Finding Small Business Financing

The first step in finding small business financing is knowing what kind of financing you need. IS the small business financing you're looking for debt financing (money you borrow to run your business) or equity financing (money acquired from investors and/or savings)?

When it comes to debt financing, most Canadian small businesses turn to our traditional financial institutions, such as banks and credit unions, to find small business financing.

Some take out short-term business loans, which need to be repaid (with interest) within a set period such as 180 days. These are sometimes called demand loans, because they can be called in by the lender (the bank) at any time.

Longer term business loans are also frequently used as small business financing. Term loans are usually used to finance particular assets, such as building renovations or capital equipment.

Other businesses depend on lines of credit for their small business financing. Through agreement with the financial institution, your business has a set amount of credit that you can draw upon. While a line of credit gives you the flexibility to pay day-to-day expenses or meet cash flow crises, whatever amount of money you use has to be paid back, and you pay interest on the outstanding balance.

Many financial institutions now offer credit cards especially designed for small businesses - and credit cards are a popular way for small businesses to finance startup and operating expenses. In fact, according to a 1998 study of small- and medium-sized enterprises by Thompson Lightstone and Company, 41 percent used personal credit cards as their main source of small business financing!

However, credit cards are some of the most expensive small business financing available, in terms of their interest rates. They're best used as a convenience for day to day expenses, if you pay off the balance in its entirety each month.

Traditional sources of small business financing are not available to all small businesses. Start up businesses may have an especially difficult time meeting bank requirements for debt financing. Let's look at the different types of equity financing that a business might pursue. Continue on to the next page to read about sources of equity financing.

For many small businesses, the prime source of small business financing is their own pockets. Small business people invest their own savings to start a new business and keep it up and running. They've either built up a nest egg from employment, or do things such as cash in portions of RRSPs to keep their dream of entrepreneurship afloat.

The good thing about this kind of equity financing is that the small business owner retains all of the equity in his/her company.

The downside is that starting a small business and nursing it through the startup phase into a healthy company can be an expensive proposition. Perhaps that's why so many small business people start their new ventures as part-time enterprises, hanging onto their "day jobs" until the business is able to stand on its own legs.

Even so, the small business person often finds outside sources of small business financing necessary. In terms of equity financing for startup businesses, the most common sources of small business financing are friends and relatives and angel investors.

Both of these groups will expect "a piece" of your business in return for equity financing. The piece may involve a portion of the ownership of the business, or mean that the investor gets to take an active role of some kind in running your business - or both. But this kind of trade-off may be necessary for you to get your business off the ground.

If your plan for getting equity financing involves attracting investors, How to Find an Angel Investor and Prepare an Investor Ready Business Plan give tips for making your search for investors more successful.

Once your business is established and has a proven track record, there will be more sources of small business financing available. You may be able to attract venture capital, for instance, or take your company public, selling shares in your company on stock exchanges.

Certainly once your business is established, you'll be able to use your retained earnings as a source of small business financing. Ensuring that you invest some portion of the money your small business makes back into the business is one of the cornerstones of a healthy financial plan.

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