One of the biggest challenges that small business owners face is financing their businesses. For most, this challenge first arises when they start their businesses, and continues until they sell or otherwise wind up the business.
The best way of handing this ongoing challenge is to manage it effectively from the beginning, ensuring that you have, and will continue to have, the money that you need to properly operate your business.
When starting your business, the first place to start looking for money is with your own resources. You might have some unused assets you can sell. Among your resources, family and friends might be prepared to help you out. Conventional lenders such as banks and credit unions are always willing to lend money to credit-worthy small businesses. Although all governments claim to support small business, unfortunately, few offer monetary assistance.
Start With Your Own Resources
According to Inc. Magazine, in most small business start ups, the personal savings of the owners finance approximately 80 per cent. Thus, the first and most obvious place to start looking for start up funding is in your own asset base. If you haven’t already done so, calculate your net worth. That is the difference between the value of all of your financial assets— cash, investments, real estate, etc.—and your liabilities—what you owe on your credit card, bank loan, mortgage, etc. If the difference is great enough, you can use some of your assets to finance your business. How much of a difference is great enough? That depends upon a number of factors: your age, family responsibilities, retirement planning, and so on. If you have any question about whether you have enough financial resources to reallocate some of your assets to starting your own business, check with your financial advisor.
There are thousands of stories of business owners who risked everything they had, even their homes, to start and run their businesses. If they ultimately achieve success and live happily ever after, they are often presented to us as models of the determination and commitment required to succeed in one’s own business. Inspirational as these stories may appear,I know from my own experience that there are far more stories of business owners risking and, unfortunately, losing everything they had.
Personal assets also include everything from cash on hand through investments to your home and recreational real estate. Which of these assets are cash or easily converted to cash? As members of a consumer society, most of us have collected things that we no longer use or enjoy. The summer property or ski chalet that no longer holds our interest, or the boat or snowmobile that drains money without yielding any enjoyment, could be sold and the proceeds used to finance the business.
Do a cost-benefits analysis of these underutilized assets. In many cases they can be sold, freeing up not only the equity but also annual maintenance costs. You will be surprised to find that without the costs of carrying that cottage or boat, your cash flow improves dramatically. You might also find that by eliminating the cost of carrying these assets, you will be able to rent comparable or better equivalents when and where you want them.
Entrepreneur Beware
Mortgaging your home to support your business is a gamble; a very big gamble. Before taking the gamble remind yourself of the advice often given to new or potential gamblers: “Don’t gamble any more than what you can afford to lose.” Can your family afford to lose their home?
If so, by all means, go ahead and mortgage it. If not, look for some alternate financing. Hot Tip
Canadians are reported to be among the world’s largest purchasers of life insurance. Much of this is whole life insurance, which is in effect a low-yield savings plan. If you have life insurance policies that have a cash surrender value, you might consider cashing these policies and replacing them with term coverage. This will provide lower-cost protection while freeing up some funds that you can use for business purposes. If you do decide to replace existing whole life insurance policies with term insurance, make sure that your term coverage is in place before canceling your existing policies.
How Much Do They Really Love You?
The same report that indicated personal assets as the most frequently used source of startup business financing also showed that financing from family and friends was the second most popular source. This widely used source of financing a business is also the riskiest. Conventional lenders like banks and other financial institutions are in the business of lending money and have procedures in place to minimize their risks and to take action when borrowers default. They can and will continue to function if a small borrower defaults.
However, friends and relatives are not as likely to carefully evaluate the risk. They are helping you and expect you to repay them regardless of what happens. Failing to repay relatives or friends can and does jeopardize these relationships. Before taking this approach, ask yourself what would happen to your relative or friend if you cannot repay the money that is advanced to you? Can you live with these consequences?
Can You Lend Me a Few Dollars?
Conventional lenders include banks and other financial institutions that are in the business of lending money. They make their money from the interest they charge on loans. Thus, applying for a loan is a normal business transaction. Do not look upon borrowing money from an institutional lender as being similar to asking a relative or a friend for a favour. Borrowing is a business transaction: You are negotiating the use of the lender’s money to purchase something you need to run your business. Treat it as you would any other business requisition.
Of all the information that goes into a lender’s decision to grant a loan, the borrower’s credit history is the most critical. With a good credit history, your application might be approved. Conversely, with a poor credit history, your application will probably be declined.By checking your own credit history before you apply for a loan, you will be able to clarify or be prepared to respond to any irregularities when asked by the lender. Once you have received a copy of your report make sure that all of the details are correct. If there are errors, follow the instructions included with the report to make the corrections. When you are satisfied that your credit history is in order, you can get on with your search for a loan.
The growing importance of small businesses in our economy has led to a wide variety of financial institutions prepared to lend money to small businesses. Today business loans are available from the following organizations:
Chartered banks
Business Development Bank of Canada Foreign banks
Credit unions
Private syndicates
This growth in interested lenders may be attributed to the federal Small Business Loan program, which in effect makes qualified term loans to small businesses “government guaranteed.” Some people believe that every small business should have a Small Business Loan at the early stages of its life. Take advantage of the competition among lenders. In order to obtain your business, one lender might be prepared to offer you more favourable terms than competing lenders will. Also, different lenders use different criteria. Just because one account manager is not interested in your business, it doesn’t mean that all other account managers at all other lenders will also turn you down. If you have a good credit history and can offer satisfactory collateral, you can probably arrange a loan with one lender or another.
When borrowing money, there are several options available: a term loan, a demand loan, and a line of credit.
