Financing Your Business
A business is most commonly financed through two methods:
1. Equity Financing
Equity financing refers to when ownership of a company (in the form of stock/shares of a corporation or units of a limited partnership or trust) is issued to investors in exchange for capital. There can be various classes of shares issued that each have varying rights and privileges. Investors obtain a return through the receipt of dividends or through an increase in the value of the shares or units.
Equity financing options include: venture capital firms, merchant banks, private placements and public financing.
2. Debt Financing
Debt financing refers to when a business raises capital by borrowing money from shareholders, partners or third parties such as banks and other financial institutions.
Third-party financing is typically offered in two forms:
i) Operating Loans
An “operating loan” is a revolving loan usually provided on a short to medium term basis to finance the ongoing operations of a business. It is usually provided on a demand basis and bears interest that varies with the market.
E.g. Business obtains a $25,000 revolving line of credit, at a variable interest rate of prime plus 1% from its bank.
ii) Term Loans
“Term loans” are typically medium to long-term loans that have a scheduled repayment over a defined period of time. The interest may be varied or fixed. These loans are often used for a capital expenditure.
E.g. Business obtains a 5 year fixed term loan at 5% interest to finance the purchase of a machine.
Personal Property Security
Many lenders require a borrower to provide some form of security over the property of the business in order to protect the lender’s investment. If the borrower defaults on the loan, the lender may be able to take ownership of the secured property. Operating financing is usually secured by inventory and accounts receivable of the borrower. Term financing is usually secured by capital assets, such as equipment. Lenders may also require parent holding companies, subsidiary companies and individual shareholders to provide guarantees and security as additional credit support. Provincial legislation (such as the Ontario Personal Property Security Act) was enacted to govern the creation, registration and enforcement of security on personal property.
Government Assistance Programs
There are a number of federal and provincial government assistance programs targeted at small to medium sized businesses. Assistance may take the form of a grant, loan, financing or advice. Typically, the availability of this assistance will depend on a number of factors including the location of the investment, the number of jobs that will be created and how it will benefit the province or country.