Welcome to Part 4 of our series on Small Business Financing in Canada. We hope that you’ve found Parts 1-3 informative and helpful. You can find the first 3 posts of the series below:
Today, we’ll discuss different types of private investors and whether they are viable sources of financing for owners looking to grow their small businesses.
Angel investors are high net worth individuals who are looking to invest in companies in exchange for equity. They are often interested in taking a more direct role in their investments and may ask to sit on the company’s board of directors or to be included in the business operation in some way. The companies that angel investors consider for investment are very early-stage and are typically unproven. In exchange for the amount of risk they’re taking on, angel investors hope to take a sizable cut of potentially large returns (typically in the form of equity ownership).
Because they are looking for a return several times their initial investment, angel investors do not usually target small businesses. And because they can usually find more affordable financing elsewhere, small businesses do not usually see angel investors as a viable source of financing.
Venture capital firms are one of the most difficult sources of financing to secure. They are a form of private equity financing, typically investing in early-stage, high-growth companies. Venture capital firms make investments in exchange for equity. The amount of equity demanded by a venture capital firm depends on the company, although 15%-30% is a relatively common range.
Increasingly, many companies are showing a preference towards asking prospective venture capital investors for convertible debt instead of just an outright exchange of money for equity. Convertible debt is a loan which can eventually be converted into equity for the lender.
Venture capital firms often wish to take a more hands-on role with their investments. They may require a seat on the board or serve in an advisory role with the firm.
This financing is particularly popular amongst high-growth technology firms. For reasons quite similar to those of the angel investors discussed above, it is very unlikely that a venture capital firm would consider investing in a small business.
Friends and Family
Friends and family are often the first step for many entrepreneurs. Friends and family can be a great resource to help get a business off the ground. When it comes to repaying this group of investors, it shouldn’t be surprising that terms are often generous. Most friends or family may simply ask for their initial investment back or a small portion of equity in the company. Raising money through friends and family is a great way to show other lenders such as banks and alternative lenders that you are personally committed to the success of your business.
While friends and family can help you start your business, it is unlikely that they have enough money to help with financing for continued growth. For a business that’s operated for several years and requires significant financing to get to the next level, friends and family are usually not an option.
If you’re a small business owner, you’ve probably noticed that the risk tolerance of angel investors and venture capital firms is opposite that of the big banks. Banks prefer businesses with lots of assets to serve as collateral, while angels and venture capital firms want companies that may not have any collateral, but that could be the next Google or Facebook.
Despite the trendiness of startups, small businesses still account for a large majority of the growth in Canadian jobs. Many of these small businesses cannot get bank financing. While successful, they also aren’t eligible for angel investment or venture capital funding.
Alternative lenders can fill the gap. We will discuss alternative lenders in detail next week, but if you’d like to find out now how affordable financing from an alternative lender can help you grow your business, check out Lending Loop. Lending Loop is Canada’s first and only peer-to-peer lender and acts as a source of fast and affordable financing to small businesses. A Lending Loop loan application can take as little as 5 minutes and we evaluate applications far more quickly than banks are able to, putting the savings from this efficiency back into the pockets of our Borrowers.