In general, as a company grows, it may or may not have the ability to self finance its growth and may require outside financing.
This can be obtained in several ways:
- Family financing – Family members are the number one source of financing for startups in Canada. This can create stress within the family group if the numbers are substantial compared to the resources of the family members who are contributing cash. Also, the new TOSI (tax on split income) rules introduced in 2018 are extremely complex and are aimed at limiting the returns that family members can receive from a family company in which they are not actively engaged in via debt or equity. Learn more.
- Shareholder financing – The shareholders of the company inject the cash that is needed to support growth out of their own pockets. In a growing company this is usually not the ideal option as it uses personal funds.
- Private financing – Obtaining funds from unrelated parties. This will involve set terms of repayment, interest, and possibly a portion of the company’s shares.
- Institution lending – Getting financing from banks or other financial institutions that will have set terms of repayment and an interest component.
Under the four scenarios, there are different financial reporting requirements:
- Family financing – In this scenario, the requirements would depend upon the specific needs of the family members involved.
- Shareholder financing – In this scenario there would be nothing more than an agreement between the corporation and the shareholder outlining repayment terms of the loan. No extra financial information is required.
- Private financing – In this scenario a company would likely be required to provide the lender with financial statements, tax returns, and other financial data.
- Institution lending – In this scenario a bank will likely require a form of assurance on the financial statements and will likely require lending ratios to be calculated on a timely basis. Depending on the financing arrangements, the bank could require reviewed or audited financial statements.
When looking at outside financing, it is very important to ensure that the company has positive cash flow and will be able to meet its debt obligations. Cash flow is a major consideration for lenders as it’s the best predictor that they will be able to fully collect the loan and loan interest.
What Do Banks Look For?
Generally speaking, banks want to know if the business is sustainable, how industry trends impact the business, and what the future looks like. These are some of the things they may look for:
Cash Flow Statement
Banks favour businesses that are diligent in preparing budget forecasts, including cash flow projections, projected revenues and growth, and the amount of capital required.
Key Performance Indicators (KPIs)
KPIs can be created for whatever a company wishes to manage, and banks may be interested in any number of them, but primarily financial metrics.
- Current Ratio. This is the company’s ability to pay off current liabilities with its current assets should the company liquidate.
- Debt to Equity Ratio. This is the proportion of debt versus the amount of equity a company has. It is useful for banks as a high D/E ratio means the company may be borrowing too much and thus a bank may be unwilling to loan more.
- Budgeted versus actual results. This would lead into industry specific downturns and trends.
- Days sales outstanding. This represents a company’s ability to collect its receivables in a timely manner (can the bank collect).
- Customer retention. How well is the company treating current customers and clients?
- Customer satisfaction. Are the company’s customers satisfied with the services and products?
- Customer growth. Is the company growing? This can be broken into population segments like the company’s industry type.
- Defect and return percentages, measuring the quality of products / services.
- Employee turnover. Can the company attract and retain high-quality employees?
If a company is raising large sums of capital through a share issuance, the Alberta Securities Commission (ASC) provides an accredited investor exemption for raising capital. This allows for quicker access to funds and less red tape in terms of reporting.
According to the ASC, “An individual is an accredited investor if:
- he/she is or was ever registered as an investment adviser (broker or mutual fund salesperson);
- he/she has net financial assets in excess of $1,000,000; or
- his/her net income before taxes exceeds $200,000 per year in each of the most two recent calendar years or $300,000 combined with a spouse in each of the two most recent calendar years.”