Private sector financing
There are many different private sector lenders and investors offering different types of financing in order to earn a return on their money. They decide whether to provide your business with financing based on an assessment of the risks and potential reward in doing business with you.
To show these investors that your business is worthy and has the potential to be profitable, you need to demonstrate that you will be able to pay back the money, whether you are:
- Starting a business
- Developing a new product
- Expanding into a new location
- Developing new markets
- Purchasing new equipment
To do that, you should prepare a professional and well thought-out business plan.
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Debt financing is a loan of money that needs to be paid back with interest.
When deciding whether to finance your business, a lender will look at your business' potential and assets.
- If you have a new business, a lender will look carefully at your business plan and may ask you to put up some personal assets (such as your car, home, or personal investments) as collateral.
- If you have an existing business, the lender may wish to see your business plan and will also look carefully at your past financial statements and your projected revenues. The lender may also ask you to put up some of your business or personal assets as collateral.
Debt can be short-term or long-term:
- Short-term debt: includes loans with a term of less than one year (operating term loans) and lines of credit.
- Long-term debt: includes loans with a term of more than one year. It is generally used to finance the purchase of major assets such as buildings, land, machinery, computers and equipment.
The amount of money you will pay the lender is set out in a contract. The payments can include fixed payments of principal (paying back a portion of the sum that you borrowed) plus interest. In some cases, the payments may involve minimum monthly amounts based on either a fixed or floating interest rate.
There are several types of debt financing, including term loans, lines of credit, credit cards, micro credit, supplier credit, commercial mortgages and leases.
Commercial term loans
Financial institutions provide commercial loans to businesses for:
- Buying long-term fixed assets, such as land, buildings or equipment
- Increasing working capital
- Investing in business expansion
- Buying another business
Commercial loans generally have a specified period for repayment, usually ranging from 3 to 5 years. They usually have a fixed interest rate as well. The loan will have a predetermined schedule for repayment of the principal interest.
You will be asked to provide an asset as collateral to secure your loan. If you are financing the purchase of an asset, then you should be able to use that asset as the collateral. If you are looking for working capital or a business expansion loan, then you will need to put up assets that you currently own as collateral. This can include buildings, real estate, equipment and accounts receivable.
Lines of credit or operating loans
A line of credit or operating loan is usually attached to your main chequing account and can be used to pay operational expenses, when there is not enough money in the business' bank account. This type of financing is ideal when there are ups and downs in your business' cash flow. It can allow you to continue operating normally, when you are waiting on payment from clients or during a temporary slowdown in revenues.
You may also be able to secure a line of credit with personal assets. For example, many banks now allow individuals to have a home owner's line of credit related to the equity in their home and this line of credit can sometimes be split into personal and business categories.
Using your credit card to finance your business is one way to get money quickly. You don't have to complete an application, and you don't need to convince anyone of the merits of your business.
However, this is also one of the most costly options. The interest rates on credit cards are often double or triple the interest rates offered on commercial loans and on lines of credit. Unless you are sure that you can pay the credit card debt off by the due date, you should avoid this option.
For convenience purposes, some banks are now linking a business owner's credit card with that person's line of credit. That can make it very convenient for you to access your line of credit and may be a good option. That said, be sure that you fully understand the fees that may be associated with accessing your line of credit via your credit card (sometimes there are per-transaction costs).
Microcredit involves providing small loans (often only a few thousand dollars with no collateral) to individuals that would not qualify for traditional bank loans. These loans can help you start a very small business.
If you are purchasing equipment or machinery, you may be able to get financing through your supplier. Many suppliers will automatically provide payment terms of about 30 days, with some extending the term to 45 days. Some suppliers of expensive equipment will allow you to finance your purchase and will make arrangements with you for a specific repayment plan and interest rate.
If you are purchasing goods to resell to your customers, you can pay for the goods up front, in which case they become your asset and you assume the risk if you cannot sell them. However, some manufacturers, in particular manufacturers of new goods that are trying to increase their market share, may be willing to have you sell the goods on consignment. That means that you need to pay the manufacturer for the goods only when the merchandise sells.
If you are purchasing real estate (land, or a building) for your business, you may be able to get a commercial mortgage. A mortgage is considered a long-term debt. It is offered by various financial institutions, including commercial mortgage companies, insurance companies, trust companies and chartered banks.
