CAT / FIA FFM Syllabus D. Financing Decisions - Finance for SMEs - Notes ^{5 / 5}

Possible sources of finance for SMEs include:

• Owner financing

• Overdraft financing

• Bank loans

• Trade credit

• Equity finance

• Business angel financing

• Venture capital

• Leasing

• Factoring

Owner financing

Finance from the owner(s)' personal resources or those of family connections is generally the initial source of finance. 

At this stage because many assets are intangible, external funding may be difficult to obtain.

Overdrafts and loans

Remember this is where payments from a current account exceed income to the account for a temporary period, the bank finances the deficit by means of an overdraft. 

It is very much a form of short-term lending, available to both personal and business customers.

Many SMEs require their bank to provide financial assistance for normal trading over the operating cycle, if for example seasonal factors mean they face temporary cash shortages.

Trade credit

Undoubtedly trade credit can be a useful source of finance early in a SMEs life. 

Its principal problem is that taking extended credit will mean the loss of early payment discounts, and the amounts involved may be significant.

Equity finance

Other than investment by owners or business angels, businesses with few tangible assets will probably have difficulty obtaining equity finance when they are formed (a problem known as the equity gap).

However, once small firms have become established, they do not necessarily need to seek a market listing to obtain equity financing; shares can be placed privately. 

Letting external shareholders invest does not necessarily mean that the original owners have to cede control, particularly if the shares are held by a number of small investors. 

However small companies may find it difficult to obtain large sums by this means.

Business angel financing

Business angel financing can be an important initial source of business finance. 

Business angels are wealthy individuals or groups of individuals who invest directly in small businesses.

Venture capital organisations

Venture capital is risk capital, normally provided in return for an equity stake.