Choosing sources of finance

When a business needs money to grow, it compares the sources of finance available. Internal sources come from inside the business, such as retained profit or selling assets; external sources come from outside, such as loan capital or share capital.

Internal sources are usually cheaper because there is no interest, fee or dividend to pay, and owners keep control of the money. Their weakness is the amount: a business can only use profit it has kept or sell assets it owns, which may be far below what a big expansion needs. Selling an asset can also remove something useful, such as a machine.

External sources raise larger sums, often quickly: a loan can be arranged in weeks, and a limited company can issue shares to many investors. They add costs, because loans are repaid with interest, and share capital, which never has to be repaid, may bring dividend payments. They can also reduce control, as lenders set conditions and new shareholders gain voting rights.

Weighing up the choice

Cost, speed, risk, control and the amount needed are the main factors, and the same five help you compare other routes to growth, such as a merger or a takeover.

Worked example

A chain of three indoor climbing centres wants £150,000 for a fourth site and has £40,000 of retained profit. Using that is cheap and keeps control, but leaves £110,000 to find. A £110,000 loan is quick and large enough, but interest raises monthly costs and the lender may ask for security. Issuing shares could raise the money without interest, but the owners would lose some control. The best choice depends on how soon the site must open, the profit it should make and how much control the owners will give up.