There are more ways to get a small business loan in Canada than ever before. This is because new lenders and solutions have emerged to meet the needs of small businesses. Unfortunately, many business owners don’t know all their options and find it difficult to understand which solution is right for them. As the Chairman of the Canadian Lenders Association and President of Lendified, I’m on a mission to educate the business community and help fix this problem.
Here is an overview of the most common business loan options available today. You can jump to any section by clicking on the topics listed in the table of contents. I hope this information helps you make the best financing decision for your business and invite you to share the guide with others who could benefit from it.
Sincerely,
If you begin searching online for the different types of small business loans you may start to think there are infinite options. Don’t get distracted by all the creative names lenders have come up with to describe their loans such as “Flexible Payment Solution”. There are modern twists on traditional products, but almost every solution fits into one of these categories:
Personal Loan and Credit Cards ⇩
Installment Loan
What it is
An installment loan, also known as term loan, is a loan for a fixed amount that is repaid in a series of installments over a fixed period of time. You are likely familiar with long term loans such as those offered by banks; however, alternative lenders have introduced options with shorter terms which are used as a working capital loan.
Amounts
Term loans can range from $5,000 to millions. It really depends on what you need the capital for and how much you qualify for.
Duration
Terms vary according to the lender and your needs. Banks typically provide installment loans ranging from 2 to 7 years for working capital and up to 25 years for real estate. On the other hand, alternative lenders offer short term business loans that are designed for working capital needs and typically range from 3 months to 2 years.
Payments
In most cases, payments for installment loans are a fixed amount which includes principal and interest. These are normally paid bi-weekly or monthly, which makes it easy for business owners to manage their cash flow. The only exception is when you have a floating interest rate, which is only used occasionally by banks and would cause your payments to fluctuate.
Application process
Traditional lenders likely will require a variety of documents to be provided in person and online, while alternative lenders will request basic information about you, your business, and bank statements for the last 3 to 12 months.
Approval time
Traditional lenders can take upwards of a month to approve a term loan, while alternative lenders take between 1 to 7 days.
Security
Banks will require you to provide collateral, a personal guarantee, and sign a general security agreement. Most alternative lenders do not require specific collateral, especially if the business loan is unsecured.
Best for
Installment loans are ideal for established businesses who can demonstrate that they have positive cash flow. Longer term loans are often used for things like real estate while shorter terms are used for working capital or to provide a bridge to other financing.
Alternative lenders mostly provide installment loans to those who can’t get enough capital from their bank.
Line of Credit
What it is
A line of credit gives small business owners access to a pool of funds whenever needed. When the funds have been used, interest is charged on the outstanding balance. After the balance is repaid, the line of credit reverts to its original balance.
Amounts
The credit limit available is based on your revenue, other debt obligations, your credit score, and anything else that could effect your ability to repay the debt. Also, your ability to provide collateral to secure the line of credit may allow you to be approved for more funding.
Duration
The “draw period” is the set time frame that the funds is allowed to be taken from the account. This draw period can last several years, depending on the agreement established.
Payments
The interest rate on a line of credit is usually variable, meaning it may fluctuate over time. The interest rates the borrower pays on a line of credit is often affected by their credit score.
Application process
A line of credit application can be done online and in-person. The process requires you to submit the following documentation:
- Government issued pieces of identification
- Size of your business’ income and assets
- Historical financial statements
- Profit and loss history
- Proof you’ve been in operation for at least 6 to 12 months
Approval time
Lines of credit can typically be approved in 3 to 14 days.
Security
A line of credit can be either secured or unsecured. A secured line of credit requires a business to use an asset to secure the line. In this situation, the business is not able to repay the line of credit debt, then the lender is able to assume ownership of that collateral. An unsecured line of credit, doesn’t have any collateral attached to it, so a lender may ask for a personal guarantee and a stronger credit profile to approve the agreement.
Best for
We find that a line of credit is most useful for businesses with fluctuating cash flow and seasonal revenue.
Merchant Cash Advance
What it is
A merchant cash advance (MCA) is technically not a business loan. It’s a lump-sum advance given to a business in exchange for a percentage of their future credit and/or debit card sales.
Amounts
The maximum amount available to you is normally capped at 10% of your annual sales.
Duration
Merchant cash advances do not have a fixed term. You will continue to make payments until the balance and fees are paid off. In most cases, the term ends up being between 6 and 18 months.
Payments
Payments are calculated as a percentage of your daily sales volume and are either taken directly from your card processor or an account controlled by the merchant advance provider. Some business owners like the ebbs and flows of this setup; however, others find it difficult to manage the constant payments.
Application process
Most MCA applications are done online and require your business to provide the following:
- Annual revenue / average monthly revenue of credit or debit card sales
- Business tax returns
- Bank account statements
- Several months of credit card or payments processing data
Approval time
Historically, merchant cash advances are one of the fastest forms of funding available. Some lenders can provide business owners with an approval and funding in 72 hours or less.
