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With Saskatchewan having the highest rate of small businesses per thousand people in Canada, a significant number of local Saskatoon businesses report that obtaining financing is one of the most challenging aspects of running a business. Small and medium enterprises (SMEs) require financing across all stages of their lifecycle; whether it’s introducing new products or services, expanding into new markets, or requiring additional talent or equipment, SMEs need to seek out new ways to raise capital to grow.
Small businesses continue to drive Saskatchewan’s economy, and for private business owners making smart, strategic decisions around capital can be the deciding factor between success and hardship. The following are a few options to consider when choosing what capital-raising option may be best for your private company.
Traditional bank loans
Traditional bank loans provide medium- or long-term financing to SMEs that are heavily reliant on debt to fulfill their cash and investment needs. Generally, banks make lending decisions based on a combination of factors, including your credit history, how much you have invested in the business, the collateral you have to offer, and the business’s profit and cash flow. The bank uses these factors to determine your capacity to pay them back — in other words, what their risk is. Since approximately 99.9 per cent of all businesses in Saskatchewan are SMEs, traditional bank loans can be challenging to find as banks’ lending criteria ensure they take on as little risk as possible.
Interest rates may be fixed for the term, so you’ll know the level of repayments throughout the life of the loan. It’s important to understand the terms and conditions you must adhere to, including covenants. Violating a covenant or term of the loan may give the lender the right to demand repayment.
Cash flow loans
A cash flow loan is a type of debt financing where a bank will lend funds, generally for working capital, using the expected cash flows that a borrowing company generates as collateral for the loan. With cash flow financing, you’re essentially borrowing against money you expect to receive in the future, and a lender will decide whether to approve you based on those projections and your past performance.
While the level of scrutiny with this type of financing tends to be lower, banks will make up for that by charging higher interest rates and other fees. However, cash flow loans may be particularly attractive for SMEs as they are often quicker to obtain and the approval rate tends to be higher compared to traditional bank loans.
Asset-based lending is any kind of lending secured by an asset. This means that if the loan is not repaid, the asset is taken. An asset-based loan or line of credit may be secured by inventory, accounts receivable, equipment or other property owned by the borrower. This financing option is often considered when a business has exhausted other capital-raising options or has immediate capital needs for inventory purchases, mergers, acquisitions and debt purchasing. Interest rates on asset-based loans are lower than rates on unsecured loans since the lender can recoup most or all of its losses in the event that the borrower defaults.
Since many small businesses may not qualify for traditional loans, SMEs widely use asset-based lending to support domestic and international trade, working capital needs and for investments. However, these types of loans require ongoing management as your company may need to fill out regular borrowing certificates which state assets and liabilities in detail.
Venture capital is money that’s provided by investors to startup firms and businesses with perceived long-term growth potential. It typically entails higher risk for the investor, but it has the potential for above-average returns. It can be a great source of funding for startups that have proven their model, with the potential for growth. Venture capital may also be a long and complicated process, but unlike bank loans, it does not leave SMEs with the burden to repay investors if the business fails.
If you’re considering venture capital, be aware that venture capital firms typically require an equity interest in exchange for their investment. They often have significant involvement in the operation and growth of your company due to the nature of their monetary contributions. However, obtaining venture capital financing can provide SMEs with a valuable source of expertise and guidance.
Since cash flow issues can be a chief reason why businesses fail, SMEs must understand how different financing options may be relevant for different stages in the business lifecycle. Since SMEs provide more than half of employment worldwide, it’s imperative these businesses receive adequate access to financing to help them grow.
Capital is the foundation of every private company. Making smart and strategic decisions around capital management today can help define your competitive position tomorrow.
Are you evaluating capital-raising options for your private company? To learn more, contact me today, or visit us at ey.com/ca/private.