Debt Funding

Debt funding is also a viable funding option for many startups. With debt funding, you borrow cash that you will have to pay back, regardless of whether or not your company is making a profit. While you may choose to incur debt (i.e. borrow cash) from friends and family, there are other kinds of debt funding you could also pursue. The most common are:

• Venture debt

  In some ways, this kind of debt feels a lot like equity — at least in the short term. The difference comes in the long term: at some point, you will have to repay this debt, regardless of company performance. For term loans, typically repayment terms are multi-year (i.e., three years being the most common term.). Non-formula lines of credit usually have a shorter term of just one year.

• AR line

  AR lines (i.e., accounts receivable-based credit lines) can be a great funding option if you are already generating revenue. It’s cheaper and less risky than other forms of venture debt. There are many lenders who are willing to finance accounts receivable. If you are experiencing a working capital gap between the time it takes to collect and make payments, you can leverage your billed accounts receivable at a significantly discounted rate. In other words, you’re essentially taking out a loan on payments yet to be paid. Most of what we see with our clients in terms of debt funding is venture debt and/or AR lines.

• Asset loan

  This is essentially a loan that is collateralized by equipment. If you need a significant amount of capital equipment, you can finance these purchases. This kind of loan doesn’t always require the equipment you are purchasing to be specifically tied to the funding you receive. Sometimes you can even use this loan to fund growth in other areas. This kind of debt is pretty hard to get, so we don’t see it too often. But it’s worth seeking out if you have equipment needs.

• SBA loan

  These are bank loans guaranteed by the Small Business Administration (SBA), usually with a lower interest rate than that of loans not guaranteed by the SBA. This guarantee doesn’t mean that you are off the hook if your business fails. In that case, you still need to pay back the loan. The main advantage to this type of loan is access: with the backing of the SBA, you might be approved for loans that you wouldn’t have received otherwise. Though none of our clients have received SBA loans, it’s still worth looking into if you’re a new startup in need of funds.

Now that you have a basic understanding of the most common funding types, you’re ready to take your company to the next level. First outline exactly what that “next level” looks like — specifically, what milestones do you hope to achieve? Then use these milestones to create financial projections that you can use to calculate how much funding you will need and what funding type is the best bet for your company.

David Ehrenberg is the founder and CEO of Early Growth Financial Services, a financial services firm providing a complete suite of financial services to companies at every stage of the development process. He’s a financial expert and startup mentor, whose passion is helping businesses focus on what they do best. Follow David @EarlyGrowthFS.