Commercial Banking
The Aga Khan Economic Planning Board for Canada is pleased to provide Jamati business owners with a general overview of commercial banking and related key insights. In addition, we are pleased to present an opportunity to speak directly with the Business Development Bank of Canada (“BDC”). BDC can help you explore commercial lending options with your bank, government capital support programs, financing for newcomers to Canada that choose to own a business and direction to partnering resources & services that may be able to support business owners.
Also discussed below are insights on general financing sources for your business including commercial banks, credit unions and private lenders. In addition, this page will explore different forms of financing including term loans, lines of credit, and specifically pertaining to real estate: commercial mortgages.
While obtaining credit is an important option to consider when financing your business, it does not come without certain risks. This page aims to help the Jamat learn and better understand some of the risks that must be considered together with the benefits using commercial banking debt.
Additionally, the Ismaili Business Support Network - Referral Program (IBSN), aims to assist Ismaili Business Owners with short-term challenges, recover from the COVID crisis, and position themselves to prosper! IBSN’s referral network of Ismaili professionals is able to provide relevant 1:1 guidance in various business areas free of charge for a minimum of 30 minutes lasting up to a maximum of 60 minutes for each business area query. Click here to ask your question or request support from an expert!
This information page is categorized into the following insights and resources:
- Direct BDC Contact for Business Owners
- Commercial Banking Services and Why You May Need Them
- Key Components of Debt and Associated Risks
- Steps to Take When Approaching a Commercial Bank
The information on this page and its contents are intended for general informational purposes only and are not intended to be professional advice nor the advice of the Shia Imami Ismaili Council for Canada or its boards, portfolios, or local councils, including the Aga Khan Economic Planning Board for Canada. Please seek the advice of a relevant professional advisor in relation to your specific situation.
It is critical that all business owners seek professional advice through their team of advisors that may include a CPA designated accountant and qualified legal counsel while exploring all available lenders to assist in determining optimal debt strategies.
The Aga Khan Economic Planning Board has launched the Business Development Bank of Canada (BDC) Initiative where BDC regional leaders stand by to take questions from Jamati business owners on commercial banking and other business issues.
Please click here to access a direct conversation with a regional BDC leader to discuss your questions about commercial banking, government finance support programs, the Newcomer Entrepreneur Loan, the Canadian Small Business Financing Loan program and related areas of interest.
Debt can be a prudent way to raise the necessary capital to expand business operations whether it be to buy new property, plant & equipment, purchase more inventory, hire more staff or make other beneficial capital expenditures. It can also be used to help move a business forward through a period of change or support the business during a temporary shock, such as the current pandemic, which is of greater risk due to changes in the market.
It is important to note that debt financing will not improve poor management, increase demand for poor quality products/services, or fix any major issues with a business on its own. In these situations, debt financing may cause more problems than it can fix.
Three main forms of debt that you may be able to receive from your commercial banking service provider: a term loan, a line of credit (unsecured or secured) and specifically pertaining to real estate: a commercial mortgage.
These different forms of debt each have different risks and requirements which the borrower should be aware of. As with any agreement, you must ensure you fully understand the terms of the agreement prior to signing, in particular paying attention to repayment terms, interest rate, operating and control restrictions, and of critical importance, terms and guarantees, which can be secured on personal and corporate assets. It is important to have a team of qualified legal and CPA accounting advisors to assist in deciding whether a loan agreement is right for you and your business.
It is also important to remember that you are required to pay back any loan you or your business takes on.
Term Loans
Conventional term loans generally provide borrowers with funds for a particular purpose (asset purchase, acquisition, project, etc.). Upon drawdown, term loans require repayment of principal and interest payments every month for a set period of time known as a Term and Amortization. Term being the amount of time the lender has committed funds to a borrower (so long as they meet their obligations) and Amortization being the life of the entire loan (from drawdown to full repayment).
Term loans may come with conditions or covenants to be met on an annual or quarterly basis. If these conditions are not met at the review period, the lender has the ability to demand repayment of the loan as the obligations of the borrower are not being met. In most cases, a breach of conditions or covenants will warrant a discussion with the lender and a plan to correct the breaches. Guarantees provided to the bank from the borrower would be used to repay the term loan should there be a breach of obligations or the bank no longer is able to finance the business.
