Capital, financing, cash flow – terms that you should definitely know when starting your business. The term external financing , which most entrepreneurs use sooner or later, is particularly important . In this post you will find out what external financing is and what advantages and disadvantages it can have for you as an entrepreneur.
What does external financing mean?
According to dictionaryforall, the definition of external financing is quite simple, because it is a type of corporate financing that comes from outside, i.e. from an external provider . External financing can take the form of so-called individual financing . A corresponding contract is tailored to you as a loan seeker in order to find a good compromise for both sides. An alternative is market financing, in which stocks or bonds serve as consideration for the contractual partners.
A distinction is made between debt financing , equity financing , mezzanine financing and self-financing (also called equity financing). In all variants, the money comes from an independent creditor.
Example of external financing
Let’s say you own a carpenter’s shop that produces high quality furniture and then sells it to wholesalers. So your company works with the B2B principle . In addition to you, another owner is involved – both hold the same shares in the joinery. Now you want to optimize production with a new machine due to increasing demand. The investment amount is 120,000 euros. The company itself could raise internal financing of 40,000 euros. The question now arises as to how you can finance the new machine with your business partner and what type of financing is available to you.
- Self-financing: First of all, you should clarify whether self-financing in the form of a capital increase for the company is possible. If you and your business partner both have the opportunity to pay 40,000 euros into the company, this offers the opportunity to make the purchase immediately. The special advantage is that you still own the full shares in the company and you don’t have to pay off any loans.
- External financing: Alternatively, you could also apply for a loan from a bank in the amount of 120,000 euros. The interest rate that must be paid on the loan amount must be observed here. In addition, the monthly repayment must be chosen so that it does not have a negative impact on the liquidity of your joinery.
- Mezzanine financing: Since the banks usually require an own share of the entire purchase price, the mezzanine financing should be exactly the right thing. In this case, internal and external financing takes place. So you could release the 40,000 euros as internal financing and apply for 80,000 euros as a bank loan as a supplement.
- Leasing: In order to free yourself from a negative Schufa entry and the dependence on a bank, you can ask the seller of the necessary machine whether a leasing contract can be drawn up. Alternatively, a supplier credit would also be possible.
Types of external financing
Depending on the liquidity, the companies involved and the reason for the external financing, different types of financing are available to you.
With self-financing , the owners of the company usually give additional money in order to be able to carry out the investment project. This money comes from the private assets of the owners of a company who are already involved.
Alternatively, shares can also be issued in order to find new investors . With the acquisition of a share, the buyer has a corresponding stake in the company and thus expect a good return.
So equity holders of all kinds have a say on important company decisions. At the same time, with self-financing, your company becomes more independent from the banks, which in turn makes it attractive to further investors.
Equity Financing – Definition
The equity financing is a form of self-financing. New investors are brought into the company, who receive shares in your company according to the amount of equity invested.
A contribution in kind is possible. For example, an important machine for production can be handed over to the company free of charge. The value of this machine then determines the corresponding share that the giver of the contribution in kind receives.
The advantages of external financing through a loan are obvious. You retain full control of your company, do not have to give up any shares and can freely decide what the money is used for.
With regard to external financing, a distinction is made between two variants :
Long-term debt financing
- Bank loan
- Bonds or debentures
- Zero coupon bond or zero bond
- Promissory note loan
Short term debt financing
- Customer credit
- Supplier credit
- Bill credit
- Bank overdraft
- Letter of credit
- Guarantee credit
In most cases, the creditor is a bank that will provide you with a business loan. However, it can also be a private lender.
You have to repay the full amount of the loan including interest within the agreed period . A corresponding Schufa entry is made, which may affect your creditworthiness for other lenders.