Sources For a Small Business
 Startup Loan and Equity Financing

Before you start going from bank to bank applying for a small business startup loan, you should develop a basic understanding of the types of start up financing available and which ones you may qualify for. In fact, we will take this a step further, and explain the basic categories for both sources of debt and equity for small business startup loans.

Personal Assets

In order to be eligible for a small business start up loan of virtually any type, the business owner must have an equity stake in the business. A general rule of thumb, which can vary considerably by business sector, is that the business owner needs to personally invest 25% to 50% of the total capital required for the new business venture.

This personal investment would be in the form of cash. Equity in Personal assets will likely also be required to support a personal guarantee of any loan funds received. In some cases, the personal investment comes out of the equity the business owner has in their house.

When the overwhelming statistics for business failure show that the majority of business startups will not survive past their third year, it’s not surprising how difficult it is to find any type of business lender prepared to take the sole or majority risk when providing a small business startup loan.

Friends and Family
Over 10% of Canadian Entrepreneurs rely on this type of financing. Friends and family can be willing to provide a form of small business startup loans, but in many cases don’t enter into any formal repayment agreement, which can lead to problems down the road if the business does not perform as expected. Friends and family may also want to own part of the business which would make the funds an equity investment that can carry a larger capital cost over time.

Credit Cards and Personal Lines of Credit
Personal borrowing is a significant source of small business startup loans. Entrepreneurs can be granted a significant amount of personal credit before leaving employment and seeking to start their own venture.

In some cases, the personal credit is a form of equity secured by residential real estate. But in many cases, the personal loan source is unsecured and can be a very expensive source of funding.

Sometimes personal credit is not the primary source of funds, but the fall back source of financing if the business takes longer to get going than projected. It can also be a small business startup loan for inventory financing which is arguably the most difficult asset purchase to finance for a startup.

Commercial Lending Institutions
Commercial lenders are still the single biggest source of small business startup loans. However, most of the relevant commercial lending products are approved and secured by personal credit rating and personal net worth. Amounts under $50,000 are most common as they can be evaluated or credit scored based on personal credit and do not require much information about the actual business application.

Government Loans, Grants, and Subsides
The Small business loan act permits qualified lenders to provide up to 90% of purchase or improvement costs for 1)land to operate a business; 2)renovations, improvements, or building purchase; 3)purchase and installation of equipment.  Outside of the small business loan act program, which is a federally supported lending program, there are regional, provincial, and local government supported business loan programs. Government funds can also be obtained in the form of grants and subsidies to cover the costs of technology and business development in certain sectors and geographies.

 Local Economic Development Funds
In many local areas, an economic development funds will be set up to provide small business startup loans and business growth loans. These lending sources (private and local government agencies) are created to fill voids left by conventional lenders and are usually geographically focused to promote the growth and development of a particular geographic area.

The funding groups can take many different shapes and can be focused on general business development as well as specific market development that the region is trying to promote.

Some loan programs will provide “micro loans” where the loan amount is for a few thousand dollars and the targeted borrowers are low income earners that are self employed.

Supplier Credit
Depending on the nature of the business, supplier credit can be a significant source of inventory and accounts receivable financing for certain startups. The suppliers will manage their risk through assessment of personal credit history and the degree of control they maintain of the inventory and the accounts receivable once the inventory is provided to the business.

Supplier financing for working capital and operating items, even if only for a few thousand dollars, can make a significant difference to cashflow management.

Leasing
Instead of an actual small business startup loan, a new business will utilize lease financing to either secure the assets they need, or to generate capital through the sale and lease back of assets they already own.

Leasing is a form of asset based lending where the lease company is not only focused on the credit worthiness and net worth of the potential applicant, but also on the resale value of the asset if a default occurs and an asset repossession and liquidation is required to payback the leasing company.

Because of the asset focus, leasing companies can many times provide financing that a conventional institutional lender could not. At the same time, conventional lenders are expanding more and more into leasing to take advantage of this financing opportunity.

Angel Investors
Outside of the business owner’s own personal equity, or the equity commitment of family and friends, the next most likely equity source for startups is the angel investor.  Angel’s are typically retired executives and/or wealthy individuals who want to invest their money and expertise in specific ventures in return for an equity stake in the business.

Venture Capital
In contrast to Angel’s, venture capital investors are usually looking for larger dollar investment opportunities. They normally focused on high potential startups that are technology based. Projects tend to be high risk and potential high reward, with a portion of management control being assumed by the venture capital financing source.

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