Term loans can range from as little as a year to 10 years in normal practice but these term lengths can also be negotiated with your lender prior to acceptance of an agreement. Interest rates can be fixed for a term or can be variable, usually based off of the bank’s prime rate plus an associated spread. More information can be found here along with a loan calculator from BDC:
https://www.investopedia.com/terms/t/termloan.asp
https://www.bdc.ca/en/articles-tools/entrepreneur-toolkit/financial-tools/business-loan-calculator
Lines of Credit
Lines of credit are loans that do not have a fixed term of repayment and normally have a higher interest rate due to the flexibility such a loan provides. Generally, lines of credit fill a gap in working capital requirements of a business. As an example, lines of credit could be used to bridge the gap between awaiting payment from a client and the cost of producing a good or service. These, and many available forms of loans (including Term Loans above) may require the borrower to provide security to the lender to ensure that the loan gets paid back. Security can be provided based on the borrower’s personal assets and assets of the business. Generally, loans without collateral will incur higher interest rates and administration fees.
Interest is paid on a monthly basis and the minimum payment generally required would be the interest accrued during the month and is based on the amount that is “drawn” on the line of credit. Keep in mind borrowers are still responsible for repaying the entire principal amount, however there is no set timeline to repay the principal as long as you continue to pay the stated interest on time and in full and within the terms outlined in your banking agreement.
In certain cases, the principal amount can potentially be due “on demand”. This means the bank can demand the entire principal amount due payable immediately should the borrower fail to satisfy the terms of the banking agreement such as not making payments in a timely manner or other material aspects of the agreement are breached. In certain cases, a lender may also choose to demand the loan if market circumstances outside of your control change as well, even though you have satisfied all your obligations otherwise.
Commercial Mortgages
Commercial mortgages are similar to any mortgage on a residential or investment property however, they are secured against a commercial property where a business operates.
Generally, net operating income (rental income less property expenses) would be used to assess the ability to meet monthly mortgage payments and assess the value of the property.
In "owner- occupied" cases where the business owns the building or the retail/office space where it operates, the cashflows of the business can be used to assess the ability to meet monthly mortgage payments. Lenders will often require that a borrower be able to demonstrate that they can more that meet their annual mortgage requirements with income from the property or from their business.
Commercial mortgages generally will be amortized over 20 to 25 years and can have either a variable or fixed interest rate. With a variable rate, the rate may go up or down depending on the lender’s “prime interest rate”. With a fixed rate, the interest rate will stay fixed from the beginning of the term to the end. In general, mortgage rates are lower than term loans and are repaid over a longer period meaning that the monthly payments on a mortgage will be lower than a conventional term loan.
Types of Lenders
Traditional Commercial Banks
Traditional banks make up the bulk of institutional lenders and are the most common option for most businesses and consumers. The biggest banks, also know as the “Big Five” banks in Canada are: RBC, TD, Scotiabank, BMO and CIBC.
Access to capital from these banks often comes with certain operating and financial restrictions. The intention of these banks is to lend to those businesses that have a sound business model, strong opportunities for success and good management.
Traditional Credit Unions
Credit Unions are another type of traditional lender with mandates that are usually centered around small business and building up a community’s business environment and well-being. Therefore, they often can have products or services with less restrictive requirements than the big banks. They may also be able to provide more customized debt options compared to traditional commercial banks.
Debt financing through the large banks and credit unions are generally the most affordable, provide the best support services and are the most desirable.
Business Development Bank of Canada
Business Development Bank of Canada (“BDC”) is a national development bank that is owned by the Government of Canada. Its mandate is to help create and develop all Canadian businesses, across all industries through access to financing, growth and transition capital, venture capital and advisory services, with a focus on small and medium-sized enterprises.
BDC provides the same category of debt options as traditional banks, however, they may be more likely to lend to those companies that are unable to obtain a loan from a traditional bank. BDC is a very good option for new business ventures should a traditional bank be unable to provide credit options. With their more flexible lending parameters, cost of financing may be more expensive than traditional banks.
Canadian Small Business Financing Loans
In addition to BDC, there is a nationally guaranteed loan program for small businesses called the Canadian Small Business Financing Loan (“CSBFL”) program. This loan is majority guaranteed by the government (up to 75% in most cases) and can fund up to 90% of the eligible costs of financing new assets such as machinery, commercial property and equipment. These loans are facilitated through banks and credit unions. Some financial institutions do not participate in this program but the majority do. Loans of this nature can be up to $1 million but cannot be used to finance goodwill, inventory, or working capital among other restrictions. Interest rates depend on the borrower’s credit rating but may not exceed the lender’s prime rate + 3%. For more information, please see the below links:
https://www.ic.gc.ca/eic/site/csbfp-pfpec.nsf/eng/home
Secondary or Mezzanine Lenders
Secondary or Mezzanine lenders aim to provide short-term financing options to those borrowers who are unable to obtain debt from traditional banks at a certain point in time. While these lenders will provide financing to higher risk borrowers and businesses for a short-term need with higher risk, these loans will require a higher interest rate.
