Financing Your Business

Welcome to the Canada Business audio workshop. This 6 part series will help you with basics of starting and growing your business and will cover some of the most challenging aspects of business ownership.

In this session we will be discussing financing your business.

Financing your Business

• Equity
• Long Term Debt
• Short Term Debt
• Leverage
• Abusing your Loan Privilege - An Example

To start your business you must purchase licenses, pay for permits, engage professional services (e.g. legal, accounting, insurance etc.), do leasehold improvements, buy furniture, fixtures and equipment etc. You may require initial retail inventory, an opening stock of repair parts, accessories or office supplies such as business cards, letterhead, envelopes, staples etc. Once you start operating, you must replenish these retail or parts stocks and pay the day-to-day wages of your employees (i.e.working capital requirements). There are financial strategies to satisfy these needs and to approach the various sources of this financing (i.e. lenders & investors).

Money that finances business is called capital. Bank loans approved for day-to-day business operations (working capital) have characteristics that make them different from those approved for equipment purchases (long term capital or capital assets). A bank loan officer can often assist you in finding a workable combination of these different types of capital. Using loans approved for purposes other than those for which they were approved is considered an abuse of your loan privilege.

Equity

Equity funds come from personal moneys of the partners (such as savings, inheritance or personal borrowings from financial institutions, friends, relatives and business associates) and from stockholders of the shares in a corporation. These funds are normally unsecured and have no registered claim on any of the assets of the business, freeing those up to be used as collateral for the loans (debt financing). Higher equity creates " increased leverage." Leverage reflects the business ability to attract other loans and investment. An equity position of $30,000 may enable the business to obtain debt financing of up to three times that amount, $90,000. A fully-leveraged business has no further ability to borrow money.

Long Term Debt

"Term" refers to the time for which money (a secured loan) is required and the period over which the loan repayment is scheduled. A long term loan is arranged when the scheduled repayment of the loan and the estimated useful life of the assets purchased (e.g. building, land, machinery, computers, equipment, shelving, etc.) is expected to exceed one year.

Short Term Debt

Short term loans usually take the form of operating term loans (less than one year) and revolving lines of credit. These finance the day-to-day operations of the business, including wages of employees and purchases of inventory and supplies.

Leverage

This is the relationship of debt financing to equity financing (leverage or debt-to-equity ratio). A proposal which involves $6000 of debt, and is based on an equity contribution of $2000 is said to have a debt/equity ratio of 3:1. Generally, the lender would like to see a new business owner who is just building a reputation have this at 2:1 or even 1:1.

Abusing your Loan Privilege - An Example

Your business plan tells the banker that your proposed business requires a revolving line of credit of $40,000 to meet its day-to-day expenses over a number of months. The line of credit is approved because the banker believes that amount of money is absolutely necessary to enable you to operate over the specified time period. Shortly after this approval, you approach the bank again, this time with a request for a term loan of $25,000 to purchase new office furnishings. The bank denies you the term loan as it does not feel that, at this stage, the business can service such a large amount of debt. Disappointed by this refusal, you nonetheless decide to buy the new office furniture, taking the required $25,000 out of your operating line of credit account.

What has occurred? The integrity of your business plan has been betrayed! With the depletion of your operating line of credit, you can no longer expect to purchase the inventory deemed necessary to achieve your projections. The business will be less able to generate the sales revenue required to service the existing (plus additional) debt; and your revolving line of credit will have surrendered its ability to revolve. You return to the banker pleading for an extension of your line of credit, but the banker, feeling betrayed, has lost confidence in your management ability and may withdraw the line of credit privilege, insist on more equity, recall the loan in its entirety or force the business into receivership. Furthermore, this performance will remain on file as a black mark against your management ability long after the business is only a hazy memory.

Equity Financing

Equity Financing Explained

Equity funds come from personal moneys of the partners (such as savings, inheritance or personal borrowings from financial institutions, friends, relatives and business associates) and from stockholders of the shares in a corporation. These funds are normally unsecured and have no registered claim on any of the assets of the business, freeing those up to be used as collateral for the loans (debt financing). Higher equity creates " increased leverage." Leverage reflects the business' ability to attract other loans and investment. An equity position of $30,000 may enable the business to obtain debt financing of up to three times that amount, $90,000. A fully-leveraged business has no further ability to borrow money.

