External sources of finance

External sources of finance come from outside the business, usually from a lender such as a bank, or from investors who put money in.

Loan capital

Loan capital is money borrowed by the business that must be repaid, with interest added on top. For example, a garden centre might borrow £40,000 to build a second glasshouse and repay it in monthly instalments over five years.

The main benefits are speed and size: a large sum can arrive quickly, and because the lender is only owed money and does not become an owner, the existing owners keep control of decisions. The drawbacks are cost and risk. Interest makes the borrowing cost more than the amount received, and the repayments must be made even in a quiet month, which can squeeze cash flow and increase financial risk — the danger of being unable to keep up repayments if sales fall.

Share capital

Share capital is raised by selling shares in a company, so investors pay money in and become part owners. It does not have to be repaid and no interest is charged, which makes it less of a drain on cash than a loan.

In return, shareholders may expect a share of the profit as dividends, and they usually expect a say in how the business is run. Selling new shares also dilutes existing owners' control. If two owners each held 50% and new shares are sold so that outsiders own 40%, each original owner falls to 30%. The two of them still hold 60% between them and keep control if they vote together, but neither can outvote the new shareholders alone.