ACCT 2220 Lecture Notes - Angel Investor, Hire Purchase, Cash Flow

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26 Jan 2013

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Raising finance - an overview
Author: Jim Riley Last updated: Wednesday 24 October, 2012
When a company is growing rapidly, for example when contemplating investment in capital
equipment or an acquisition, its current financial resources may be inadequate. Few growing
companies are able to finance their expansion plans from cash flow alone. They will therefore
need to consider raising finance from other external sources. In addition, managers who are
looking to buy-in to a business ("management buy-in" or "MBI") or buy-out (management buy-
out" or "MBO") a business from its owners, may not have the resources to acquire the company.
They will need to raise finance to achieve their objectives.
There are a number of potential sources of finance to meet the needs of a growing business or to
finance an MBI or MBO:
- Existing shareholders and directors funds
- Family and friends
- Business angels
- Clearing banks (overdrafts, short or medium term loans)
- Factoring and invoice discounting
- Hire purchase and leasing
- Merchant banks (medium to longer term loans)
- Venture capital
A key consideration in choosing the source of new business finance is to strike a balance
between equity and debt to ensure the funding structure suits the business.
The main differences between borrowed money (debt) and equity are that bankers request
interest payments and capital repayments, and the borrowed money is usually secured on
business assets or the personal assets of shareholders and/or directors. A bank also has the power
to place a business into administration or bankruptcy if it defaults on debt interest or repayments
or its prospects decline.
In contrast, equity investors take the risk of failure like other shareholders, whilst they will
benefit through participation in increasing levels of profits and on the eventual sale of their stake.
However in most circumstances venture capitalists will also require more complex investments
(such as preference shares or loan stock) in additional to their equity stake.
The overall objective in raising finance for a company is to avoid exposing the business to
excessive high borrowings, but without unnecessarily diluting the share capital. This will ensure
that the financial risk of the company is kept at an optimal level.
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