Funding a startup or early stage company has always been challenging. One in every three small business owners cites lack of capital as the primary reason behind business failure. As monetary policy continues to tighten, liquidity will become more of a problem for companies raising capital.
Many companies in the tech space are finding themselves turning to debt raises over equity as the venture capital environment becomes tighter. Many other companies prefer debt over equity for other strategic reasons.
Here are some of the best pathways for raising debt in the current economic climate and what to know about them.
Conventional Bank Loans
Traditional bank loans are a common way to fund tech startups. The debt structure for startups differs significantly depending on the lender. The rates vary depending on how much money you need and how much collateral you can offer as security.
Banks usually require that you have some kind of business plan, a financial statement summarizing your income streams and expenses, and a credit report detailing your credit history.
You may also need to provide personal guarantees from other people who know you well enough to stand behind your business idea’s potential success.
If you’re looking for a loan, it’s worth exploring Small Business Administration (SBA) loans. The SBA offers two types of loans:
Standard 7(a) Loan
These are available to businesses that are just starting out and have little-to-no credit history, and they don’t require any collateral. The interest rate is fixed over the life of the loan, and there’s no prepayment penalty.
SBA 504 Direct Loan
This program is geared toward more established businesses with more assets and steady cash flow. You require collateral to secure financing.
There may be additional fees involved with SBA funding options — for example, if you take out an SBA 7(a) loan, there will be origination fees associated with your application.
Both types offer competitive rates compared to other business funding sources such as private equity or venture capital options.
Debt from Private Investors
Private debt funds are increasingly popular alternative investment avenues where private lenders provide capital to acquire debt for startups instead of equity. The funds can come from family and friends, venture capitalists, or angel investors.
These private investors may need to see the potential of your business idea before deciding to offer a debt structure. You may need to prove that your idea is viable and will succeed if given a chance.
A detailed business plan and financial forecast report can go a long way in convincing these investors.
Performance Guarantee Insurance
Performance guarantee insurance (PGI) is similar to a debt guarantee, except it covers the lender’s risk if the borrower fails to meet contract terms in its business. This means that your insurance policy essentially helps de-risk your business in the eyes of a lender– and can also help with securing more favorable terms on capital.
“Most performance guarantee insurance coverage takes shape as a response to mitigate the specific concerns about which potential investors are most worried.” says Nemo Perera, CEO of Edge Management, which helps companies employ this strategy to raise funds.
“The Edge Management process involves analyzing a project from a risk standpoint, identifying risks of concern to investors, and structuring a basket of coverages that mitigate those risks and ease investor concerns.”
Perera went on to explain that a strategy using PGI is ideal for business owners seeking to raise capital while preserving maximum equity as opposed to commercial bank lending which could require an equity contribution.
Funding Your Startup Through Debt
Debt can be a useful tool for funding your tech startup, but it needs to be used carefully. Traditional lenders may require collateral, guarantors, and your credit history before approving the loan.
Performance guarantee insurance can allow you to access cheaper loans with a third-party insurance firm taking on the risks.
Edge Management can assist your startup in conducting an effective risk assessment before picking up PGI coverage. Contact us today to learn more about PGI financing.
This a Contributed Article.