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Skip to 0 minutes and 4 seconds Most small businesses will only have a few people who are prepared to invest in the company, perhaps just family and friends. So if you want to expand faster, you need to consider an alternative form of finance. Esther Thompson of Teahuggers explains why. Well, I started out the business with my own funds initially, and that took me up to eight months of trading. and then, I got a start-up loan, which is a very straightforward transaction. And with that start-up loan, I’ve got a mentor who’s been brilliant. And now, I’m looking for other loans or potentially investors to join the business for both to strengthen my cash flow but then also to help mentor the business as it grows.

Skip to 0 minutes and 52 seconds A second source of investment is through borrowing. This usually occurs when a bank lends money to a company and charges them interest on the loan. Our business therefore owes this money to the bank and we call this a liability, rather than capital, because it is owed to someone other than the business owners. Let’s assume we go to our bank– with a business plan, of course– and persuade them to lend us a further 10,000 pounds to buy 20 more cameras. Our balance sheet now looks slightly more complicated, but it is represented by the relationship, assets equals capital plus liabilities.

Skip to 1 minute and 34 seconds If we manage to sell all of the cameras for 800 pounds each, we would then be looking at a profit of 41 times 300 pounds, which equals 12,300 pounds. From the funding provider’s point of view, lending is usually seen as a safer choice. The bank gets a known amount of interest each year, whether or not the business is profitable. Shareholders only get to share in profits if the business is successful. Also, most forms of loan capital will have a repayment date. So the bank will get back exactly what they lent to the company. Most large companies have a combination of both equity investment and loans for technical and tax reasons that we don’t need to consider on this course.

Skip to 2 minutes and 22 seconds However, in today’s business environment, banks are reluctant to lend unless there is a concrete business case. If a business has borrowed money and there is a downturn in sales and worsening cash flows, this may mean it cannot pay the interest on its loans or repay the loans when they fall due. The lender may call in the debt. This means they ask for the loan to be repaid. This may then cause the business to fail. Paul Bulpitt of the Wow Company explains the dangers of borrowing.

Skip to 2 minutes and 57 seconds In terms of financing growth, I think what we saw during the recession was a lot of the banks calling in their loans and you saw businesses having to make decisions that were dictated to by banks. So I think I’d always say, as far as possible, to try and finance it yourself to whatever degree. What better asset is there to invest in than your own business that you have control over? This can be frustrating for a business owner, as effectively, the bank manager is making the final decision as to whether you can launch a new product or buy new goods to sell at a profit.

Financing growth: debt

An additional source of finance for a business is to borrow money.

In the last video we saw that many businesses seek equity investment to help finance their growth. Finding investment can be challenging however, particularly for smaller businesses.

As we will see in this video, another source of cash for businesses to invest in growth is for them to borrow money, usually from a bank. This is called a liability, as Alice explains.

Once you’ve watched the video, in the downloads section there is a document where you can again see how our example camera business would need to update its balance sheet in light of the money it has borrowed.

What’s next?

We saw in this video that borrowing money comes with certain risks, and that the demands of lenders can sometimes limit a business’s freedom to develop and expand. In the next step we’ll consider some of the innovative new approaches to financing growth that have emerged in recent years.

Have your say

In this video we saw a few of the risks associated with borrowing money. Can you think of any other dangers for an organisation that borrows money? Share your ideas in the comments on this page.

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This video is from the free online course:

The Importance of Money in Business

University of Leeds