Business Financing Services

Alternative Types of Financing

There are many different types of options available to finance a business. They include (but are not limited to) the following:

1. Schedule A Bank Loans

This is the most common type of debt financing found in Canada. And although it is one of the cheapest forms of financing, it is also becoming more difficult to qualify for. Banks normally take a general security agreement on all of the assets of the company as collateral for the loan. Advances are usually based on percentages of current assets (accounts receivable and inventory). Financial covenants (debt to equity, working capital, interest coverage etc.) also form part of most loan agreements with Schedule A Banks.

2. Asset Based Loans

Asset Based Loans (or "ABL's") are similar in nature to a conventional loan from a Schedule A Bank but with a few distinct differences:

a. Asset based lenders are more concerned with the asset values securitizing the loan rather than the profitability of the company;

b. As a result, asset based lenders' reporting and audit requirements are more stringent (i.e. weekly rather than monthly reporting of asset values is usually required);

c. The interest rate charged is higher;

d. The amounts advanced as a percentage of current asset values is usually higher;

e. Often there are no financial covenants. In cases where covenants are required, there are only one or two and they are usually debt coverage covenants rather than the standard financial ones.

ABL's are a great financing option for companies who have strong liquid assets that turn on a regular basis. When using an ABL, the additional funds that are advanced will assist in the working capital needs of the company and should outweigh the additional interest and monitoring fees charged by the lender.

3. Factoring

This involves the sale of a company's accounts receivable to a Factor. The Factor purchases receivables at a discount off of the face value of an invoice. The discounted amount is advanced to the company upon the presentation to the Factor of a valid invoice. The Factor then collects the receivable from the company's customer. The Factor's profit is made up of two amounts:

a. The difference between the face value of the invoice and the amount advanced (the original discount); and

b. The additional discount (interest) earned while the invoice remains outstanding.

Most Factors have the right to sell back receivables to the company if they determine that the receivable is uncollectible. This usually occurs after the receivable has been outstanding for 90 days but could be earlier than this. This is known as a full recourse factoring facility.

The advantage of factoring is that funds are available to the customer immediately after goods are delivered and an invoice is generated. Plus the amounts advanced are usually greater than one could get via an ABL or conventional loan. If a business has a lot of customers who pay on a timely basis and has immediate short term cash requirements, factoring can be a great option. The downside to factoring is that it is quite expensive relative to conventional operating loans. Effective interest rates can range from 15% to 30% per annum based on the credit worthiness of the business.

4. Purchase Order Financing

Purchase order financing is similar to factoring but it goes one step further. The lender will advance funds to a business based on a signed purchase order from its customer. In many cases once the goods or services on the purchase order are delivered to the customer and an invoice is generated, the lender will become a factor and purchase the invoice to repay the purchase order loan.

This type of financing is useful in situations where a business is having a hard time establishing credit with its suppliers. Quite often the business will use the proceeds from the loan to pay for the goods to be delivered to its customer. But as with factoring, this type of financing is not cheap, with rates in the 15% to 30% range.

5. Convertible or Sub-Debt

Holders of convertible debt have the right to exchange the debt for a given number of shares in the business. Depending on the loan, the right to exchange can be at any time up to and including the expiration of the loan, or at certain points (for example anniversary dates) during the term.

In most cases, this type of debt is subordinate to a primary lender.

6. Capital Pool Companies

This is a relatively new option for well run small to medium sized businesses that have outgrown their current lender. It is also a mechanism that allows a business access to the public markets that would normally have not been possible due to their size.

The mechanics involve the formation of a Capital Pool Company ("CPC") that trades as a public company, offering its shares on the TSX Venture Exchange. Once the offering is completed (the initial offering can be a maximum of $2 million), the CPC is essentially a shell company with money to invest in a qualifying business.

The CPC then has 18 months to complete a transaction whereby a qualifying business is rolled into the shell via a reverse takeover.

One of the advantages of a CPC is that it allows business owners to raise capital quickly and relatively inexpensively, while at the same time offering investors the liquidity associated with a public listing.

The main disadvantage is that the company is now public and all of the associated costs of being public (regulatory fees, annual meetings, financial reporting - quarterly and audited annual financial statements that require full and transparent disclosure of all of the company's activities etc.) are now a reality. Plus the company must meet size and liquidity tests on a continuous basis in order to maintain its public status and avoid being de-listed.

Click here and we'll show you how Aries will determine what's the right alternative for your company.