Sources of Finance for Limited Companies

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For business finance, there are many alternatives to a bank.
For business finance, there are many alternatives to a bank. (Image: bank image by Pefkos from Fotolia.com)

Limited companies attain their finances from myriad sources and what is ideal for one company might not work for another. In deciding on where to source finances, a limited company has to carry out a careful analysis of its needs and -- as noted by The Mill Consultancy -- the amount of risk involved and how much equity it is willing to give up.

Short Term and Internal Sources

Most start-ups finance their business from the personal savings of shareholders. Other internal sources of finance include loans and grants from family and friends. When the business is expanding and shows signs of profitability, earned profits are re-invested into the business instead of distributing them among shareholders. Company assets not critical to the business could be disposed of and the earnings could be used to finance company operations.

Banks

Banks provide a ready external source of finance for limited companies. Finance from financial institutions can take the form of loans or overdrafts. For most start-ups, an overdraft is preferred to a loan as the former provides for flexible terms of payment and does not tie the company to the lender for a long period. Moreover, an overdraft does not require collateral -- which is the case with most long term loans. While an overdraft is flexible and can be paid off quickly, it is more expensive than a long-term loan; the company therefore needs to carefully assess its cash-flow situation before deciding on this matter.

Other External Sources

A limited company can obtain funds by issue of shares to a third party. While this improves the company’s balance sheet, it has the drawback of limiting the influence of the original shareholders’ influence on the running of the company. Similar to the issue of shares is acquisition of funds from venture-capital organizations. Venture-capital houses are able to inject huge amounts of money into a company but -- as when new shares are issued -- they play a controlling role in the management of the business and could require a seat on the company’s board. On the plus side, providers of venture capital bring with them years of expertise in business management and will ultimately help strengthen the company. Most venture-capital houses, however, will only work with well-established companies and might not be ideal for start-ups.

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