Lease and asset-based financing
Leasing vehicles, equipment and other assets can help keep your business up-to-date, allowing you to upgrade assets as needed.
Similarly, leasing substantial assets such as real estate can free up capital, allowing you to pay off debts or finance growth.
Investors that provide equity funding get a share in the ownership of your business and in your profits in return for their contribution. The amount of money that you pay the investor depends on how well your company does.
Equity funds are usually unsecured, which means that the investor does not have a claim on any of the assets of the business. You can still use your assets as leverage when trying to get additional debt financing. As a result, using a combination of equity and debt financing might allow you to access a larger pool of money for your business.
There are a wide variety of equity financing solutions, including angel investors, venture capital, business incubators and initial public offerings.
Angel investors are generally wealthy individuals who invest in small businesses and start-ups with the intent of earning a higher rate of return than they could through other investments. Many of them are successful entrepreneurs themselves and can provide both financing and business expertise to the businesses they invest in.
Venture capital businesses make equity investments in businesses with high growth potential, typically in the early stages of business development. It is a good option for businesses that are not yet large enough to raise money through an initial public offering (on the stock market) and that may be considered too risky a venture for traditional commercial loans.
Venture capital businesses take on the risk associated with investing in small, less mature businesses with the hopes of making a significant return on their investment. These investors will usually insist on having significant control over the ownership of your business and the management decisions you make.
Venture capital is usually only available to leading-edge businesses developing highly innovative new products and services.
Crowdfunding is usually done over the Internet, for a fee, through crowdfunding platforms and funding portals. Participating in online communities dedicated to this type of fundraising can help you collect donations, offer rewards and take pre-orders.
Financing is just one of the areas where business incubators can help your business. In fact, not all business incubators provide funding, but many of them do.
Not all incubators offer the same list of services, but they behave as a one-stop shop to support entrepreneurs through the start-up stage. They provide a wide array of business support services, including:
- Help with the development of your business plan
- Office space
- Administrative services
- Technical support
- Access to advisors like lawyers and accountants
- Networking opportunities
- Educational events and seminars
- General business advice
Initial public offering
An initial public offering is the process of listing your business on a stock exchange. You sell shares in your business over the stock exchange and the shareholders collectively are the owners of your business. The money that you raise by selling the stocks can be used to finance the growth of your business and the profits that you make are divided among the shareholders.
An initial public offering is only a good option for a very small number of businesses. There are significant drawbacks to this option, including:
- A high failure rate, especially among businesses with proceeds of less than $1 million
- The significant risk of your shares being underpriced, in which case you do not get good market value for your offering
- The high cost of an initial public offering (costs include meeting regulatory requirements, preparing the required prospectus, paying fees, and the work of various professionals who will assist you with your offering)
- Businesses often are pressured to focus on short-term results to meet investors' desire for a return on their capital, rather than focusing on the long-term growth strategy
Businesses should be extremely cautious about proceeding with an initial public offering and seek the advice of experts in the field.
Other types of private-sector financing
Beyond traditional debt and equity financing, there are other options you can consider to finance your business and keep your cash flow running.
Love money is money that your friends and family invest in your business. This can be a convenient way of raising funds, especially if you are having difficulty obtaining financing through other means or if you don't have sufficient personal assets to put into your business. However, you also need to be cautious. If your business is not successful and you are not able to repay your friends and family, this can put a significant strain on relationships.
If you do get money from your loved ones, it is best to put a contract in place to formalize the arrangement. Talk to your lawyer about drafting up an agreement that includes details like the amount of the investment, the interest rate or share in the profits, the proposed plan for repayment, and any security or guarantee that you are providing for the loan.
Advance payments or deposits from clients may provide your business with a source of financing. For example, you may consider asking for a deposit before production begins on client orders, so that you can pay for the required materials. This will also provide you with protection against non-payment. Another option is to charge your customer a retainer fee when you provide regular services on an on-going basis.
If you have an immediate need for cash and have uncollected accounts receivable, factoring may be an option for your business. This involves selling your accounts receivable to another business for a percentage of their value (often around 90 percent). The business that purchased your accounts receivable is then responsible for collecting the money from your customers and accepts the risk of non-payment.
Find private-sector financing
There are a wide variety of private sector organizations that may provide financing to meet your needs.