Published on October 1, 2007
Financing a Small Business: Financing a Small Business Larry Johnson, BSc, CA Meyers Norris Penny LLP Starting Up: Starting Up Personal sources Close friends and family (love money) Venture capital Angels Business incubators/accelerators Government Grants Personal Sources: Personal Sources Savings RRSP Home Equity Personal line of credit Personal overdraft facility Close Friends and Family: Close Friends and Family May be prepared to advance you funds based on your character and/or their knowledge of your business. Funds can be provided either as equity or debt. Pricing of equity at this formative stage will be arbitrary. Terms and conditions of loan will likely be based on the nature of the relationship between you and the lenders. Loan may carry interest or may be interest free with or without fixed repayment terms. Loan may be convertible into equity, it may have equity kickers (options/warrants) or bonuses based on performance. It is important to have a formal agreement. Venture Capital: Venture Capital Venture capital financing is generally a second stage financing. Venture capitalists look for technology driven businesses with high-growth potential in sectors such as information technology, communications, and biotechnology. Venture capitalists generally take equity positions in companies. The initial dilution to the founders may be very steep. Founders can buy or earn the equity back through options/performance warrants, etc. There is a risk or ceding control to venture capitalists. Formal shareholders’ agreement is a must. Angels: Angels Angels are generally wealthy individuals who wish to invest their money in promising early-stage companies. Typically, these investors are successful entrepreneurs and they can also invest their experience, expertise, and connections. Angels tend to finance the early stages of the business with investments in the order of $100,000 to $500,000. In Canada, Angels have financed approximately twice as many firms as have institutional venture capitalists. Angel investments may take the form of debt or equity. Debt almost always has wither equity kickers or conversion features to equity. Angel investors generally take an active role in the business. Angel Sources: Angel Sources Calgary Angel Network Keiretsu Forum Calgary National Angel Organization Private Equity Investors Business Incubators/Accelerators: Business Incubators/Accelerators Business incubators/accelerators invite start-up companies to share their premises, as well as their administrative, logistical, and technical resources. Incubation phase can last up to 2-3 years. Once the product is ready, the business usually leaves incubator’s premises. Businesses that receive this kind of support often operate in sectors such as biotechnology, information technology, multimedia, or industrial technology. Businesses that were supported by an incubator have a better success rate over those which were not. Government Grants: Government Grants Federal and provincial governments have loan, guarantee or grant programs for the following: Creation of jobs or technology Exporting Training Capital Investments Website http://strategis.ic.gc.ca/epic/internet/insof-sdf.nsf/en/h_so03325e.html Government Programs and Agencies: Government Programs and Agencies Canada Small Business Financing Program Alberta Women’s Enterprise initiative (AWE) Western Economic Diversification Agriculture Financial Services Corporation (AFSC) Community Futures Development Corp. Micro-Credit Canadian Youth Business Foundation Aboriginal Business Canada Business Development Bank of Canada Export Development Corporation Canada Small Business Financing Program: Canada Small Business Financing Program Designed to encourage financial institutions and leasing companies to make their services available to small businesses. All businesses operating in Canada with revenues less than $5 million (other than farming, not-for-profit organizations, religious, or charitable organizations) qualify under the program. Loans up to 90% of the cost of the following: Purchase of buildings to operate the business Leasehold improvements Purchase or improvement of new or used equipment Canada Small Business Financing Program (continued): Canada Small Business Financing Program (continued) Loan is available up to a maximum of $250,000 If approved, federal government guarantees 85% of lender’s losses in the event of default. Interest rates – prime plus 3% for floating loans and residential mortgage rate plus 3% for fixed loans. Application for CSBFP can be made at any financial institutions. Alberta Women EntrepreneursLoan Program: Alberta Women Entrepreneurs Loan Program Provides small business start-up and expansion loans up to $100,000. You must be an Alberta woman owning at least 50% of your business and you must have 51% or more operating control of your business. You’ll need a business plan and AWE’s business advisors are available to help you to complete one. Advisors will also explain the loan program criteria and how the application process works. AWE requires less security from applicants than an ordinary financial institutions, however a strong credit history is a must. On average 50% of loan applications submitted are approved. Western Economic Diversification: Western Economic Diversification First Nations bank micro loan program for start-ups. Anyone can apply Business loan up to $25,000. Terms up to 5 years. Purpose: product development, marketing, equipment, or asset purchases. Agriculture Financial Services Corporation (AFSC): Agriculture Financial Services Corporation (AFSC) AFSC provides financial and management assistance to qualified small and medium-sized Alberta businesses and farms which are unable to obtain reasonable terms and conditions from the private sector. Loans may be used for a number of