Security
Similar to a term loan, a merchant advance provider will require a personal guarantee and general security agreement.
Best for
A merchant cash advance is suited for businesses that have strong credit/debit card sales and aren’t able to qualify for other types of funding. This is because a merchant advance can be very expensive and come with risks any business owner should know before committing to one. Unfortunately, each week we hear stories of business owners being convinced to get a merchant cash advance without fully understanding what they were getting into.
Invoice Factoring
What it is
Invoice factoring is when a business sells their accounts payable or invoices to a lender for a discount. Once a business assigns their account, they then receive what is called an advance rate. This rate is usually 80% of the value of the factored invoice. The lender then collects the payment from the invoiced client, and forwards it to the business after deducting a service fee.
Amounts
How much you can borrow depends on the amount of the invoice. The creditworthiness of your customer is also important. For example, you will likely be able to borrow a higher % of an invoice if it is from a big company like Costco.
Duration
You can usually borrow against invoices for a period between 90-120 days.
Payments
Once the lender collects the payment from your client, they will take a fee and forward you the remaining funds. This fee is usually 0.5% to 5% of the invoice amount per month.
Application process
An invoice factoring application is typically done online. Examples of the information you will likely have to provide include:
- Accounts receivables / payable aging report
- Details of outstanding invoices to be funded
- Commercial credit of your clients
- Invoices that are payable within 90 days and free of liens
Approval time
Getting approved for invoice factoring can happen in as fast as 24 hours.
Security
The purchased invoice often represents all the collateral you need to provide.
Best for
We recommend using invoice factoring to only fix temporary cash flow problems. We believe that factoring shouldn’t be viewed as a long-term solution due to its high cost. Factoring is often used by companies that need to pay expenses before they are able to collect on their invoices. These companies have increasing accounts receivable balances that caused by either a boost in revenue or customers with extended payment terms.
Equipment Lease
What it is
An equipment lease is an extended rental agreement under which the owner of the equipment allows you to use the equipment in exchange for periodic lease payments. You will find that this option is similar to the approach taken when you lease a car.
Amounts
Leases can vary from a few thousand dollars to millions, depending on the value of the equipment. For example, one company might lease furniture while another leases aircraft. It is important to know that many leases require a down payment.
Duration
Terms for equipment leases are based on the useful life of the equipment so it depends on the type of equipment you are getting. At the end of the term, you normally will have the option to buy the equipment at its fair market value, extend the lease, or give the equipment back.
Payments
Lease payments are typically paid in fixed monthly installments and are based on a variety of factors including the type of lease, residual value of the equipment, term, and your business history. You may be able to deduct your monthly rental payment or the cost of the equipment to get some tax benefits. We recommend that you speak to a CPA to confirm this before making a decision.
Application process
Equipment loans can be done in person through a bank which may require a business plan. Meanwhile, private lenders allow the application to be quickly done online. Both types of lenders will ask for the following information:
- References from banks and trades
- Personal and/or credit bureau ratings
- Equipment information and location
Approval time
You can generally get approved for a lease within a few days.
Security
An equipment lease typically uses the equipment as collateral and doesn’t require a general lien on the business.
Best for
An equipment lease is best for companies who deal with rapidly changing technology or need equipment for a short amount of time to complete a project. This option is very popular in industries such as agriculture, medical, and oil and gas. We suggest weighing the pros and cons of using equipment leasing before committing to an equipment lease.
Commercial Mortgage
What it is
A commercial mortgage is a loan secured by a commercial real estate such as a shopping centre or office building.
Amounts
A lender uses a loan-to-value (LTV) ratio to assess the loan amount relative to the value of the property. Banks generally finance between 65% to 80% of the value of commercial real estate, which will most often lead to mortgage between $250,000 and $25,000,000.
Duration
The term of a commercial mortgage typically ranges from 5 to 20 years.
Payments
Lenders expect a down payment of 20-35% of the value of the property. A larger payment known as a balloon payment is made at the end of the loan to pay off the remaining principal. Commercial mortgages may also have prepayment restrictions. This is a penalty designed to deter you from paying the debt before a loan’s maturity date.
Application process
Lenders will evaluate the following when considering offering you a mortgage:
- Debt service coverage ratio – this is the ratio of cash available to the required loan payments
- Your credit history
- Your business’s profitability and financial projections
Approval time
An application for a commercial mortgage takes a few weeks to complete.
Security
This type of business loan uses the subject commercial property as collateral.
Best for
Commercial mortgages are ideal for those looking to purchase real estate they currently lease or build a new location.
Business Credit Card
There are 5 main sources small business owners go to get loans in Canada:
Traditional Lenders
Many Canadians think of the Big 5 Banks when asked what the traditional approach is to getting a business loan. These large financial institutions dominate the banking industry, but there are other traditional lenders including credit unions and smaller banks that offer financing.
