Examples of External Financing Alternatives
Original post by Dennis Hartman of Demand Media
Every business needs money to invest in its own operations and growth. Where that money comes from depends on a business's market position, size and financial strategy. External financing, which is money that comes from outside the company instead of from existing internal savings or profits, gives businesses of all sizes access to money from several types of investors.
Selling stock is a common external financing alternative for businesses. Stock passes control of a company, as well as the chance to profit from its growth, to investors who buy shares. However, it also delivers a quick influx of cash as individual and institutional investors pay for shares in an IPO, or initial public offering. Businesses that elect to sell stock must first register with a stock exchange and provide financial details so that investors can make informed decisions. This process requires time and money, which limits its usefulness to businesses that can afford the process and are large enough to attract investors who have many other options elsewhere in the stock market.
Venture capital is another external financing alternative for businesses that can attract investors with resources and the willingness to take a risk. Like stock buyers, venture capitalists invest their own money into a company and lose, or profit, as its value changes. However, unlike stockholders, venture capitalists invest large amounts without the intermediary of a market to set prices and regulate transactions. Venture capitalists may become involved in business operations to protect their investments.
Lines of Credit
Businesses use lines of credit to supply ongoing funding as needed to meet expenses. A line of credit, which can come from most types of commercial banks, provides an open-ended loan that a business can use to augment its cash flow. For example, if a business has a slow month and doesn't have substantial cash savings, its line of credit will allow it to issue paychecks and pay for necessary business expenses such as wholesale merchandise, raw materials and a lease on an office or other place of business.
Each external funding alternative has its own benefits and potential risks or costs. Selling stock is initially expensive and causes a business's original owners to lose much of their control of the company. Lines of credit subject businesses to interest charges and place the assets they use as collateral at risk. Venture capital is a highly competitive field, with many start-ups and established businesses competing for limited funds from investors. However, a business that attracts a venture capitalist can receive money without giving up ownership or paying interest.
- New York University; Internal versus External Financing: An Optimal Contracting Approach; Roman Inderst and June 2003
- Candid Capital: Personal and Business Implications of Raising External Finance
- Small Business Money: External Financing Sources Part 1: Revolving Lines of Credit
About the Author
Dennis Hartman is a freelance writer living in California. His work covers a wide variety of topics and has been published nationally in print as well as online. Hartman holds a Bachelor of Fine Arts from Syracuse University and a Master of Arts from the State University of New York at Buffalo.
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