purposes, including land or equipment, or refinancing existing loans. Management assistance includes counseling in areas such as accounting, construction, finance, marketing, and production. Agriculture Financial Services Corporation: Agriculture Financial Services Corporation Alternative source of business financing when traditional lending institutions can’t help. Business must be in Alberta Up to $1 million Purpose: Purchase of land, building, equipment, inventory and to supplement working capital or to purchase an existing business or restructure debt. Community Futures Development Corporation: Community Futures Development Corporation Programs for businesses located in rural areas Provide loans up to $125,000 In place to contribute to local economic growth. www.communityfutures.ca Micro-Credit: Micro-Credit Micro-Credit is a loan under $25,000 May serve as working capital, seed capital, investment capital. Available from various sources. Most programs offer additional assistance. Contact Information: Contact Information Canadian Youth Business Foundation: Canadian Youth Business Foundation National organization founded in 1996. Provides loans up to $15,000 to qualified candidates between the ages of 18-34 years of age. Website has loan application on www.cybf.ca Aboriginal Business Canada: Aboriginal Business Canada Loan programs up to $75,000 for aboriginal entrepreneurs. Next Level: Next Level Next Level is either the business has commenced operations but requires financing for working capital, expansion or acquisitions. OR Developed its product and/or technology to a level where it is ready for commercialization. Financing Options for Next Level: Financing Options for Next Level Equity Bank financing Leasing Supplier credit Subordinated debt Debt vs. Equity: Debt vs. Equity Slide25: Assets = Liabilities + Equity (own) (owe) (invested) Debt vs. Equity: Debt vs. Equity Debt No ownership given up No dilution Fixed or floating rate interest rates based on type of financing Fixed or no fixed repayment terms Can be paid off over time Equity Share ownership, partnership, proprietorship Share of profit, dividends No repayment Equity is difficult to eliminate Certain degree of debt in every business can be beneficial if the rate of return on equity is greater than the cost of debt.: Certain degree of debt in every business can be beneficial if the rate of return on equity is greater than the cost of debt. Issues: Issues Excessive debt increases the risk of business failure in a down turn. Investors require greater return from highly leveraged companies. More Likely Scenario: More Likely Scenario Debt FinancingWhat do they want?: Debt Financing What do they want? Security Collateral Personal guarantees Personal Character – personal credit rating Experience Age Commitment – ownership risk Industry Type of industry Past performance/future potential Management ability Liquidity Timely principal and interest payments Ability to realize on disposal of assets Financing Proposal: Financing Proposal Business Plan Meeting Make an appointment Be prepared/practice Know your business plan/proposal Invite lenders to see your business Ask for a response time Negotiate Loan Approval: Loan Approval Key factors for obtaining loan approval are: Ability to service debt Sufficient collateral Credible debt service projections Net worth and debt to equity levels Management (strength and depth) Relevant business experience Age of business Type of business Historical track record Ongoing Relationship: Ongoing Relationship Meet regularly Treat your lender like a partner Educate your lender Keep your promises Report good news and bad news Type of Banking Facilities: Type of Banking Facilities Operating Loans Typically based on accounts receivable (75% of receivables under 60 days) inventory (50% of non-perishable inventory) Operating loans have maximum limits Floating interest rate (prime plus 1,2,3%) No fixed repayment terms (although payable on demand) Owners’ personal guarantee is normally required. Letters of Credit: Letters of Credit Generally based on specific contracts Specific draw down requirements Guaranteed by assignment of proceeds on contract. Owners’ personal guarantees may be required. Term Loans: Term Loans Usually relate to the financing of capital assets. Has fixed repayment terms Interest rate may be fixed or floating Security: fixed or floating charge debenture on all assets, capital assets, owners’ personal guarantees. Loan Covenants: Loan Covenants Positive Covenants Maintaining specified ratios (current ratio, debt-to-equity) Interest coverage Negative Covenants Limits on capital expenditures Payment on dividends Reporting Requirements Monthly financial statements Accounts receivable listings Leasing: Leasing Advantages Often advantageous when obtaining equipment Monthly lease payments are tax deductible Allows for preservation of line of credit/capital Predictable – fixed payments Does not require a large down payment Disadvantages Ownership Penalties Supplier Credit: Supplier Credit Many manufacturers of machinery and equipment have developed credit programs that are variations on debt financing They provide the goods and you pay for them with interest over a specified period. Subordinated Debt: Subordinated Debt Ranked second to bank loans in accessing security therefore termed subordinated debt. As a result commands a higher interest rate (12% to 18%) with equity kickers. They many be convertible to equity at specified rates or may be issued with options/warrants to purchase equity. The principal amortization of a subordinated debt loan is often deferred until after the senior debt is retired. The term for a subordinated debt loan is typically six to ten years. The End: The End Please take a moment to fill out your course evaluations and place them in the tray located at the back of the room.