Getting a loan for your small business isn’t as easy as walking onto the set of Dragons’ Den — let alone your local bank — and making a pitch for funding.
Small business loans are considered risky — the business may lack collateral, credit history or steady cash inflows. That’s why, even if you get a loan, it will come with a steep annual interest rate. To even qualify, banks typically require that you’ve been in business at least a year (sometimes two), which is an immediate non-starter for start-ups.
But if your small business needs working capital and you’ve been rejected by your bank for a loan, what do you do? First off, here are a few reasons why you may have been rejected, as well as some resources to find other types of capital.
The 5 Cs
Lenders base their decision to accept or reject a loan application based on the 5 Cs of credit: character, capacity, capital, collateral and conditions.
Character translates into your credit score, created by reports generated by credit bureaus. Depending on the bureau, your business credit score is typically ranked from 0 to 100 — however be aware that there can be changes from bureau to bureau (and even multiple rating scales within each). Overall, the higher the score the better when searching for loans and funding. If you’re struggling to pay back previous debts and have a low score, you’re unlikely to be approved for another loan.
Capacity measures your ability to repay a loan by comparing income against debts.
Capital relates to how much of your own money you’ve invested in your business.
Collateral is an asset, such as inventory, equipment or real estate, that provides assurance to the lender — if you default, the lender can repossess the collateral.
Conditions relate to how you plan to use the money, which influences the lenders’ decision-making process.
Fortunately, traditional bank loans aren’t the only way you can fund your small business. The 5 Cs can also provide a guideline for finding alternative funding sources, such as these:
If you’re good at sticking to a strict budget, this DIY approach could work for you. Rather than borrowing money and taking on debt, you ‘bootstrap’ by using your own savings or even selling some assets to finance your business. This may involve working a side gig to pay the bills while your business gets off the ground, pre-selling products to fund development or charging a fee upfront for services rendered.
Friends and family
While some may scoff at the idea of borrowing from the ‘Bank of Mom and Dad,’ this is a legitimate way to fund a new business — referred to by lenders as ‘patient capital.’
Indeed, a loan from a spouse, parents, family or friends pours $8 billion a year into Canadian businesses, according to Canadian Business. While it may not come with a high annual interest rate, it can come with baggage — of the emotional kind. Be sure to set expectations, including loan terms and payback date.
This approach requires you to give up some equity or ownership in your business. If you’re willing to do so, an angel investor can help to get your business off the ground — typically to the tune of $25,000 to $100,000 (venture capitalists tend to support much larger investments).
The downside: you no longer have 100 per cent control of your business. The upside: You aren’t crippled with debt, and you benefit from their connections and expertise. Organizations such as NACO (National Angel Capital Organization) and AngelList help to connect start-ups with investors.
If you have an early-stage, technology-driven business — one that’s high risk, but with high-growth potential — you may qualify for VC funding. The Business Development Bank (BDC), for example, has a venture capital team entirely devoted to entrepreneurs, focused on IT, energy/cleantech and healthcare.
Like angel investors, venture capitalists will require you to give up some equity or ownership in your business — after all, they want a healthy return on their investment.
There’s a range of grants, loans and financing programs available to small businesses from the federal government. The CSBFP (Canada Small Business Financing Program), for example, provides up to $1 million in financing for purchasing land, property or equipment.
The hardest part is sifting through all the programs to find the right one for you. The Canada Business Network website provides a listing of various federal and provincial programs. Fundica is a free search tool that matches your profile with grant, tax credit, loan and equity funding programs in Canada.
You’ve probably heard about incubators or accelerators in the tech world, but there are also economic development incubators focused on job creation and revitalization efforts.
An incubator invites a start-up to share their premises and often its technical resources — for up to two years — helping a fledgling business get off the ground. MaRS, an “innovation hub” in Toronto, offers a listing of business incubators and accelerators in Canada.
P2P lending takes place in an online marketplace, facilitated by a third-party lender — and it’s gaining traction in Canada. The pros? There’s less red tape than a traditional bank loan application, interest rates are competitive and approval rates tend to be higher — and you can apply even if your credit isn’t top notch (though your rate will be higher).
Even if the banks won’t fund you, the masses might. A crowdfunding platform or portal allows you to collect ‘donations’ to fund your small business or take pre-orders on a new product. This approach, however, exposes you to copycats, so be sure to protect your intellectual property.
According to the federal government, crowdfunding is an option in British Columbia, Saskatchewan, Manitoba, Ontario, Quebec, New Brunswick and Nova Scotia (it’s being considered by other provincial and territorial securities regulators).
If you don’t need half a million dollar — maybe just five grand — then you might qualify for a microloan. The federal government, as well as credit unions and non-profit organizations, offer microcredit (small business loans of less than $20,000). Many programs are location-based and aimed at people who don’t qualify for traditional bank loans. The Balance offers a listing of 20 microloan sources in Canada.
Whichever approach you take, ensure your application is successful by following the 5 Cs, providing a clear mission statement and calculating estimated sales and profits. The banks may reject you simply because you haven’t been in business long enough, but alternative funders are more willing to take a risk — for a potentially greater reward.