Small Business Financing
Small businesses are an important contributor to Canada’s economy. Starting or growing a small business takes planning, hard work and money to make it happen. There are various ways to finance your small business including debt and equity financing, and government finance programs. Each small business is unique and has its own specific finance needs.
Money that you borrow to run your business. You must repay your money in full, usually in instalments, with interest. The lender usually assesses a variety of factors such as the strength of your business plan, management capabilities and financing to evaluate your company’s chances of success. Debt financing can include some of the following:
Line of Credit: Also called an operating loan, a line of credit provides a business with money to cover day-to-day expenses. As funds are used, the established credit line is reduced. Your line of credit is replenished when you make payments towards it. Like a demand loan, it’s usually secured by assets, receivables, inventory or other means. The loan has a limit and you pay interest only on the amount outstanding, usually on a daily basis.
Credit Cards: Actually a type of short-term operating loan, they allow you to make relatively small purchases today and pay for them later. As long as you pay off your credit card every month, you pay no interest on the loan. (You may have to pay an annual fee for the card.) Many financial institutions provide credit cards designed for small businesses. These cards help you keep track of your day-to-day spending and expenses and relieve you of some time-consuming bookkeeping. Some banks and other financial institutions also have card-based products that access business lines of credit.
Business Term Loan: It provides medium- to long-term financing to cover some or all of the cost of capital equipment, expansion or renovation of buildings. Term loans are usually secured by the asset being financed, and they come with different repayment schedules, interest rates and periods, depending on the purposes of the loan.
Leasing: Unlike a loan, leasing is like a long-term rental. At the end of the lease, you don’t automatically own the asset – you have the option to buy it at its residual value. A lease requires little or no money down and is an alternative to purchasing such items as cars, machinery or office equipment. By leasing instead of buying, your business can usually write off the monthly lease expenses.
Supplier Credit: Many manufacturers of cars, machinery or computers have developed credit programs that are variations on debt financing. They provide the goods; you pay for them, with interest, over a specified period. In addition, some suppliers will offer various terms of sale, letting you take three months to pay, for example, or they may offer discounts for prompt payment.
Equity financing is accumulated from savings and investors. Outside investors typically receive a portion of your company’s equity in return for their investments.
The most likely sources of equity financing for start-ups are you and people you know. It’s not easy to attract investors to a new business. No matter how sure you are that your business with succeed, others will not always share your confidence. Without a track record of steady earnings from the business, you have only your enthusiasm, character and talent – and, of course, your business plan – to persuade them to invest in your idea.
- Personal Savings: Many entrepreneurs invest their own savings when they start a business. It makes sense as your own money is the most readily available. If you invest your own money in the business, other people will feel more confident about investing theirs.
- Love Money (friends and relatives): Many entrepreneurs rely on friends and relatives for at least a portion of their financing, either on a debt or equity basis.
- Government: Most governments in Canada operate programs to boost employment, training or technology transfer. A government program may pay some or all of your costs of developing a new technology, for example, or training new employees.
- Informal Investors (“Angels”): Angel investors are often seasoned professionals looking to put their money into promising businesses, hoping to earn a larger return on their investment than through more traditional methods. Usually, angels want to play an active role in the management and/or strategic planning of the business they invest in. Your own professional advisers, such as lawyers, accountants and bankers can often direct you to these informal investors.
Equity Financing for Existing Businesses
Once you get your business going, you may want to raise more money to pay for its expansion or for other purposes. Equity financing at this stage is available from additional sources, including:
- Retained Earnings: As your business begins to generate a profit, you can use the money to pay for its continue growth. Most growing businesses combine their retained earnings with other forms of equity and debt financing as they expand.
- Venture Capital: Venture capital is typically targeted at high growth, high-tech sectors.
Firms providing capital for ventures offer financing in exchange for ownership in the company. Venture capitalists generally prefer to see a business in operation before they put their money behind it. They expect a healthy return on their investments, often generated when the business starts selling shares to the public.
- Going Public: This option is available primarily to fast-growth companies. This is when you offer and sell equity interests in the company (e.g., shares, warrants, options) through a stock exchange or broker network. Going public involves a rigorous process of regulatory compliance and promotion.
The Canada Small Business Financing Program (CSBFP) is a federal government initiative that seeks to increase the availability of loans for establishing, expanding, modernizing and improving small businesses in Canada. Under the program, a small business must apply for a loan at a financial institution. If the loan is granted by the financial institution, the federal government will reimburse 85 per cent of the lender’s losses in the event of default.
Develop a long-term financing strategy.
Be sure that your credit history is accurate. Before a loan is approved, financial institutions check your credit rating and the credit capacity of your business through a credit reporting agency.
Find financing to suit your business.
Use all your contacts – friends, family and other entrepreneurs for advice.
Be prepared to walk away from a deal that you do not like.
Consider the various ways to find financing. Payments in advance, for example, can provide a cushion to get you through a production period.
Regard your lenders as suppliers. They want your business as much as you want their product, which in this case happens to be money.
Re-examine the capital structure of your business from time to time to make sure it is still appropriate. The proportion of bank financing, owner’s equity, and private investment, for example, may rise of fall, depending on market circumstances.