Startups have a few options for debt financing, depending on their stage of development and the purpose of the funding. One viable option is debt financing through a bank. Still, you must consider how potential investors will view any debt instruments you’ve used to finance your startup to the point where they will invest in your business.
Debt financing with credit cards
Credit cards provide a useful source of month-to-month credit for early-stage businesses. They usually require either a personal guarantee from the founders or a security interest in the company’s assets to the lender.
Canadian banks tend to take and hold a number of different forms of security, even though one type might legally suffice. Equity investors prefer to limit the lender’s security rights to just what is required.
In the early stages of a startup investing a small amount of the business’ cash balance in a segregated guaranteed investment certificate (GIC) can effectively provide collateral and secure a credit card line for business uses, such as travel and other ancillary expenses.
Using this approach, you can limit the bank’s interests to just the proceeds of the GIC, rather than all business assets, which will make your equity investors much more comfortable.
It may be possible to arrange leasing through your bank, but they might require you to have been in business for some time (typically two years) before providing a lease. Equity investors tend to accept lease arrangements as the security for a lease is usually limited to the equipment financed under the lease.
Leasing spreads payments for your capital equipment over a number of years as a long-term rental in exchange for interest built into the lease payments. Depending on the terms, your company may or may not own the equipment at the end of the lease.
Demand or short-term bank loans
Demand or short-term loans tend to be the first type of loan that start-up companies qualify for and private investors permit. The most common type of operating loan available to early-stage startups involves the financing of liquid assets (for example, receivable amounts). This type of loan includes the
- Canada Scientific Research and Experimental Development Tax Incentive Program
- Ontario Investment Tax Credit and Trade Accounts Receivable (A/R) balances from customers
These loans tend to be based on a percentage of the assets—usually 70 to 80% of the asset value. Loans are repayable on demand or upon a specific condition. For example, with tax credits, repayment would be triggered when your company received a cash refund of tax credits.
Banks will require a copy of your filed tax return to finance tax credits. Interest rates for demand loans vary with the level of risk. Equity investors tend to support these types of loans for early-stage companies where the funding will extend the company’s cash runway and enable them to raise additional financing.
Debt financing with a line of credit or operating loan
A line of credit provides cash to cover day-to-day expenses. The line of credit decreases as you use funds and replenishes when you repay the amount borrowed. Similar to a demand loan, the line of credit is usually secured by assets, such as receivables or inventory.
The loan has a limit and you pay interest on the balance outstanding, usually on a daily basis. However, a small standby fee may be charged on the full value of the line of credit. Equity investors tend to prefer that your business achieves a certain level of scale before allowing you to add lines of credit to your capital structure.
Bank term loans
Bank term loans tend to be secured by the specific asset financed by the loan. A loan through the Canada Small Business Financing Program might be available to early-stage companies. Certain Canadian chartered banks provide loans up to $500,000 for the purchase of equipment and leasehold improvements. Equity investors tend to accept bank term loans, especially when the security for the loan is limited to the fixed assets financed by the loan.
For more information on small-business loans, contact:
Canada Small Business Financing Program
235 Queen Street
Ottawa, ON K1A 0H5
Houston, T., Johnson, A., & Smith, E. (2006, September 15). Technology Startups: A Practical Legal Guide for Founders, Executives and Investors. Retrieved April 9, 2009, from Fraser Milner Casgrain website at http://www.techstartupcenter.com/
Canadian Banker’s Association. Retrieved April 9, 2009, from http://www.cba.ca.
Canada Business Services for Entrepreneurs. Retrieved April 9, 2009, from http://www.canadabusiness.ca.
Royal Bank of Canada. Retrieved April 9, 2009, from http://www.rbcroyalbank.com/business/financing/small_bus_loan.html.