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Does a Canadian Business Owner choose debt or equity for growth ?

Guest post by: Stan Prokop

Article Overview: The article highlights some of the sources of business financing for business owners and financial managers .

Does a Canadian Business Owner choose debt or equity for growth ?

We can safely say that business owners and their financial managers are pre-occupied most of their business lives in raising money for their firm. This of course goes all the way from the business start up at the earliest stage of a company, to some of the largest companies on public stock exchanges.

The goal, whether for the small company, or the large one, is essentially the same - How do I get the right amount of capital into the company, balance by the right amount of risk. As we all know business owners and stockholders of even public companies want to be able to sleep at night knowing that excessive risk has not been taken in the capital raise. The final outcome of any bad decision in this area is of course the worst outcome, business failure and bankruptcy.

How complicated is the decision. Well we can certainly simplify things by saying that business capital comes from only 5 areas:

1. Bringing in new owners with money – for public firms that’s stock issuance

2. Issue debt or bonds

3. Bank and Independent Finance Company financing

4. Lease financing

5. Suppliers

Supplier credit is sometimes one of the most important, and, guess what, cheapest forms of financing available to firms, and often the most overlooked. Every business buys goods and services on credit. If a company can negotiate longer terms and higher credit lines with suppliers it becomes a method of increasing cash flow. This is a bit of a balance act though, as business owners do not want to let supplier relations deteriorate by non – payment to key suppliers.

Lease financing is an excellent way to buy equipment. Equipment and other assets can be financed over short or long terms. Properly negotiated leases will maximize use or disposition of the asset at end of lease term.

Bank financing is of course an obvious method of raising business capital and working capital. The best run firms have operating lines of credit, commonly called ‘ revolvers’, which margin inventory and receivables, allowing the business to borrow against those usually significant assets .

It is the large companies that tend to issue bonds. These are repaid at fixed amounts and rates. It is uncommon for smaller businesses to employ this type of capital raise.

Growth companies can utilize stock issuance to raise capital. This is done on various stock exchanges based on the size and capitalization and overall credit rating of the company.

In summary the various methods of raising capital are sometimes not always appropriate for all firms at all times. The right decision comes from each business owner understanding risk and reward in the context of where their company is at now financially. The textbooks call that a ‘capital structure policy ‘. To the small business owners it’s more simply – where can I get capital or cash flow at best rates and structure. There are unfortunately no magic formulas to guide the business owner in this area – an in fact decisions have to be reviewed all the time on an ongoing basis based on current economic and borrowing conditions, in the context of the companies current financial performance and growth prospects . It’s great to achieve all the bank financing you need – that can’t always be done, so business owners take different financial paths over different areas of time.

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Article Tags: business finance options, Business financing decisions



Related Forum Posts
Using your home for collateral is one thing, but... - Putting up your home for collateral is one thing, but utilizing the equity in it to finance a business is a whole other ball game and could be damaging in the long run. Do you know that if you completely finance your business with home equity instead of a busienss loan you will not be able to obtain a working capital loan later down the road? should you run into some financial troubles or wish to expand or remodel with working capital loan, you won't be able to get it if you finaced by personal means. It's always best to build a track record with a lender for future use and it's always better to be in business debt rather than personal debt. I always say: "You wouldn't hire a Plumber to do the Electrical in your home, so why would you finance a business using your home equity? Equity loans are for your home, business loans are for your business. You may however, utilize some of the equity in your home for loan down payment (depending upon your qualifications) and we can help determine whether that would be more helpful or damaging to your loan by pre-qualifying you for free. when using your home for collateral, it doesn't necessarily mean you will lose your home (in the event you cannot pay your loan payments). Lenders are always willing to work with you once you have a loan with them and they have already taken on the risk. they typically only utilize what they lien if nothing else can be resoloved (so it's basically a last resort) to go after what they lien.
the BDC - Hi Renee, the BDC is a great lender to many Canadian businesses. I've heard many horror stories from businesses that have had problems with the BDC, but I think it all depends on which account manager you deal with (that's the case with most lenders). Anyways, I have a great relationship with the BDC Toronto office, and was successful earlier this year in getting two service based companies loans under the BDC Innovation financing program ($100,000 and $150,000, both for marketing and growth initiatives). Here's an article I wrote about the BDC late last year for an Accounting Firm's newsletter: The Business Development Bank of Canada is a financial institution belonging to the Government of Canada, with the mandate: “to encourage innovation and stimulate the growth of small and medium-size Canadian companies.” The BDC usually looks for companies with a sound management team that possess solid growth potential. The BDC can provide working capital solutions to complement traditional bank financing. The BDC’s lending practices are somewhat different from the traditional chartered banks. With the BDC, borrowers receive a guaranteed term, meaning that financing cannot be recalled without due cause. As opposed to the chartered banks, where facilities are typically demand loans and can be recalled at any time. The BDC has very flexible repayment terms, including deferring principal payments, amortizing loans for up to an 8 year term, or offering seasonal and/or progressive payment options. This allows businesses to structure their cash flow accordingly. The BDC is willing to lend to companies that are more leveraged than traditional banks would consider. As well the BDC is willing to finance higher loan-to-value ratios than the chartered banks max out on. The BDC also offers subordinated debt, where they will postpone their claim to a chartered bank. Sub-debt can be very advantageous to many companies, because the BDC ties the repayment terms to the company’s cash flow projections. The pricing model can be setup as normal interest payments, royalties on sales, bonus interest based on milestones, warrants or some combination of these items. The BDC lends sub-debt to businesses based on historical cash flow, management and growth potential. The innovation financing program provides small businesses with funds to carry out marketing and/or growth plans, increase inventory, and/or develop new products. The BDC funds all types of businesses including start-ups, however will not fund any business that earns 50% or more of their profits from alcohol sales or gambling. The cost of borrowing from the BDC is generally higher than the chartered banks. The BDC’s base rate generally starts at two points above regular bank prime, and then the risk premium is applied to these rates based on each project's potential and the amount of risk involved. The BDC may not be ideal for all businesses, but as an alternative and/or complement to traditional bank financing, the BDC could be a very attractive solution.
Private Equity Needed - I am entertaining the idea of going back to private equity for my Business due to the lack of interest and stability from the Financial Institutions. I had private equity in the past for my business and I believe it works best for me and my company. Should anyone have an interest or would like to point me in the right direction, I would love to hear from you. Sincerely, Kyle Lowe President H&L Motorcars
re: restaurant start-up - I'm not sure about government grants for restaurants, but my recommendation would be to approach a lender that offers loans under the Canadian Small Business Financing Loan program where the government will guarantee 85% of the loan. You can borrow up to $250,000 to finance equipment and renovations under this program. Restaurants are very risky business, however some of the Chartered Banks will look at restaurants if there is enough of an initial equity investment and you have a solid business plan (experienced management team, good concept and strategic location).
Re: Did you meet your goals in 2010? - Hey Yinka, I met some of my goals, but I didn't meet others. One of my goals was to get out of debt. I managed to do so, only to get back into debt due to an unforeseen circumstance. Business-wise, I didn't quite reach the goals I had; although, I came much closer than I did back in 2009. At least it was an improvement, and I expect to reach my goals for 2011. Best wishes for you, and I hope you can reach all the goals you set.


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