Types of Available Financing

There are two type of financing available to business: equity and debt. Simply stated, equity is the money that you put into your business. Debt is what you borrow from others to invest in your business.

(Please note that there is a hybrid type of financing known as "mezzanine financing" which is somewhere between equity and debt. For instance, the investors lend with the right to convert their loans into shares of the company when the company eventually goes public, or after some definite period of time has elapsed. However, this typically only applies to larger firms who intend to go public at some future point.).

Most owner/managers running a service SME might think of "equity" as being the personal funds they have invested in their business through a) the expenses they have incurred in marketing and promoting their services, b) the funds invested in purchasing computer or office equipment, or c) the amounts not paid in salary that were used to develop the business. The word "debt" conjures up i)funds borrowed from friends or relatives to start the business or ii)perhaps a bank line of credit obtained after you have been in business for some time and have developed accounts receivable against which you could borrow bank funds (if you are in a service business, it is unlikely you would have inventory against which you could borrow).

In both cases, you are likely typical of many service SMEs. In a recent study undertaken for the Canadian Bankers Association (CBA) concerning access to financing for small and medium-sized businesses in Canada, the researchers found that, for SMEs who currently financed their companies at least partially through loans from banks or other financial institutions (51% of the population surveyed), 75% report that an operating line of credit is the facility utilized most frequently. With regard to equity sources, retained earnings and personal savings were mentioned most often (40% and 39% respectively) by those surveyed, as a source of financing.

But there are numerous other sources of funds available to help you finance your SME service business. However, most relate to debt because SMEs typically would not reach a size that would make them attractive for public or private investment. In this module, we outline some of the sources and methods for obtaining both debt and equity funding. The module is not intended as an exhaustive list of all such sources, but should nevertheless touch on many of the methods that can be used to garner the funds necessary to help make your business more competitive.

One word of caution concerning debt. If you enter into a "formal" arrangement to borrow funds (as opposed, for instance, to the "informal" use of credit cards where the amounts are smaller and there is limited personal contact with the lender), you are agreeing to take on a "partner"(not in the legal sense, but rather from the perspective of a third party who now has a keen interest in your business) . That "partner", by virtue of the funds invested in your business, has the right (and the obligation) to keep fully up-to-date on what is happening with your business. You in turn have the obligation to keep the lender informed and, in many cases, depending on the terms of the loan agreement, to refer to the lender before making any major decisions concerning your business. It also means of course that you are responsible for making timely interest and principal payments; the failure to do so means that you will put yourself in a difficult administrative and legal position. Thus if you can avoid borrowing, avoid it. You will continue to be your own and sole master. If you must borrow, do so knowing that you are fortunate to be able to use someone else's money. Put yourself in their shoes and be prepared to nurture the relationship you will have with that "partner".