Twenty-five to fifty percent of your own money in the business shows a lender or investor that you are prepared to share the risk alongside his/her money (your commitment to the project). As the business grows, you should always try to keep your own equity (ownership) at approximately 25% of the total project (as per the current balance sheet). Earnings retained in the business will increase both your equity position and your leverage.

Shareholder Loans represent equity (and, on occasion, debt) paid into a private company by relatively few "partners in profit and risk" in exchange for share ownership. The shareholder loan may be secured by the share certificate(s) alone or by a debenture. If it is secured by a debenture or something other than the participation in the profits, then technically it is not equity. Most financiers of commercial debt will insist on a priority claim against assets and force this shareholder to a secondary or subordinated security position.

A stockholder's liability in a limited corporation is limited to the value of the shares he/she has purchased. Normally there is no claim by these stockholders on the business' assets; rather they have accepted the risks and rewards that go with that business. The rewards are direct participation in the profits of that business as well as any appreciation in the perceived value of the shares. The risks represent the possible reality that the share-value could drop to zero. True equity money is unsecured and directly reflects the faith of the investor in the business, its management and the commitment of its principals to it.

Venture Capitalists could be companies with more retained earnings than they require for reinvestment into their own operations, holding companies who wish to diversify their bases; "venture capital corporations" formed for tax advantage reasons; or individuals seeking to shelter excessive earnings from high taxes or hedge their fixed incomes against inflation. Venture capitalists are usually shareholders, secured by share value and legal agreements.

Sources of Equity Financing

Family, Friends, Inheritances & Personal Mortgages

The most accessible sources of personal money are inheritances, mortgage extensions (on a personal residence) and family and friends. But venture cautiously, many cherished friendships and family relationships have been destroyed through inadequate protection and provision for personal creditor repayment related to the possibility of a business failure.

If you borrow money from family members and/or friends, consider setting the loan up on a straight business basis. You may also want to provide some personal security or personal guarantee outside of the business itself. The offer of a deferred repayment scheme of some kind may be welcome.

Most often these persons are assuming a high risk with little real basis for the investment as a favour to you. Your concern about protection for their money will go a long way to ensuring their future cooperation and avoiding dissension. They will be most favourably impressed if you can show them a well thought-out and orderly presented business plan, even though they may not have specifically requested one.

Partners

In seeking out a general equity partner, it will be wise to identify persons who have not only the money to complement your contributions (equity), but who are knowledgeable in the industry itself, connected in the industry and who have expertise in the areas of the business in which you do not. Limited partnerships have special provisions to limit the direct involvement of the partner in decision-making as well as their liability in the debts of the company.

Investors

In seeking active investors (venture capital) for a project, look first within the industry. Logically, an investor will prefer to invest in a business he/she understands. You will also have far less explaining or selling of the concept to do. There is a possibility that once they have made that investment, they will also be looking pro-actively to involve your company in the other things they may be doing, and their influence in the industry may well provide access to additional contract opportunities in the industry.

In seeking passive investors who will have little or no involvement in the project, try to find those groups of professionals who have steady income (to tax shelter) and a prime responsibility of their own that allows them no time to interfere in yours (e.g. a doctor or group of medical practitioners, a dentist with a busy practise, or a lawyer or professional financier preoccupied with their own activities).

Approaching Equity Investors

In seeking partners who will be putting their own money into the venture, you must be prepared to accept the fact that a partner will most often expect to be involved in the decision-making process of the venture. At the very least, they will expect to be kept updated regularly on your activities.

These persons are being asked by you to take a relatively unsecured position in the company and should be presented with a sophisticated, detailed business plan that reveals everything related to the financial basis for carrying on this business. The prospective investor will rigorously evaluate the abilities of the management team, the financial strength of the company structure and principals, and the commercial viability of the enterprise as to the risk factors portrayed in the projected financial submissions.

This evaluation will normally require a detailed business plan (in a bound presentation format) which provides extensive information on the management of the company or project; a detailed history of the business concept, its products, its production methods, operations and costs, its target markets and position in the marketplace; the purpose to which this additional equity (cash infusion) will be applied (in intimate detail); any assets the company owns as well as a detailed summary of all liabilities (debt) and shareholdings etc.; and extensive financial information and projections.

Assistance to prepare this presentation or prospectus can be accessed through private financial consultants, the Management Services arm of your local Business Development Bank of Canada or at the Canada Business.

