Every startup would need funding to fuel a business idea. The startup capital would usually come from the CEO’s pocket. However, as time goes by, the business would need more capital for growth and expansion purposes which could be generated from external sources.
Raising funds from the market would provide you several options such as the following: crowdfunding, equity financing, government aids, and debt funding.
What Is Debt Funding?
Debt funding refers to an investor lending funds to a business or enterprise at a certain agreed period of time and with corresponding interest. It would be similar to that of buying stocks or bonds in exchange for funding which serves as a certificate of the loan. The interest rates for debt funding are remarkably high especially for startup ventures because it’s a high-risk loan in case a business goes bankrupt.
In the case of Equity Financing, funding won’t require startups to pay back the loan however the investor gets a position in the Board of Directors or BOD and has direct involvement or say when in comes to making business decisions.
It goes without saying that this is the huge advantage of going for debt funding because your only responsibility would be to pay off the loan amount plus accrued interest on the pre-set time and the investor would have no role in the business. This would provide startups total freedom to man their empire without any external manipulations.
What Are Your Options?
Yes, you do have tons of options in securing a loan. However, every wise CEO must assess his or her startup needs and also capacity to make repayments before taking out a loan.
Short-Term Loan
There are additional expenses that a startup would need to take care of apart from the capital. Such expenses would include rental and maintenance costs, employee wages, recurring payments for stocks or equipment; and the like. The maximum term of short-term loans would usually be a maximum of one year. This has a short term period with very minimal or zero collateral needed plus low-interest rates.
Long-Term Loan
Starting a business would need enough capital to get the business rolling. You would need funds to allocate for raw materials, equipment, technology, initial inventory, office space or setup, and rental payment to get started. Your funding needs would really depend on the business type and resources required. The funding from long-term loans would be for adding up capital for expansion which is primarily to gain leverage in the business.
Long-term loans would normally have a term of more than a year which is also equivalent to a higher rate of interest compared to short-term loans. Such loans would usually be requested at the initial or starting phase of the business at which the investors would commonly make use of company assets regarded as collateral for the loan.
Advantages And Disadvantages Of Debt Funding
There are many factors to consider when taking out a loan especially for startups. Debt funding has its pros and cons which allow you to make a well-informed decision on whether you should proceed or not.
Advantages
- Debt funding is set for a stipulated period of time which allows you to have a steady cash flow for a year or more.
- You get full control of business or company decisions, the company bonds would be considered as a certificate of loan and does not equate to having company share. Once you are done with repayments, the investor’s role would end right then and there. With that in mind, the investor would take no part or have no say in any company decisions.
- With debt financing, you have the freedom or privilege to use the money for any business purposes at any time you want. Unlike equity financing which is targeted for specific uses only at which the investor can also intervene once the money is being used for other purposes besides what is in the signed agreement.
- Startup CEOs or entrepreneurs get to enjoy fixed interest rates with debt funds.
Disadvantages
- With debt funding, your assets are treated as collaterals or securities. In the event that the business faces bankruptcy and unable to pay back the loan, the assets like properties or cash in the bank would then be seized by either the investor or the bank.
- You are required to make repayments for debt funding regardless of the status of your business. So whether your business has earned profits or gone bankrupt, repayment is still compulsory.
- The high interest rates would make you think twice about entering debt financing. The interest isn’t actually based on your profit because either way, you really are mandated to repay your loan. So, whether you have incurred losses or gains, the interest would still be the same.
Guide on How To Raise Debt Funding
Look For The Right Investors
The first step to raise debt funding is to conduct research to locate the list of top-notch and highly reputable investors or companies that provide startup debt funding. Check into the background or credibility as well as the track record of the company. You can depend on word-of-mouth advertising or social media chatter to select the right investors for your loan needs. There are also banks and other private financial entities that provide debt funding to startups.
Check Your Funding Needs
Would you need a long-term loan or a short-term loan? Look into where you are now at your business and check how much fund allocation you would need to keep the business moving forward. If you are into expanding territories or opening up new branches and even upgrading your technology, then a long-term loan would fit you. If you are aiming for funding expenses for rent and payout for your staff, then a short-term loan would be your quick fix to it.
Check On The Terms And Conditions Plus Interest Rates
A lot of startups would just jump the gun when taking out loans or debt funding without checking on important details such as the interest rates, the term of the loan, and the fine print which states the terms and conditions. While getting your funding fast is important, you would avoid problems along the way if you only carefully check on the terms and conditions as well as other details like interest rates, repayment schedule, and other fees that go with the loan.
Making a Solid Business Pitch
This is the final step to getting debt funding. You would have to persuade or convince the investor that your startup idea is worth their attention and investment. You can then present company balance sheets (if available) as well as your business plan and marketing strategies for short- and long-term goals. The investors would then have to verify these conducting due diligence checks on the data presented.
Startups are meant to grow and expand. That is the vision of every budding CEO or entrepreneur. No one wants to have their business ideas just go to dust or down the drain. Debt funding can provide you the capital you need to make your business thrive even in the most competitive ecosystem.
While some people would not want to take out loans or borrow, there is always such a thing as good debt. Every startup needs a fighting chance in this industry, and finding the right investor or company to provide debt funding would be a good start to your success route.
