When to seek a loan for your innovation projects
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Let’s say you have an innovation project in mind for your business. You’d like to develop a novel product, acquire sophisticated new equipment or streamline your production processes. How will you pay for the project?
If you’re like most entrepreneurs, you’ll probably dig into your everyday cash, instead of seeking a business loan.
Only 5% of Canadian small and mid-sized entrepreneurs said they planned to get a loan to finance their innovation and R&D projects in 2016, according to a BDC survey of 4,000 entrepreneurs. Four in five said they would use internal funding. (The rest planned to use a line of credit or other financing, such as a credit card.)
Using cash can lead to a crunch
Using up your working capital for longer-term projects can cause problems for your cash flow. Even if you have solid profits and plenty of cash on hand at the moment, what happens if sales suddenly drop or you’re faced with unexpected costs?
An innovation project is best funded with a loan if it involves the purchase of long-term assets. You should try to match the loan’s term to the asset’s expected lifespan.
If you have several innovation initiatives, you may want to use both a term loan and your line of credit—each matched to the underlying asset or purpose. Here are some examples.
- Technology—Technology such as computers or other devices typically have a useful life of three to five years. If your innovation project involves buying such technology, a short-term small business loan is appropriate. That way you won’t still be paying for the item when you’re no longer using it.
- Equipment and machinery—If your project requires assets with a longer life such as vehicles or machinery, consider a medium- or long-term loan.
- Non-asset innovations—If your innovation project doesn’t involve an asset, it can still be useful to obtain a loan if you don’t expect an immediate payoff or don’t want to take risks with your cash flow. It’s helpful to prepare financial projections for your business to get an idea of your financing needs and potential innovation budget.
Talk to your banker
If you decide to seek a loan, talk to your banker about the best type of financing and term duration.
For example, a line of credit or a small loan may be suitable if you have a smaller-scale innovation in mind, but lack sufficient cash.
On the other hand, if you want to launch a new product, create an R&D centre or embark on innovations to improve your business productivity, it may be appropriate to seek a term loan or mezzanine financing (a specialized type of loan that requires minimal collateral).