Long Term Debt Financing

• Characteristics of a Term Loan
• Types of Loan Security Agreements
• Approaching Long Term Debt Lenders

Characteristics of a Term Loan

"Term" refers to the time for which money (a secured loan) is required and the period over which the loan repayment is scheduled. A long term loan is arranged when the scheduled repayment of the loan and the estimated useful life of the assets purchased (e.g. building, land, machinery, computers, equipment, shelving, etc.) is expected to exceed one year. Long term loans are normally secured, first, by the new asset (s) purchased (up to 65%) and then by other unencumbered physical assets of the business (for the remaining 35%) , or failing that, from additional funds from shareholders or personal guarantees from the principals. On the balance sheet, the equipment purchased shows up in the long term assets section, while the counterpart loan information is shown in the current and long term liabilities portions. The useful life of the assets is directly reflected in their depreciation schedules.

Debt lenders (creditors) make loans to businesses that exhibit strong management ability and steady growth potential. A written business plan, including a cash flow demonstrating the business ability to repay the loan principal and interest over the term of the repayment schedule, is mandatory. The lender will expect you to have appropriate insurance to protect the assets.

Characteristics:

• Principal repaid over a period of time directly related to the useful life of the asset(s) (e.g. land and buildings - up to 30 years, computers - 3 years).
• Loan carries both interest and principal repayment provisions in a set repayment schedule. Early repayment may entail a penalty because the lender had not planned an alternate investment for that money.
• The percentage interest rate normally remains constant for the term of the loan. Each payment of principal reduces the balance of principal remaining and the subsequent interest is calculated on this reducing balance.
• Different lenders make different types of term loans. Term loans often carry lower interest rates than operating loans because the term is fixed and the loans are secured by assets (asset-backed).

Types of Loan Security Agreements

Promissory Note

A promissory note is a written promise to pay a specified sum of money to the lender either on demand or on a specified date.

Realty Mortgage

The realty mortgage is a loan (mortgage) whose proceeds are applied to the purchase or re-finance of land and buildings. A charge against the title is registered with the Province.

Chattel Mortgage

The chattel mortgage is a mortgage on specific assets other than land and buildings. A lien charge against the title is registered with the Province.

Pledge

The pledge is an agreement similar to the chattel mortgage, except in that possession is transferred to the lender but title remains with the borrower, e.g., your stocks and bonds held by the bank.

Floating Charge

The floating charge is an agreement which designates that all the remaining assets in Debenture the business, not already mortgaged as security for other debts, will be taken as the security for the new debt. The title remains with you but the debenture is registered with the Province.

Personal Guarantee

This agreement says you will agree that if the limited company is unable to repay the loan, you will do so personally. If this is in addition to other securities, you would be wise to try to negotiate a limited guarantee to cover the shortfall in the security for the loan. Try also to recover your personal guarantee as soon as the business has paid off its obligation or can carry the debt on its own security. That personal guarantee places those things you and your family hold dear at risk for the debts of the business.

Postponement of a Claim

The Postponement of a Claim allows the lender to ask for assurance that the company will not repay the shareholders until the secured lenders have been repaid in full.

Approaching Long Term Debt Lenders

The predictability of repayment and degree of control over loan security makes the asset-based long term loan the preferred investment of most lenders and lending institutions. Provided that the equity requirement, leverage factors and asset-based security is adequate, a variety of lenders can be found to conclude these loan agreements.

These long term debt financing sources can be divided again into the sub-categories of:

• Mortgage Lenders.
• Term Loan Lenders.
• Equipment Leasing Lenders.

Most people approach the subject of borrowing money with some trepidation. You should never view borrowing money from a commercial loan institution as begging for money. Rather, consider that you are offering the financial institution an opportunity to do business with you - to make a sale.

You will be renting money from people who, in turn, are soliciting your business. Banks, credit unions, finance companies and others need your business to make their money work for them. Loans are just another commodity on a retailer's shelves, and it becomes your challenge, in conjunction with the loans officer, to find the one that best fits your circumstances.

The Loan Officer's job is to rent money at profitable rates of interest with a minimum of risk. The loans officer needs to feel comfortable that he/she has recommended an astute investment, predicated on tested principles of lending (business plan with financials from which ratios can be developed), when your case is presented by the officer to the bank's loan review board.

