Where does a start-up get the money it needs, and which source fits best?
Sources of finance for a start-up or established small business: short-term sources (overdraft and trade credit) and long-term sources (personal savings, venture capital, share capital, loans, retained profit and crowd funding), and their suitability.
A focused answer to Edexcel GCSE Business 1.3.4, covering short-term sources of finance (overdraft, trade credit) and long-term sources (personal savings, venture capital, share capital, loans, retained profit, crowd funding) for a start-up or small business.
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What this dot point is asking
Edexcel wants you to name and judge the sources of finance a start-up or small business can use, split into short-term sources (for day-to-day needs) and long-term sources (for lasting investment), and to choose the source that best fits a situation.
Short-term sources of finance
An overdraft is ideal for short, unexpected gaps, for example covering wages in a slow month. It is flexible (you only borrow what you need) but expensive if used heavily, and the bank can withdraw it. Trade credit is, in effect, an interest-free short-term loan from a supplier: the business sells the goods before it has to pay for them, which helps cash flow. Its limit is that it only buys time; it does not raise capital.
Long-term sources of finance
The choice involves trade-offs. Personal savings and retained profit are cheap (no interest, no loss of control) but limited and, for savings, risk the owner's own money. Loans keep ownership but lock the business into repayments. Share capital and venture capital bring larger sums and, with venture capital, expertise, but the owner gives up part of the business and its profits. Crowd funding can fund a product and prove there is demand at the same time, but is uncertain and takes effort.
The right source depends on the amount needed, the time period, the risk of the business, and how much ownership the entrepreneur is willing to give up. A brand-new business with no track record often relies on personal savings, trade credit and crowd funding, because banks and investors are cautious about unproven ventures.
Try this
Q1. State one advantage of using personal savings to finance a start-up. [1 mark]
- Cue. No interest to pay and no loss of control, because it is the owner's own money.
Q2. Explain one reason a new business might find it hard to get a bank loan. [3 marks]
- Cue. It has no track record or trading history, so the bank sees it as risky and may refuse or charge high interest.
Exam-style practice questions
Practice questions written in the style of Pearson Edexcel exam questions on this dot point, with worked answer explainers. The year tag is the paper they imitate, not the source.
Edexcel 20202 marksState two short-term sources of finance a small business could use. (Paper 1, Section A)Show worked answer →
A 2-mark state question, one mark per correct short-term source.
The two short-term sources Edexcel lists are: overdraft and trade credit.
Markers want the short-term sources specifically. Long-term sources (loan, share capital, retained profit) are not short-term, so they do not earn the marks here. Since Edexcel names only two short-term sources, both must be given.
Edexcel 20229 marksA start-up needs to buy equipment and launch. Justify whether a bank loan or crowd funding would be the better source of finance for this start-up. (Paper 1, Section C)Show worked answer →
A 9-mark justify question (Section C) needs a clear choice, a developed chain applied to the start-up, and a judgement against the alternative.
A bank loan provides the full as a lump sum repaid with interest over an agreed term, which gives certainty and keeps full ownership, but a new business with no track record may be refused or charged high interest, and repayments must be met even if sales are slow.
Crowd funding raises money from many small backers online; it can also test demand and build a customer base, and avoids interest, but it is uncertain (the target may not be reached) and takes time and effort to run a campaign.
A strong answer judges based on the start-up's situation: if it has a appealing consumer product it can showcase, crowd funding both funds it and proves demand; if it needs the money guaranteed and quickly and can meet repayments, a loan is safer. The judgement must be supported, not a list of both. Markers reward the reasoned decision.
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Sources & how we know this
- Pearson Edexcel GCSE (9-1) Business (1BS0) specification — Pearson Edexcel (2017)