Part 1: What Are the Funding Options for My Venture? — Savings, Loans, and Grants

Funding is crucial to the success of a venture. When you’re just getting started on your business, reading about all the funding options can be daunting. The optimal funding option or funding mix also differs by type of business and your personal financial situation. Thus, I’ve compiled a list of funding options available for a new founder. I will be explaining which one is best suited for certain circumstances and sharing some resources for founders in Canada.

This is part 1 of the article and discusses personal savings, loans, and grants. Part 2 of the article focuses on equity fundraising.

Out-of-Pocket

This is also known as a personal investment — the most obvious funding option. You should be the person that is the most committed to your business. With this funding option, make sure to budget your personal expenses for the next few months beforehand so that you do not run out of cash in the process. It can take a few months or many years for a business to generate positive profit. Out-of-pocket as a funding option is best suited for small businesses with quick revenue generation and low fixed costs. For example, it is very suitable for a bakery business that operates from someone’s existing kitchen (no fixed cost needed, low variable costs associated with each new product, quick revenue generation, and turnaround time). However, it is not suitable for a business with higher fixed costs — such as a restaurant that is renting a location; or a business that generates revenue very slowly — such as a social media platform that needs intense growth over years before generating positive revenue.

It is worthy to mention that even for businesses with higher fixed costs and slow revenue generation, the founder needs to put in some personal savings as part of the funding. When a founder puts in their own personal savings to the business, it is a reassuring sign for investors, loan providers, friends and family that they are fully committed. This can be a convincing factor for them to provide funding to this business.

Family and Friends

Family and friends know your dedication to the business and work ethic the best to trust your success. Funding from family and friends can take place in three different forms: gift, loan, and equity. A gift is simple — your family and friends simply want to see you succeed and support your business without asking for anything in return. Loan investments make them a lender. Although there are personal relationships, it is important to make sure you have a solid written contract in place to keep your promise to pay back to them in the future and ensure both parties understand the terms. Equity investment from family and friends makes them an investor in your business. They will be a partial owner of the business. Equity fundraising will be discussed in part 2 of this article but at the early stages of fundraising, it is important to give out equity carefully. There is only a total of 100% of equity in your business, and the more you give out early on, the less you will have in later stages of fundraising (and there will potentially be many stages). Usually, equity should be given to investors that can provide not only money, but also experience, time, mentorship in the industry, and connections. It is absolutely awesome if your family or friends can provide that! However, if they cannot, you need to reconsider how much equity you are providing to them based on your company valuation or just focus on gifts and loans.

If you are having trouble borrowing from your family and friends (and know that they have disposable income)— it is time to recheck your business model. Financial institutions and investors may not know your business and your work ethic enough to believe in you. However, if your family and friends are not willing to support you, then perhaps this business doesn’t seem viable.

Take this opinion from me with a grain of salt — some of the most successful companies have business models that seemed ridiculous back in the day!

Line-of-Credit (LOC)

A line of credit (LOC) is a preset borrowing limit with a financial institution that a borrower (you) can draw on at any time. Its main advantage is built-in flexibility with interest, payment sizes, and other rules set by the lender.

A line of credit can be secured or unsecured. This depends on the size of the LOC requested and the evaluation of the borrower’s credit history or business viability. Secured LOCs require you to put something as collateral in the case of default. Collateral is a valuable asset pledged against debt such as real estate, automobiles, or personal valuables. Unsecured LOCs do not require such collateral in the case of default. For better understanding, credit cards are very similar to unsecured lines of credit — you do not put any assets against your credit, and the borrowing limit is relatively low. Secured LOCs are lower in risk, lower in interest rates, and higher in credit limits due to the sense of security for the lender. On the other hand, unsecured LOCs are the complete opposite. They are typically subject to higher interest rates and have lower credit limits due to the higher risk faced by lenders to provide funding for you.

1. Revolving LOC

A line of credit can be revolving or non-revolving. A revolving LOC is similar to the concept of a credit card, where you have an upper limit and can borrow and pay back whenever and the upper limit renews when you pay back in a never-ending revolving cycle.

Businesses can use revolving LOCs to borrow on an as-needed basis instead of taking out a fixed loan (discussed in the below section). The lender evaluates the market value, profitability, and risk taken on by the business and extends a line of credit based on that evaluation. As with almost all LOCs, the interest rate is variable!

2. Non-revolving LOC/ Business Loan

A non-revolving LOC provides the option to borrow a set amount and repay it in monthly installments until the loan is paid off. Once an installment loan has been paid off, consumers cannot spend the funds again unless they apply for a new loan.

Places to get a revolving LOC or business loan: almost every financial institution! It will be easier if you already have an account and good credit with the institution. Choose based on your own circumstances.

• Tangerine: https://www.tangerine.ca/en/products/borrowing/tangerine-line-of-credit
• Simplii: https://www.simplii.com/en/borrowing/secured-line-of-credit.html
• RBC: https://www.rbcroyalbank.com/business/loans/index.html

Financial institutions look for businesses with a good track record or excellent credit scores to lend to. Businesses should consider borrowing a revolving or non-revolving LOC if they have high confidence that the business will generate revenue in the future, but currently requires high investments that the founder does not have. For example, opening a restaurant requires high fixed costs (renting a venue, purchasing furniture) and high variable costs (labour, food ingredients) but provides a relatively secure return in normal circumstances. This owner can consider taking out a LOC. A founder should not consider LOC if the business is high risk — for example, a venture that is in the beginning stages of working on a new type of pharmaceutical product. This type of venture is high-return yet extremely high risk, and should not take out a LOC.

Government Grants

Government grants are funding provided by the government that does not require anything in return. Getting grants is extremely tough. There is strong competition for any grant available and the criteria for awards are often stringent in terms of the business’ geography, industry, etc. Generally, most grants require the founder to match the grants from out-of-pocket funds, depending on the granted.

Writing a grant application is a huge task that requires a lot of dedication, but can be useful in understanding your business better! The grant generally asks for project descriptions, the social or economic benefit of the project, a detailed work plan with how the grant costs will be spent, and relevant experiences of the team. This is very helpful for the founder to think through whether they are optimizing their current expenses and whether their business is viable in the current economy.

A grant is helpful for any type of business, no matter the size, risk, or funding need. However, businesses that fit the current strategic outlook of the government are much more likely to receive the funding than others. For example, a small retail business suffering from losses due to COVID-19 is much more likely to receive grants than an online clothing shop that is not affected as much.

Grant resources:

• Government of Canada Business Benefits Finder: https://innovation.ised-isde.canada.ca/s/list-liste?language=en_CA&token=a0B0b00000OGBoqEAH

What are your thoughts and experiences with these funding options? Feel free to share with me :)

As mentioned, getting loans is time-consuming and difficult in most cases — if you require help with developing a well-rounded business plan and pitch, don’t be shy to shoot me a message.

Sources:

1. BDC: https://www.bdc.ca/en/articles-tools/start-buy-business/start-business/start-up-financing-sources
2. Investopedia: https://www.investopedia.com/terms/l/lineofcredit.asp#:~:text=A%20line%20of%20credit%20(LOC)%20is%20a%20preset%20borrowing%20limit,an%20open%20line%20of%20credit.
3. Small business: https://www.thebalancesmb.com/starting-a-business-finding-small-business-financing-2948106