Debt versus equity: When do non-traditional funding strategies make sense?
How can debt be stable and reliable? Seems like an oxymoron, but the reality is that while equity investors are looking for growth, debt investors just want to get paid back with interest.
Entrepreneurs trying to raise funding for their new businesses are faced with a maze of options, with most taking the common route of equity rounds. There’s clearly a lot of venture money to be raised — and most tech entrepreneurs happily take it in exchange for equity. This works for some, but too often founders find themselves diluting their equity to unrecoverable portions rather than considering other financing options that allow them to hold on to their company — options like debt capital.
Even if you’re growing quickly, not all founders want to set a valuation for their company. In that case, you can offer investors “convertible debt.”
Despite the VC flurries of 2020 creating an ecosystem of seemingly endless equity, it’s important for entrepreneurs and founders to understand that there is no one-size-fits-all model for raising capital. Debt capital, which refers to capital raised by taking out a loan, is an alternative route that entrepreneurs should consider.
Understanding the real cost of venture debt and when it makes more sense than the traditional equity route relies on an understanding of what you and your company hope to achieve.
Understanding your goals
We mainly see two kinds of startups today: Those that want to try something new, and the ones that focus on making things faster, cheaper or simpler. Facebook, Twitter and Instagram are good examples of the first kind — social media didn’t exist before the internet. Discount airlines, cell phones (not smartphones) and integrated circuits are good examples of the “faster, cheaper, simpler” variety, because they simply displaced familiar incumbents.
Many entrepreneurs are eager to be the next “try something new” success story, and I applaud them for feeling that way. Carving out your own market is a fast-track to entrepreneurial stardom if you’re successful. But unless your main goal is to be famous, it’s often impractical and distracting.
People tend to think that category creation is less risky than incumbent disruption. However, as long as you’re truly faster, cheaper and simpler, patience and strategy can propel you to where you want to be.
Just as there are different market approaches, there are a number of funding strategies that work best for your goals. Landing investments from leading VC firms has benefits and is a good avenue to opt for if you’re a young startup carving out a market and in need of validation and experience. These firms bring trusted advisers that are laser-focused on growth and have the resources and experience to navigate the murky waters of category creation.