Starting a Business Raising Finance

Ordinary share capital Shares represent ownership of a company. If you hold one share worth £1 in a company then you are a part owner. Ordinary shares will pay a dividend (a share of the profits) and give voting rights (one vote per share). They do not give as much protection as preference shares. If the firm goes into liquidation preference shareholders will be paid out before ordinary shareholders. However, small businesses are unlikely to raise money on the London Stock Exchange. Instead, they will raise money from a number of, mainly local, sources. These tend to be family, friends or formal equity funding finance. Formal equity funding finance has three main forms: 1. Business Angel investors 2. Venture Capitalists 3. Alternative Stock markets

Ordinary share capital 1. Business Angel investors Wealthy individuals that are looking for an investment opportunity where they provide funding and expertise in exchange for a share of the business. 2. Venture Capitalists Similar to business angels, these are firms that provide investment for smaller businesses that they consider to have growth prospects. 3. Stock markets These provide new investment via a flotation. However, they are unlikely sources of investment for a new business. Run video clip from internet Visit Angels Den

Loan capital Loan capital is when a lender provides capital (money) to a borrower, and the borrower agrees to repay the borrowed money with interest, over a period of time. The AQA specification states that candidates need to understand two forms of loan capital: Bank Loans – these are usually for a specific time period e.g. 5 years and carry a fixed rate e.g. 6% of the initial sum on a yearly basis. Bank Overdrafts – an extension of credit from a bank. This allows firms to borrow money (go overdrawn) from their bank account.

Bank Loans Advantages Disadvantages Quick and easy to secure Fixed interest rates allowing firms to budget Improved cash flow - vital for a small business The borrower retains ownership of the company Disadvantages Interest must be paid – this particularly hurts a highly geared company (at least 50% of its capital from loans) A firm normally provides security (collateral) against its assets Often more expensive than other forms of finance – a firm can be charged for early payment

Bank Overdrafts Advantages Disadvantages Only borrowed when required allowing flexibility Only pay for the money borrowed Quick and easy to arrange No charges for paying off the overdraft Disadvantages The bank can call it in at any time Only available from your current bank account Interest payments tend to be variable – making it more difficult to budget Banks may secure the overdraft against the business’ assets

Venture Capital Venture capital is also known as private equity finance. Venture capitalists (VCs) will invest large sums of money in a business in return for shares in the company. Typically, VCs will invest at least £50 000 in a small regional business although this can rise into millions of pounds. The VC will look for a high rate of return in a specific time period. They look for a strong business plan, sound management and a proven track record, making it difficult for start-up firms. BBC What do Venture Capitalists do?

Sources of finance available to start businesses Venture capital Advantages Large sums of money for investment Expertise to help the business Makes it easier to attract other sources of finance Provides the required capital for expansion Disadvantages A long and complex process Expert financial projections are likely to be required Initially expensive for the firm e.g. legal and accounting fees Partial loss of ownership to the VC Interference from the VC

PERSONAL SOURCES Friends and family – this is a widespread practice. It should be made clear that they should only invest amounts they can afford to lose and the agreement should be put in writing. This sort of agreement can often cause problems with personal relationships with people wanting their money back or trying to interfere in the running of the business. Personal savings and mortgages – this ensures that the owner is in full control and savings provide a cheap source of finance. However, often a start-up business quickly realises that they have not researched the market thoroughly enough and there is a high rate of failure among new businesses leaving the owner to lose all of their personal savings or their house!

The context for a small business The AQA specification requires the candidate to be aware of the advantages and disadvantages of raising finance in specific contexts. Candidates should take into account the legal structure of the business – it is easier for a partnership to raise finance than for a sole trader. Shares are only an option for companies. Each source of finance has different benefits and drawbacks. When answering questions it is advisable to think about where the finance comes from and what the different providers of finance are looking for. Also consider what the finance will be used for. It should also be remembered that only some sources of finance are appropriate for a small business – they are unlikely to float on the Stock Exchange!

Questions – Raising Finance State and justify an appropriate source of finance for the following purchases for a florist setting up as a sole trader Delivery Van Additional Stock Premises Advertisement in local paper How would your recommendations change if you were a Private Limited Company Why is a florist unlikely to secure the financial backing of a Venture Capitalist?