Financing for Start-ups: There Are More Options Than You Think

October 7, 2016

Seeking the best solution to finance your start-up venture is essential to the long-term success of your business. The right solution depends on the current, as well as expected future, needs of the business. The majority of lending institutions base their credit decision on two factors, the business plan and the strength of the owner’s personal guarantee.

The main financing options for start-up businesses are:

  • Government guarantee loans offered by traditional banks;
  • Term loans or lines of credit with a traditional bank;
  • Factor financing (accounts receivable financing); and,
  • Equipment leasing.

Government Guarantee Loans

Government guarantee loans, which are offered by traditional banks, can be used for the purchase of equipment and leasehold improvements up to a maximum value of $350,000.

  • The loan cannot be used for working capital or the purchase of inventory.
  • The amount lent to the company is tied to the cost to purchase the assets or complete the leasehold improvements.
  • Traditional banks will look for the ability to not only personally guarantee the loan but also if the owners of the business have the wherewithal to inject money in the event the company requires it.
  • Rates on the government guarantee loans are capped at prime +3% and are typically repaid over 60 months.
  • A benefit to the borrower is they will only have to personally guarantee 25% of the loan value. Typical industries would be food service, manufacturing and retail.

Term Loans or Lines of Credit

Traditional bank financing via either a term loan or operating line of credit can be used to fund initial inventory purchases and to provide working capital.

  • In order to secure traditional bank financing, the entrepreneur will need to have a proven track record, strong personal net worth and the ability to invest in the business as required.
  • Typically, the bank will want to keep the debt to equity ratio below 4:1, which means for every dollar the bank advances to the company they expect the owners of the business to invest a quarter.
  • The difference between a traditional bank loan and a government guarantee loan is the amount advanced to the company does not depend on the purchase of assets or cost of leasehold improvements.
  • Also, the owner of the business will have to personally guarantee 100% of the loan value. Rates and term will depend on the strength of the business plan and the personal guarantee of the entrepreneur.

Factor Financing (Accounts Receivable Financing)

Accounts receivable factoring could be an option for a start-up which has good, credit worthy customers. The credit adjudication for the lender depends largely on the strength of the customer, not the business.

  • The factor company does not need a strong personal guarantee from the business owner as their decision is mainly based on the strength of the customers.
  • A benefit of factor financing is it allows the business to collect on its receivables immediately after invoicing and build up working capital to support future orders.

Equipment Leasing

For a business which requires significant equipment purchases at start-up, leasing is an option.

  • The typical term is 36 or 48 months and rates range from prime to 22% depending on the strength of the borrower and type of asset.
  • The lender will typically lend 100% of the cost of asset including installation and delivery costs. Equipment leasing cannot be used to purchase assets such as leasehold improvements or HVAC units which after installation become part of the physical building.
  • The borrower will have the option to purchase the asset for a nominal amount at the conclusion of the lease.

Eric Friedberg is a Senior Consultant with the Business Financing group at Farber. He focuses on arranging innovative financing solutions for small and medium-sized enterprises(SMEs) and early stage companies. Eric can be reached at416.496.3078 and efriedberg@farbergroup.com.