Financing – A Black Box
Financing is often a black box for the CEO of an SME. The main activity of the manager is not to do financial management but to manage the business, to create products and to sell them. In order to demystify the matter, this article is the first in a series of several articles devoted to business financing.
SMEs contribute greatly to the Quebec and Canadian economy. Their launch or expansion requires a lot of effort and, above all, funds. Each SME is unique and has specific financing needs that must be tailor-made. We hope that our articles will provide answers to your questions on this less often discussed subject, without overwhelming you with too much complex information.
Equity Financing (Part 1)
Equity financing is an important source of capital for businesses at all stages of their development. This type of financing allows you to remain debt free but on the other hand, a percentage of the company or the company's profits must be transferred to the investor. In contrast, some entrepreneurs borrow money to finance their business; in doing so, they go into debt and have to repay their loans with interest. This way of doing things allows you to retain full ownership of the company, but the entrepreneur alone absorbs the risk. It should be remembered that all debt financing requires risk sharing between the lender and the entrepreneur, either through a capital outlay (in equity or in the form of an advance) or in self-generated funds from current operations.
Equity financing mainly comes from the main promoters of the SME or through a reinjection of retained profits. Access to external financing, in the form of venture capital, is very restricted in Quebec according to certain findings and studies . If the company's business plan is rigorous enough to convince an investor, and the entrepreneur is surrounded by an outstanding management team, access to equity capital then becomes possible.
Equity financing has certain particularities. Unlike bank financing, equity financing does not include any guarantees for investors. The only guarantee is that the company is profitable so that the investor can make an attractive return based on the future value of their stake. The required rate of return is higher than bank financing because guarantees are non-existent. It is not surprising that access to this type of financing is difficult for a start-up business or one operating in a sector of activity offering little return, for example, catering, retail, etc. .
Sources of capital
- Personal investment of the main promoters of the company (personal savings, pension fund, RRSP, personal loans, etc.)
- Retained earnings (reinvestment in order to contribute to growth)
- Friendly capital (family, suppliers, partners)
- Crowdfunding
- Financial angels (entrepreneurs and experienced professionals)
- Development capital ( Desjardins Entreprises Regional and Cooperative Capital, Fondaction, Fonds FTQ , Investissement Québec and BDC )
- Formal venture capital (public or private companies)
- Public offering of savings (IPO) (massive need for capital, supervision by the Financial Markets Authority)
Main uses of funds obtained
- Priming/Startup
- Growth
- Green economy
- Information technology company
- Export and new markets
- Management buyout (MBO)
- Financing the next generation
- Development and R&D
- Bridging loan (bridge)
Benefits
- Does not involve any financial charges (except dividends)
- For formal and development venture capital, provides access to strategic partners
- Increases liquidity significantly compared to other forms of business financing
- Increases the company's borrowing capacity but reduces the level of control exercised by the owner
Disadvantages
- Dividends are not tax deductible (for the company)
- Very strict securities laws
- Administrative burden (establishment of formal committees and a board of directors in certain cases)
Source of information
We invite you to consult the Réseau Capital directory to find the ideal partner to finance your business if you are looking for external capital.
Réseau Capital is the only investment capital association that brings together all stakeholders in the investment chain working in Quebec. Réseau Capital has more than 425 members (private capital investment companies, tax-advantaged funds and public funds and others).
Canadian Venture Capital and Private Equity Association (CVCA) is the Canadian arm of Réseau Capital. This association brings together nearly 1,500 members.
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References: Journal Lesaffaires, Réseau Capital, CVCA.