Small Business

When the Bank Says No

Your best financing alternatives in four common scenarios

Written by ProfitGuide Staff

Apart from your rich Aunt Gladys and your own savings account, bank financing is usually the cheapest and most immediate source of funds you can get. Yet what if your firm needs capital and your banker turns you down?

There’s no shortage of alternative financing options. While some of these sources are little known, they should be understood by all entrepreneurs-because you can’t always know when you’ll need money. To help shape your understanding of higher-profile options, PROFIT asked finance specialists where they would advise a growing company in solid financial shape to seek capital in the following common scenarios.

OBJECTIVE: Avoid a cash-flow crunch
SCENARIO: You require working capital to finance inventory during a two-month cash-flow squeeze. Payment terms on your receivables are 90 days, so you won’t collect enough of what’s outstanding in time to raise the $250,000.

Your best bets: Call your suppliers. If you’re a good customer, you might be surprised by how willing they are to extend terms. They might, for instance, let you pay a third of what you owe now and the rest once your receivables come in, says Jason Sparaga, president of Spara Capital Partners Inc., an Oakville, Ont.-based investment bank and corporate finance consultancy.

Many suppliers may not even charge interest for extending 30-day credit terms to 60 or 90 days, provided you’re a reasonably solid customer-and the supplier isn’t itself cash-strapped. The quid pro quo is an understanding that you’ll give them more business, says Frank Hayes, president of Stanley Software Finance Inc., a Toronto-based financial consultancy and merchant bank mainly for software firms.

Another good bet is the Business Development Bank of Canada, a federal agency with the mandate to help small and medium-sized businesses. If you need short-term money beyond what your bank is comfortable lending, the BDC can offer a working capital top-up.

If that doesn’t pan out, try an asset-based lender, such as Mississauga, Ont.-based General Electric Capital Canada Funding Co. or Halifax-based Congress Financial Capital Co. ABLs provide working capital secured against your inventory, which they measure far more frequently than banks do-often weekly or even daily. Because they keep such close tabs on you, “they’ll lend a greater percentage against those assets than a bank would,” says Hayes. “But they’d also charge a higher interest rate and fees, because they have to do more administration and take on more risk.”

Don McLauchlin points to another option for companies with real estate assets. The vice-president at Roynat Capital, a Toronto-based merchant bank specializing in long-term capital for mid-sized companies, says you should be able to negotiate a three-month moratorium on a term loan from your mortgage lender: “A mortgage is a 50- or 60-year asset, so a three-month deferral won’t spook a lender.” But you’ll need to convince the lender that you have a firm grasp of your cash flow, as well as a persuasive explanation for why your firm is in a crunch and why that situation won’t persist.

OBJECTIVE: Lease production equipment
FUNDING NEEDED: $1.5 million
SCENARIO: You want to lease new equipment so you can boost output enough to supply larger companies.

Your best bets: Ask whether the equipment maker offers financing. Many will fund about 90% of the cost through in-house leasing arms or relationships with major commercial financiers such as GE Capital, Toronto-based ABN AMRO Canada or Hewlett-Packard Financial Services Canada Co. of Mississauga.

The BDC is another good option. And don’t overlook credit unions. “If you’re a significant local player, especially if you’re a unionized business, they’ll love you,” says Sparaga. Credit unions may be more flexible than other lenders about the rate, amortization term and initial interest-free period. Unfortunately, with exceptions such as VanCity in Vancouver and the giant Mouvement Desjardins caisses populaires across Quebec, many local markets lack credit unions with the capacity for large-scale lending.

Hayes says you may qualify for major savings by leasing from a foreign equipment maker. Many of them offer low-cost financing at below-market rates, thanks to a subsidy from the company’s home government.

OBJECTIVE: Stop paying rent
FUNDING NEEDED: $4 million
SCENARIO: You want to purchase the building you operate in.

Your best bets: Sparaga generally warns against buying your building, urging firms to invest in their own growth, not real estate. But if you opt to do so, he advises approaching the BDC first. It finances many commercial mortgages of $1 million to $5 million, funding up to 90% of the price, sometimes more. Banks typically loan only 60% to 65%. Also, with its government mandate, says Sparaga, “if you’re in a troubled loan situation, there’s no one better to owe money to than the BDC, because they don’t want to look bad by calling in a loan.”

One challenge is choosing from all the organizations that love to lend against real estate, because, as Hayes puts it, “it’s not going anywhere, and it’s in a safe country.” Other than the BDC, your options include insurance companies, pension funds, Roynat, private lenders and credit unions.

Here’s where a good financial advisor can point you not only to the right institution but to the right person there. If you don’t already have an advisor, find one through your business network, starting with your accountant or lawyer.

The lender may cover only 65% to 80% of the total cost. If you don’t have the cash for the rest, Hayes recommends trying to negotiate a vendor takeback, in which you take out a second mortgage from the seller. But, because they’d rank among your creditors behind the first mortgage’s holder, you’d pay a risk premium of a few percentage points above the rate for the first mortgage.

OBJECTIVE: Make an acquisition
FUNDING NEEDED: $8 million
SCENARIO: Having grown your firm to $20 million in revenue, you want to finance a friendly acquisition while minimizing dilution of your equity.

Your best bets: Negotiate multiple sources of funding. This is a tricky task, says McLauchlin: “the home-run scenario, in terms of complexity.”

Here, retaining a financial advisor is not just a good idea but essential. Work with your advisor to assemble a package that starts with the cheapest financing, then the second-cheapest and so on. You might begin with $3 million in senior debt (which means the lender is first in line if you default) from a financial institution at the prime rate or prime plus 1%, secured against fixed assets such as machinery, equipment and real estate.

Next, you might add a vendor takeback, in which the acquired firm issues a $2-million promissory note payable over two to seven years. McLauchlin says one benefit for the vendor is that this strategy would defer tax on the $2 million until it gets the cash. Sparaga says, “you’d almost insist on a vendor note for 10% to 25% of the purchase price.” This would typically cost prime plus 2% to 3%.

The next $1 million might come from a subordinated debt lender such as Roynat, Toronto-based BMO Capital Corp. or the BDC’s sub debt group. (Sub debt ranks behind senior debt if you default.) Because this debt would be secured against the company’s cash flow rather than its assets, you’ll pay a risk premium. Sparaga says sub debt typically costs prime plus 6% to 10%.

For the final piece, you might turn to an equity investor. Roynat, the BDC, a high-net-worth individual or private equity fund might supply $2 million in return for a minority stake in the merged company and a seat on its board of directors. This financing would be by far the most expensive. The investor would likely expect an annualized return of 20% to 40%, depending on the perceived risk, collectible once it sells its stake. This would compensate it for being an unsecured creditor with an investment it couldn’t liquidate for perhaps three to seven years. Avoid such expensive financing if you can, although you may need it to ensure the merged company has enough cash flow.

Originally appeared on