You may decide that it is time to seek external investment sources to fund your business activities and, to grow  and scale your business ventures or to help get your start-up off the ground. Investment received from outside the company is known as external sources of finance. It is a viable option if you are looking to raise a larger sum of money and if the business is limited by internal funds. There are two types within external investments that you should know about: debt finance and equity finance.

Let’s go through some examples:

- Overdraft: Traditionally regarded as a short-term source of finance, which is commonly used in small companies and start-ups due to its accessibility. When the current account’s bank balance goes below zero, the business will then owe the bank the money that was taken out, including interest charged on the overdrawn balance.

- Bank Loan: This is a common source of finance that provides a medium-to long-term finance option and involves interest charged on the monthly repayments for a fixed period of time. Although you can borrow a greater amount of money in comparison to an overdraft, there are some factors to consider. Generally, the bank will require that the loan is secured against some form of collateral, which is typically a tangible asset. If you are a small business, this maybe against the directors family home, if they equity in it. Failure to pay back the loan will result in the bank seizing the collateral. Despite this form of borrowing being rather costly, you will not have to compromise giving up ownership of the company via shares.

- Venture Capital: These are investors employed by venture capital firms that look to invest money from their collective funds in start-ups with high growth potential. They will expect a return on their substantial investment. It is important that you look for investors who can offer your company relevant experience and knowledge to help it grow. But, you will have to consider that such a form of funding will result in venture capital firms having a more active role in your company's operational decision-making.

- Angel: Similar at a glance to venture capitals, angel investors are affluent and entrepreneurial individuals that invest their own personal funds in return for some of the company’s shares. These wealthy individuals are likely to invest in a start-up during the very early stages, whereas venture capitalists prefer to invest later down the line of a start-up. When it comes to control, angel investors are usually less involved than venture capitalists, often seen as taking a more passive and consultative role.

 - Family and Friends: This can be money loaned from family and friends with the benefit of little to no interest charged. You may find this to be an easier source of funding with greater flexibility in regards to repayment terms. Alternatively, friends and family may invest through a share of equity, which is seen as a long-term investment. This means that part ownership of the company is given through shares, resulting in a dilution of yours and any existing shareholder’s ownership. You could look into issuing non-voting shares to family members and friends, which offers the benefit of no involvement in the company’s operations and decision-making. They are, however, able to reap the benefits from any distribution of profit or dividends.

- Crowd Funding: This can be explained by collecting small amounts of capital from many individuals to help finance the new business venture. Unlike traditional financing methods, this source of finance is open to all individuals who are interested in and willing to invest in the start-up, through online crowdfunding platforms and social media, to help boost your crowdfunding campaign. 

There are different types of crowdfunding to consider:

1. Donation-based crowdfunding: backers fund the project or cause for the benefit of the community and do not expect a return.

2. Reward-based crowdfunding: individuals invest in the company’s project in exchange for a product or service offered by the company.

3. Equity-based crowdfunding: investors receive shares of the company in return for their investments.

4. Debt-based crowdfunding is seen as receiving a loan from a large group of willing investors.

- Trade credit: An easily available short-term finance option for businesses, where payments for goods and services can be made at a later stage rather than paying upfront. As well as building a good rapport with your suppliers and the opportunity for the early payment discount, it also benefits the company through better cash flow management. This means you can prioritise your expenditures accordingly. 

-Grants: There are plenty of grants available to give your company external investment. These will be given providing your company meets the specific conditions. Grants are typically provided by the government or charitable organisations. Although it may take a long time to obtain this source of external investment, partially due to the extensive paperwork involved, certain grants do not require repayment as long as the criteria of the grant funder are met.

- Hire purchase + Leasing: These are types of debt finance that allow businesses to utilise the asset for a set period of time. Let’s go through the differences between the two.

Hire purchase allows the business to purchase the asset through regular instalments rather than paying the full cost upfront. The asset is not owned by the customer until all the payments have been made.

However, with leasing, ownership will not be transferred from the leasing company to the customer. Leasing allows the business to rent the asset, and at the end of the contract, there are a couple of options available, such as extending the contract, purchasing the asset, or returning the asset.

Advantages of external investment:

The main advantages are that your company will have access to a wider range of capital and funding, which offers the opportunity to grow and expand your business, even if you have limited internal funds and savings. It offers the added benefit of focusing on using your internal financial resources for what is required.

Through equity financing, companies receive the benefit of investors providing expert advice and valuable knowledge to help the start-up grow. They can also assist with company strategy through their experience in the industry. Their contacts and connections may offer the opportunity for additional funding for the company.

Disadvantages of external investment:

The disadvantage of external investment is that, depending on the source, there can be a loss of control and ownership. With equity investments, investors will require you to forgo a portion of the company’s shares in return for their investment. With share ownership, investors will be able to vote and be a part of the company’s decision-making process. This can mean the company is going in another direction from what you originally envisioned. Distribution of profits is also another drawback to consider; you may have preferred to reinvest the profits into the company to fuel its growth instead.

Interest costs are also important to consider. For example, with loans, there is the added cost of interest rates to consider. It is always good to review the company’s ongoing expenses and also ensure that the company has sufficient funds to make the monthly repayments on time. Failure to make the monthly repayments may result in the bank seizing the assets that the loan was secured against.

Factors to consider :

You need to consider the following factors that will influence your choice and the source of external investment that is best suited to your business or start-up. 

- What is the purpose of the external investment? You need to consider what the finance will be used for within your company or start-up.

- How long is the finance required for? Options for short-, medium-, and long-term sources of finance are available.

- How much (value or amount) of external investment is required?

- Time period: how long is the finance required for?

- Other factors to consider when receiving finance are the repayment terms, additional fees like interest rates, loss of ownership or control, and so forth.

It is always important to consider the pros and cons of different types of external investment. As always, doing thorough and extensive research on the available finances will help you arrive at a suitable decision. Hopefully, this article has briefed you on some of the sources of finance and also raised points for you to consider when selecting the best choice for your company. Find out more about running a small business.