Mortgage Lenders

The institutional providers of first level mortgage lending include the Insurance Companies, the Banks, the Trust Companies and the Pension Funds. There are also long term mortgage loan financiers to be found in the private sector. The twenty-five year long term mortgage though, has largely disappeared; a maximum five year term reflects the character of today's long term mortgages. Many of these smaller private mortgage financiers advertise their services aggressively, especially where those offerings relate to mortgage extensions on property in strong real estate markets.

A first mortgage will earn the lender approximately 12% interest, a second mortgage, 15%, and a third mortgage, 18% - 20%. These lenders can be easily located and your approach to them assisted (or prepared for you for a fee) through consultants known as mortgage brokers (provincially licensed and bonded).

Approaching the Sources of Mortgage Financing:

Mortgage financiers must normally be approached with a prepared proposal, which will be judged on the basis of who the borrower is (i.e. personal financials); the type of building and its use; the location of the property; its condition of repair; its value established by professional appraisal, comparative sales, cost and income; the company balance sheet; and the projected or actual cash flow. Again this approach can be prepared for you by contacting a provincially licensed and bonded mortgage broker.

(Long) Term Loan Lenders

The providers of basic long term loans include the Banks, the Trust Companies, the Insurance Companies, the Pension Funds and various Loan Specialists.

Approaching Sources of Long Term Loan Financing:

Term loan evaluation tends to be more rigorous and sophisticated than mortgage loan evaluation. In summary, this lender is evaluating the abilities of the management team, the collateral available to support the loan and the commercial viability of the situation, as indicated in the projected financial submissions.

This evaluation will normally require a detailed business plan (in a bound presentation format) which provides extensive information on the management of the company or project; a detailed history of the business, its products, its production methods, its operations, its position in the marketplace; the purpose for which the loan is intended (in intimate detail); any security available to be pledged; and extensive financial information and projections.

Assistance to prepare this presentation can be accessed through the Management Services arm of your local Business Development Bank of Canada or the Start-Up Centre of the Canada Business.

Equipment Financing/Leasing Lenders

The providers of term loans to finance equipment include the Banks, the Trust Companies, the Insurance Companies, the independent sales finance companies and, on occasion, the equipment vendors themselves.

Note:  Equipment purchase is an eligible activity under the terms of the Canada Small Business Financing (CSBF) Program, a program of the Government of Canada, which can be requested to provide a guarantee to the financial institution to allay a portion of the risk of the Canada Small Business Financing (CSBF) Program. Information on this is available from your local commercial bank, or the  Canada Business.

Approaching Sources of Equipment Financing/Leasing Lenders:

These financiers (the commercial banks, the trust companies, the credit unions) look for many of the same proofs of commercial viability that the Long Term Loan people require. Again, a bound business plan is in order. Remember to make the financial information in the plan easy to locate. The role of the loans officer in the commercial banks is to prepare a loan summary report from your information, which will be submitted to his or her loan supervisor with the officer's recommendation to support or reject. These financiers are eligible under the CSBF program loan guarantee.

If the purpose of the business plan is primarily to procure the capital financing to purchase an expensive new piece of machinery or to upgrade an existing production line, include a dual scenario financial argument. One full set of financial projections should be provided utilizing the existing numbers and the current equipment situation (balance sheets, cash flow and Pand L's). A second full set of financial projections should cover the same period of time and show the situation as if the new equipment were in place (balance sheets, cash flow and P and L's).

Include an expectation of the useful economic life of the new equipment and resale value over the course of its useful life.

The Business Development Bank of Canada (BDC) (ineligible for the CSBF Program) is also a key lender when it comes to equipment purchases and fixed asset acquisitions in general. While the BDC does not offer discounted interest rates, it can choose to schedule the repayment over a longer term than the commercial banks.

Sales finance companies, in cooperation with the equipment suppliers (vendors) commonly offer sales finance programs and lease-back options on their equipment. The onus is upon you to ask your vendor if he/she has access to any such finance programs, or if the vendor will finance the purchase directly.

Short Term Debt Financing

• Short Term Debt Explained
• Operating Term Loans
• Revolving Lines of Credit
• More Short Term Instruments
• Approaching Short Term Debt Lenders

Short Term Debt Explained

Short term refers to the time for which a loan is required and the period over which its repayment is expected to take place. Short Term Loans usually take the form of operating term loans (less than one year) and revolving lines of credit. These finance the day-to-day operations of the business, including wages of employees and purchases of inventory and supplies. Supplies are used up quickly and inventory is sold resulting in stock-turns. Also bridge financing (interim loans with a short, fixed term) can be used to finance accounts receivable contracts, which are relatively risk-free, but delayed for one to three months.

