These days, it can be pretty hard for new businesses (and even developed businesses) to secure enough funding through traditional lenders. Alternative lending refers to non-traditional forms of funding, instead of the usual bank loan methods to secure an injection of cash.
Traditionally, many business owners end up asking the big banks to lend money on shameful terms, and will then be required to pay this amount back with higher interest rates. This is known as debt funding, and the conditions of the loan are known as debt covenants. But conditions can become incredibly stringent, and where alternative finance options now exist, it’s time for the modern business owner to take advantage of alternative lending and lenders in Canada.
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Alternative business funding options
There are so many alternative lending options in Canada when it comes to business finance. Generally, these can be split into two categories: non-dilutive and dilutive funding. Non-dilutive refers to investments that do not require founders and owners to exchange a portion of their company. Alternatively, dilutive funding requires a percentage of the equity to be exchanged to fulfill the investment raise.
Asset finance
Asset finance refers to the agreement of a financial loan by securing the current company assets as collateral. Typically, these assets are integral pieces of equipment or resources that the business wouldn’t survive without.
Generally speaking, asset finance is well-suited for businesses that have a short and bad credit report or would struggle to raise funding elsewhere. Since the equipment is a physical investment with a long lifespan, it’s a more ‘secure’ version of business funding. This means that borrowers who choose this form of finance will often benefit from more flexibility in their loan terms, compared to traditional banks.
How does it work?
Your business secures the loan with current assets, allowing them to be repossessed in case it is not repaid.
The other way that asset finance might work is through the form of hire purchase. In that case, your business receives the asset that they would use the loan to pay for (typically, a piece of equipment that is integral to the business growth) without having to pay for the entire value invoice upfront.
The risk here for the borrower is the collateral is the loaned item, so if you don’t stick to your repayment terms, and miss your regular installments not only removes the piece of equipment from your ownership but also reduces your business operations, financial situation and credit to worse than before.
Equity finance
Equity finance refers to funding in exchange for a portion of the business owner. It is one of the most similar types of alternative lending to traditional banking applications, however, companies are not tied to huge interest rate repayments. Instead, they reimburse the investors using company equity.
Equity finance is a good option for businesses that envision a longer development period and growth projects before they profit from the new investment. This is because the major benefit to equity finance is that there is no immediate repayment period- companies receive funding through profit.
Of course, however, founders will have to acknowledge the fact that they are relinquishing some control over the decisions and direction of the company. That is the price of equity finance.
How does it work?
Typically, your business will sell a percentage of its shares to a known investor in exchange for a cash injection. If business owners don’t already have the network, such introductions usually occur in pitch settings, where start-ups who require security will try to find an angel investor by pitching to multiple teams at once.
There are plenty of alternative lenders who like financing with equity since they have business acumen and genuinely believe that they can help drive the growth of companies. The caveat here is finding angel investors who align with your brand and potentially even already have a background in the industry.
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Equipment finance
Equipment finance is another type of alternative lending, that extends on the idea of a hire purchase that was previously mentioned. It’s a form of alternative funding that benefits the small business in two ways at once;
- by providing the equipment required to develop and grow the business
- by creating a financial plan to repay the cost of the high-value equipment in conjunction with the reception of profits
Equipment finance is a type of innovative funding, that is well-suited for the agriculture business, where farmers and producers would not generally be able to afford the cost of associated equipment upfront. Alternatively, transport businesses, such as the purchase of a new van, often work well with equipment financing.
How does it work?
Equipment financing works through the start-up leasing a piece of machinery for an agreed period, usually between 1 and 7 years. Alternative lenders offer loan installments to be repaid in monthly payments throughout the lending period and interest rates are at low rate (much lower than short-term loans) compared to traditional bank financing.
It’s important to note that with most alternative lenders, the lender’s fee associated with this type of finance is higher than other forms of alternative business finance since the equipment being leased is just so expensive.
However, it is still a good option for smaller businesses looking to scale up. This is because equipment lenders are willing to provide finance without relying on solid trading history, meaning that many businesses can accelerate their road to profits.
Property finance
Property finance is defined by its end goal: securing development opportunities for residential and commercial properties.Property developers can raise financing through many funding alternatives to mortgages, including:
- bridging loans
- ground-up loans
- refurbishment loans
These types of loans can be difficult to secure, and most often depends on the applicant’s circumstances. However, those with a background in property development are more likely to reach an agreement with a lender.
