Should Your Startup Business Use Debt Funding?
Originally published in All Business
It’s a Catch-22: to start your business you need capital, but in order to raise capital, you need to have a business. For those of us who don’t plan to raise venture capital anytime soon, is debt (like a bank loan) the right route to take?
To find out, we asked eight successful entrepreneurs from the Young Entrepreneur Council (YEC) the following question:
Q. What pros — or cons — should you weigh when considering getting startup capital in the form of debt (whether in the form of bank loans or even friends & family)?
Their best answers are below:
1. Debt Capital
Because debt doesn’t dilute your company, debt capital is a great choice for many startups. One downside to debt is its lack of added value. Although venture capital funding leads to connections, networking opportunities and mentorship, debt funding is money only — no added benefits. For new startups looking to build their startup ecosystem and gain valuable support, this can be a real concern.
David Ehrenberg, Early Growth Financial Services
2. Future Investors
First-time entrepreneurs often look to loans for initial capital. However, if the startup grows successfully, it will likely require future rounds of funding. Many experienced angel investors and venture capitalists see existing debt as a red flag that lowers their chances of investing in your startup.
Neil Thanedar, LabDoor
3. Interest Costs
Debt means interest. Even if you’re dealing with a family member, you should make a point of paying interest. That interest can make your startup costs much more expensive than they might have been otherwise. You need to keep debt to an absolute minimum, even if you can’t avoid it entirely.
Thursday Bram, Hyper Modern Consulting
Money is the most tangible investment in your company. Unfortunately, sweat isn’t worth its weight in gold until it produces money. I suggest you get traction first and show that your product can make money, then you’ll have more leverage at the negotiating table. A person with money invested will want to see returns quickly, which could be to the detriment of good, timely decision-making.
Andy Karuza, Brandbuddee
5. Stock Dilution
We raised our first $2.6 million in convertible notes. We felt this gave us more flexibility in terms of fundraising and that delaying a formal valuation of the company until later in the game was advantageous to us. Our con — stock dilution when shares are converted to bonds — was outweighed by the pros, which included reduced interest.
Danny Boice, Speek
6. Debt and Equity
There is no rule of thumb to use when determining whether a startup should take on debt. Debt can often be faster, easier, cheaper and less of an overall headache than equity. Understanding your business needs and how effectively you will use capital can determine if debt is right for you.
Adam Lieb, Duxter
7. Realistic Projections
The big con in taking on debt is that you need to generate cash to make payments. That seems obvious, but big-eyed entrepreneurs often forget about their ability to execute, and making sales becomes significantly more important when you choose equity over debt. Make sure to create realistic projections; do not take on so much financing that you need exceptional growth to avoid default.
Aaron Schwartz, Modify Watches
8. Buffer Time For Loans
I think it requires a certain relationship to take a loan from friends or family. I always strongly caution against borrowing from friends or family for business or personal reasons. It most certainly adds stress to the relationship and will often change it permanently. That said, there are certain friends and family with whom we can finance. However, always add buffer time to pay back loans.
Gideon Kimbrell, CLUBSCORE, INC
The Young Entrepreneur Council (YEC) is an invite-only organization comprised of hundreds of America’s most successful young entrepreneurs. In partnership with Citi, the YEC recently launched #StartupLab, a free virtual mentorship program that helps millions of entrepreneurs start and grow businesses via live video chats, an expert content library and email lessons.