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Debt financing. Thats business funding that is 'non-equity', the business owner and manager can benefit from several business funding solutions.
A good, solid way to begin is to determine which solutions are available and to understand the pros and cons of each when debt financing occurs, including the advantages of debt financing versus other business capital solutions.
WHAT IS DEBT FINANCING
Assuming debt on your balance sheet reflects the need to have the debt paid back with interest payments, transactions can be both secured and unsecured. Debt finance can be used for a variety of corporate goals to raise capital in the company, including acquisitions.
Regarding debt finance solutions, it's paramount to remember that the lender, finance firm, bank, credit unions, etc., is not sharing profits and is at risk—as such, their only focus is getting paid in times of historically low interest rates or in a higher rate environment
In a way that’s the benefit, i.e. one of our ‘pros’ of taking on debt - You know exactly what conditions and rates come with the loan ( hopefully!) -
It's just up to you to ensure you have the cash flow to repay. So broadly speaking, you're very much in control, unlike being at the whims of an equity investor.
Financial Growth Barriers Breakthrough
Business growth requires capital, but many Canadian entrepreneurs face rejection from traditional lenders. The frustration of watching opportunities slip away due to funding gaps creates sleepless nights and stalled ambitions.
Let the 7 Park Avenue Financial team show you how correct debt funding offers tailored financing solutions that align with your business cycle, providing timely capital without sacrificing ownership or control.
Uncommon Takes on Debt Funding
Contrary to popular belief, strategic debt can actually lower your overall cost of capital when used to pursue high-ROI projects that traditional equity investors might consider too conservative
Debt funding can serve as a valuable financial discipline tool, as the repayment structure forces businesses to maintain consistent cash flow management practices they might otherwise neglect.
Specialized debt funding options in certain sectors can provide industry-specific expertise and connections that prove more valuable than the actual capital itself.
HERE ARE THE KEY SOURCES OF DEBT FINANCING AND BUSINESS FUNDING IN CANADA
Let's recap some of the key sources of debt financing in Canada - they are some of the best options for financing a business!
Bank loans
Government Small Business Loans
Leasing
Mortgages
Also included in our list of types of debt financing are:
Inventory financing
Receivables factoring / Invoice Financing - Accelerating working capital.
Asset-based credit lines
Tax Credit Monetization
Sale Leaseback
Supply Chain /PO Finance
Short-Term Working Capital Loans / Merchant Cash Advances
Venture Debt Financing / Private Debt Market - debt plus an equity component, such as a warrant, equity funding, etc, when a company raises money in this manner
These latter 6 monetize current assets, so they are a bit of a hybrid - No Long Term Debt
THE BALANCING ACT BETWEEN DEBT FINANCE AND EQUITY FINANCING
Most companies quickly discover that no firm can be properly financed with 100% debt, so it’s important to consider the relationship between debt and equity.
Equity becomes the business owner's risk, so managing your debt load is probably also prudent. Equity financing dilutes ownership equity and carries a higher risk, so most business professionals agree that debt financing is less expensive than the risk involved in owner equity.
What factors affect a company's ability to get debt financing? In smaller to medium-sized firms, the owners' credit status and history are critical to debt providers.
Is size important in debt financing? It sure is! Many firms constantly struggle to acquire more debt and interest expense based on their growth needs.
We can guarantee to clients that if the proper cash flow projections and a solid business plan or executive summary aren't available, realistic, and accurate, not much debt financing will take place, and owners may have to consider equity financing from owners/shareholders.
INTEREST RATES IN DEBT FINANCING SOLUTIONS
Rates and repayment terms are critical in debt financing. They are typically commensurate with your firm's risk profile and the nature of the firm, bank, or other financial institutions you are dealing with.
The same pretty well goes for collateral, whether personal or corporate, as a 'backup' to the debt financing facility and interest repayments around your financing transaction.
DUE DILIGENCE AROUND DEBT CAPACITY IS IMPORTANT
Exercising diligence and caution is critical when taking on debt for your firm. The actual ratio of debt to equity is a good number always to monitor. Two-time debt-to-equity is a commonly respected ratio. When it’s higher than that, you're forced to generate extra cash just to pay and service that debt.
