There are four major types of debt financing for a new business; these four types are: Shareholders loans; Canada Small Business Financing Loans; Operating loans; and Term loans. Each is discussed in greater detail below.
(1) Shareholders Loans: This is known as an owner’s investment, but in the form of a loan. If you decided on incorporating your business (Corporation), then you will have the option to invest as a shareholder. The process involves the bank lending the money to the owner of the business, and then the owner in turn loans the money to the latter. Some advantages to an owner investing in the form of a loan to their business are that the owner will be entitled to deduct the interest payments incurred as a business expense. If you were to purchase shares then in the business (the process known as equity investment), you will then be in receipt of dividend payments. Another advantage is that it is easier to withdraw your money, when the investment is in loan form.
(2) Canada Small Business Financing Loan (CSBF): According to the Canadian Small Business Financing Act, the federal government of Canada, guarantees certain start-up projects, loans through one of the Canadian chartered banks (i.e. Toronto Dominion), or a credit union. Statistically speaking, some one-third of these loans had been issued to businesses that have been in operation for less than one year. CSBF loans are available to any firm that operates with profit as their key motivator, excluding charities, and non-profits from the mix, unless they have annual gross revenues exceeding $5 million. The maximum that can be issued is $250,000. There is a mandatory up-front payment of 2% of the loan the recipient is entitled to.
(3) Operating Loans (Line of Credit): An operating loan, otherwise known as a line of credit, is money that is loaned to help finance short-term firm needs such as inventory and accounts receivables. Lines of credits are often used by more than 75 percent of all small business borrowers that help aid in their overcoming of short-term financing issues. On most occasions, the operating loan is the biggest aspect of the loans outstanding of a small business’ debt obligations. The amount of which you are eligible for often follows one of these two criterions:
(A) Your authorized borrowing limit, which is determined by forecasting what the company’s projected peak cash needs in any one month of the year would be
(B) Your margin needs (requirements), which indicates that you can borrow only up to a specified percentage of the accounts receivables outstanding in any one month. Some banks have been known to finance up to 66 percent of a small business’ accounts receivables that are deemed to be less than 60 days old.
(4) Term Loans: These loans are used specifically for medium-long term financing of assets that are fixed such as equipment or furniture. Some, one-half of all Canadian small businesses, are the largest source in which loans medium term (2-5 years) and long term (5+) are financed to. Under most circumstances the business will only be allowed to borrow up to 75 percent of the value of fixed assets in question. Through a fixed schedule of payments, the owner will be expected to repay back these loans. Term loans can be paid with either a fixed or a floating rate of interest. “Fixed rates” suggests that the interest rate stays the same over the period of the loan. As “floating rates” are interest rates that fluctuate with changes in the prime rate. Fixed rates are not often available for loans that are less than $25,000, in which banks will often charge higher interest for a fixed term.