Financing for Entrepreneurs

09-Apr / Articles / 0 COMMENTS / by cdobbin

I am often asked about access to capital by owners looking to grow their businesses and I speak to the issue in front of various groups.  For mature businesses, there are two options, debt and equity, each of which bring to the table their own uniqueness.


From a lender’s perspective there are a few factors that borrowers should understand as follows:


  1. Cash flows generated by a business pay the loans and the underlying assets of the company provide security for those loans;
  2. Loan agreements are designed to support the views of the lender with respect to the ability of the company to repay obligations as they become due;
  3. Lenders look to have security preserved and want clear communication from an owner well in advance of an issue in order to maintain a healthy working relationship; and
  4. Lenders pay very close attention to the five Cs of credit – Character, Capacity, Capital, Collateral and Conditions.  This is the method used to determine the credit worthiness of an applicant in assessing a likelihood of default.  If you don’t pass Character, a lender won’t even consider the other Cs.


Let’s cover the general opportunities for accessing capital and proceed from lowest risk to highest risk.


Operating lineTo use banking terms, these lines can be revolvers or asset based lending (more on the differences in a future post) but generally are used to fund working capital requirements.  Operating lines are common to almost every business and the standard margins are 75% of good quality accounts receivable less than 90 days old plus 50% of inventories.  The percentages can go higher with or without insurance from organizations such as Export Development Canada.  Security usually also includes a General Security Agreement (GSA) over the remaining assets.  All of the banks offer operating lines.


Senior term debtThis type of financing is used to fund a company’s growth plans and is secured by a fixed charge on the company’s fixed assets.  The debt usually has a term of five to seven years, and has interest rates that usually range from 1.0% – 3.0% over Prime.  There is often some “blue sky” associated with these types of loans meaning that the value of the security may be less than the amount of the loan itself.  All of the banks offer senior term debt financing as do non-bank lenders, leasing and finance companies.


Subordinate and MezzanineI have written a previous blog on mezzanine financing so I won’t go into details here.  If we consider subordinate financing separately, it is used to fund growth plans, acquisitions, reductions of senior debt, reorganizations or returns of capital.  Subordinate financing is cash flow type lending with a second charge on fixed assets and the interest rate increases beyond that of senior term debt.  The interest rate can range from high single digits to upwards of 20% but there is a lot of flexibility in structuring.  The pool of lenders for subordinate and mezzanine financing in Canada is actually quite small as compared to the U.S.  with very few players at the low end of the market.  The high end of the market attracts pensions funds, insurance funds, and international lenders.  Subordinate financing will attract lenders with at least $500,000 of three year trailing EBITDA.


Royalty financingI have separated this category out from mezzanine financing on purpose because it is relatively unknown in the market.  That is due to the fact that for mature companies there is one large established player and at least one newcomer to the market.  This form of capital is long term.  In fact, the lenders are quite happy to never be paid out (on the pretense that the underlying company continues to perform well).  The effective interest rates are based on growth (or in certain cases a decline) in a company’s revenue and the return expectations are similar to the upper end of subordinate financing.  This is cash flow type financing, becomes more a long term or even permanent part of the capital structure and is quite unique in the Canadian market at the moment.


Equity:  From a growth perspective, one of the more effective ways to accelerate growth of value over the mid-term, without worrying about debt pressures, is to raise equity.  This can be done through individuals, loosely held groups that have banded together to make investments, family offices, venture capital funds, investment firms or private equity groups.  There is ample capital available to companies with earnings greater than $2MM that have sound management teams.  In fact, I would argue that there is more capital available than there are quality deals.  The return expectations differ as does the investment hold period depending on the group making the investment but there are hundreds of organizations looking to make such investments across North America.  The challenge for some of these groups has been finding the right owner for which to partner.


There is no shortage of available capital for established and growing businesses.  Proper selection of the type of capital depends on the situation at hand.  Until next time – Grow. Acquire. Exit.


Chris Dobbin is a chartered accountant and the owner of the Precipice Capital Group of Companies.  He arranges growth capital for business owners, management teams and private company boards and advises them on M&A and corporate divestitures.  Chris sits on the Board of Directors of the Private Capital Markets Association of Canada and has been awarded the Private Equity and Private Debt Deal of the Year Awards.   


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