How does it work?
Each form of property finance is different with its own set of rules, but, generally speaking, are secured against the property that you are developing. These are short-term loans and the investment plus interest repaid once sold. Lenders who specialise in investing in property in the UK may therefore acquire your property if you fail to repay the loan.
Crowdfunding
Crowdfunding mimics the act of an initial public offering (IPO), with ordinary members of the public being able to buy shares in your company. It gathers small amounts of money from a large number of people that are willing to invest in your business.
All types of businesses can benefit from crowdfunding- but those who are most successful are typically playing into the current consumer trends of the public. For example, most recently, sustainability and ESG type investments have raised the most money from crowdfund opportunities.
How does it work?
Crowdfunding is a form of peer-to-peer lending which is less regulated than an IPO. For example, it is not covered by the financial services compensation scheme. Investors receive a much smaller amount of shares in the company than regular equity investors, since they incur a much more minimal cost.
There are two types: equity crowdfunding and reward crowdfunding. Equity crowdfunding awards a percentage of the company to the investor, who becomes a shareholder. Alternatively, reward crowdfunding help businesses raise money by offering products in return for a successful raising round.
The large draw towards both types of crowdfunding is that investors feel compelled to support the company from the point of investment, building an army of super fans that are interested in enabling your brand to thrive.
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Grants
Many governments, agencies and non-profit organisations offer grants towards businesses that have distinct purposes or goals. With a simple application, small business owners can get access to development funding that is not required to be repaid.
In this way, small business grants are one of the most attractive forms of investment for many start ups. Thankfully, there are a huge number of top startup grants available in the UK.
How does it work?
Grants work as an alternative finance provider through providing an income on an application basis. Eligible businesses may need to qualify for grants through certain business structures or goals, and grants are usually through matched-funding means alongside other forms of investment.
Charities offer research and development based grants to small businesses in tech, usually after a grant writer application or a round of pitching.
Research and development funding
Investment in research and development (R&D) can advance your company faster than its competitors. By having the means and resources to develop products, R&D funding facilitates better technology without compromising on cash flow.
The premier example of R&D funding in Canada is the tax credit loan. Companies working in innovative fields can benefit from an advance of the tax credit loan that they would receive at the end of the tax year for expenses relating to development. In Canada, companies can deduct expenses relating to R&D, which equates to around one-third of all spending.
How does it work?
Research and development funding works by advancing the refund your company is already due to receive. CRA allows eligible companies to claim back expenses relating to salaries, subcontractors, and other development costs (to an uncapped amount). This is to simply advance money to ensure your business’s cash flow is smooth and growth can continue.
Bootstrapping
Bootstrapping refers to localized business funding from the company founders themselves. All of the cash injection into the business has been found through revenue streams, re-introducing profits back into the business to scale development and growth.
Bootstrapping is very well-suited to small businesses and borrowers who want to remain in full control of their company operations without relinquishing equity, as well as those who do not have the credit history to qualify for traditional bank loans. However, it’s not always possible for pre-profit companies: where is the money coming from?
How does it work?
Every company does bootstrapping differently. Some founders rely on their initial rounds of sales, whereas others ask for investment by family and friends as their alternative lender. In some cases, business owners will simply delve into their personal bank accounts and use up money gained over years of saving.
When company founders truly believe in their product, they’ll often prefer to bootstrap the process. But it can have higher risks than other forms of alternative investment, considering the emotional and financial toll that this method of alternative business funding offers.
How does it work?
Every company does bootstrapping differently. Some founders rely on their initial rounds of sales, whereas others ask for investment by family and friends as their alternative lender. In some cases, business owners will simply delve into their personal bank accounts and use up money gained over years of saving.
When company founders truly believe in their product, they’ll often prefer to bootstrap the process. But it can have higher risks than other forms of alternative investment, considering the emotional and financial toll that this method of alternative business funding offers.
Alternative lenders and financial institutions
For every type of alternative lending out there, you’ll find a huge number of alternative finance providers and financial institutions willing to help with financing your company. The trick is to find the agency or funding option which best suits your circumstance. At Fundsquire, we specialize in Growth Finance through the R&D Tax Credit, Grant Advance scheme, and Revenue-based funding opportunities.
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