Financing a Startup Company Series: Debt & Micro Loans
The post concludes our series on Financing a Startup Company and focuses on debt and micro loans. The Small Business Administration’s Microloan Program has been around since the early 90s and provides small loans (up to $50,000) for startup businesses. The loans are distributed by local nonprofits.
Asset based loans: some lenders will issue loans that are secured by a startup’s accounts receivable and inventory. Thus, the company can put its future revenue up as collateral to raise funds now. Because lenders typically lend only up to around 70% of the value of accounts receivable and 50% of the value of inventory, this is often not a useful option for startups with little inventory or accounts receivable. These loans are often best suited for manufacturing, distribution and service companies that need an infusion of cash to grow.
Advantages: The advantages of using debt financing is that it is non-dilutive to the founder’s equity. They can be a good source of funding for acquiring new assets, where the asset collateralizes the loan.
- Loans include a contractual obligation to repay the loan over a period of months or years. The terms of repayment could be difficult for a startup that is still months away from earning enough revenue to pay back the loan. Unlike equity based fundraising, debt often requires periodic (e.g. monthly) payments on the principal and interest.
- Interest rates on loans to startups can be quite high.
- Finding a source of debt financing can be difficult: many traditional creditors, such as local banks, are unwilling to lend money to unproven startups.
- Many lenders require collateral and can have rigorous approval processes
- The more money that you need, the more financial and other documentation the lenders will require
- Loans can impose restrictive covenants on the company’s finances and how the business must be run.