To learn the nitty-gritty of business, succeed and step up the industry ladder, the foremost requirement for any startup is funding, which would help it grow, expand and upscale to success. Funding for startups essentially comes from two sources – equity or debt financing. Since equity funding takes away the autonomy of business decisions and debt fund doesn’t, many startups these days prefer and resort to startup debt financing instead. But to do that, it’s important to know, identify and assess the sources of debt funding.
Choosing startup debt financing as the funding process doesn’t end the woes for an entrepreneur. Hence, it is important to understand the way debt financing works beforehand. This would help the founder analyse and assess the methods better as well as compare and pick the sources of debt funding.
Startup debt financing acts is a loan given by the investor to the entrepreneur for a specific period, at a given rate of interest and against company assets as debt securities and certain terms and conditions. Here, the startup borrows the fund selling company bonds, that is the certificate of lending. The fund has to be repaid to the investor at a scheduled date, and non-repayment enables the bank or the investor to seize the assets and get back the money. Startups are usually levied a high rate of interest to cover and compensate the investor from losses incurred by the company.
However, providing debt fund against company bonds doesn’t give the investor a right to interfere in the company matters or business decisions. Thus, the startup founder retains their autonomy over business strategies and matters of the enterprise and gets to run their company the way they like. The freedom to function with greater autonomy is always tempting, and can be an advantage in a highly-competitive market, where investors will want a greater say in how the startup is being run.
Related Article: Debt Funding Guide For Startups
When a founder decides to raise funds for the business through startup debt financing, they also need to identify and compare the sources of debt funding based on the rates of interest, security requirements, tenures offered and other terms and conditions, to make the right choice.
When it comes to sources of debt funding, there are plenty of options available in the market for the startup to choose from. While some banks or NBFCs provide debt funds to new business, these days individual investors, commercial lenders, venture capital firms or big business groups also participate in debt funding rounds. Here, the source has to be chosen wisely, after carefully analysing the requirement of funds and the situation or position of the company to go for startup debt financing and comparing the rate of interest, the credibility of the lender and terms and conditions associated.
Comparing the rate of interest and other requirements are extremely necessary for a startup to avoid unnecessary hassles or losses at a later stage.
As sources of debt funding, banks, NBFCs or venture capital firms might offer lower interest rates, but the collateral requirement, documentation and terms and conditions are often much more stringent. Terms and conditions or documentation might be more flexible and easier in case of the rest, but they are more likely to demand higher interest rates and collaterals to avert risks. Here, the startup has to assess the situation in terms of repayment, interest and availability of assets to pick the right source.
An entrepreneur can choose the source of debt funding according to their requirement. This can be better explained through examples of debt finance.
Let us consider examples of debt financing for an app-based food delivery startup. A food delivery startup operates and reaches customers through a mobile app or website, which provides options of eateries, restaurants and take-away counters based on the location, cuisine and user’s customised choices.
For running this business, the entrepreneur has to set up offices and infrastructure, deploy technology and devices, arrange delivery vehicles and hire employees. Here the capital costs on setup, infrastructure, adoption of technology and devices, and buying vehicles would require bulk funding and, therefore, long term loans are profitable. Further, if the startup decides to expand, it would require more offices, more infrastructure, devices and vehicles, leading to another round of capital costs. Thus, sources providing long-term debt financing with relatively lower interest rate and collateral requirement would be a good choice here.
The rents for offices, maintenance fees for infrastructure and devices, and salaries of employees are payable monthly and come under recurring costs. These can easily be financed through short-term loans. Often individuals and commercial lenders are approached for these short term loans with a tenure of one year. Payment through credit cards is quite popular in case of these recurring costs.
Wisely chosen sources of debt funding guarantee lesser worries and hassles for the startup entrepreneur, letting the entrepreneurs concentrate on their business. Debt funds are a safer bet for an entrepreneur as the investor gets no share in the company, and there is no interference from outside in business decisions. No wonder startup debt financing is gaining more popularity, with time, in India where the ecosystem is relatively new and the entrepreneurs mostly first-timers.