If it's true that small- and mid-sized enterprises (SMEs) are the engine that powers a nation's economy, then it only stands to reason that readily available financing serves as the motor oil that keeps the entire engine's parts in good...
If it’s true that small- and mid-sized enterprises (SMEs) are the engine that powers a nation’s economy, then it only stands to reason that readily available financing serves as the motor oil that keeps the entire engine’s parts in good condition and running smoothly.
There are numerous ways to secure financing and the methods for doing so vary from country to country. But the universal challenge that any enterprise faces – at almost any stage of growth – is to find the one method (or combination of methods) that fits its own unique set of goals and circumstances at a particular point in time.
Factors like company size and maturity, industry niche, credit history, potential for growth and external market conditions all inevitably play into the equation. Also important is the cost of borrowing those funds, because rates can vary widely from lending source to lending source.
Here is a brief rundown of some typical methods of financing that can be useful to SMEs in both established and emerging economies around the world.
Borrowing from family and friends is often the easiest way to obtain funds, particularly for start-ups. The costs of borrowing the money are often less than with other methods.
But intermingling business with personal relationships has its potential drawbacks, which is why we advise clients who choose this method to set up the transaction in a formal, business-like manner.
Give your lenders paperwork that acknowledges their loan and the terms of repayment. Make sure their rate of return is reasonable (this includes making a loan to yourself). And give lenders an “out clause” that allows them to ask for their money back at any time.
Home equity loans and credit card financing are two other methods of self-funding. But they also come with a level of personal risk to the borrower that is often beyond the tolerance of all but the most seasoned entrepreneurs.
A traditional bank loan has been the go-to method of financing throughout the world for thousands of years, and it remains the first resource that the vast majority of businesses turn to today for either a short-term line of credit or a longer-term loan.
Ideally, you’ll want to build a business relationship with a bank well before you need to ask them for funds. Let the bank get to know your business and get to know you as a credit-worthy customer.
When it comes time to request a loan, be sure you are fully prepared with a clear explanation of how much money you need, why you need it and how you will pay it back. Then back up your application with documents that will increase your chances of getting a positive response.
In Canada, government-sponsored grants or loans are designed to assist SMEs with seed capital or financing to enhance an existing operation. Many local governments sponsor similar programs.
And most provinces offer financing geared to growing specific areas of the economy that policymakers believe require nurturing. In some cases, the interest rates are especially favorable if the funding leads to job creation.
Unlike a loan, a grant typically does not have to be repaid. However, there is a significant amount of research and paperwork involved. Grant programs can be highly competitive, with specific, detailed formats that need to be followed carefully when applying.
There are a number of creative methods of financing for enterprises that are up and running, including asset-based financing, receivables financing and factoring. While each technique comes with its own benefits, drawbacks and costs, what ties them together generally is the use of an existing, tangible asset of the enterprise as collateral for the loan.
Supplier or vendor financing is also a creative alternative in certain situations where funds are needed to acquire expensive capital equipment. Manufacturers and leasing companies will almost always offer financing and at interest rates that are relatively attractive.
Perhaps the most difficult financing path for owners to take is working with outside investors. There are multiple options for accessing funds in this way, but all of them involve giving up some measure of control of the operation of the enterprise. Owners are advised to tread carefully when considering these types of arrangements.
Equity financing may be the simplest of these options. Equity is defined as the value of the enterprise, minus what is owed. An owner can raise funds by selling a portion of this equity, but the buyer will then be a “partner,” and will have partial control of the enterprise. This arrangement can work well between businesses that complement each other.
When the full equity of an enterprise is sold, it is considered a merger in which the enterprise becomes part of the enterprise that purchased it.
Individual angel investors provide financing to early-stage enterprises that demonstrate the potential to offer a better rate of return on the angel’s money than more traditional investments would. These individuals may also offer their experience and contacts to the operation in addition to funding.
But expect to give up some control in return, in the form of a board position, a formal consulting role or an ownership stake. The same holds true of a venture capital firm, which is essentially a group of investors who have pooled their funds to finance early-stage, high-risk enterprises with the expectation of a potentially large return on their investment.
The specific goals and circumstances of an enterprise will dictate whether any one of the techniques above makes sense. Be sure to seek the guidance of trusted advisors as you consider the options.
Harris Kligman is Tax Partner with Kestenberg Rabinowicz Partners (KRP) LLP www.krp.ca in Markham, ON; Bill Rucci is a Partner with Rucci, Bardaro & Barrett in Boston, MA www.rb-b.com. Both firms are members of Russell Bedford International, a global network of independent firms of accountants, auditors, tax advisers and business consultants with offices in over 80 countries.
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