We're sure that we make debt sound somewhat like a burden. That is not the case, though, as the right amount of debt and overall leverage can make your company more successful. If there is one guarantee in life, debt is cheaper than equity.
Remember also that there are a number of non-bank firms that can supply the debt you need if our Canadian banking system rejects you. The owners' credit situations may sometimes factor into business loan approvals.
Case Study: Benefits of Debt Funding
When a Canadian manufacturing business landed a significant contract with a national retailer, it represented an incredible opportunity and a considerable challenge. The agreement required doubling production capacity within 90 days – a timeline that would demand substantial capital investment.
The owner had limited options as a successful but still-growing business with three years of operation. Traditional equity investors wanted too large a stake for the required capital, which would have meant surrendering significant control of the company built from the ground up.
After consulting with a business funding advisor, the firm pursued a strategic debt funding solution that combined equipment financing for new production machinery with a working capital line of credit.
The equipment financing leveraged the new machinery as collateral, securing favourable rates with a 5-year term matching the assets' expected useful life. The working capital line provided flexibility for inventory expansion and staffing needs.
Results:
- Production capacity increased by 115% within the required timeframe
- Revenue grew by 87% in the first year after expansion
- Sarah maintained 100% ownership of her business
- The debt was structured to align with cash flow, maintaining healthy financial ratios
- The company established stronger banking relationships, leading to better terms for future funding needs
CONCLUSION
In many cases, interest rates and size of the loan or loans you seek might be appropriate but the overall conditions the loan demands may not be suitable.
There are numerous factors to consider when financing your business -
Considering the debt solution for business credit? Answers to " How does debt financing work?"
Call 7 Park Avenue Financial, a trusted, credible, experienced Canadian business financing advisor who can assist you with your debt financing options and funding needs when your company borrows money.
FAQ
What types of debt funding are available to Canadian small businesses?
Canadian small businesses can access various debt funding options, including traditional bank loans, government-backed financing through BDC, merchant cash advances, equipment financing, invoice factoring, business lines of credit, and online alternative lenders. Each option serves different business needs and situations, with qualification requirements and terms varying significantly across lenders.
How do lenders evaluate my business for debt funding approval?
Lenders evaluate businesses based on credit history, time in business (typically minimum 6-24 months, depending on the lender), consistent revenue (often seeking $10,000+ monthly), debt service coverage ratio (ideally 1.25 or higher), industry risk factors, and collateral availability. They may also consider personal guarantees, especially for newer businesses. Having clear financial statements and a solid business plan significantly improves approval chances.
What are the typical interest rates and terms for business debt funding in Canada?
Interest rates for Canadian business debt funding typically range from 4-7% for bank loans and government programs, 7-15% for equipment financing, and 10-45% for alternative lending options. Terms vary from 3-6 months for merchant cash advances, 1-5 years for term loans, up to 10 years for SBA loans, and 15+ years for commercial mortgages. Rates depend on business strength, industry risk, and security provided.
What documentation will I need to apply for business debt funding?
For business debt funding applications, you'll need to provide business bank statements (typically 3-6 months), business and personal tax returns (2-3 years), financial statements including balance sheet and income statement, business plan for larger loans, proof of business registration, government ID, and industry-specific licenses. Alternative lenders may require fewer documents while traditional banks and government programs typically require comprehensive documentation.
What types of collateral can I use to secure better debt funding terms?
Various business assets can be collateralized to secure more favourable debt funding terms. Common options include:
- Commercial real estate properties
- Equipment and machinery
- Inventory with stable value
- Accounts receivable
- Business vehicles and specialized tools
- Cash savings or investments
- Personal assets (though this should be approached cautiously)
- Intellectual property in certain industries
What are the main differences between secured and unsecured debt funding?
