Kevin Whittam, Kashif Zaman
Canada offers business opportunities to those seeking to finance a foreign business in Canada and there is a wide range of financing options available in Canada for new and expanding businesses. These options range from shareholder infusions of capital to sophisticated institutional financing.
A Canadian entity (whether corporation or partnership) operating as a new business in a Canadian province such as Ontario, is often initially funded solely by its shareholders by way of equity, debt or a combination of the two.
External Debt Financing
When a Canadian entity needs external financing, third-party lenders will typically require that any shareholder loans (and any security for such loans) be deeply subordinated to the third-party debt.
Types of Loans
Third-party financiers typically offer a business an operating or term loan, or a combination of the two, which can be provided on an unsecured or secured basis.
Operating or revolving loans are typically provided on a short- to medium-term basis to finance the company’s working capital requirements, acquisitions, recapitalizations and capital expenditure projects.
Term loans are usually medium- to long-term loans available for a fixed period of time and repayable on the occurrence of prescribed events of default or on demand. They are often amortized over the term of the loan, with required periodic payments of principal and a bullet payment at the end of the term. Regularly scheduled interest payments are usually required.
Loans will most commonly be made available in Canadian or U.S. dollars, with interest charged on the basis of a Canadian bank prime rate for Canadian dollar loans or U.S. base rate for U.S. dollar loans. There is also a LIBOR (London Interbank Offered Rate) option for U.S. dollar loans. Bankers’ acceptances are also available.
Lenders often require a borrower to provide, at a minimum, security over the assets being financed and, in many cases, over all of the borrower’s personal and real property, including after-acquired property. If a revolving facility (a type of credit facility which allows a company the flexibility to drawdown, repay and re-draw on the loans advanced under the credit facility) is being provided to a company by a different lender than the term lender, the term lender may require a second lien on the primary collateral security of the revolving lender and vice versa. Lenders also may require parent holding companies, subsidiary companies and individual shareholders to provide guarantees and security as additional credit support.
Each of the common-law provinces in Canada has enacted personal property security legislation that is similar to the U.S. Uniform Commercial Code Art. 9 regime that governs the creation, registration and enforcement of security on personal property. Ontario and most of the other provinces in Canada have also enacted securities transfer legislation, modeled on the U.S. Uniform Securities Transfer Act, creating a comprehensive set of rules for the transfer of securities and other investment property (including the creation of security interests in such property). The Civil Code of Québec governs such matters in Québec. The federal Bank Act also permits banks to receive security over raw materials, work in progress and finished goods inventory, as well as other specified assets and equipment. Sources of debt financing include domestic Canadian banks, foreign banks (which operate subsidiaries and branches in Canada), “near” banks and other financial institutions.
Domestic and foreign banks
The domestic Canadian banks offer debt financing and provide cash management and investment services. Most domestic chartered banks have a highly developed network of branch operations throughout the country. Since some of them also have a presence in the U.S. and internationally, these banks can be a useful liaison for a foreign investor establishing a business in Canada.
The federal Bank Act governs the activities of domestic and foreign banks operating in Canada. It authorizes Schedule I (domestic) banks and Schedule II
(foreign subsidiary) banks that are controlled by foreign banks to conduct a full banking business in Canada including the ability to accept retail deposits. As well, Schedule III banks (foreign bank branches of foreign banks), are able to conduct a full banking business in Canada except they may not accept retail deposits.
While unable to take deposits, life insurance companies in Canada manage segregated investment funds, including pension funds, and provide medium-to long-term financing. Trust and loan companies in Canada are generally incorporated under the federal Trust and Loan Companies Act and take deposits and provide debt financing.
Credit unions, “caisses populaires” in Québec and the financing arms of major industrial companies and hedge funds also provide financing. In addition, financing can be secured from conventional real estate mortgage lenders for real property.
Other financing sources
Acquiring capital assets from a manufacturer on a conditional sale basis or by way of a lease, either on an operating or capital basis, allows a company to pay for assets from its regular cash flow over time, reduce or eliminate the need for a substantial initial payment, and secure tax and/or accounting advantages. Many lease finance companies will buy assets specified by the company and then lease those assets to the company, allowing the company to convert its existing assets to capital while retaining use of those underlying assets in the business.
A company may sell its accounts receivables to a factor who will advance a percentage of the amount of the receivables. When its receivables are paid in full, the company will receive the balance of the amount, less any fees and interest charged by the factor.
In a securitization, certain assets of a corporation are pooled and transferred into a separate legal entity which finances the purchase of this portfolio by issuing debt or debt-like instruments into the capital markets, secured by the portfolio assets. Securitization can offer competitive pricing since pricing is based on the quality of the assets and credit enhancements, rather than on a company’s corporate covenants.
External Equity Financing
Private equity (PE) funds provide equity capital to companies that typically have high growth potential. In Canada PE funds have been particularly active in financing buyouts. The strategies adopted by PE funds can vary significantly, depending on the stage of a company’s life at which the investment is made. These funds may provide “seed” or start-up capital, as well as financing for expansion and development, to assist in a rescue/turnaround or to fund a buyout. Many private equity funds will focus in a particular industry or geographic niche.
Venture capitalists (VCs) are considered a subset of private equity. VCs are private or publicly sponsored pools of capital that are interested in taking a minority equity position in a company in exchange for significant influence over the management and direction of the company. VCs may also make debt financing available, for example, through subordinated, convertible or mezzanine debt.
VCs often invest in a company at the early stages of development, before sufficient predictable cash flows have been generated to attract institutional debt financing. VCs have a fairly strong presence in the IT, clean technology and life-science sectors.
Government Assistance Programs
Many federal direct subsidy programs have shifted toward repayable loans. Others no longer offer government loans, but rather facilitate financing through commercial loans and bank financing. The federal Business Development Bank of Canada provides business loans, loan guarantees and export financing; offers management training programs; and has formed strategic alliances with many domestic banks. Export Development Canada provides financial assistance to exporters.
Also, both the federal and provincial governments offer investment programs which will provide equity capital to businesses, often partnering with private equity or venture capital firms. Examples of these include BDC Venture Capital and the Ontario Energy Technologies Fund.