Short term operations money may be secured against first, any unencumbered physical assets of the business; second, additional funds from shareholders or personal guarantees from principals. On occasion, inventories can be used as temporary security for operations loans. Bridge financing is normally secured by assignment of all the receivables and personal guarantees. On the balance sheet the accounts receivable, inventory and supplies stocks show up in the current assets section, while the counterpart loan information is displayed in the current liabilities section.

Lenders normally charge a higher base rate of interest for operating loans reflecting this relatively weaker security position. The amount of the operating line of credit, will be determined from the projected cash flow information in the business plan. Lenders favour businesses that exhibit strong management, steady growth potential and reliable projected cash flow (demonstrating the business ability to pay the monthly interest payments on this line of credit from its projected revenues in a written business plan).

Operating Term Loans

Operating Term Loans for working capital are used to enable a retail, service or manufacturing business to purchase raw materials, retail or parts inventories, process or promote these and pay monthly expenses including principal and interest on outstanding term loans, wages and salaries, rentals, leases, utilities, etc.

If a business was able to sell all its inventory (stock) at full margin and collect the cash for it immediately, realizing its profit before it had to pay suppliers for that stock and before it had to pay its monthly expenses, that business might require no particular working capital loans. However, most are not cash businesses and don't enjoy that luxury. They face build-ups of day-to-day and monthly expenses such as stock parables, wages, rentals, leases, etc., often in advance of collecting the cash sales revenues to pay the trade suppliers, the labour commitments and the regular overhead expenses.

Operating Term Loans (Working Capital) are commonly offered by credit unions and non-commercial lenders who are unwilling or unable to offer operating (revolving) lines of credit to their customers. This term loan is made like any other term loan, and is fully secured against unencumbered assets, personal guarantees and co-signers.

Revolving Lines of Credit

A line of credit is a long term commitment by a commercial lender to honour the day to day cheques of a business up to a maximum figure agreed to in consultation with the business. The lender retains a number of signed drafts (notes held for discount) from the business on hand to use as required to place funds as needed into the account. The business was made responsible for depositing all sales revenues on a regular basis into the account to "buy down" the outstanding loan balance whenever there were the funds available to do so.

This up and down, fluctuating nature of the loan amount (account balance) is why it has come to be called a "revolving line of credit." There is no scheduled repayment of principal because there is no set principal amount of the loan. The interest rate normally floats at 2%-3% above the prime rate and is applied to the largest amount of loan outstanding in that account during the course of any month. There are no other account service fees.

Traditionally, revolving lines of credit are the preferred borrowing formats of most commercial businesses and manufacturers. The normal sources of these loans are commercial lenders, the chartered banks, and more recently, some credit unions. Most commercial businesses require differing amounts of cash each month to meet their actual operating commitments for that month; they want to pay only interest justified by the actual usage of borrowed cash (without penalties); and pay nothing at all when revenues are entirely sufficient to pay the month's expenses. This requires a special kind of loan that can provide long-range flexibility (allowing the principal of the loan to vary from month to month); that can temporarily cancel the loan without penalty in a month where borrowing is not required; and that can provide an almost automatic approval from the lender for each new loan amount (to a maximum overdraft). While some of this might be achieved by a Bank Overdraft Scheme, the more commonly accepted way is to use a revolving line of credit.

More Short Term Instruments

Modern Overdraft Scenario

More recently the banks have fine-tuned this program to what could be called a planned overdraft scheme. The bank will approve a business for a certain overdraft amount. They no longer work with a series of pre-signed drafts. The actual interest rate has been dropped to a point to two points above the prime rate and a system of service charges for the overdrafts has been substituted to make up the difference.

Interim Loans

Interim loans are a type of bridge financing intended to "bridge the gap" between the time a specific receivable is received in cash and the time the company's parables become due. The assignment of the receivables is the primary security for the loan. This is quite common where a government agency purchase has been made. The lender knows the customer will pay, but also that the cash may take some time to collect. When a government financial assistance program makes an award, reimbursable only after the moneys have been spent or the project is in place, bridge financing is an appropriate format.

Assignment of Book Debts (Receivables)

The receivables are assigned to the lender to secure the operating line of credit. These are still collected by the business, but in the event of business default, the lender can assume collection of these directly. The assignment is supported by the monthly submission of the list of receivables.