Mezzanine debt should only be considered after comprehensive due diligence on the borrower’s business stability and ability to payback the loan through a traditional bank, sale or further investment.
https://www.thebalance.com/what-is-a-mezzanine-loan-debt-and-equity-financing-4687180
Private Lenders, Credit Cards
There are private lenders who will also provide high-cost debt to those borrowers unable to secure financing from traditional banks or secondary financiers. In addition, several credit cards will propose financing options to corporate borrowers, which would have incredibly high costs and limited flexibility in loan terms or support during challenging times. These borrowers or the company itself may likely be deemed to be high risk if all other sources of debt financing has been denied. Such elevated risk lending will generally have very expensive rates and fees, very restrictive terms and require significant personal and business security.
It is important to be very cautious in taking on loans from private lenders and funding your business through credit card financing. Below is a graph of the relationship between the risk and cost of financing options:
Definitions in Typical Loan Agreements
It is essential that one takes the time to carefully read and understand the terms of each loan agreement that is under consideration. All contracts are not made equal and can have different terms including cost of financing, operating and financial requirements, guarantees and security. It is critical to seek advice from an experienced corporate lawyer and accountant among other advisors that can provide guidance on your business. Ultimately, the borrower must make the final decision on what terms to accept and take responsibility to pay back the loan.
We have provided a glossary of commonly used terms in loan agreements for a general understanding of terms that may appear on loan agreements:
https://hls.harvard.edu/dept/sfs/glossary-of-loan-terms/
Personal vs. Corporate Guarantees
Guarantees are agreements to pay back a loan. The agreement can be for the company itself to pay back the loan and/or in many instances, an agreement that the individual personally will pay back the loan. In this situation, the lender will have the right to a borrower’s personal wealth and assets, such as the borrower’s family home, to pay back the outstanding loan. A personal guarantee agreement would still be enforceable even if the business itself is bankrupt.
Personal guarantees are often requested in financing arrangements, especially in owner-operator scenarios. It is important that borrowers understand the risks and the ability of their business to meet the obligations of lending arrangements so as to limit the risk of a call on personal guarantees. Personal guarantees can be discussed and negotiated with most lenders, (for example limiting to a dollar value).
A corporate guarantee is an agreement for a borrower’s company or companies to provide the guarantee. The lender usually cannot force the sale of any personal assets in the situation where only corporate guarantees were given, however, some exclusions apply to this rule. Please consult with a legal expert prior to engaging in an agreement with any form of guarantee whether personal or corporate.
In both cases, it is important to negotiate away from or some limitation to any guarantees that are required. While this will be difficult in new banking relationships or new businesses, significant thought and consideration must be placed on this item.
More information regarding this topic can be found here:
https://www.lawdepot.ca/law-library/faq/personal-corporate-guarantee-faq-canada/#.X5neGYhKiUk
https://corporatefinanceinstitute.com/resources/knowledge/credit/corporate-guarantee/
Defining What You Need
Borrowers must approach a bank with a strong business plan. A plan will provide confidence to the bank about the long-term potential success of your business, ensure you borrow only what is reasonably required and have the ability to pay back the loan.
Please note that each lender is generally open, and at times will expect, to negotiate and change certain terms of the loan.
Borrowers should explore several sources of debt for the best terms and rates and seek professional advice from your accountant, lawyer and other important advisors related to your business prior to agreeing to a loan.
More resources and a downloadable business plan template can be found here:
Business Plan Template
Guide to Getting a Business Loan
https://www.bdc.ca/en/articles-tools/money-finance/get-financing/how-to-get-business-loan-canada
Tips for Negotiating a Term Loan
https://hbr.org/1982/03/how-to-negotiate-a-term-loan
https://www.businessnewsdaily.com/11097-negotiating-tips-business-loan.html
Preparing to Meet with Your Bank
How to Build and Maintain a Relationship with a Bank
A positive, open and trusting relationship with your bank is critical to ensure that your business succeeds and will likely, over time, result in more favorable terms and costs. The better and longer a relationship is with a bank, the easier and cheaper it will be to finance your business and increase the chances of a successful business. Also, maintaining a strong banking relationship may provide greater support during periods of market instability and when managing business challenges.
More information can be found here:
https://www.allbusiness.com/how-to-build-a-better-relationship-with-your-bank-15604653-1.html
https://newdirectioncapital.com/build-good-relationship-bank/
https://www.investopedia.com/terms/r/relationship-banking.asp