External finance: who provides it

Family, friends and banks

• Family and friends: may lend or invest on easy terms with little paperwork, but the amounts are often small and a business failure can damage relationships.
• Banks: provide loans and overdrafts. They expect a business plan, charge interest and often want security (collateral), such as property, which can be seized if repayments are missed. New firms with no track record can find bank finance hard to get.

Peer-to-peer funding and crowd funding

• Peer-to-peer (P2P) lending: an online platform matches businesses that want to borrow with individuals who want to lend, cutting out the bank. Interest rates can be competitive and decisions quick, but lenders' money is not protected like a bank deposit and rates for riskier firms are high.
• Crowd funding: many people each put in a small amount through an online platform, in return for a reward (often the product), shares (equity crowd funding) or interest. It can also test demand and build publicity. But the target may not be reached, the idea is exposed to copying, and the platform takes a fee.

Business angels and other businesses

• Business angels: wealthy individuals who invest their own money in small, high-potential firms in return for a share of ownership (equity). They often bring experience and contacts, but take part of the profit and some control.
• Other businesses: a supplier may offer trade credit, a larger firm may invest in a partner, or a firm may lease equipment from a leasing company. Investment from another business may come with conditions or a loss of independence.

Choosing a source: suitability

Match the source to the situation:

• Size of the amount: small (friends, crowd funding) or large (banks, venture capital).
• Purpose and time period: short-term needs suit overdrafts and trade credit; long-term assets suit loans or share capital.
• Legal form: only companies can sell shares.
• Risk and track record: banks prefer established firms; angels accept higher risk for a share of the business.
• Control: equity finance gives away ownership; debt does not, but must be repaid with interest.

Worked example

A two-person app start-up with no assets needs $150,000 and has no trading history. Assess whether a bank or a business angel is the more suitable source.

1. Bank: will want security and a track record, which the firm lacks; interest and repayments would start before the app earns money.
2. Business angel: accepts high risk for equity, no repayments, and may bring tech contacts.
3. Cost: the founders give up part of ownership and future profit.

Answer: A business angel is probably more suitable, because the firm cannot offer security or service debt yet, though the founders must accept losing some control.

Check yourself

1. A business angel is best described as
   • a bank manager who approves overdrafts
   • a wealthy individual who invests in a small business in return for a share of ownership
   • a government department giving grants
   • an online platform matching borrowers with lenders
   Show answer

   a wealthy individual who invests in a small business in return for a share of ownership. Angels invest their own money for equity and often give advice too.

2. Peer-to-peer lending involves
   • businesses lending to each other through trade credit
   • selling shares on a stock exchange
   • a bank lending to another bank
   • individuals lending to businesses through an online platform
   Show answer

   individuals lending to businesses through an online platform. P2P platforms cut out the bank as intermediary.

3. Which is an advantage of crowd funding beyond raising money?
   • It never involves fees
   • It can show whether there is demand for the product
   • It always reaches its target
   • It gives the business a bank credit rating
   Show answer

   It can show whether there is demand for the product. Backers are often early customers, so the campaign tests the market.

4. Why do banks often ask for security (collateral) on a loan?
   • To lower the business's tax bill
   • Because it is required for all overdrafts by law
   • So they can take an asset if the loan is not repaid
   • To become a shareholder
   Show answer

   So they can take an asset if the loan is not repaid. Security reduces the bank's risk.

5. A drawback of borrowing from family and friends is that
   • relationships may suffer if the business fails
   • the interest rate is always very high
   • the lender gains limited liability
   • a business plan is legally required
   Show answer

   relationships may suffer if the business fails. Mixing money and relationships is risky.

6. Which factor most limits a sole trader's choice of external finance?
   • It cannot borrow from banks
   • It cannot use trade credit
   • It cannot issue shares
   • It cannot use crowd funding
   Show answer

   It cannot issue shares. Only companies have share capital; sole traders rely on loans, savings and similar.

7. Explain one advantage of finance from a business angel compared with a bank loan.
   Show answer

   There is no interest or repayment, so cash flow is not drained, and the angel may bring expertise, advice and contacts.. Angels take equity, so no interest or repayments, and they often bring expertise and contacts.

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Sources

• Pearson Edexcel International Advanced Subsidiary/Advanced Level in Business specification (2018)
• Pearson qualifications: Edexcel International Advanced Level Business (2018)

Last updated 8 November 2026. Spotted a mistake? Tell us.