Security under Section 88

Section 88 of the Bank Act allows a business to use goods-in-process, future crops, livestock, etc., as security. Possession and title are retained but the lender has certain rights with respect to the sale of the finished products.

Security for Working Capital Loans

The lender uses accounts receivable (the money owed by customers) and inventory as the security (collateral) for the loan. For accounts receivable lenders may lend between 50% and 75% of the total outstanding receivable, first deducting any invoices which have gone over 90 days. On inventory, lenders may lend up to 50% against cost based on supplier invoices. Any additional cash required must come from your own resources or by careful management and recirculation of the business' profits and cash.

Personal Guarantees

The principal makes an agreement that if the limited company is unable to repay the loan, he/she will do so personally. If this guarantee is on top of other security, attempt to negotiate a limited guarantee to cover only the shortfall in the security. Recover the personal guarantee as soon as the business has paid off its obligation or can carry the debt on its own security. A personal guarantee places all those things you and your family hold dear at risk.

Postponement

If there are also loans from shareholders, the lender may ask for an agreement that the company will not repay the shareholders until the secured lenders have been repaid in full.

Approaching Short Term Debt Lenders

Mortgage Lenders

The institutional providers of first level mortgage lending include the Insurance Companies, the Banks, the Trust Companies and the Pension Funds. There are also many short term loan financiers to be found in the private sector. Many of these advertise their services aggressively, especially where their offerings relate to mortgage extensions on property in stable real estate markets.

These can be easily located through licensed and bonded consultants known as mortgage brokers. These offerings normally involve terms of one year or less with liberal provisions for renewal. For these reasons these mortgages often charge only interest, but have hefty penalties for returned cheques and late payments.

A first mortgage will earn the lender approximately 12% interest, a second mortgage, 15%, and a third mortgage, 18% - 20%. Many of these will have, in turn, leveraged and sourced two thirds of their funds for this mortgage from an institutional or commercial lender, and accordingly they will have to comply with various restrictions placed on their investments by that lender.

Private mortgage financiers would normally be approached after you have exhausted the commercial channels and been rejected from dealing directly with them due to some weakness in your equity or personal guarantee abilities.

Approaching Mortgage Lenders:

There are many short term mortgage loan financiers to be found in the private sector. Many of these private mortgage financiers advertise their services aggressively, especially where those offerings relate to mortgage extensions on property in strong real estate markets.

Commercial Banks and Credit Unions:

The Commercial Banks and Credit Unions are normally prepared to offer financing based on accounts receivable bridging and/or inventory purchases. Revolving or operating lines of credit (and overdraft schemes) are offered by the major commercial banks and some credit unions.

Approaching Commercial Banks/Credit Unions:

Loan evaluation tends to be more rigorous and sophisticated than mortgage loan evaluation. In summary, this lender is evaluating the immediate abilities of the management team, the collateral available to support the loan and the short term commercial viability of the situation, as portrayed in the projected cash flow financial submissions. This cash flow projection will normally be included in a detailed business plan (in a bound presentation format) providing extensive information on the management of the company or project; a detailed history of the business, its current products, its production methods, its operations, its position in the marketplace; the purpose for which the loan is intended (in intimate detail); any security available to be pledged; and extensive financial information and projections.

Assistance to prepare this presentation can be accessed through the Management Services arm of your local Business Development Bank of Cananda or the Start-Up Centre of the Canada Business.

Trade Creditors, Factors and Commercial Finance Companies:

Trade Creditors offer terms of 30 days before payment for stock purchases is due. With newer, unproven operations, C.O.D. (Cash On Delivery) is often required. Occasionally, in a buyer's market, an important large dealer will be offered 60 day payment terms. Often a 2% discount will be offered to dealers who pay within 10 working days and a penalty (e.g. 1.5% per month interest) will be imposed on account balances unpaid after 30 days.

Factoring Companies may buy accounts receivable outright without recourse and assume all the risks of collection. These may advance funds against purchased receivables, less a percentage.

Commercial Finance Companies often advance funds upon assignment of receivables and warehouse shipping/receiving receipts. They will also consider short term equipment financing.

Approaching Trade Creditors, Factors and Commercial Finance Companies:

Sales finance companies, in cooperation with the product suppliers (vendors) commonly offer sales finance or factoring programs and lease-back options on their equipment. The onus is upon you to ask your vendor if he/she has access to any such finance programs, or if the vendor will finance the purchase directly, through a factor or floor-planner scheme. Small office equipment may often be purchased on a lease-to-buy arrangement. Generally, these will expect a less detailed business plan, but will be particularly interested in the parts that relate to sales projections, stock movement and replenishment and monthly cash flow information.

