How to finance an asset-light business

What type of companies tend to have few assets?

“Tech companies—particularly those that have not reached a certain level of maturity—often have few assets,” explains Dubé.

Some have offices, for example, but most do not. Their other assets are often intangible in that they cannot be seen or touched, such as patents or intellectual property. Because their value is more difficult to assess, they are less favoured by banks.

Here are some examples of companies with few assets to pledge as collateral:

Software as a service (SaaS) companies providing access to software on a subscription basis.
E-commerce companies, which often have inventory. These short-term assets are often less attractive to long-term lending institutions. That is because inventory is often financed on a short-term basis, using a line of credit, for example.
Cleantech companies sometimes own equipment. However, in many cases, there may not be enough equity in the equipment when it comes to meeting the company’s financing needs.
Companies in the media industry that typically have assets of lesser collateral value, such as filming equipment, in their early stages.

Why is securing a loan for a business with few assets more difficult?

A company with few assets cannot offer much in the way of collateral to secure a loan. The lending institution, therefore, takes on more risk by granting such a borrower a loan, as it will have difficulty recovering those funds should the business cease its operations.

Many start-ups in innovative sectors have few assets and a shorter track record. Their profits are often modest, as the funds are reinvested in the business. This makes obtaining institutional financing more difficult.

Why apply for financing?

Below are four of the main reasons why businesses with few assets apply for financing, according to Dubé.

1. Develop new technologies

Many companies have ideas for innovative projects such as developing new software or new technologies.

However, such projects may be difficult to finance using borrowed capital. There is a better chance that a company’s application will be accepted if it is already generating revenues and profits through its existing products or services.

2. Increase market share

Expanding into new markets may be an easier way to secure financing from lending institutions, says Dubé. This type of project can generate more revenues through a product or service with a proven track record in the market in which it was originally launched.

To that end, the company may want to invest in sales and marketing, for example.

3. Recruit

Lending institutions may also finance a recruitment project if it stands to generate additional revenues for the business.

4. Obtain certifications

Companies seeking to enter specific industries must obtain certifications. “Let’s consider the example of a company specializing in data hosting,” says Dubé. “To continue to grow, attract new customers and build confidence in the services provided, it will need to obtain certifications. To that end, it may apply for financing to cover the cost of cybersecurity consulting services, for example. Canadian companies collaborating with the military are also required to obtain certain certifications.”

What financing options are available to businesses with few assets?

Businesses with few assets to pledge as collateral often have limited access to financing. Here are three options that could benefit your business.

1. Cash flow financing

This type of financing is based on a company’s ability to generate positive cash flow in the future. In such cases, the lending institution determines that the company will make a profit at a specific point in time.

Since such loans do not involve pledging a particular asset as collateral, the terms and conditions differ greatly from those for a mortgage, for example. The interest rate is likely to be higher and the repayment period shorter. This implies a higher level of risk, which also leads to larger payouts. There is also a possibility that you will be asked to provide a personal guarantee, that is, a personal commitment to repay the loan should the business cease its operations.

This type of loan is usually short term, often less than seven years. However, there are a number of flexible, customized financing options available, such as subordinate financing, that can be adapted to meet a company’s needs in various situations.

2. Equity financing

This type of loan is a form of financing that involves obtaining funds in exchange for shares in a company.

Equity financing is widely used by businesses in the tech industry. Companies are not bound by set time limits and amounts to repay the funds raised, as is the case with loans, for example. It is often considered a form of patient capital in that it is a longer-term loan. It provides greater flexibility, making it possible to finish developing a product, for example. However, shareholders must give up shares in their company, which can be very costly and sometimes even lead to a loss of control.

Equity investors can offer advice and a network of contacts that could benefit the business.

Below is a summary of the advantages and disadvantages of both types of loans:

Advantages of cash flow financing

Business owners retain control and do not have to give up part of their equity stake in the company.
Interest on a loan is tax deductible, which can reduce a company’s tax burden.
Customizing repayment terms based on projected financial performance is sometimes possible, making it easier to anticipate cash requirements.

Disadvantages of cash flow financing

The loan must be repaid under various terms and conditions, which may reduce cash flow should revenues fall or projected profitability drop.
This type of loan requires a certain degree of cash flow stability.
Borrowing conditions are often more restrictive for businesses with few assets to pledge as collateral.

Advantages of equity financing

Unlike with loans, there is no obligation to repay funds secured through equity.
You may be able to benefit from greater strategic support.

Disadvantages of equity financing

Your shares will be diluted. This may eventually lead to the loss of some control over your business and cost you much more than the interest on a loan when the business is sold.
Raising capital using equity can be a long and costly process.

Combining both options

By combining the two financing options, you could benefit from the advantages of each and end up with an additional financial cushion.

For example, you could:

use equity financing to fund research and development projects for new products
use cash flow financing for market development and marketing

How do banks assess applications?

When financing applications are made, banks must ensure their investment is viable and secure, while considering the following questions.

Managerial quality

Do you have any entrepreneurial experience?
Have you been successful in the past?
Do you have a strong management team in place?

Ability to secure financing

You may have received contributions from friends and family, but have you ever been able to attract angel investors, venture capitalists or institutional private equity firms?
If your company runs into financial difficulty, will you be able to raise equity capital or approach other financial institutions?