In the midst of this global pandemic, startups are working tirelessly to keep their business running. For many, that means securing financing that will help to maintain business continuity today and also extend to future planning.
The health of your business is more important than ever, and the capital choices you make now will have a lasting impact on the trajectory of your company. The pressure’s on, but this is not the time to rush blindly into a financing deal that may not be advantageous for you or your company.
As you navigate this challenging new terrain, we want to help. Here are some considerations to keep in mind as you evaluate the best financing options for your business—today, and in the long-run as you continue to reach for growth milestones.
Debt financing meets the current needs of startups
While COVID-19 has been highly disruptive, it hasn’t lessened the need for startup funding. In fact, we’re continuing to see significant demand for financing among startups in North America.
But the funding landscape has shifted once again.
Equity capital, like venture capital, has always been difficult to secure, but the current crisis has exacerbated the situation. VCs are using available funds to support their existing portfolio companies.
With less equity capital available, more entrepreneurs are turning to debt financing to meet their short- and long-term needs. Debt financing offers quick access to funds, enables you to retain equity ownership and control of your business, and alleviates the pressure for rapid growth—all critical advantages in this current environment.
However, not all debt financing is equal. You need to approach your search for capital with eyes wide open.
3 questions to help you choose the right financing option
The best option for your company depends greatly on how you weigh the trade-offs of the various financing options. To help figure out what you need, start by considering these three questions.
1. How will you use the funds?
Do you have immediate needs like making payroll in three days or acquiring inventory? Do you need a cash cushion during the gap months while you wait for customers to pay you? Many startups looking for this type of “working capital” are turning to the federal stimulus programs, along with credit cards, lines of credit, and short-term loans to help them meet these short-term needs and maintain operations.
Whether you’re simply trying to keep the lights on or experiencing growth during the pandemic, every company needs to identify growth milestones and plan for the future. This calls for “growth capital” to fuel longer-term, strategic initiatives.
Entrepreneurs seeking growth capital can opt for term loans, which are repaid with a fixed amount in recurring payments over a predetermined time frame. Note that some lenders also provide a “forward commitment” on top of the term loan, which allows businesses to draw additional funds as they need them at a later time.
Another option for growth capital is Revenue-Based Financing (RBF), which offers a flexible repayment schedule to accommodate the ups and downs of your monthly net revenue.
2. What’s the total payback amount?
When you start to compare growth capital options, you’ll quickly learn that different lenders have vastly different terms. To determine the true cost of capital, you first need to calculate the all-in cost—the full amount you will be required to pay back—and the timeframe in which you need to pay it back.
Factors like annual percentage rate (APR), time value of money (TVM), and fees (both explicit and hidden) will all play into the all-in cost.
3. What other controls or covenants will the lender require?
To make sure you don’t significantly change the credit/risk profile of your business after they lend to you, lenders may impose certain conditions in their loan structure, like having a minimum of $100,000 in the bank at all times.
Investigate the fine print and make sure you have a clear understanding of how the loan’s cost and control components will impact your operations. For example, if the loan has debt covenants, run some what-if scenarios against your historical data to see when the covenants would be breached.
Assess the strength of your partner
Once you’ve answered those three key questions, the final consideration is to assess which lender you want to partner with.
Bringing on the right financing partner is one of the most important decisions you’ll make in your fundraising journey. You need to find a capital provider who will offer the right funding structure based on your needs and who has the ability to grow with you. You also need a partner who can provide more than funding, including connections, value adds, and introductions to other capital sources.
Use this checklist to assess the strength of your lending partner:
What is the lender’s track record in assessing risk?
Do they prioritize incremental growth?
Do they have additional capacity to grow with your company?
Are they stable and in a position to support your ongoing capital needs through the recession and recovery?
What is their reputation with other entrepreneurs in the community?
Is your lender willing to provide advice, mentorship, and networking within the industry?
EJN Financial is here to help you be successful and we remain dedicated to supporting your financial needs during these difficult times. If you would like to speak with someone directly, contact us and we will be in touch shortly.