What they offer
We see Canadian banks and credit unions offering all types of loans except for invoice factoring and merchant cash advances. The most common are mortgages, credit lines, and installment loans.
Who they serve
Although traditional lenders have programs and products to help those starting a business, they tend to focus on serving established businesses that can provide collateral. These lenders can be conservative and decline businesses for a variety of reasons. This is understandable since they make very little money from smaller business loans, find it difficult to scale up their lending efforts, and want to avoid the risk of getting bad publicity for charging higher rates (even if the rates are appropriate for the risk they’re taking).
You may see some traditional lenders partnering with alternative lenders to broaden the segment of the business community they serve. This is an exciting trend unfolding in Canada that will only improve your access to capital.
Pros and Cons
Pros
- Lowest cost of capital
- Products for those starting a business
- Other services in addition to financing
Cons
- Lowest approval rate
- Lengthy and difficult application process
- Most likely to require collateral
Our advice
While traditional lenders can be very conservative, we suggest building a relationship with a few of them. This will help you eventually access capital at the lowest cost possible, even though the process of getting a loan may be more involved.
Alternative Lenders
The phrase “alternative lender” is an overarching description for any small business lender that isn’t associated with a traditional bank or credit union. These lenders are often considered online lenders or “fintech” companies because they deliver financial products and experiences by leveraging technology. In a relatively short amount of time, alternative lenders have become the fastest growing group of lenders in Canada. In fact, some estimate that over $1 billion in alternative lending solutions has already been delivered to small businesses.
What they offer
Alternative lenders in Canada currently offer all types of business loans, except for long term installment loans and commercial mortgages.
Who they serve
Alternative lenders serve business owners who can’t get enough capital from their bank, need funding quickly to capitalize on an opportunity, or are simply looking for an easier process. They do not fund those looking to start a business.
Pros and Cons
Pros
- Higher approval rates than traditional lenders
- More short term options
- Faster and simpler process
Cons
- Payments can be more frequent depending on the lender and loan type
- Rates can vary from just above bank rates to very high
- Not all alternative lenders are equally credible
Our advice
See what an alternative lender can offer you and make sure they are trustworthy. Also, find a lender that only runs a soft credit check so you can get a quote without having your credit affected.
Government
Business Loan Interest Rates and Fees
When to Get a Business Loan
Sometimes it is a great idea to use a business loan to take the next step in your business. Other times it may prevent your business from moving forward. Below we provide an overview of the main indicators for both scenarios.
When Not to Get a Business Loan ⇩
When to Get a Business Loan
To Capitalize on an Opportunity
A business opportunity could come in various forms. We see a lot of small business owners using a loan to:
- Renovate their space
- Open a new location
- Invest in training and develop new staff
- Launch a marketing campaign
- Purchase inventory for busy seasons
- Buy new equipment to improve productivity
- Hire staff
Regardless of the opportunity, make sure the potential return outweighs the costs.
To Increase Working Capital
Working capital is the cash used to manage your daily operations. Sometimes it’s necessary for businesses to take out a working capital loan to cover their daily expenses until they are cash flow positive again. For example, it is common for seasonal businesses to get a loan to stock up on inventory for busier seasons.
To Build Business Credit
As a business owner you always want to be building your business credit. Without a strong credit score, you may find it difficult or increasingly expensive to get the funding you need. We recommend that you build your business credit by taking out a smaller loan while making your payments on time. This tactic proves that you are financially responsible which will strengthen your business credit score.
To Refinance Other Debt
Some forms of business financing are more expensive than others. For example, Merchant Cash Advances are known to be more costly than installment loans. Many small business owners use a business loan to refinance one or many other loans. If you’ve found yourself in this situation, you should consider consolidating your debt. There are many solutions that can help you consolidate your debt at a lower rate, which will help save your time and money.
To Handle A Surprise
Every entrepreneur has run into a surprise they weren’t expecting. From broken equipment to floods, a business loan can help you bounce back.
When Not to Get a Business Loan
To Pursue A High-Risk Opportunity
Not every business idea is a home run. Before you take on debt, you should consider if the investment is the best move for your company. For example, you should re-think investing $20,000 into a marketing video that you hope will go viral. These types of investments may have potential, but the risk/return trade-off isn’t worth it.
When You’re Struggling to Pay Your Other Obligations
When you apply for a loan, the lender will do their best to determine the money going in and out of your business. This is to ensure that you’ll be able to repay both your existing obligations and your new loan. If you can’t meet your current obligations, taking on more debt may just put you in a deeper hole.
Expert Tip
“It’s important to know if the benefits of the opportunity will outweigh your costs. You can lose out on opportunities to grow your business if you don’t secure the funding you need to get there.” – Eoghan Bergin, Small Business Funding Specialist
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