This is probably one of the most asked questions in the startup community around the world. What makes founders believe that securing venture capital funding is the first step towards success? A highly overlooked fact is that almost every company with a billion-dollar valuation already had what was needed to be successful. Rather, it was the venture capital firm that cashed in on their talent.
Under the watchful eyes of venture capitalists, founders, often fuelled by impulse, make decisions to impress investors. Suddenly, crunching numbers to meet the criteria of a venture capital firm leaves your business objectives on the back burner instead of where they should be: Focusing on your true north star – your customers.
What if you wanted to grow your business without venture capital backing? How can you sustain momentum until you attract the right kind of investment partner you can trust? Here are 5 debt financing options for pre-venture capital-backed companies.
Starting with baby steps, a common source of debt financing when companies are first starting out are family, friends, co-founders, board members, and your own piggy bank. These loans work well as convertible debt structures, which carry low interest rates and convert into equity at a certain date in the future (when you are likely to be able to raise a round of equity financing). However, the danger of convertible debt is you will need to pay people back from your own pocket if you are unable to raise equity or additional growth capital by a specified time.
Tech investment banks and other online lenders are another classic source of debt financing. Unsecured or secured personal/business loans can be used to support your startup’s financial needs. However, banks do not like participating in high-risk projects and are not geared towards encouraging growth. As a result, many tech and SaaS startups may have a hard time qualifying. For short term or emergency needs, alternative online lenders can provide a faster and more convenient financing option compared to bank loans. Keep in mind that these will come with much higher interest rates. Loans from alternative online lenders should be used sparingly and should not be used for growth capital.
MRR Line of Credit:
For SaaS companies that have stable monthly recurring revenues, an MRR line of credit may be a better choice for debt financing compared to traditional bank loans. Lenders can typically provide anywhere between 3-5x your MRR.
A/R Factoring:
Accounts Receivables (A/R) Factoring provides advanced funding by using your accounts receivables as collateral. This is great if your subscription service allows customers to pay at varying intervals. A/R Factoring can help even out your cash flows, which allows for more predictable growth.
While venture debt is often associated and most commonly used by venture-backed companies, some lenders, such as Flow Capital, do provide venture debt loans to non-VC-backed companies. Structured as a fixed term loan with monthly interest payments, venture debt is a great option to extend cash runway, fund growth initiatives, or to bridge the company to an upcoming round of funding.
For more information about venture debt, read our Founder’s Guide to Venture Debt.
Revenue-based financing is a flexible form of debt financing where payments are based on a percentage of monthly revenue. This type of financing is especially useful for companies with subscription-based models and/or those with high growth aspirations. The flexible monthly payments are designed to accommodate the natural ups and downs of the company’s revenue without demanding equity.
For more information about revenue-based financing, read our Founder’s Guide to Revenue-Based Financing.
While venture capital is a great option for early-stage startups with unpredictable cash flow, little brand recognition, and a goal of growing quickly to multi-million-dollar valuations, companies that don’t fall into this category may be better off seeking alternatives to venture capital. With these five debt financing options for pre-venture capital-backed companies, founders can focus on growing their business at a pace that better fits their goals.
