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What are the risks of external financing?

External financing carries risks such as increased debt, loss of control, higher interest rates, and potential for bankruptcy.

One of the primary risks of external financing is the accumulation of debt. When a business borrows money from external sources, it is obligated to repay the loan with interest. This can put a significant financial strain on the business, especially if it is not generating enough revenue to cover the repayments. If the business fails to meet its repayment obligations, it could face legal action from the lender and potentially go into bankruptcy.

Another risk is the potential loss of control over the business. This is particularly relevant when a business seeks external financing through equity financing, where it sells a portion of its ownership in exchange for capital. The new shareholders may have voting rights and can influence the direction of the business, which may not always align with the original owners' vision.

Higher interest rates are also a risk associated with external financing. Interest rates can vary greatly depending on the lender, the type of financing, and the creditworthiness of the business. Higher interest rates mean higher costs for the business, which can eat into profits and make it more difficult to achieve financial stability.

Lastly, the risk of bankruptcy is always present with external financing. If a business is unable to repay its debts, it may be forced into bankruptcy. This can result in the loss of the business and significant financial hardship for the owners.

In conclusion, while external financing can provide a business with the capital it needs to grow and expand, it also carries significant risks. It's important for businesses to carefully consider these risks before deciding to pursue external financing.

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