By Scott Hinsperger

Running a successful business today involves many challenges, not the least of which is the seemingly never-ending requirement for financing. Financing for growth and expansion, financing for facilities, infrastructure and marketing, financing to acquire machinery and equipment, financing for raw materials and inventory. The list goes on and on.

     There are many types and structures of financing products available in the marketplace for businesses today, and more are being created all the time. While every business has different needs and requirements for financing, depending on such factors as their industry, their financial and credit situation, the prevailing tax laws, and so on, it is helpful to remember that most financing products will fall under one of three main categories: equity, debt and asset-based financing. The following discussion provides an overview of these three “pillars of financing” that can help provide the foundation for growth of a successful business.

Equity
Equity financing requires that you give up some of the ownership of your business in return for investment capital. For most business owners, the initial equity contribution to start their business comes from themselves, their family and/or their friends. As a business grows and establishes a track record, additional rounds of equity financing can come from more “arms length” sources, such as business colleagues (professional advisors, business associates, suppliers or even customers), Angel Investors (typically high net-worth private individuals with capital to invest in attractive projects), or venture capital firms. Alternatively, equity capital can be raised by a public offering, with the help of a securities dealer. Most equity financings involve the issuing of shares in the busi­ness. There are many types of shares that can be created and issued by companies, each conveying varying degrees of ownership and varying “rights” to the owner of such shares.

Debt
Debt financing involves financing your business by borrowing money.

     There are more different types of debt financing products available today than any other type of financing. Methods of debt financing include: term loans, demand loans, bridge loans, operating loans (line of credit), Floor Planning, Inventory Financing, Factoring, Letters of Credit, Credit Cards, and many more. Most types of debt financing are available from chartered banks, trust companies, credit unions and commercial finance institutions; although debt financing is also available from the same types of non-institutional investors discussed above. In general, debt financing involves the borrowing of money from a lender, under a loan contract which sets out the terms of re-payment of the amount borrowed (the “principal”), together with a profit to the lender (the “interest”) over a period of time (the “term”) which may or may not be strictly defined. Payments may be “fixed” over the term of the loan, or “floating,” where they may change depending on movements in interest rates. In virtually every type of debt contract, the borrower must pledge something to the lender as collateral (security) for the loan. Collateral may take the form of a com­bination of tangible assets owned by the busi­ness (equipment, land, buildings, inventory) or intan­gible assets (personal guarantees, existing and future receivables) or a combination thereof. In addition, many debt financings require a General Security Agreement from the borrower, which gives the lender first charge against all assets of the business.

Asset-based financing
Asset based financing typically involves using Leasing or Conditional Sales contracts to acquire capital equipment, machinery or vehicles. The most common type involves leasing. While there are many different types of leases, in general a lease involves a contractual relationship wherein one party (the “lessee”) rents or leases an asset from another party (the “lessor”) over a fixed period of time, for a fixed payment — usually monthly, quarterly or annually. In most cases, the pay­ment is fixed over the entire term so that it does not increase or decrease; however there are excep­tions. The payments over the term include a profit for the lessor. In a leasing arrangement, ownership of the asset over the life of the term resides with the lessor, although most leasing contracts written today contain provisions that allow the ownership to transfer to the lessee at some point, after payment of an additional amount of money over and above the stream of lease payments. Usually businesses find that leasing is made available to them through equipment, machinery or vehicle dealers. In some cases, the dealers themselves (or the manufacturer of the asset) underwrite the lease, providing the capital and collecting the payments. However most leases today are actually underwritten by a third-party leasing company. Some of the chartered banks provide lease-financing arrangements for their customers (usually for mid-ticket sized transactions — greater than $100 to $150k and above), but most leases are underwritten by companies that specialize in this type of transaction. Conditional Sales contracts are another form of asset-based financing available to businesses. Generally manufacturers of new equipment provide this type of contract (but possibly underwritten by a third-party financial institution). In a conditional sales contract, the purchaser has possession and use of the equipment or asset, but the vendor retains ownership until the contract is paid in full, at which time the ownership transfers to the buyer. Like leases, conditional sales contracts have a profit built in for the underwriter.



Scott Hinsperger is executive vice-president of Alliance Financing Group Inc., a leading Canadian provider of small business financing solutions. He has 10 years’ experience in the Leasing and Financing industry and six years’ in Franchise Consulting and Development, primarily in the small to medium-sized enterprise (SME) market.