Secured debt funding requires specific business or personal assets as collateral, offering lower interest rates, higher borrowing limits, and longer repayment terms. Unsecured debt funding doesn't require collateral but typically features higher interest rates, lower maximum amounts, and shorter repayment periods. Secured options are generally better for established businesses with valuable assets, while unsecured options provide faster access to capital for businesses without significant collateral or those unwilling to pledge specific assets.
How do seasonal business cycles affect debt funding decisions?
Seasonal business cycles significantly impact debt funding strategies by determining optimal funding timing and structures. Businesses should:
- Choose lines of credit for fluctuating needs rather than term loans
- Time larger funding requests during strong revenue periods
- Consider revenue-based repayment options that adjust with business cycles
- Build additional reserves before low seasons
- Select longer-term debt with flexible prepayment options
- Avoid short-term high-interest funding before predictable slow periods
- Match repayment schedules to revenue patterns
Would refinancing existing business debt improve my company's financial position?
Refinancing existing business debt can significantly improve financial positioning when:
- Interest rates have decreased since original borrowing
- Your business credit profile has substantially improved
- You can extend terms to reduce monthly payment pressure
- Consolidating multiple debts simplifies financial management
- You can eliminate or reduce personal guarantees
- Better cash flow management aligns with business seasonality
- You can remove restrictive covenants limiting business options
- Early repayment penalties don't outweigh refinancing benefits
How can debt funding be used for business acquisition?
Debt funding serves as a powerful tool for business acquisitions when properly structured:
- Government SBL loans offer favourable terms for qualifying acquisition deals
- Seller financing can bridge valuation gaps and align incentives
- Leveraged buyouts allow acquisitions with minimal equity contribution
- Asset-based lending can utilize target company assets as collateral
- Earnout structures can convert portion of purchase price to performance-based debt
- Mezzanine financing combines debt and equity features for larger deals
- Interest-only periods can allow business integration before full payments begin
- Debt can be structured to match projected cash flows of the acquired business
What warning signs indicate that a business has taken on too much debt funding?
Several indicators suggest a business may be overleveraged with debt funding:
- Debt service coverage ratio falling below 1.25
- Rising percentage of revenue dedicated to debt payments
- Declining working capital despite stable or growing revenue
- Increasing reliance on extending payables to manage cash flow
- Difficulty meeting loan covenants or requesting frequent waivers
- Using new debt primarily to service existing debt obligations
- Declining gross margins while debt levels remain stable or increase
- Management focus shifting from growth to debt management
- Passing on growth opportunities due to limited financial flexibility
- Increasing personal guarantees or collateral requirements from lenders
Statistics on Debt Funding
- According to the Business Development Bank of Canada (BDC), 26% of Canadian small businesses cited accessing sufficient financing as a major challenge for growth in 2023.
- The Canadian Federation of Independent Business reports that approximately 82% of small businesses used some form of debt financing in the past year.
- Alternative lending to Canadian small businesses grew by 33% in 2022, compared to just 4.5% growth in traditional bank lending.
- The average approval rate for small business loans from major Canadian banks was 67% in 2023, down from 75% in 2019.
- The average business loan amount in Canada is approximately $250,000, though this varies significantly by industry and business size.
- Equipment financing accounts for roughly 22% of all business debt funding in Canada.
- Businesses that work with professional advisors are 31% more likely to receive approval for debt funding applications.
Citations / More Information
- Business Development Bank of Canada (BDC). (2023). "Canadian Business Investment Trends Report." Retrieved from BDC Economic Research. Main website: https://www.bdc.ca
- Canadian Federation of Independent Business. (2023). "Small Business Financing in Canada: Annual Report 2023." CFIB Research Publication. Main website: https://www.cfib-fcei.ca
- Statistics Canada. (2022). "Survey on Financing and Growth of Small and Medium Enterprises." Government of Canada. Main website: https://www.statcan.gc.ca
- Deloitte Canada. (2023). "Alternative Lending Landscape in Canada: Market Analysis and Future Trends." Deloitte Financial Services Report. Main website: https://www2.deloitte.com/ca/en.html
- Ernst & Young. (2023). "Capital Allocation Strategies for Canadian Businesses." EY Canada Business Report. Main website: https://www.ey.com/en_ca
