Many young businesses face the tough challenge of finding money to grow after the initial investment from family and friends. Businesses can turn to alternative sources of financing to obtain capital, including equity investors, factors, government-backed loans and sub-debt.
These investors need compelling reasons to provide funding. They also require a higher return on investment and might have limitations. Businesses should be prepared to demonstrate profitability and future growth potential and weigh the pros and cons carefully to minimize the risks.
Angels are high-net-worth individuals or networks that invest in early-stage businesses that have proven potential for strong returns. On average, funding ranges from $300,000 to $500,000 but can go upwards of $2 million.
Expect angels to take anywhere from 20% to 40% equity in the business. The typical duration of the investment lasts between seven and 10 years, and it can be used in combination with other types of financing.
"We invest in high-growth businesses with product market fit and a credible business model that has potential to be repeatable and scalable, even if there is no stable history of revenue," said Thealzel Lee, of E-Fund.ca, a Vancouver-based angel fund.
However, because of their limited pool of funds, angels are highly discerning about their investments.
They can provide timely financing and, in the case of an angel network, access to the collective brain trust of the entire community.
"The day-to-day involvement of the angel investor can range from none to taking an advisory or senior management position within the company," Lee said. "This can be especially beneficial if the company requires access to the angel's network and industry expertise."
If liquidity is a challenge, early-stage businesses with revenue might turn to factoring where they outsource their accounts receivable for a discount. Considered bridge lending, factoring can be advantageous to relieve short-term cash flow issues because of its flexibility and fast turnaround.
It is ideal for seasonal businesses, due to its on-and-off lending ability, or companies with long payable time periods.
"Our clients are young, small- to-medium-sized businesses which have high-quality, high-concentration, business-to-business accounts receivable," said Cassandra Consiglio, president and CEO of Pyx Financial Group, a Vancouver-based factoring firm. "We qualify based on sales growth. For new companies that are fulfilling orders right out of the gate, this is an excellent option." Factoring discounts range between 1% and 3% with terms that usually last from six months to one year. Consiglio advises that factoring is best used short-term.
The Canada Small Business Financing Program is another alternative for young, growing businesses. According to Industry Canada, the program offers a maximum interest rate of prime plus 3% and requires profit-making businesses with gross annual revenue of less than $5 million. The total of the loan must not exceed $500,000 with a maximum term of 10 years.
The program is designed for banks and credit unions to originate and administer loans with a federal government guarantee, increasing the ability of small businesses to borrow. The average loan is $146,776.
The loan is limited to financing owner-occupied real estate, leasehold improvements and equipment. Other issues to consider include difficulty securing the loan and finding a lending institution that supports the program.
Subordinated debt financing might also be available to early-stage businesses that expect to be profitable in the next 12 to 18 months, such that they can take on, and repay, debt. Based on cash-flow, the rate of return is typically in the mid-teens with terms of three to five years.
Sub-debt can provide financing in amounts of between $500,000 and $10 million and is a quick, tax-efficient, less expensive option in comparison with equity. In addition, business owners maintain control of operations.
Entrepreneurs understand that it's hard work to build a new business, and it can be even tougher finding financing beyond personal connections. The key to securing funding is persistency and the ability to present a strong business case that demonstrates a strong return on investment. •
This column is one in a series on financing options for stages of business. The next instalment will discuss sources of capital for growing businesses.
Robert Napoli (firstname.lastname@example.org) is vice-president of First West Capital, a division of First West Credit Union that finances acquisitions, buyouts and growth. His column appears monthly in Business in Vancouver.