Alternative Financing Solutions for Small Businesses

Traditional financing – such as bank loans – can be hard to access, time-consuming to apply for, and even restrictive for your business. Which is why so many alternative financing options exist for Canadian small businesses. Alternative financing just means any form of financing available outside of the brick-and-mortar banking system, and here we’re going to look at some of the most popular alternative financing solutions for common small business needs.

Alternative Financing Solutions: Structural Funding

1. Angel Investor

What is it?

A wealthy private individual (often a successful entrepreneur themselves) who invests their own money into a company (usually start-ups and early-stage businesses) in exchange for an equity stake. They often offer valuable industry expertise and connections as well, which can help your business flourish.

Pros

• Money is not a loan and does not need to be paid back
• Obtain valuable guidance to help your business succeed
• Angel investors can act quickly and with less red tape than banks
• Angel investors are less risk-averse than traditional investors, and so are more likely to invest in new or unproven companies

Cons

• You must give up some control of the company
• Finding an angel investor can be difficult
• Not suitable if either very small or very large amounts of money are needed

2. Venture Capital

What is it?

Venture capital (VC) firms are large companies that invest money in businesses in exchange for equity. They tend to focus on start-ups and small businesses with a high potential for growth, and usually offer support on an ongoing basis.

Pros

• Potential for substantial funding
• VCs are less risk-averse than banks and so more likely to invest in small or new ventures
• Money is not a loan and does not need to be paid back
• Obtain valuable hands-on support to help your business succeed

Cons

• You must give up some control of the company
• VCs have high standards for investment
• Finding a VC can be difficult
• VCs focus on rapid growth, which may not be right for your business

Alternative Financing Solutions: General Funding

1. Merchant Cash Advance

What is it?

A cash advance on future credit card sales; repayment happens automatically at point-of-sale, via a small percentage being deducted from each credit card transaction. As repayment happens as a percentage rather than a fixed weekly or monthly sum, how long it takes to repay depends on how many sales you make. You can read about merchant cash advances in detail here.

Pros

• Easy to access
• Flexible repayments that fluctuate according to sales volume
• No need to calculate repayments or budget
• No restrictions on what borrowed funds can be used for
• No collateral needed 
• No loss of company control

Cons

• Relies on business accepting credit card payments regularly
• Borrowing amount dependent on expected sales volume
• Can become expensive
• No control over repayments
• No positive credit score impact from proper repayment
• Reduces profit margins

2. Invoice Factoring

What is it?

A cash advance on outstanding invoices that your business has issued to its customers. Customers pay the financing entity directly, which then deducts its fees and pays your business the remainder.

Pros

• Easy to access
• No restrictions on what borrowed funds can be used for
• No collateral needed

Cons

• Can be expensive
• Reduces profit margins
• May depend on customers’ credit scores
• If customer invoices go unpaid, your business is on the hook
• Borrowing amount dependent on outstanding invoices
• Older invoices may be not eligible for financing
• May impact customer relations

3. Peer-to-Peer Lending

What is it?

Financing offered by individuals (and sometimes other businesses) to businesses, outside of the traditional loans market. Many peer-to-peer (P2P) lenders and borrowers connect on dedicated online marketplaces.

Pros

• Easier to access funding than with big banks
• Can find and apply for financing options quickly
• No restrictions on what borrowed funds can be used for
• Competitive interest rates
• Potentially flexible loan terms
• Access to both small and large amounts of money

Cons

• Transparency and regulation less than with other financial marketplaces
• Cost very dependent on the lender (and may not be entirely transparent)
• No regulatory or insurance protection for P2P loans

4. Tax Credit Loan

What is it?

A cash advance based on a business’s known, pending tax credit refund. 

Pros

• No restrictions on what borrowed funds can be used for
• Easy to access for qualifying businesses

Cons

• Only applicable to businesses that are eligible for CRA tax credits

5. Crowdfunding

What is it?

Financing received from multiple private individuals, usually relying on many people, each contributing a relatively small amount. People contribute in the expectation of some form of reward – a product, a share of profit, etc.

Pros

• Helps build a loyal customer base
• Easy to set up a crowdfunding project

Cons

• Requires extensive marketing to attract attention from potential funders
• No guarantee how much money will be raised

Alternative Financing Solutions: Purpose-Specific Funding

1. Purchase Order Financing

What is it?

A cash advance based on existing purchase orders with your company, usually structured so that funds are given directly to your suppliers, so they can provide the items you need to fulfill the orders. Once your customers receive their orders, they pay the financing company directly – and they then deduct their fees and give you the remainder.

Pros

• Allows you to take on orders you would otherwise be unable to fulfill
• Does not require loan repayments, as the structure means the financing company is paid back directly by your customers
• No collateral needed
• Easy to arrange

Cons

• Relies on having orders in-hand
• Borrowing amount dependent on existing orders
• Can be expensive
• Fees depend on how quickly your customers pay for their orders
• Lose control of much of the process
• Funds are very purpose-specific
• Reduces profit margins

2. Equipment Financing

What is it?

Financing for a business-specific piece of equipment or machinery, typically offered by the equipment manufacturer or vendor. The funds are secured against the piece of equipment itself, and repayments typically happen regularly over a set period of time, as with a standard loan.

Pros

• Provides immediate access to needed equipment
• Conserves working capital by spreading the cost of new equipment over time
• Potentially a cheap form of borrowing
• More easily accessible than a traditional loan
• No additional collateral needed, as equipment itself is the collateral
• Positive repayment history helps build business credit
• Potential for tax relief at year-end

Cons

• Funds are very purpose-specific
• May require a downpayment
• Eligibility may depend on business specifics
• Loan term may outlast the life of the equipment
• Risk of losing the equipment if you do not make the repayments
• You hold responsibility for maintenance and repairs

3. Small Business Grants

What is it?

A non-repayable amount of funding from a government or other entity; grant amounts and purposes can vary greatly, so it’s important to find one that suits your business’s needs and situation. See here for more on small business grants in Canada. 

Pros

• No repayment necessary
• Provides credibility
• Often comes with non-financial benefits e.g. visibility, mentoring

Cons

• Can be difficult to find
• Application process can be lengthy
• There may be restrictions and reporting requirements for the funds
• May be a lot of competition for the same grant

Find the Right Solution For You

Alternative financing can allow businesses of all types to access funds vital to their success, but not all types of alternative finance are created equal. Make sure you’ve done your research and know what will work best for your company. And if in doubt, chat with BizFund to learn more about your options.