8 Things You Never Knew About Debt Financing

While you may assume the best and only route to launching and scaling up your startup is through funding from VCs or angels, or maybe even crowdfunding, there is still a lot to be said about debt financing. Yes, the money has to be paid back within a designated amount of time and often with interest.
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While you may assume the best and only route to launching and scaling up your startup is through funding from VCs or angels, or maybe even crowdfunding, there is still a lot to be said about debt financing. Yes, the money has to be paid back within a designated amount of time and often with interest.

However, there are some other things you may not realize about debt financing that will have you thinking more about it as a viable option.

There's this thing called venture debt. Some venture firms offer venture debt financing, including loans that include an interest-only period upfront followed by the start of loan repayment. This offers more time to repay the debt while creating a bridge to handle rapid startup growth. Venture debt is not for those companies in their early stages who do not have an established model or solid revenue streams in place. The interest rate on venture debt tends to be higher than other debt options. You are more likely to get venture debt financing if your startup history shows some venture equity funding at some point that illustrates that others have already invested in your company.

Friends and family count as debt financing. It's not like you are asking your friends and family for huge sums of money, but you can create a significant base of financial support. It is recommended that you create loan agreements with repayment terms, interest, and whatever else ensures you separate the personal from the business aspects of your relationships. If you go this route, make sure you treat it like any other debt and stick to the repayment plan rather than to assume that, because they love you and are passionate about what you are doing, you can skip a few months of payments. No one wants awkward holiday dinners or rifts with loved ones.

It's still possible to use credit cards to finance your startup. While the recent past showed that many people used credit cards to finance their entire lives and businesses only to default on their debt, credit card companies are tentatively opening up the loan pool again for business people to dip their toes in with some lending options. As the least expensive debt financing option, it can provide access to significant funds and provide an extra thirty days to float purchases or the cash advances you may use from these cards. Just remember to use credit cards smartly and look for those business cards that give you options for points or cash back bonuses that you can use to reduce the monthly payments. Be careful with this easy to access plastic money because it can bite back in terms of ruining your credit profile as well as cost you extra money in interest.

New lending platforms. With the emergence of crowdfunding and other online platforms, other companies have devised a way to create business models that allow various lending products for small businesses and startups. This includes OnDeck with its fast short-term loans and the long-established Lending Club, which provides a range of loan products to small businesses and consumers. Many believe these new lending platforms are really giving banks a run for their money by filling a real need for trustworthy lending options that can help businesses borrow money rather than just seek equity financing.

The Small Business Administration has new alternative loan programs. Recognizing the void that was left when many banks stopped providing loans to small businesses, the Small Business Administration (SBA) began developing new types of alternative loan programs especially directed at entrepreneurs. These loans typically have much lower or no costs at all associated with them except the interest and principle payments. You often get a longer term to pay the money back plus have minimal collateral requirements. In recent years, there have been even more SBA products and programs focused on stimulating the national economy by supporting the small business owner. One word of warning is that those entrepreneurs who may have less-than-stellar credit may not be able to qualify for some of SBA's lending options.

Banks are back to offering traditional loan products. Because interest rates seem to be remaining on the low side, there is an opportunity again to seek traditional debt financing from bank loans. However, after recent years of giving out loans to anyone, banks are once again returning to a standardized approach to ensuring as little risk as possible so be prepared to show assets, sustainable cash flow, and/or working capital to obtain bank financing. That includes showing collateral like real estate, equipment insurance policies, and accounts receivable that all could be used in case you cannot make the monthly payments.

Alternative debt financing methods include Rollovers as Business Startups (ROBs). In essence you are borrowing from yourself to start a business or purchase a franchise because ROBs take money from your retirement funds. It can be done and has proven to work for some, but this strategy does come with plenty of risk and is not for the risk-averse. ROBs are also very complicated to form and manage, so it is best to seek professional advice when considering this type of debt financing vehicle.

You can consider revolving credit or lines of credit that allow you to use debt on an as-needed basis. Also known as trade credit or vendor credit, many out there may assume that this type of debt financing is not sizable enough to help them. However, when it comes to some of the business basics, including office supplies and equipment, this type of debt financing is not a bad option to cover at least some of your expenses. Balances are also not due in full so they can be carried over time although many trade credit accounts are Net 30, so be sure you know the terms on each account you open and use to determine which offers the most value to you in terms of delaying payment and maximizing your current flow.

The debt financing route means you do not have to share your company profits, give away an ownership percentage, or deal with someone who wants to make different strategic decisions for the direction of your startup. Just remember that debt financing requires an even greater focus on cash flow and payments are due -- regardless of whether your business succeeds or fails.

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