Understanding Alternative Financing Options
In the world of business, funding is the lifeblood that fuels growth and drives success. For entrepreneurs and business owners, whether you are starting a new business venture or expanding an existing business, securing the right funding option is paramount to realizing your vision.
We have recently covered in previous blogs various business structures like Sole Proprietorship, Partnership and Corporation and learned how to Prepare a Budget and Forecast. We’re going to continue on our journey by learning about the different types of financing available, the unique features of each, potential drawbacks and considerations associated with them.
Let’s get started!
Types of Business Financing in Canada
There are a variety of business financing available in Canada and they can generally be categorized into 3 distinct types:
Alternative Financing Options (we will cover this one in this blog)
Alternative Options
When it comes to financing your business in Canada, traditional bank loans and government-backed financing are not the only options available. In fact, there is a wide range of alternative options that can provide innovative and flexible solutions to meet your business’ funding needs.
If the first two options don’t work for your business, these alternative options can provide you with a creative way to secure capital. These alternative options include everything that does not fall into traditional bank loans or government-backed financing.
Here are just some examples of alternative financing options that are available:
Crowdfunding – you can raise capital by soliciting small contributions from a large number of individuals
Peer-to-Peer Lending (P2P) – these platforms connect businesses directly with individual lenders who are willing to provide loans
Invoice Financing – you can sell your outstanding accounts receivable to a financing company to gain access to immediate cash
Angel Investors – individuals or companies who provide capital to early-stage businesses in exchange for equity or convertible debt
Venture Capital – these firms invest in high-growth potential businesses in exchange for equity
Trade Finance – these firms assist businesses engaged in international trade by providing working capital for importing or exporting activities
As seen above, there are a variety of options that are available for businesses and each option has its own unique features, benefits and eligibility criteria.
👍Features of Alternative Financing Options 👍
There are several key features when it comes to alternative financing options:
#1: Flexibility in Funding
Alternative financing options often offer greater flexibility compared with traditional loans or government-backed financing. You can access funding for a variety of purposes such as startup funding, expansion, working capital, inventory management, R&D or even equipment purchases. It depends on what you need the funding for.
#2: Speed and Efficiency
There is usually an expedited application and approval process so you can gain access to capital quickly. This is great if you need the funds immediately.
#3: Diverse Range of Financing Options
There are a wide variety of different options available (see above) and each of these options offers unique terms and structures that suit different business needs. You can choose the option that works best for what you want to achieve.
#4: Access to Niche Markets
These options often target specific industries, sectors or underserved markets. This helps businesses connect with lenders or investors who are interested in or have expertise in a specific field.
#5: Non-Traditional Collateral Requirements
These lenders or investors may often consider alternative forms of collateral such as business revenue, receivables, intellectual property or even future cash flow projections. For example, if your business doesn’t have any tangible assets (something you can see and touch), traditional bank loans may not work as they usually require a tangible asset as collateral.
#6: Investor and Lender Network
Many of these financing options already have an established network of investors and lenders who are actively seeking investment opportunities. Businesses can connect with these investors and lenders who have the expertise, industry knowledge or even connections to other investors or lenders.
👎Potential Drawbacks of Alternative Financing Options 👎
After going through the features, there are also some potential drawbacks to consider as well:
#1: Higher Costs
These alternative financing options often come with higher costs compared to traditional bank loans or government-backed financing. These costs may come in the form of higher interest rates, fees or might require a percentage of future revenues or equity in exchange for their funding. It’s important to assess the total cost of financing to determine if the benefits outweigh the higher costs.
#2: Limited Funding Amounts
There may be limitations on the amount of funding that is available so these options may not be suitable for larger-scale projects or substantial capital requirements.
#3: Stringent Eligibility Criteria
In order to qualify for funding, there are usually specific eligibility criteria that businesses must meet. For example, credit history, minimum revenue, time in business or even industry focus.
#4: Potential Dilution of Ownership
Some of these options may require you to sell a portion of shares or equity in exchange for the funding and this means there is a dilution of ownership and decision-making authority.
#5: Lack of Established Track Record
These financing options may lack the long-standing reputation and credibility compared with traditional banks or government-backed programs. It’s essential to do due diligence and research to ensure you will be working with reputable and trustworthy lenders or investors.
#6: Limited Availability for Certain Industries
There may be limited availability or suitability for certain industries or sectors. Businesses operating in niche markets or those with unique business models may face difficulties in finding the appropriate funding options.
#7: Potential Complexity and Administrative Burdens
There may be additional complexity and administrative burdens with these options that can be time-consuming and divert resources away from your core business operations. For example, managing investors, meeting reporting obligations or ensuring that you meet specific terms and conditions.
Other Considerations
We went through the features and drawbacks of alternative financing options but there are still some additional considerations to think about that will allow you to make an informed decision about whether to pursue this financing option.
Business Strategy Alignment
Evaluate how alternative financing options align with your business strategy and long-term vision. Do these funding sources support your growth plans, complements your business model and aligns with your values?
Risk Appetite and Tolerance
Assess your risk appetite and tolerance when considering these options because some of them may involve higher levels of risk. It’s important to understand the risks associated with each option and determine whether you are comfortable with the trade-off.
Relationship and Network Building
Beyond just funding, it often involves building relationships with investors, lenders or crowdfunding communities who can provide valuable industry insights, mentorship and networking opportunities.
Time and Resource Commitment
Each financing option may require a different time and resource commitment since some may have a more extensive application and approval process, due diligence requirements or ongoing reporting obligations. Figure out if your business has the capacity to handle the additional workload.
Expertise and Guidance
Seek professional expertise and guidance when navigating the world of alternative financing. These may include financial advisors, lawyers, accountants or industry experts who can provide valuable insights and ensure compliance with regulations.
Impact on Existing Financing
If you have existing financing, make sure to review any contractual obligations, covenants or restrictions to ensure compatibility with alternative options.
Exit Strategy and Long-Term Plans
What is your exit strategy and long-term plans for your business? Some options may have specific terms and conditions that could impact your ability to exit or change your financing structure in the future. It goes back to the first point of Business Strategy Alignment.
Your Turn
We covered a lot of ground on alternative financing options which is necessary if you want to pursue this type of financing. We went into the features and drawbacks of this type of financing and I provided you with some additional considerations so that you can make an informed decision. Do you have a better understanding of this type of business financing and how it can help you reach your business goals?
If you’re not sure, it will be worth it to go through this blog again. If you still have questions, make sure to contact us to see how this type of financing can help you reach your business goals!
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At JTL CPA, we are Ontario’s virtual accounting firm. Our goal is to automate your accounting and bookkeeping processes in a way that increases financial visibility. Pair that with our value-added approach and tailored advisory solutions gives you the ability to make sound decisions from good data. Check out our website here: https://www.jtlaccounting.com.
Thank you for making it to the end of the blog post. If there are topics that you would like to learn more about in the future, please let us know down in the comments.
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