L10

Informal Financing & Bootstrapping

• "Bootstrapping" = self-financing the venture primarily with personal resources.
  • Often the first and most important source for start-ups.
  • Relies on ingenuity, frugality, and determination to stretch limited funds.
• Typical owner-based funds:
  • Personal savings, personal loans, or personal lines of credit.
  • "Love money" supplied by family and friends.
• Cautions & implications
  • Minimizes dilution of ownership but concentrates risk on the founder.
  • Encourages discipline in cash management (founder feels every dollar).
  • May delay or eliminate need for external capital if growth is controlled.

Borrowing From Family & Friends

• Potential issues
  • Blurred lines between personal and professional relationships.
  • Risk of damaging relationships if the business struggles.
• Best-practice checklist
  • Do not accept more than the lender can afford to lose.
  • Share your goals, timelines, and foreseeable problems honestly.
  • Put everything in writing:
  • Treat funds as a business loan, not a gift.
  • Spell out interest, payment schedule, and remedies for default.
  • Include a repayment provision (exit strategy).
  • Obtain independent legal/accounting advice so all parties understand tax and estate consequences.
  • Alternative: ask relatives or friends to co-sign a commercial loan instead of advancing cash directly; reduces relationship strain and builds credit history.

Building a Relationship With Your Banker (Formal Financing)

• Why cultivate the banker?
  • Access to larger pools of capital once bootstrapping limits are reached.
  • Adds credibility with other stakeholders (suppliers, investors, government programs).
• Strategy points
  • Make the banker part of the advisory team; share periodic updates, invite them to visit the operations.
  • No surprises: disclose bad news early; bankers hate sudden shocks.
  • Respect lending policies (ratios, covenants, documentation).
  • Maintain an up-to-date written business plan with realistic financial projections.
  • Prepare sufficient collateral plus personal and spousal guarantees; understand the banker’s discretionary limits (amounts they can approve without committee).

Credit Fundamentals

• Definition: Credit = money loaned or capacity to borrow.
• Lenders order a credit report to evaluate risk.
• Five key factors determining a credit decision (and weighting):
  • Bill-payment history $35\%$
  • Utilization ratio: money owed vs. available credit $30\%$
  • Length of credit history $15\%$
  • Mix of credit (installment, revolving, mortgage, etc.) $10\%$
  • New credit inquiries/applications $10\%$
• Action item: obtain and review your own credit report to correct errors before applying.

Unsecured Credit

• Definition: loans extended without collateral; lender relies solely on borrower’s promise to repay.
• Generally limited in amount and granted only to borrowers with strong credit histories.
• Examples: some credit cards, signature lines of credit, micro-loans.
• Higher interest rates than secured credit because lender’s risk is higher.

Other Formal Sources of Start-Up Capital

• Angels (high-net-worth individuals investing personal funds, usually for equity).
• Suppliers (trade credit, extended payment terms, or consignment).
• Customers (pre-payments, milestone payments).
• Leasing companies (fund equipment without large upfront cash).
• Employees & Employers (stock options, wage deferrals, profit-sharing).
• Micro-lending programs (small loans, often paired with mentoring).
• Government programs (grants, loan guarantees, tax credits).
• Venture capitalists (institutional equity investors seeking high growth & exit via IPO/exit).

Debt vs. Equity Financing – Core Concepts

• Debt financing: lend money expecting full repayment + interest.
  • Lender does not gain ownership.
• Equity financing: invest money for a share of ownership and future upside.
  • Investor participates in profits and governance.

Debt Financing – Advantages & Disadvantages

• Advantages
  • Retain full operational and ownership control.
  • Obligation ends once loan is repaid (finite term).
  • Possible to diversify by borrowing from multiple lenders.
  • Information requirements are usually well defined and standardized.
• Disadvantages
  • Misusing funds can create repayment difficulties and credit damage.
  • Mandatory servicing (interest & principal) regardless of business performance.
  • May require collateral and personal guarantees, risking personal assets.

Equity Financing – Advantages & Disadvantages

• Advantages
  • Brings additional expertise, networks, and credibility.
  • No legal obligation to repay funds if business fails (risk shared).
• Disadvantages
  • Potential incompatibility in vision, timeline, or management style.
  • Difficult and costly to unwind an ownership relationship.
  • Dilutes the founder’s share of future profits and control.

Finding the Right Capital Structure

• Objective: balance debt and equity to satisfy
  • $\text{Your personal risk tolerance (owner)}$
  • $\text{Operational and growth needs of the business}$
• Over-leveraging (too much debt) increases insolvency risk.
• Over-dilution (too much equity) may demotivate founders and complicate decisions.
• Iterative approach: begin with bootstrap + modest debt; add equity when scaling requires larger resources.

Detailed Types of Debt Financing

• Shareholder loans (inside debt lent by owners; flexible terms, subordinate to bank debt).
• Canada Small Business Financing (CSBF) loans (federally backed; lower collateral requirements, capped amounts).
• Operating loans / Lines of Credit (revolving, cover working capital fluctuations).
• Term loans (fixed schedule, often used for equipment, renovations, vehicles).

Detailed Types of Equity Financing

• Sole proprietorship/partnership capital (owner’s personal investment).
• Incorporated business structures:
  • Common shares (voting, residual claim on profits).
  • Preferred shares (priority dividends, limited voting rights).
  • Convertible debentures (hybrid: debt converting to equity under conditions).

Crowdfunding – An Emerging Alternative

• Definition (Dictionary.com): “raising money from a large number of people, typically through a website, for a project or small business.”
• Mechanics
  • Large crowd each contributes a small amount ⇒ reduces individual risk.
  • Campaign still requires meticulous planning: story, budget, perks, timeline.
  • Campaign traction doubles as market validation & early adopter community.
• Common models
  • Donations (philanthropic, no reward expected).
  • Rewards/pre-orders (backers receive product or perk).
  • Equity crowdfunding (ownership shares; subject to securities regulation – not referenced in transcript but industry context).
• Leading platforms (reward/pre-order focus)
  • Kickstarter: http://www.kickstarter.com
  • IndieGoGo: http://www.indiegogo.com
  • RocketHub: http://www.rockethub.com

Practical & Ethical Considerations Across All Financing Methods

• Transparency fosters trust—provide realistic projections and timely updates.
• Maintain written agreements to minimize misunderstandings (family, friends, angels, lenders).
• Align financing choice with growth strategy, risk profile, and exit plan.
• Preserve personal and professional relationships by separating emotion from financial decisions.