Once you have decided on the type of venture you want to start, the next step on the road to business success is figuring out where the money will come from to fund it. Where do you start? Part four of our series ‘Business Funding’ is dedicated to financing your company through debt.
Like equity financing, debt carries a degree of risk represented by a loan with an interest payment. Debt financing includes both secured and unsecured loans. Security involves a form of collateral as an assurance that the loan will be repaid. Technology companies are more likely to be approved for unsecured loans as most of them are usually asset light.
Debt comes in many forms. In this series, we will cover the different types you could have access to:
1. Consumer Loans: An amount of money lent to individuals for personal, family or household purposes. As an entrepreneur, you can qualify for a consumer loan to self-fund your company. The amount you can borrow usually depends on your credit report, credit score and income. Consumer loans can be secured through banks or alternative lenders (the leading firm in this category is Borrowell).
2. Micro Loans: These are small business loans that are usually lent for up to $35,000. However, some lenders will allow micro loans up to $50,000. Micro loans are generally used for startup cash but are sometimes given to newly launched small businesses for working capital.
3. Factoring: A type of debt in which a business sells its accounts receivable (i.e., invoices) to a third party (called a factor) at a discount (60% – 80%). A business will sometimes factor its receivable assets to meet its present and immediate cash needs. If your startup is not operating on invoice basis, then this is not the option for you. The leading firm in Canada is FundThrough.
4. Business Credit Line: Enables you to borrow up to $100,000 - $150,000 and pay interest only on the money borrowed. You can draw and repay funds as you wish, as long as you don’t exceed your credit limit. This is a good option to finance purchase orders or short-term expenses.
Another type of debt that is gaining popularity and interest from entrepreneurs is revenue based financing or revenue sharing which is a type of funding whereby investors inject capital into a business in return for a percentage of its revenue. The loan payments are tied to monthly revenue, going up for strong-revenue months and down for low-revenue months. This debt repayment structure has a time limit or return cap – once reached, the debt is repaid.
Revenue based financing could be the answer for entrepreneurs in need of capital to grow because of the following characteristics:
- It’s a loan, but different from the one you would get from a bank.
- It’s more expensive than bank loans, but cheaper than equity (no equity involved).
- There are no fixed payments, no set time period for repayment and no collateral to secure.
- It’s not suitable for businesses with low gross margins.
Revenue based financing is a great way to fund a company, especially if entrepreneurs cherish their equity. There is no need to agree on a valuation of the business, there’s no personal guaranty, and there are no worries during a down month of sales because payments are tied to a percentage of revenue not an interest rate.
Stay tuned for more. In the final piece of the puzzle we will talk about securing a lead investor for your company.