from its bank account for its business activities.
It is vital that any business that takes out a loan or an overdraft meets its repayments.
The business needs to decide carefully which is appropriate - loans or overdrafts - as they will each carry different conditions. Overdrafts, for example, tend to carry much higher interest rate repayments.
Business owners need to think carefully about cash flow issues (e.g. loans, overdrafts etc.), and how to manage them; many perfectly good businesses fail because they do not manage their cash flow effectively.
8.3 Personal Sources
Owners of small businesses often invest their own money into their business. This money could come from:
- Personal savings
- Inherited funds
- Selling of personal assets
- Taking out personal bank loans
They do this because they want the business to survive and grow. It is quite challenging for a small business to get credit for financing it; hence the reliance on personal funds.
The ultimate risk is that any business can fail and the owner lose their personal assets.
Activity 23 – What is the major risk of an individual investing their own money rather than acquiring finances from another source?
8.4 Ordinary Share Capital
Limited Companies issue shares to investors as a means of raising capital. In return, the investors receive a portion of the company which is equivalent to the number of shares purchased. The business uses the flotation of shares to make its shares available to the general public for sale.
There are two types of shares:
- Ordinary Shares
- Preference Shares
Ordinary shares are sold to the investor who in return receives a portion of the profits that the company makes. This is given in the form of a dividend which changes annually to reflect the performance of the business.
Preference shares are given to preferential investors at a fixed dividend rate, regardless of the performance of the business. These preferential shareholders are always paid before the ordinary shareholders.
Issuing ordinary shares tends to reduce the power of ownership of the original owners of the business as it reduces their relative shareholding. Unless the business owners retain 51% of the business, they could risk losing control of the whole business to its shareholders.
Businesses can acquire finance through internal or external sources. Internal sources include retained profits and the owners’ funds. External sources include also can include mortgages, hire purchases.
- How do businesses raise finance?
- What are the different sources of finance for the business?
- Highlight the benefits and drawbacks of the various sources of finance.
Have a look at this video: