You’ve got big dreams and big plans for your start-up, but now you’re wondering where the ‘big money’ comes from. Not to worry; you have options. In addition to investing your own funds, you can finance your start-up via debt, equity, or some combination of the two. Let’s break it down:
Whether it comes from family and friends or from a financial institution, a loan (i.e. debt) is one of the main sources of financing for entrepreneurs. In addition to the necessary financing, debt is useful when cash flow comes into your business in peaks and valleys. Because – trust me – these peaks and valleys won’t always align with your company’s expenditures.
A conventional loan for a business is money borrowed from a lender such as a bank, a credit union or a more specialized organization dedicated to entrepreneurship such as the Business Investment Corporation (BIC), the Business Development Bank of Canada (BDC) or the Community Business Development Corporations (CBDC). In exchange for receiving a loan, your company, as the borrower, will sign a loan agreement that sets out the terms of repayment and the covenants (both positive and negative) that your business will have to abide by while the loan is outstanding.
Not surprisingly, many lenders are hesitant to advance large sums to business start-ups “on their face”. You can solve this problem through secured lending: using the business’ assets (building, accounts receivable, inventory, intellectual property etc.) as collateral for the loan. Or you can sign a personal guarantee: if you have personal wealth or assets, you may be able to personally guarantee the loan to your business.
There are tradeoffs with debt financing. The borrowing costs of debt can be high, especially for a start-up. In addition to interest, lending agreements typically set out restrictions that the business must abide by, such as regular submission of your business’ financial progress. As well, with security documents and personal guarantees, there is always the risk of assets being seized and sold in the event of non-payment. Prior to signing any lending agreement, have your lawyer review the terms so that you are clear on your obligations as borrower.
Equity equals ownership. Rather than a creditor, your financier is an investor in your business. This can range from “love money” to “angel” investors or venture capitalists. Think Dragon’s Den; these are investors who want a share in your business in exchange for their financial commitment. But no need to stress, securing equity financing is typically much less daunting than pitching to ‘The Dragons’.
Equity can simply be financing received from family and friends. It’s often dubbed “love money” because those closest to you invest as a way of showing love and support. This generally provides the least stringent arrangements for you as a business start-up. Your family and friends are more interested in helping you than receiving the highest of returns on their investment.
“Angels” such as those organized by the Newfoundland & Labrador Angel Network offer business start-ups opportunities to connect with affluent members of the province who are looking to invest in local companies. Angel investors offer informal venture capital. This means they generally have no direct operational control in your business but can offer significant oversight. Consider however, that with the typical high risks associated with start-up businesses, angels generally expect a high return on their investment. Venture capital is institutional in nature and generally provides larger sums of money to companies as compared to angel investors. This type of financing is essentially formalized angel investments – venture capitalists play more of a role in dictating the way your business is run.
Finding the Right Mix
Remember that any financing relationship, from loans to “love money”, is a legal relationship. It is important that you have proper documentation and receive good professional advice before signing any contract. But don’t get overwhelmed by all the options. Sit down with your lawyer to determine the right mix of debt and equity for your start-up.
This Cox & Palmer article is intended to provide information of a general nature only and not legal advice. Individuals are advised to obtain legal advice when it comes to their specific circumstances.
Anna M. Cook is a partner in the St. John’s office of Cox & Palmer. Anna’s practice encompasses three main areas of law: Corporate & Commercial, Labour & Employment, and Privacy & Access to Information. In addition to her successful practice, Anna is proud to support the entrepreneurial spirit. Through her active involvement with SIFE Memorial and the Newfoundland and Labrador Organization of Women Entrepreneurs (NLOWE) Anna contributes a valuable voice that helps build the leaders of tomorrow.