Finding the Right Business Loan for Your Small Business
In Canada, entrepreneurs and small businesses finding the right financing can make the difference between success or failure. Yet some businesspeople may not be aware of the options they have when it comes to small business financing. This article explore Canadian small business loans and other forms of financing for Canadian small businesses.
Financing for the Purpose:
When you are considering finding financing for your small business, you need to consider the purpose of the financing and match it to the right type of financing. What is being financed will help dictate the amount you can borrow and the type of loan or financing you should use.
Equipment is relatively durable and so it can be financed over a period of time. How long it can be financed, or the term is dependent on the equipment’s expected useable life. For example, a vehicle might be financed for 3 to 6 years whereas a piece of industrial machinery might be financed over many more years. There are a few common methods of financing equipment:
- Term Loan: A business term loan may be obtained from a bank, developmental lender, or other financier (see below). It involves amortizing the loan amount over a period of months or years till the loan is repaid with interest. With longer amortizations there may also be periodic adjustments of the interest rate if it is a fixed rate (the interval is known as the term).
- Leasing: For some equipment it may make sense to lease. Leasing has the advantage of the payment being expensed vs. with a loan only the interest is expensed (depending on the type of lease). In addition, most leases won’t count against your company’s debt-to-equity ratio which is a key measure used to qualify for loans. However, despite these advantages, if the equipment is durable and doesn’t need replacement often it may make sense to borrow to buy it instead. For more on this see – Business Assets: Lease vs Owning.
- Operating Line of Credit: A business operating line of credit is a revolving loan with a set limit that can be drawn on, partially or fully repaid, and then redrawn against up to the credit limit. Using an operating line of credit to purchase equipment isn’t usually advisable because most lines of credit must come to a zero balance on a regular basis. Having said that, it could be used for less expensive equipment as opposed to arranging a separate loan.
Generally, there are two main options for financing inventory:
- Operating Line of Credit: A business line of credit is essential for most businesses that have inventory. This is because there are times when cash flow is low (e.g., beginning of a busy season) and new incoming inventory is not yet sold which creates a cash flow issues. A business operating line of credit is essentially a revolving loan with a set limit that can be drawn on, partially or fully repaid, and then redrawn against up to the credit limit.
- Suppliers: Suppliers can be a way to finance inventory. If the business has established credit with the supplier, you may be able to negotiate longer terms such as 90 days or longer. This can help your ability to purchase inventory earlier in your season(s) and get it sold therefore improving your inventory turns, cash flow, and profitability.
Some companies need to grant credit to their business customers. As a result, they may need to cover their cash flow until they are paid by their customers. The are a couple ways of covering the cash flow due to having accounts receivables:
- Operating Line of Credit: An operating line of credit is the main way companies cover short term cash flow issues due to having outstanding receivables. An operating line of credit is a revolving loan with a set limit that can be drawn on, partially or fully repaid, and then redrawn against up to the credit limit.
- Factoring: For some receivables it may make sense to sell them to a Factor. A Factor is essentially a funding source that agrees to pay a company the value of an invoice less a discount for commission and fees. The Factor is usually concerned more with the credit worthiness of the business that is to pay than the company selling the receivables. As a result, factored receivables are not considered a loan and therefore usually doesn’t affect the selling company’s credit ratios. Factored receivables may work well for larger receivables or receivables where the company has longer payment terms but still have good credit (e.g., government contracts, oil companies, etc.).
Leasehold improvements are generally financed through a term loan. A term loan may be obtained from a bank, developmental lender, or other financier (see below). It involves amortizing the loan amount over a period of months or years till the loan is repaid with interest. Generally, leasehold improvements can be amortized for the term of the lease only.
Canadian small business can finance working capital using an operating line of credit. An operating line of credit is a revolving loan with a set limit that can be drawn on, partially or fully repaid, and then redrawn against up to the credit limit.
Financing a business purchase involves a package of financing that will includes financing the purchase of inventory, equipment, leasehold improvements, working capital, and the goodwill of the business. For more information see our article – How to Finance Buying a Small Business.
Types of Financers
Canadian small business financing can be a complex tangle of different options. Depending on what is being financed there can be multiple sources of financing for each need. Indeed, depending on the project, more than one financier may be needed. To help you chose from the options that are appropriate for you, we have put together a short discussion of some of the more common options:
Most financial institutions won’t likely finance one hundred percent of anything with the typical percentage of financing ranging from forty to eighty percent depending on what is being financed and the industry the business is in. That means, if the business doesn’t yet have enough cash or equity to meet the lenders requirements then an additional investment may be needed.
Many businesses can find patient capital from friends and family. Other sources may be mature business owners in your community (sometimes called Angel investors). These types of investors want to see your business grow and invest in your community. But you can also offer them a good return on their money if you have a strong stable business. You can have them invest in preferred shares in your company (which can be voting or non-voting) and pay them a regular dividend. Dividends are taxed at a much lower rate than regular income or interest income so there can be significant payback on their investment if you can provide a good dividend.
Banks and credit unions will offer Canadian small business loans including both operating lines of credit and term loans. The terms and interest rates will vary by the industry (some industries are higher risk), the type of loan, and the credit worthiness of the business. Obviously, its appropriate to seek the options provided by your company’s bank but you may also consider shopping for financing at other banks/credit unions as well.
Most major banks can use the Canadian Small Business Financing Program (CSBFP) to acquire new or used business assets. This program is a guarantee program, like the Canada Mortgage and Housing guarantee, that the Government of Canada offers the banks in order encourage them to finance small businesses. Loans, made through the program, can finance the purchase or improvement of land or buildings used for commercial purposes, the purchase or improvement of new or used equipment, and the purchase of new or existing leasehold improvements (e.g., renovations to a leased property by a tenant). While this government program, which is accessed through the mainstream banks, can finance a significant portion of the purchase it does not cover everything. It also comes with higher costs including insurance fees, administrative fees, and prescribed interest rates.
Developmental lenders can often be a compliment to mainstream banks. They can often finance things that the mainstream banks are unwilling to finance. In addition, they may be able to offer more flexible repayment terms as well. Most developmental lenders will offer some advice and coaching as part of their services as well. There are a number of development lenders that specialize in providing Canadian small business financing such Community Futures, Business Development Bank – BDC, Futurpreneur, etc.
There are variety of companies that provide leasing options for businesses in Canada. Some vendors have their own leasing companies (such as car companies) while other vendors rely on outside leasing companies. You should shop around because there are a variety of interest rates and terms applied to various leases. In addition, some leasing companies will have more experience in leasing the equipment that you are interested in buying and may offer better terms.
Private lenders can be a solution when other sources aren’t available or aren’t able to provide the terms you need. However, caution should be used as these lenders are not regulated. So shop around and do your due diligence to ensure that the terms of the loan are acceptable.
Understanding the Canadian small business financing options can help you find the right financing for your business. The key is to understand the financing that is best for the purpose of the financing and then shop around for the right combination of financing to create a financing package that is right for the project and your business.
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