Debt or Equity: What Kind of Fundraising Does Your Start-Up Need Now?

Debt or Equity: What Kind of Fundraising Does Your Start-Up Need Now?

Once you’ve done your market research, written a business plan, and tested your idea, it’s time to take action and grow your business. But growing businesses isn’t free, which means you need upfront capital to put your plans into motion. Where do you start?

First, you need to do a little bit of soul-searching about your business needs and goals, particularly when it comes to questions of scalability, cash flow, seed money, growth acceleration, and how much equity you wish to retain.   

Once you have answers to these crucial questions, you need to consider what kind of fundraising is appropriate, which involve careful consideration and close examination of your business’s needs for both present and future growth. There are three main types of fundraising:

Debt

Debt fundraising is ideal if an owner needs seed money and is confident she can repay the loan quickly. In this situation, an investor loans the start-up money which it agrees to pay back, with interest, at an agreed-upon date. An investor does not buy a portion of the company, is not entitled to future profits, and will receive only repayment of his loan plus interest. The owner preserves her stake in the company and does not share her future profits. 

However, the start-up must repay the loan and interest regardless of its revenue or profit. That means a business needs enough cash flow to compensate investors and support ongoing business operations, which demands careful budgeting. One must also consider that a high ratio of debt to equity can make a company appear risky and unstable to investors.

Equity

Equity fundraising is ideal for start-ups who are looking to raise a significant amount of funds to propel business growth. Here, investors exchange their upfront investment for a stake in the future growth of the business. Due to the potential for a sizable return on investment, equity fundraising also has the potential to attract highly selective investors with deep pockets. There is no loan to repay. 

However, equity fundraising is based on the valuation of your business, which involves striking a delicate balance. Overvaluing your company alienates investors and increases pressures on the start-up, but undervaluing your company could result in a lack of funds and the owner’s loss of equity. Once you set your company’s valuation, you must also avoid offering too little or too much equity to investors.

Convertible Note

A convertible note is a hybrid of debt and equity fundraising. A start-up borrows money from an investor with the understanding that the start-up will repay the loan on time or convert the loan into a share of the business. This form of fundraising might be appropriate for businesses that are not ready to value their company or are unsure about what their growth trajectory will be.

But the same flexibility that protects the start-up might drive away investors looking for more certainty in their investments. Investors typically want to know that the startup will wither pay back the loan or give them a defined stake in the company, which convertible notes can't guarantee.

Depending on your goals, one type might be more appropriate than the others. That’s not to say your business is stuck with one kind of fundraising for the life of the start-up; owners can switch between fundraising types when appropriate. It’s all about what’s right for your business.

Assure that your business is well-funded. To seek fundraising advice tailored to your start-up, schedule a consultation. What other kinds of fundraising have you tried?  

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