“Money, money, money
Must be funny
In the rich man’s world
[…]
All the things I could do
If I had a little money”
(“Money, Money, Money” by ABBA)

Start-up capital is the fuel that transforms your idea into a full-blown business. Start-ups typically require capital at three stages: (1) initially to get off the ground; (2) to fund their operations until they reach a basic level of profitability; and (3) to expand and scale their operations.

Now, how can your business source that start-up capital? The two major approaches are either for it to borrow it (and thereby to incur debt) or to issue stock (equity) to investors (and thereby exchange an ownership stake for the money received.) Both approaches have their respective advantages and disadvantages.

Debt Financing vs. Equity Financing

Debt financing has the advantage of generally raising money quickly without ceding any type of control over your business. Small amounts can also be borrowed or lines of credit may be set up to borrow money on an as-needed basis. The loan’s terms determine the time period over which it needs to be repaid as well as the associated interest rate. However, paying back the loan can place a strain on your business. In addition, lenders often insist on taking personal guarantees from business owners before lending to start-ups. Giving a personal guarantee means that you are personally agreeing to pay the lender back if your business is unable to do so. Having to sign over more than one line at the end of the agreement is often the tell-tale sign of a personal guarantee.

The question of a personal guarantee is only relevant for incorporated businesses as all debt incurred by unincorporated businesses are automatically guaranteed by the business’ owner. To lean more about different business structures, see Which Business Structure to Choose for your Business.

Equity financing has the advantage of raising money which does not have to be repaid. This greatly reduces the pressure on your business and removes a trailing drain on your cash flow. Equity raises may also allow your business to receive substantial amounts of capital as your business’ ability to repay such amount is not relevant. The downside of issuing stock is that you are partially ceding control of your business to your new investor. As this investor has an interest in the growth and safety of their investment, they need to be kept informed about what is happening at your business and may even insist on being part of its decision-making process. If this investor obtains a majority stake in your business, they have the deciding vote on questions affecting your business including even whether you should work for the business! Of note, only incorporated businesses (or partnerships) can benefit from equity funding.

For both debt and equity financing, you must carefully read all of the associated paperwork. If you don’t understand some of the clauses or want to negotiate the deal’s terms, consult with a lawyer.

I recently was involved in a file where a business signed up for a line of credit from its bank with the business’ owners signing everything on their own, only for those owners to learn too late they actually personally guaranteed the debt, which led to them having to go through a bankruptcy process. Take this story as a cautionary tale of the importance of fully understanding what you are signing.

Sources of Debt Financing

The main sources to borrow money for your business is through your network of family and friends, or from a bank.

Loans from family and friends often have the advantage of being interest-free and with very favourable repayment terms. However, be mindful of the consequences on your family or friend relationships if your business is unable to repay the borrowed money. To reduce the risk on this front, only borrow money which your family member or friend can afford to lose.

Banks make money by loaning out their customers’ deposits at a higher interest rate than that which they pay to their customers. Assuming your business has a decent repayment capacity (generally assessed by looking at its cash flow) or has assets of value (over which the bank can take security), banks will likely loan your business money. A good starting point is to approach the bank which you personally use as you have more history with them which will make them more inclined to loan your business money.

Certain para-governmental organizations also have small business loan offerings, such as the Business Development Bank of Canada (BDC). It is worthwhile to check those out as well even though their terms are often still quite onerous.

Another option is for you to personally lend money to your business. This applies to either money which you already have or to money which you can personally borrow and then relend to your business. Keep in mind that there may be tax consequences if you repay yourself back with interest as you will likely have to declare this interest income on your personal tax return.

Types of Equity Financing

All incorporated businesses can issue stock in exchange for money or services. A distinction must be made here between a share subscription where a business sells its shares directly to an investor as opposed to a shareholder sale where a shareholder sells his or her shares to someone else. Only a share subscription results in money going to the business as, otherwise, it goes directly to the shareholder who sold their shares personally. In addition, a share subscription reduces (dilutes) the ownership stake of all current shareholders. For example, if your business initially issued 100 shares, a shareholder who owns 25 shares has a 25% ownership stake in the business. However, if your business then issues another 50 shares to a new investor, the initial shareholder’s ownership stake falls to roughly 17% (25/150).

Potential investors can be found in your circle of friends and family, higher net-worth individuals or venture capital funds. As a general rule, a private business cannot sell stock to people who are not friends or family of its owners or operators unless such individuals are wealthier as this would violate National Instrument 45-106.

Once again, be mindful of the consequence of selling stock to your friends and family as a failure of the business or a loss on the value of those shares can negatively affect those relationships.

In the case of a company whose valuation is harder to determine, so to say the parties have difficulty to figure out the price at which stock should be issued, consider proceeding via SAFE or KISS agreements which allow the determination of the share price to be put off to a later event. A detailed description of those types agreements may be found in SAFEs and KISSes: the (New) Way to Invest in Start-ups.

Business Grants

As a final option, verify whether your business is eligible for any nonrefundable grants from the government or from local start-up incubators. It goes without saying that receiving money which does need to be paid back or exchanged for equity is your ultimate fundraising option.

* * *

In all cases, be very careful about what you tell potential investors or lenders to encourage them to subscribe for shares or lend your business money, as false or misleading statements can lead to you being personally sued.

Moreover, only seek to borrow or raise amounts of money that your business actually needs, maybe with the exception of a line of credit which does not need to be drawn upon.

Finally, if you are looking to raise money to hire personnel or another business, consider approaching them to see if they are interested in rendering those services (or part of the cost of their services) in exchange for shares. This way you can cut out the middleman. Best of luck with your money raising and feel free to reach out if you would like some assistance in this regard!