Updated: Mar 13
Entrepreneurs typically look to venture capital—selling a portion of their business to VCs—for growth capital; however, they are now more frequently considering debt as a viable complement to venture equity.
Alternative forms of funding have gained popularity as a growth funding alternative, particularly for later-stage businesses looking to reduce dilution and maintain a positive cash flow.
What you decide now, will affect your business later.
What is growth debt?
Growth debt is an alternative source of funding for fast-growing late-stage startups.
It might go along with equity financing. When used properly, it can assist businesses in expanding without requiring founders and investors to incur unnecessary dilution or give up control of the company. The proceeds, which are typically structured as a 10–12 month loan, are used to finance working capital, expansion plans, and acquisitions.
Growth debt, in contrast to conventional bank lending, is accessible to businesses without substantial assets to use as collateral.
The benefits of using growth debt financing
1. Debt is typically cheaper than equity.
First and foremost, businesses that anticipate significant growth will save money by financing their operations with debt. You should consider two factors to compare the costs of debt (a loan) and equity (owning a piece of your company):
(1) the interest you’d pay the lender over the duration of the loan and
(2) the portion of profits you’d potentially give up to an investor upon the exit of the business.
In most situations where you anticipate a significant increase in valuation, debt will be less expensive than equity—and the smart decision.
2. Maintain control of your business.
Giving up board seats is a common requirement for equity financing. This implies that there will be a greater diversity of views on how the company should be managed to meet its growth objectives and new expectations. Now that your company has gone through several equity-raising rounds and welcomed a few new board members, you might find yourself in a position where you are no longer the company's sole decision-maker.
On the flipside, most growth debt lenders do not require a seat on the board.
They generally don’t get too involved in your business as long as you make on-time payments and meet pre-agreed-upon performance metrics.
3. Debt can lower your after-tax cost of capital.
Debt can reduce the after-tax cost of financing a company's operations, which, depending on the company's taxable income, is one of the main reasons why so many businesses opt to use it. The majority of interest and debt financing costs are tax deductible for federal income tax purposes, which lowers the amount of income subject to taxes.
Most interest is tax deductible; dividends paid on equity are not.
4. Quicker access to capital
If you've raised equity financing in the past, you are aware of how time-consuming it can be. You may have also felt disappointed after devoting so much time only to have plans fall through at the last minute. Raising debt financing can be completed in as little as 4-6 weeks, as opposed to raising a VC round, which typically takes between six and nine months.
This has the advantage of giving you more time to focus on what really matters—growing your business— along with quicker access to the money. You can save time by taking on debt both at the beginning and throughout the loan's life.
Are you curious to know if growth debt is appropriate for your company?
At Debtworks, we are committed to providing flexible debt solutions to borrowers, particularly in this time of uncertainty. We have significant partners in our ecosystem to enable you to capitalise on growth opportunities.
If you would like to learn more about how debt works, please feel free to write to us at email@example.com