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Five common options for financing your small business

Posted on November 2, 2018 at 11:20 AM

Five common options for financing your small business

Which method you choose depends on your company's current situation and its goals

For most small businesses, financing can be a challenge. Whether you need bridge capital to keep the business running in tough times, or structured debt for long-term growth, it pays to have a strategy for seeking out those elusive financing dollars. Statistics Canada found that just over half (51.3 per cent) of businesses requested external financing in 2014.

Equity-based financing options like venture capital often make the headlines, but less than one per cent of small businesses requested this in 2014. Debt-based financing is far more common, as is trade credit from suppliers.

Here are five financing options to turn to, depending on the type of small business you run, and its situation.

Bootstrapping

Funding yourself is a long-established and responsible way to get a small business off the ground. Bootstrappers are risk takers but also lateral thinkers. Rather than saddling themselves with debt or giving up ownership of their small company, they will use their own savings and potentially sell some assets to help finance their business in the early days.

Bootstrappers may work a side gig until they are confident that their new business idea has the legs to stand on its own. They may pre-sell products and services to help fund early-stage development. The successful ones cleave to one overarching principle: get to revenue quickly. If you’re going to bootstrap your company, the only thing that counts is the sale.

Small business loan

A small business loan is the most traditional route for those taking a debt-based approach to small business financing. Banks are often a first port of call, although they are naturally conservative, and they understand the higher risk involved with smaller operations that may have little to no credit history or collateral. This can make bank loans difficult to secure and could drive businesses toward such alternative lenders as OnDeck. Always ensure you understand the exact terms – and your payment commitments – before agreeing to a loan.

In Canada, another option is the government’s Small Business Financing Program, which provides up to $1 million in financing for purchasing or improving land, property or equipment. There are limitations though: working capital, inventory, labour and advertising are all excluded under this initiative.

Friends and family

If conditions from a financial institution are not to your liking, you could always borrow money from the Bank of Mom & Dad. Friends and family funding is a common way for small, high-growth businesses to get started, but it comes with some baggage.

It’s easy for money issues to cloud personal relationships, so small business people pursuing friends and family financing must be careful not to let emotion get in the way. Set out clear expectations around loan terms, including a percentage and payback date. Just because you were raised by those doing the lending doesn’t mean you can do away with legal advice. It keeps everyone on the same page.

Angel investors

Small business owners willing to give up some equity can go in search of an angel investor. These full-or part-time investors put their own money into early-stage businesses, hoping for future return if they succeed.

You may give up part ownership of your company to these investors, but they often bring contacts and experience difficult to find elsewhere. It also means that you aren’t saddled with loan payments that can cripple your cash flow. AngelList connects investors with startups, while Canada’s National Angel Capital Organization has a directory of potential investors.

These investors suit entrepreneurs with high-growth businesses and a clear exit strategy. Would-be Mark Zuckerbergs should apply. Owners of family-run laundromats with no plans to take over the world should look elsewhere.

Crowdfunding

If your business idea is that good, why not spread it around? Crowdfunding is a growing financing model, with $133 million raised in 2015 alone, according to a report from the National Crowdfunding Association of Canada. Consumer-focused businesses with some digital element to their products or services tend to do well with this model.

You can crowdfund using two broad approaches: reward/donation-based models, or debt/equity funding. The former are unregulated outside of traditional consumer protection and business laws. Selling equity in the company or taking loans with some promise of payback will bring you under regulatory scrutiny, but is still possible in some regions.

The Government of Canada’s Canada Business Network says equity crowdfunding is currently an option in British Columbia, Saskatchewan, Manitoba, Ontario, Quebec, New Brunswick and Nova Scotia. Conditions vary between provinces and depend on exactly how your crowdfunding process works.

The upsides to the crowdfunding model are also often its downsides: it’s highly transparent, meaning that early-stage companies still in product development can spread the news of their idea far and wide, building a community of followers. It also means that others could pilfer your intellectual property and copy your idea before you launch, so some legal protection is a must.

Small businesses pay scant attention to cash flow, to their detriment

Five tools for forecasting your small business cash flow

The type of money you raise and how you raise it depends on your small business’s current situation and its goals. One thing unites them all, though: a level head and a solid grasp of cash flow and operations will help you to project the financing you need, and to manage the money should you be lucky enough to secure it.

Source: Financial Post


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