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Running out of cash is one of the biggest reasons startups fail. Starting a business takes capital, and for many founders, the first step in executing your big idea is finding a way to access the funds. Whether you’re bootstrapping from your basement or taking out a loan, how you plan to finance your new venture is one of the most important decisions you’ll make along the way.
Choosing the right startup business loan depends on your industry, product offering, and the time you’ll need to get to market. Different businesses have different capital requirements, but considering these requirements ahead of time will help you find the right mix of financing options and build a strong foundation for your startup to grow.
What to Consider When Seeking a Startup Business Loan
The amount of capital you’ll need depends on both set-up costs and working capital. Set-up costs are the funds required to get your business up and running, such as incorporation fees or equipment purchases. Working capital is the money required to cover your overhead (such as your monthly G&A expenses or payroll), so your business can continue running until you make a profit. If you’re considering startup business financing, ask yourself:
- How much will it cost to set up your business?
- How long will it take for you to break even?
- What will it cost to keep your startup running until then?
In addition to these financial needs, consider the following:
- The amount of your own capital you have available to spend
- Whether you know any personal investors (like friends or family, or colleagues) who might be interested in backing your idea
- Your personal assets or credit score
- Whether or not you’re eligible for SR&ED tax credits or government grants
The answers to these questions should help you find the right mix of funding for your business. A SaaS startup bootstrapped by two software developers will have lower set-up costs than a parts manufacturer who needs significant funds upfront to buy machinery. However, the SaaS company may require more working capital as they develop and market its product over time.
Small changes in interest rates can make a big difference to your startup’s balance sheet. Even with great personal credit and a sound business plan, it’s still a smart idea to compare financing options (or a combination of options) to get the best possible rate.
When is Debt Financing Better Than Raising Equity?
In certain situations, selling equity is attractive for several reasons. In addition to being interest-free, it can come with the expertise and credibility of larger financial backers or venture capital firms. While equity financing can be an asset at various points in a startup’s life cycle, there are also times when it’s a better idea to take on debt. For example, debt can be useful when:
- Increasing your startup’s valuation between equity rounds, such as through investing in marketing spend to boost revenue or grow your customer base.
- Purchasing physical assets like vehicles or machinery where using the asset as collateral reduces the interest rate on the loan.
- Buying materials or scaling production to fill a large order, meet higher demand or handle increased sales.
- Getting your startup through a cash flow crunch.
Debt can also be preferable when your business qualifies for a low-interest term loan or line of credit. However, most recommend a mix of debt and equity to achieve an optimal capital structure.
Getting Your Loan Approved: What do Potential Lenders Look For?
Traditional lenders usually require proof of stable cash flow over time, steady revenue growth, or enough collateral to cover the risk of putting out funds. They will also look at financial ratios that measure your business’s liquidity, leverage, and profitability.
Early-stage startups often need more resources, so many entrepreneurs end up using their personal credit or savings to finance their capital needs. This isn’t necessarily a bad thing, as putting your own capital into the business can help build credibility for a loan later on.
Lenders will also consider your loan based on a solid business plan or relevant professional background (for example, a physician partnering with an experienced MBA to open a medical technology company). To get your loan approved, you might also need to provide relevant information on your own net worth, proof of business insurance, and articles of incorporation.
Types of Loans
Bank loan
Bank loans are short or long-term debt options financed by traditional lenders. They provide your startup with a sum of money that will need to be repaid, with interest, at the end of a given term. The interest and principal are usually paid in monthly instalments.
Bank loans can be both secured and unsecured. A secure loan offers the bank a form of collateral, which it can seize and liquidate if you cannot repay the loan. For early-stage startups with little credit history, this collateral is often a requirement of the loan.
P2P/Crowdfunding
Like bank loans, ‘peer-to-peer’ or crowdfunded loans are a form of short-term or long-term debt. However, these alternative loans are financed by a pool of investors instead of a single institution. The interest rates associated with these loans will vary, and collateral may or may not be required. They can appeal to lenders seeking a higher rate of return, as well as startups looking for more accessible options.
Invoice Financing
Invoice financing is a good option for companies facing a cash flow crunch. With it, companies can borrow money against unpaid account receivables. Invoice financing offers a quick way for startups that need access to capital to fulfill existing customer orders or inject needed funds into other parts of their business.
Line of Credit
Lines of credit let your business borrow up to a certain amount and only pay interest on what you use. You can borrow when you need funds, repay the amount, and then borrow again. This is typically cheaper than invoice financing for cash flow issues but will usually require a more established credit history.
Equipment Loan
Equipment loans are used to purchase machinery or equipment for your business. These loans are secured against the equipment itself, so it’s possible to get a more favourable interest rate on the purchase than using a line of credit or term loan. One thing to note, most companies will only finance 80% of the equipment, leaving you to fund the remaining 20% by other means.
Tax Credit Financing
Financing tax credits help businesses inject capital when they need it most instead of waiting for their refund. Startup’s with eligible R&D costs can finance their Scientific Research and Experimental Development (SR&ED) tax credit to access these funds quickly. This frees up cash for working capital and allows founders to take care of operational needs without sacrificing their investment in the startup’s future.
With no dilution, fast turnaround, and high loan-to-value, SR&ED financing is a flexible way for founders to access the capital they need when they need it the most.
Is your company looking to finance a tax credit? Click here to contact the Venbridge team. We’d be happy to help!