Alternative Sources of Financing

• Suppliers Inventory Buying Plans
• Renting and Leasing vs. Buying
• Leasehold Improvements
• Advance Payment from Customers
• Factoring Accounts Receivables

Suppliers Inventory Buying Plans

An alternate way of realizing working capital is through supplier financing. Suppliers may be willing to extend payment terms to 60, 90, or even 120 days. Some suppliers offer 2% discounts for early payment (within 10 working days) and penalize slow paying dealers with monthly interest charges. Other aggressive suppliers may offer floor planning or factoring options to assist dealers in financing stock purchases. Occasionally, such a supplier promotion plan will enable a dealer to pay for specific items only as they are sold (supplier retains ownership of goods until paid for).

These plans entail your empowering a representative of the supplier to enter your premises and take spot-counts of the supplier's merchandise in your stock. The supplier then invoices you for what has been sold according to the representative's report, and replenishes your stock to the original agreed level. This system also permits the supplier to constantly alter the mix of his/her merchandise on your shelves, quickly replacing slow moving items with those that seem to sell more quickly in your particular market.

Renting and Leasing vs. Buying

In aggressively competitive equipment markets, most leasing companies will be pleased to arrange lengthy leases on equipment and computers with an option to purchase in order to close the sale for the supplier. Renting or leasing can free up equity capital for investment in other areas of greater return; free up borrowing power (improves cash leverage) for more critical borrowing; requires no down payment; fixes the rate for a set term; allows you to deduct the full expense from your taxable income; and still allows you the flexibility to exercise purchase options at a later date at a predetermined price.

Leasehold Improvements

When you are negotiating a lease for a rented premises, remember that a substantial amount in leasehold improvements will be going into that location. The person in the best position to oversee the leasehold improvements as a security for the loan is the landlord. Moreover, the landlord or property manager will often agree to provide a portion (a dollar amount per square foot allowance), or all of your leasehold improvements against a longer term lease. A three or five year lease gives you a reasonable negotiating position for including leasehold improvements in the deal and paying for these through your rent over the course of the lease. This may represent $30,000-$60,000 of start-up expenditure for retail locations, for example, and off-laying that can significantly reduce the start-up cash and equity required. In addition, it can make a balance sheet appear healthier when its ratios are examined. A skilled lease (contract) lawyer, acting on your behalf, can perform great service in this kind of negotiation.

Advance Payment from Customers

You might consider negotiating a full or partial advance payment from customers to help finance the preparation costs related to taking on their business. In some project oriented industries, it is customary to receive a stepped (partial) payments payable at defined stages of project progress, prior to the completion of the project.

Consider requiring a deposit for all work (normally deposits are held in trust pending completion). This will reduce the need for a line of credit. Deposits collected for work that involves special orders for goods or services will serve to prove the customer was committed to the order and will prevent the business having to absorb costs resulting from non payment.

Factoring Accounts Receivables

An effective way to grow a business with limited working capital is by utilizing a factoring company to discount your accounts receivable. In fact, with good supplier credit and a professional factoring company, you may need a lot less capital than you think. The factoring company can also provide you with credit management expertise.

What happens is basically the same thing that happens when a retailer accepts a credit card. You receive the money right away while it is the factoring company who waits for payment. By having the use of your money right away, you can begin to concentrate on making the next sale. A strong focus on sales is the key to success for every new business.

Factoring is more expensive (typically 3 - 5% of your invoice) than most other forms of finance, therefore; it is important to find ways to build it in (pricing) and earn it back (suppliers). There are also savings realized by not having to perform necessary credit functions yourself. If you can use the factoring monies to add new business, then the costs or factoring are fairly easy to justify.

By factoring your receivables, you do not increase debt or dilute equity. You are simply given access to your own money when you want it rather than when your customer chooses to pay. As you build your own working capital, you can reduce the amount that you factor and carry more of your own accounts receivable. Eventually you can become completely self-financed. (Special thanks to First Vancouver Finance for this information on Factoring).

This concludes session 3 of the Canada Business audio workshop series, for further information on anything discussed in this episode please contact the Canada Business service centre near you by calling 1-888-576-4444.

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