Hot Tip
When applying for a loan, you must submit a business plan along with your application. Don’t rely on the plan that you prepared in Chapter 7. Instead, prepare a plan using the format suggested by the lender. Although your format may contain all of the relevant information, the lender’s staff is more likely to find the numbers they are looking for if the information is displayed in a for-mat familiar to them. If they can’t find the numbers, they may assume that the information is not there and simply refuse the loan applica-tion without looking further. Term Loan
A term loan is similar to a mortgage in that both are in place for a set term or period of time and both are secured by a charge against specific assets. A mortgage is secured by a charge against real estate whereas a term loan is normally secured by a charge against business assets such as machinery, equipment, and vehicles.
However, unlike a mortgage, which is normally restricted to 75 per cent of the value of the real estate, a term loan could be obtained for the full amount of the security. Normally, mortgages bear a set rate of interest with payments also being a set amount. Term loans, on the other hand, may be subject to either a fixed or floating rate of interest and may also have variable payments. Further, unlike mortgages, term loans can often be increased or even paid off in advance. Clearly, term loans offer owners the flexibility they need in running their businesses.
Demand Loan
In these kinds of loan arrangements, the lender has the right to demand payment of the outstanding balance at any time, with or without notice. Although it may carry a flexible interest rate, there is little flexibility when it comes to repaying the loan when the lender demands payment. Demand loans are best used to cover short-term temporary cash needs. Because they can be called in at any time, it is not good management practice to base a large portion of your financing on demand loan.
Line of Credit
A line of credit is a flexible and popular source of funding for small businesses. Except for the lower interest rates, using a line of credit is like using a credit card to obtain cash advances. When you need funds, you can draw against a predetermined credit limit without having to ask your banker for approval. When you have excess funds, you simply repay the amount borrowed together with accumulated interest. As long as there is money flowing into your business, a line of credit will allow you to cover the inevitable temporary shortfalls in your cash flow.
If you are tempted to get a cash advance from your credit card to pay a critical account, make sure that you will have the funds to repay the cash advance almost immediately. And if you are that sure that you will receive the funds, why not talk to your banker and arrange a loan until the funds arrive? Paying high credit card interest rates can seriously impair your cash flow.
Entrepreneur Beware
Credit cards are the most expensive way to finance your business. Therefore, apart from using your credit card to charge relatively small operating expenses that will be paid when due, this method should not be used.
Building Block
In dealing with your banker, it is important to develop and maintain a relationship of mutual trust and respect, starting with your first con-tact. If you want your banker to trust and respect you, try demon-strating your trust and respect for him or her. Regardless of the reams of papers that go into applying for and maintaining a loan, in the final analysis, it is your personal credibility and that of your banker that makes or breaks the relationship. Work hard to ensure that this credibility is there from the beginning.
Who Wants to Invest in My Business?
Realistically, there are only two equity financing options available for small business. One option is asking your friends, relatives, and network contacts to invest in your business. Unlike asking these people to lend you money, this approach involves asking them to buy a share of the business in return for a share of the profits. However, unlike traditional investors, friends, relatives, and network contacts who invest in your business are, in fact, investing in you, and they expect to get their money back, regardless of what happens to your business.
Should you choose to follow this approach, make sure that the investment is properly documented: This means properly prepared subscriptions, minute book records, and actual share certificates. Also make sure that in your zeal to attract investors, you do not violate the provisions of any applicable securities legislation. This legislation prohibits public offerings of shares without specific conditions being met. Although there is usually an exception for shares to individuals with whom you may have an existing relationship, it is your responsibility to ensure compliance with all relevant legislation. Check with your lawyer if you have any doubt about whether or not you can proceed with a sale of shares.
Where Else Can I Get Financial Help?
Government Funding
With governments at all levels focused on debt-reduction, most sources of business financing have been eliminated. Limited public funds are more likely to be committed to providing training and obtaining advice. There are, however, situations in which governments will provide funding to supplement the equity in a business. Check with the appropriate Canada Business Service Centre listed in Appendix B to see if there is any funding available in your jurisdiction.
Leasing Equipment
Leasing has become a very popular financing option. It has been estimated that more than 10 per cent of all business equipment is now leased. Virtually all types of business equipment can now be leased, from laptop computers to large specialized machinery. In most cases, the vendor can connect you with a leasing company willing to purchase the equipment and lease it to you. In actual operation, the leasing company owns the equipment and you simply pay for the use of it. You might also have an option to purchase the equipment at the end of the lease.
Leasing offers similar, and sometimes superior, benefits to both mortgage financing and term loans. The table below outlines the benefits of leasing compared with these financing options.
Leases Compared with Mortgages and Term Loans
| Item | Lease | Mortgage | Term Loan |
| Rates fixed for duration of term | yes | Yes | no |
| Term and payments flexible | yes | no | Yes |
| Free up working capital | yes | no | sometimes |
| Additional collateral required | mo | no | sometimes |
| Straightforward documentation | Yes | no | no |
| Payments deducted as expenses | Yes, with some exception | Interest only | Interest onl |
Once your business is well established and you have a good track record, you will have more financing options available. These additional options include factoring (the sale of your accounts receivables), franchising, and going public (selling shares to the public). In the meantime, your challenge is to get your business up and running so that you will qualify for these options when you need them.
The Least You Need to Know
The first place to look for financing is with your own resources.
Friends and relatives may help you but they will expect to be paid back regardless of what happens to your business.
Traditional lenders are in the business of lending money. They base their decisions on established business criteria.
It is difficult to locate individuals who are willing to invest in your business. There is little government financial assistance available.
