Question from GrnBayLife: I recently started a service-based business that has essentially no physical assets and no receivables. The business is showing profits, however I need additional funds to advertise in new markets and continue to grow the business. Realistically, what are my chances of securing a loan from a bank to do this? What are other alternatives available, other than friends and family?
Robert Bissett, senior vice-president of GTA commercial banking district at Bank of Montreal: The financing of a new business venture is often challenging. However, financial service providers in Canada have developed a number of innovative solutions to assist small business owners in accessing credit. Companies in the start-up phase generally rely on the financial resources of their owners, family and friends, or early-stage investors (known as “angels”), to finance the establishment of the business. This initial seed and start-up capital is normally supplemented by the Canadian banks and other lenders upon commercialization of the enterprise. Credit facilities for companies at this business stage will normally be supported by the personal guarantee and net worth of the owners.
In some scenarios, additional funding can be raised through mezzanine debt financing and third party equity providers. As the business becomes established and cash flow stabilizes, traditional bank credit facilities come into play in the financing of your company. At BMO Bank of Montreal, we recently reaffirmed our commitment to financing small and medium-sized enterprises with the announcement of an additional $1 billion in capital being made available to fund new business loans across Canada.
Some other alternatives available for financial solutions include institutions, such as the Business Development Bank of Canada, and Economic Development Canada, that partner with Canadian banks to meet the financing needs of small businesses. You will also want to make sure that you are taking advantage of the many cash management (collection/disbursement /information) tools available to ensure that you optimize your cash flow.
Zenon Iwachiw, senior director and regional manager of commercial services at Meridian Credit Union: Traditional low-cost lenders, like credit unions and banks, provide businesses with operating loans secured by current assets (accounts receivable, inventory) or term loans secured by fixed assets (equipment, buildings, etc.). In order to expand a start-up business, which provides service and/or labour, most entrepreneurs need to inject capital, usually from personal resources (personal lines of credit, home equity loans) and/or family and friends.
Venture capital sources and equity funds, typically much higher-cost lenders, would want either a demonstrated track record or evidence of intangible assets (patents, exclusivity of services). Failing all of the above, one should establish a circle of business support, which could include one's lawyer, accountant, personal banker, etc., to help “spread the word.”
The absolute best means of advertising, of course, is word of mouth from satisfied customers.
Mary Gagliardi, vice-president for GTA East at the Business Development Bank of Canada (BDC): Aside from friends and family, there are many sources of financing that include debt financing. These consist of both short- and long-term debt financing, term loans, lines of credit, credit cards, micro credit, supplier credit, commercial mortgages and leases. Entrepreneurs who are in the start-up phase often leverage personal assets to secure financing. They may also use personal credit facilities to fund their business.
Alternatively, entrepreneurs who are in the early growth phase (first 12 months of sales), and who don't have tangible assets can benefit from BDC's experience in helping innovative start-ups. Such entrepreneurs stand greater chances of accessing financing if they meet the following criteria:
• Can demonstrate realistic market and sales potential.
• Possess experience or expertise in their chosen field.
• Demonstrate key personal characteristics of a successful entrepreneur.
• Have assembled a competent management team.
• Have invested reasonable financial resources in the enterprise.
• Can provide personal and credit references.
Question from Alan Lukachko: I'm looking at financing some contracts with a term of three to six months. The contracts would be in the $100,000 to $150,000 range. I require a 35 per cent deposit with the contract, another 35 per cent payment at one to two months as work progresses, and the balance on completion. We would get one or two contracts a month for the next two years. What is the best way of doing this? Term loan or line of credit? Could signed contracts be used as collateral? What kind of interest rate would the financier expect? Any other comments or caveats would be welcome.
Mary Gagliardi : Depending on the current situation of the business it may be beneficial to look at both options individually and assess the best strategic approach for the business vis-à-vis a line of credit (LOC) or term debt.
A LOC is a revolving solution for financing a project over a short period of time to support day-to-day operations. If the company can manage the short-term strain on cash-flow by not having access to this portion of the LOC, then this may be an appropriate option. If you are looking to finance the project over a longer period, a term loan would be a suitable option to consider. A term loan will free up your operating credit line for the day-to-day operations.
The security and/or collateral to be taken for the LOC or the term loan could only be determined after an assessment of the company. Typically the LOC interest rate would be lower than that of a term loan. The interest rate can range significantly depending on the type of project being financed, the type of security being provided and the level of risk that the lender attaches to the business.
