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Methods for Financing Your Company
Canada Business Service Centres - CBSCs
Once you've completed your financial calculations, statements, and
projections, you will have a clearer idea of how much money you need to
raise in order to finance your business. The two main ways of financing a
business, equity financing and debt financing, will be discussed in this
chapter.
Equity Financing
Equity capital is the amount of money that you and/or your partners put
into the business or raise from other investors. Equity is not debt. While
investors share in the profits (or losses) of the business, their
investment is not a loan.
Remember that to attract investors (shareholders) or partners, you must be
able to demonstrate both the profitability and the reasonable risk of your
business venture. The best way of doing this is through solid financial
planning..
Consult your lawyer and your accountant before you enter into any equity
agreement for your small business.
Personal Investment from Self, Friends, and Relatives
Personal savings, securities, real estate, and other personal assets are
the most obvious source of cash for equity financing. Friends and relatives
may provide additional sources of funds. In most cases, the small business
owner must assume the largest share of the risk- this means making the
largest investment in the business.
Personal investment in the business by you, your family, and your friends
demonstrates a faith in, and a commitment to, your business. This is
important to other potential investors and lenders. In fact, banks and
other lending institutions have established guidelines for the amount of
investment that is required before they will lend money to a business. This
is sometimes called the debt-to-equity ratio, and it varies depending on
the type and nature of your business.
Partner Investment
If you cannot supply all the equity capital needed to finance your small
business, you may have to find one or more partners willing to put money
into the venture. obtain- in a partner means that ownership of the
business, including its profits and liabilities, is normally shared.
In most cases, partners want a say about how the business is run. limited
partners, sometimes called silent partners, can contribute financially to
your business without participating in its management. Limited partners are
normally only responsible to the business or its creditors in proportion to
the amount they have invested in the partnership; however, parties
considering a partnership agreement should seek legal vice on this and
related issues.
Shareholder Investment
A business may be incorporated as a private or public corporation. A
private corporation can have up to 50 shareholders, but it cannot sell
shares to the general public. The vast majority of new small business
corporations are private.
Ownership is shared in a private corporation, generally in proportion to
the amount investment of each shareholder (which may be translated into the
number of voting shares each person owns). You must be able to demonstrate
the viability and profitability of your business venture to attract
potential shareholders.
Because public corporations can sell their shares to anyone, they provide
the greatest opportunity for raising equity capital. However, offering
shares to the public can be a long, complicated and expensive procedure. A
detailed prospectus of the business' operations must be filed with the
Alberta Securities Commission.
Nevertheless, when your business becomes sufficiently large and prosperous,
a public share offering can be an attractive method of obtaining financing.

Employee Investment
Another way of raising funds is to ask employees to invest in the business.
You might consider making your most talented and dedicated employees a
partnership offer, or, if your business is incorporated, you could sell
stock to employees to provide a form profit sharing.
Employees may be willing to invest in your business because they understand
its products or services, trust the management, and are able to closely
monitor their investment. Having a stake in the business can positively
influence employees' working habits since they will benefit from its
success. On the other hand, when employees have a share in the business, it
could prove difficult to remove, retire, or replace them if they become
unproductive or uncooperative.
Venture Capital
In Canada, a number of venture capital firms provide equity financing,
usually for high risk enterprises with potential. Most venture capital
investment is directed to the expansion of existing businesses. As a
general rule, venture capitalists plan to liquidate all or part of their
investment in your business at a substantial profit within five to ten
years.
Venture capitalists are in a high-stakes, high-risk business. In
negotiations, they will aggressively try to make the best deal they
possibly can with you. Besides fast-growth prospects, they look for sound
management and a high degree of financial commitment on the part of the
small business owner/operator.
While most venture capitalists do not wish to become involved in your day-
to-day operations, they will require representation on your board of
directors. Some venture capital sources may consider equity participation
if your venture meets their criteria.
Debt Financing
With your equity capital in place, you are now in a position to approach
lenders for a business loan. Debt capital is the money your business
borrows. It must be fully repaid with interest, over a specific time
period. While lenders do not share in business profits as investors do,
they must be repaid with interest whether the business is showing a profit
or not.
Potential lenders include the following:
. Banks and Trust Companies
. Alberta Treasury Branches
. Credit Unions
. Private Investors
. Commercial Finance Companies
. AFSC Commercial
. Business Development Bank of Canada
As a small business owner/operator, you should familiarize yourself with
the lenders requirements before determining the type and the source of your
debt financing.
When determining the type of debt financing that is right for your
business, remember this basic rule:
. Finance day-to-day operations (working capital) with short-term
operating loans,
. Finance long-term fixed assets with longer-term loans or mortgages
Business Term Loans (Financing Fixed Assets)
Major purchases require foresight and careful planning. The fixed assets of
a business, such as land, buildings, and equipment, are usually financed
through a combination of equity capital contributed by the owner(s) and
business term loans.
A business term loan has a maturity of not less than one year and usually
not more than 15 years. The security offered for repayment is usually the
assets being financed. The repayment schedule is generally based on the
useful life of the asset. This type of debt financing is frequently
referred to as fixed-asset financing.
Lenders will finance only a percentage of the value of the asset being
purchased. For example, a bank may lend up to 75% of the value of a truck,
to be repaid within five years, and up to 80% for a building, to be repaid
within 12 years.
The benefits of a business term loan are the following:
. The loan agreement is based on the borrower's ability to repay the
loan out of earnings
. As long as the borrower meets the terms of the loan agreement, no
payments other than the regular installments will be required before
the due date of the loan
. A long-term working relationship is established between lender and
borrower
When lending on a medium to long-term basis, credit institutions tend to
focus on the 'earning power of your business over a period of years.
Therefore, to obtain long-term loans, your business plan must convince
lenders of the viability and profitability of your business venture over
time. If the loan is given to a limited business ( corporation) , the
lender may require your personal guarantee so, if the business cannot repay
the loan, you will be personally liable.
Source:

This material has been summarized from Financial Planning for Small
Business, Alberta Economic Development, with permission.