Download Finance - Leeds Beckett University

Sources of Finance
Bank Overdrafts
Purpose
Temporary measure 1:0 cover short-term cash shortfalls arising
from:
 General working "capital needs during the production cycle.
 Seasonal fluctuations.
 Minor acquisitions of fixed assets with short estimated lives.
Advantages
 The system is simple and arrangements can be negotiated and
set up very quickly.
 Amounts may be drawn or repaid within the agreed limits at any
time without prior notice.
 Comparatively cheap. Interest is calculated on the actual balance
owing on a daily basis.
 Once agreed the facility will generally be renewed each year if
the company remains creditworthy.
 Bank does not require participation in the management of the
business
 No loss of control in voting power.
Disadvantages
 Legally repayable on demand though reasonable notice (at least
one month) will usually be given. You will be told the period of
the facility.
 Security in the form of a fixed or floating charge on business
assets or unlimited personal guarantee may be required.
 The rate of interest charged rises with increases in the bank's
base lending rate.
 Subject to renewal each year.
 Bank may want to see annual accounts, details of stock, debtors,
creditors levels etc.
Costs
 Interest is charged depending on the bank's assessment of the
risk it is taking. The greater the risk, the higher the rate of
interest (assume base rate is 10%).
 Calculated on daily balance, but debited on bank statement
quarterly or half yearly.
Bank Loans
Purpose
 Refinancing of permanent/'hardcore' overdrafts.
 Financing the purchase of assets with estimated lives of between
5 to 10 years.
 Financing increased working capital requirements.
Advantages
 Not repayable on demand but by a series of instalments over an
agreed period.
 Repayments may be arranged to correspond to the estimated
cash flow arising from the asset acquired or the projected cash
flow of the business.
 Flexible repayment commencement dates.
 As both terms and amounts are fixed, helps cash flow
forecasting.
 No loss of control in voting power.
Disadvantages
 Security in the form of a fixed charge on business assets or
unlimited personal guarantee is usually required.
 If defaults of capital or interest payments occur, the bank is
usually entitled to demand full repayment of the whole loan.
 Business track record is usually required.
Costs
 Interest is charged above bank base rate depending on the
bank's assessment of the risk involved. (Assume base rate is
10%)
 Banks usually also charge an arrangement fee.
 A settlement penalty will be levied if the loan is repaid before the
end of the term.
Equity
The equity capital of a business is the owners' interest in it,
consisting of the share capital invested by them plus retained
profits.
Purpose
 Ensures that the company is properly capitalised. The debt:
equity ratio should not exceed 1:1.
Advantages
 Maintains the capital base upon which more debt financing can
be raised.
 If investors prefer capital growth to regular dividend payments,
this reduces cash outgoings.


New investors may also have business skills to contribute in the
management of the company.
Not affected by rises in interest rates.
Disadvantages
 There may be some loss of control; ownership of over 50% of
shares gives control over the business in most normal situations;
ownership of over 75% of shares gives total control.
 It is often difficult to find a suitable equity investor.
Costs
 Any annual dividends paid.
Factoring
Factoring is a continuing arrangement whereby the factor purchases
the trade debts due to a business, as they arise. Usually cash
payments of up to 80% of each new sales invoice are made, with
the balance, less charges, being paid when the invoice is settled.
Purpose
 Provides short-term finance to resolve cash flow problems arising
from:
 Funds being tied up in trade debtors.
 The cash demands of rapid expansion.
Advantages
 Provides a quick method of collecting debts.
 A large element of cash flow becomes predictable.
 The factor takes care of the maintenance of the trade debtors
ledger and the collection of debts.
 No loss of control.
Disadvantages
 The factor only takes over approved (good) debts.
 If value of total invoices taken over is high, the service charge
could work out expensive.
Costs
 Interest is charged at usually 20/0-3% above bank base rate or
finance house base rate.
 In addition there is a service charge for handling the debtors
records, debt collection, etc usually ranging between 0.75% and
2.0% of invoices purchased.