BDC has created a specific loan solution, the Market Xpansion Loan, dedicated to expansion financing that has similar features to a LOC but is structured as a term loan. The Market Xpansion Loan product is a term loan that allows the entrepreneur to request BDC re-advance any repaid portion of the loan.
Other financing options that may be appropriate for your business include purchase order financing and factoring. Both offer advantages in specific situations and may be appropriate if a line of credit or term loan facility is not available.
Zenon Iwachiw : In order for a contract to be assignable to a lender and therefore treated as a receivable, the “work” must have been completed and thus payable on negotiated terms. Contracts that are essentially agreements to provide future service or labour have no value to a lender, since the agreement to pay is fully dependent on the completion of future services, which by definition may or may not happen to the satisfaction of the buyer and thus may be challenged or refused.
If your up-front deposit is for the purchase of materials, which can be substantiated, and then future deposits obtained are for work that has been completed, a lender will be able to treat this as an acceptable business receivable, which can be margined. Traditional low-cost lenders, such as credit unions and banks, offer operating lines of credit against the current assets of a business (receivables, inventory). Rates would be based on a prime-rate-plus-spread variable, dependent on the evaluated risk and strength of the business (retained earnings/capital).
Robert Bissett: Rather than a term loan or a line of credit, normally we would recommend a financing program allowing the company to draw down on the credit facility against the value of the assigned contract. The loan advance is repaid as the various contract milestones are met and funds are received from your customer. The signed contract is taken as security, although additional security may be required depending of the financial strength of the borrower.
Banks frequently partner with companies such as Economic Development Canada, under its Export Guarantee Program, and Northstar Trade Finance Inc., to enhance our customers' ability to finance export-related contracts. It is important for your bank to understand your business model and target market, so they can customize financing solutions to ideally suit the needs of your business.
Question from T Nim: I run a 15-year-old established consulting company that launched a new software division in 2009 in the smart phone space (after a number of years of R&D). We have a long track record of profitability and we are using this and external funding to launch this high-growth opportunity. Given we're a knowledge-based organization, traditional banks have been less than interested in us. We've raised $1.5 million through friends, family and accredited investors but we are seeing increasing opportunity in our marketplace that will require financing in the $3 million to $5 million range. Where would you suggest are the best places for us to look?
Zenon Iwachiw : First of all, make sure you investigate and/or apply for the SR & ED Tax Credit Program (scientific research and experimental development).Given the amount of equity you have raised, combined with a long track record of profitability, you should certainly investigate traditional low-cost lenders like credit unions or banks that will lend on current and fixed assets. A strong cash-flow may allow a lender to offer some flexibility, with respect to normal loan covenants/ratios. Additionally, equity funds can be approached, most of which have distinct areas of expertise in certain fields and set “sweet spots” of dollar-lending.
A combination of these lenders may be ideal for you.
Mary Gagliardi : The company profile you describe sounds like a good candidate for BDC's subordinate financing group. It focuses on the small-cap market, financing primarily private companies with investments of $500,000 to $10 million. Traditional banks determine lending value based on the assets on a company's balance sheet, whereas the subordinated financing group determines investment level based on enterprise value.
Your company's long track record of profitability and projections for the new software division would be assessed to determine whether subordinate financing could provide the $3 million to $5 million that you are looking for, or whether existing shareholders would need to inject additional funds.
Subordinate financing investments have a flexible structure, with a typical term of three to seven years and repayment by way of regular monthly payments or cash flow sweeps according to a particular company's needs. In your case, we could also postpone principal payment for a defined period (12 to 24 months) to allow for the software division to begin contributing positive cash to the overall operation before repayment begins.
Question from PatrickH: I was hoping the panel could give us some advice on the use of commercial cards in managing small business finances. Are there any commercial card programs designed specifically for small businesses? If so, how can small businesses use these cards to help them manage our finances? And what are the real benefits of doing so? If not, can we benefit from card programs typically designed for larger companies?
Robert Bissett: Commercial credit cards play an integral role in the cash management process for small and large businesses. Generally speaking, the cards allow businesses to streamline purchases, consolidate billing and payment methods, improve cash flow, and enhance purchasing information and analysis. In addition, most commercial credit card offerings provide for optional employee cards, allowing business owners to delegate and control purchasing authority.
Companies that purchase products or services in the U.S. can also make use of a U.S. dollar credit card that assists in mitigating the cost and uncertainty associated with fluctuating exchange rates.
BMO Air Miles MasterCard for Business was specifically designed with the small business owner in mind, allowing the company to participate in the Air Miles Reward program in addition to the benefits outlined above.