External Funds: Financial Resources from Outside the Corporation

An in-depth guide to external funds, including sources like bank loans, bond offerings, and venture capital infusions, their types, applicability, historical context, and more.

External funds refer to financial resources acquired by businesses from sources outside the company. These funds are pivotal for corporate growth, operational expansion, and substantial projects that the business’s internal funds cannot independently support. Common sources include bank loans, bond offerings, and venture capital infusions.

Types of External Funds§

Bank Loans§

Bank loans are a traditional method of financing whereby a corporation borrows money from a financial institution. These loans are typically secured by collateral and have a fixed repayment schedule.

$$\text{Loan Amount} (L) = \sum \left( P + \frac{P \times r \times t}{100} \right)$$

• $L$ = Loan Amount
• $P$ = Principal
• $r$ = Interest Rate
• $t$ = Time (usually in years)

Bond Offerings§

Bond offerings involve a corporation issuing bonds to investors who, in turn, provide capital. This form of debt financing obligates the company to pay back the bond principal with interest at predetermined intervals.

Example: A $1,000 bond with a 5% annual interest rate (coupon rate) maturing in 10 years will pay annual interest of $50.

Venture Capital§

Venture capitalists invest substantial sums in growing companies in exchange for equity, or partial ownership, in the corporation. This infusion of cash helps younger companies scale operations swiftly.

Historical Context§

The reliance on external funding dates back to the expansion of international trade in the 17th century, where companies like the British East India Company raised capital through bond issuance. The modern landscape, however, has evolved to include sophisticated instruments like initial coin offerings (ICOs) and crowdfunding platforms.

Applicability§

Business Expansion§

Firms utilize external funds to finance large-scale projects, acquisitions, or enter new markets.

Research and Development§

External funds are critical for innovation, allowing enterprises to invest in R&D and stay competitive.

Operational Sustainability§

In times of economic downturns, external funds can provide the necessary liquidity to sustain operations.

Comparisons§

External Funds vs. Internal Financing§

• Source: External funds come from outside the firm, while internal financing is generated within the company’s operations.
• Cost: External funds often come with an interest cost or equity dilution, whereas internal financing typically does not involve immediate explicit costs.
• Flexibility: Internal funds may offer more flexibility with fewer restrictions compared to the conditions tied to external funds.

Related Terms§

• Debt Financing: Raising capital through borrowed funds.
• Equity Financing: Raising capital through the sale of shares in the company.
• Leverage: The use of debt to amplify returns.

FAQs§

What are the primary sources of external funds?

Primary sources include bank loans, bond offerings, and equity investment from venture capitalists or angel investors.

How do external funds impact a company's financial health?

They can bolster a company’s growth and market position but also increase debt liability or dilute ownership stakes.

What is the role of credit rating in bond offerings?

Credit ratings assess the financial stability and creditworthiness of a company, influencing investor confidence and interest rates offered on bonds.

References§

1. Brigham, Eugene F. & Ehrhardt, Michael C. “Financial Management: Theory & Practice.”
2. “Investopedia” for definitions and financial principles involving external funds.
3. Harvard Business Review for case studies on venture capital and corporate growth.

Summary§

External funds are an essential component of corporate finance, offering avenues for growth that internal resources cannot always support. These funds come primarily from bank loans, bonds, and venture capital, each with unique implications for a business’s financial health. Historical evolution and modern innovations add layers to our understanding and application of these funds.

For a comprehensive exploration of internal financing, click here.