Sources of Finance: Share Capital, Loan Capital and Venture Capital
Businesses raise finance from internal sources, such as retained profit or the sale of assets, or external sources. The main external sources are share capital, money raised by selling ownership stakes (shares) in a limited company, which does not have to be repaid but dilutes existing owners' control and entitles new shareholders to a share of future dividends; loan capital, borrowed money such as a bank loan or a debenture, which must be repaid with interest but leaves ownership and control unchanged; and venture capital, finance from specialist investors who take an equity stake, usually in a young or high-growth business too risky for a conventional bank loan, often in exchange for a say in how the business is run. The right source depends on the amount needed, how long it is needed for, the cost, and how much control and risk the existing owners are willing to give up.
Before you start
Make sure you're comfortable with these topics first:
Method
- Sort a given source of finance into internal (retained profit, sale of assets) or external (share capital, loan capital, venture capital, trade credit), since exam questions often test this distinction directly.
- Learn the defining features of share capital: no repayment obligation, but it dilutes the percentage ownership and control of existing shareholders and creates an ongoing expectation of dividends.
- Learn the defining features of loan capital: must be repaid with interest regardless of how the business performs, but existing owners keep full control since lenders do not normally get voting rights.
- Learn what makes venture capital distinctive: it targets young, high-growth or high-risk businesses that struggle to get a conventional bank loan, and investors typically want an equity stake and some influence over decisions in exchange for the capital and expertise they provide.
- For a calculation, work out the total cost of loan capital as principal plus (principal x interest rate x number of years), and compare it with the ownership given up under share or venture capital finance.
- For a choose or justify question, apply the amount, time period, cost and control trade-off to the specific numbers and circumstances given in the case, rather than listing generic advantages and disadvantages.
Worked example
A private limited company needs to raise 100,000 pounds. Option A is a bank loan at 6% interest per year, repaid in full after 5 years, with only the interest paid annually. Option B is selling new shares, which would reduce the founder's ownership stake from 100% to 70%. Calculate the total interest cost of Option A over the 5 years, and comment on which option better preserves the founder's control.
- Calculate the annual interest payment on Option A: 100,000 x 6% = 6,000 pounds per year.
- Calculate the total interest paid over 5 years: 6,000 x 5 = 30,000 pounds.
- Calculate the total cost of Option A: the original 100,000 pounds principal plus 30,000 pounds interest = 130,000 pounds repaid in total.
- Compare control: under Option A the founder keeps 100% ownership and full control throughout, since a lender does not normally receive voting shares.
- Compare control: under Option B the founder's stake falls to 70%, so decisions requiring shareholder approval now need the new shareholders' agreement.
- Conclude: Option A costs an extra 30,000 pounds in interest but fully preserves control, while Option B raises the money without a repayment obligation but permanently dilutes the founder's ownership to 70%.
Practice questions
Type your answer and press Check to be marked straight away, or reveal the answer and mark yourself.
Q1State whether retained profit is an internal or external source of finance.Show answer
Answer: Internal.
Q2Define share capital.Show answer
Answer: Money raised by a limited company selling shares, i.e. ownership stakes, in the business.
Q3Give one disadvantage to existing owners of raising finance through share capital.Show answer
Answer: It dilutes their percentage ownership and control, and creates an ongoing expectation of dividend payments.
Q4Explain one reason a fast-growing technology start-up might use venture capital rather than a bank loan.Show answer
Answer: A start-up with no trading history and high risk of failure is unlikely to be approved for a large conventional bank loan, whereas venture capital investors specialise in funding exactly this kind of high-growth, high-risk business in exchange for equity.
Q5A business borrows 50,000 pounds at 8% interest per year, repaid after 3 years with only interest paid annually. Calculate the total interest paid over the 3 years.Show answer
Answer: 50,000 x 8% = 4,000 pounds per year; 4,000 x 3 = 12,000 pounds total interest.
Q6State one way loan capital differs from share capital in terms of control.Show answer
Answer: Loan capital does not normally reduce the owners' control since lenders do not receive voting shares, whereas issuing new share capital dilutes existing owners' percentage control.
Q7Give one reason a well-established, profitable company might prefer retained profit to loan capital.Show answer
Answer: Retained profit carries no interest cost and does not need to be repaid, so it avoids both the extra expense and the repayment obligation that a loan creates.
Exam-style questions
Written in the style of a A Level Business exam paper, with a full mark scheme.
A private limited company wants to raise 200,000 pounds to fund an expansion. Explain one advantage and one disadvantage of raising this through loan capital rather than share capital.
Show mark scheme
Tick each line you got. Your score builds from the marks on the scheme.
Nothing ticked yet - 6 available
A private limited company run by two founders needs 150,000 pounds to open a second site. Option A: a 5-year bank loan at 7% interest per year, interest paid annually, principal repaid at the end. Option B: selling new shares to a venture capital investor, reducing the founders' combined stake from 100% to 65% and giving the investor one seat on the board. Analyse the factors the founders should consider when choosing between these two sources of finance.
Show mark scheme
Tick each line you got. Your score builds from the marks on the scheme.
Nothing ticked yet - 12 available
See real A Level Business past-paper questions, with official mark schemes →
Free printable worksheet
Want more practice on paper? Download the sources of finance: share capital, loan capital and venture capital worksheet pack - 6 pages of exam-style questions with a full mark scheme. One email opens every download in this browser for 14 days - no account, no card. Print it for personal and classroom use.
Next topics
Not quite what you needed?
Tell us what is missing on sources of finance: share capital, loan capital and venture capital, or which topic to write up next. Every request is read, and we reply to every one.
Build a full practice pack.
This topic is one of hundreds in the library - pick the ones a student needs and generate a printable PDF in minutes.