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Should my startup borrow money instead of selling equity?

FundraisingEquityCosts

Borrowing costs less ownership than selling stock, which is why every founder asks. It also has to be paid back on a schedule, with interest and fees, by a company that may not yet have revenue, and the lender will hold a lien over the company's assets that lets it take them if payments stop. Venture debt exists for companies that have closed an equity round and want to extend the runway it bought before the next one. It is not a substitute for that round, and a bank will not lend to a company with no investors and no revenue on the strength of an idea.

What it usually funds

Equipment, working capital against receivables, a corporate card, and growth capital that stretches the runway a few months so the next round can be raised at a higher valuation. The lenders in this market are specialist banks and venture debt funds, and they lend alongside equity investors rather than instead of them, often sized as a fraction of the last round.

What it costs

The interest rate is only part of it. There are closing fees, sometimes a fee at the end, prepayment penalties, and warrants, the right for the lender to buy a small slice of the company, commonly up to a percent or two. There are covenants, promises about cash balances or revenue that, if broken, let the lender call the loan. And there is reporting: monthly financials, sometimes board materials. The lien will cover all the company's assets, and the negotiation is often over whether that includes the intellectual property outright or only a promise not to pledge it elsewhere.

When it makes sense

When the company has a clear plan to repay from revenue or from a round its investors have signaled they will support, when the amount is modest against the company's cash, and when the lender is one that has worked with companies through bad quarters rather than one that competes on rate alone. The wrong lender in a bad month is a company sold off to repay a small loan.

A convertible note is also debt on paper, but it is designed to convert into stock rather than to be repaid, and its holders are investors. This article is about real loans, from lenders who expect their money back.

Written by the lawyers who built Arabella. This is legal information, not legal advice for your situation, and reading it does not make us your lawyers. For a real dispute or a high-stakes decision, talk to a licensed attorney. More questions.