Private Loan
Purpose
 These may be used for whatever purpose required as long as the
lender does not object.
Advantages
 Probable flexibility of terms.
Disadvantages
 If family or friends are involved, could cause ill feeling in event of
default.
Costs
 Flexible -as agreed between parties.
Regional Venture Capital
These regionally based companies provide equity and loan finance
from £50,000 up to £500,000. Some have specifically targeted
funds to provide investments of between £5,000 and £150,000. The
normal deal is about £100,000.
Purpose
 To provide expansion finance for the business, marketing or
research and development costs.
Advantages
 To provide expansion finance for the business, marketing or
research and development costs.
 As equity finance.
Disadvantages
 Investors want a high return on their investment.
 Need to generate sufficient cash in the long term to make the
agreed payments of capital in the long term and interest and
dividends in the short term.
 Specifically legally binding contracts and covenants.
 The imposition of a non-executive director on the board.
 Regular information and consultation on the performance of the
business to the Venture Capital firm.
 Agriculture, retailing and sole property development is normally
excluded.
Costs
 Need to show a viable business proposition.
 Time in agreeing the deal.
Small Firms Loan Guarantee Scheme
The maximum loan provided under this scheme is £250,000 for
established businesses and £100,000 for new businesses.
Purpose
 To improve access to debt finance for viable businesses which
are unable to gain conventional finance because of a lack of
collateral or trading record, or a combination of both.
Advantages
 Established firms can obtain guarantees of up to 85% and are
charged a premium of 0.5% while new businesses can only
access guarantees for 70% of their loans and are charged a
premium of 1.5%.
 The maximum loan period is for 10 years.
Disadvantages
 Cost of finance and funding the higher interest charges and
ultimate repayment.
Costs
 Time and effort in obtaining the finance.
 Restrictive covenants.
Business Angels
Purpose
 High net worth individuals invest in unquoted companies and
businesses that are willing to risk their capital in return for a
return on their investment.
Advantages
 Raising funds in the form of equity finance strengthens the
balance sheet.
 Assistance from the business angel in the development of the
business.
 It is surprisingly difficult to raise between £10,000 and £250,000
and business angels supply equity funds to fill this gap.
 Most investments are between £10,000 and £50,000.
Disadvantages
 Interference from the business angel in your business.
 Business angels may be seeking a high return on their
investment (20% - 30%).
 Loss of management freedom, dilution / loss of control,
pressures to change the management team, lack of knowledge of
external financiers.
Costs
 The need to develop a personal relationship with the business
angel and the costs associated with preparing and presenting the
business proposition to the business angel network.
 Finding a compatible business angel.
Enterprise Investment Scheme
Permits individual investors to subscribe for new ordinary shares in
unquoted trading companies and receive personal tax relief at the
lower rate and on the gain made in the business.
Purpose
 As this is another form of equity funding its main purpose is to
ensure that the company is properly capitalised. The debt: equity
ratio should not be greater than 1:1.
Advantages
 As for equity.
 Amount raised may exceed value of shares because of the tax
relief available to the investor. Business angels use it.
Disadvantages
 As for equity.
 Equity together with his/her immediate family and business
partners may not own more than 50% of the shares in the
company.
 Scheme is only open to UK residents.
 Maximum investment in the any company is £150,000 and
£25,000 in anyone year.
Costs
 Professional fees for obtaining Inland Revenue approval for
personal tax relief, which the company may have to bear.
Grants
Purpose
 Grants try to promote public policy objectives. Examples of
grants are those which pay for training, innovation and
technology
transfer
and
development,
assist
regional
development, employment, redeployment, research or expansion
or exporting.
Advantages
 Grants are a useful subsidy and aid cash flow.
Disadvantages
 Experts find it difficult to keep track of grants available.
 Not available in all areas and sectors.
 Usually only available for specified projects and business would
be expected to contribute.
 Grants may impose restrictions.
Costs
 Time spent finding appropriate grant, satisfying criteria and
completing paperwork.