Debt financing: the non-dilutive option to fuel growth

There are, generally, two ways to finance your startup: one is through equity, and the other is through debt. In order to fuel growth, at the very early stages entrepreneurs usually use their own savings, or seek investment in return for equity, from friends and family. Once traction is achieved, financing options become more diverse but are still mainly focused on investment in exchange for equity.

Later stage startups have often in the past used debt financing to pump-up their balance sheets, however this option is now becoming increasingly popular among earlier stage startups as well. Debt financing is a type of loan that comes from a specialist lender or a debt fund, and unlike venture capital, it does not give lenders equity stake in the business. It does, however, come with interest costs. It is a solution for fast growing companies that lack the assets or cash flow for traditional debt financing instruments. It was imported to Europe around 20 years ago and is now on an upward trajectory . In 2021, startups raised a record €8.9 billion ($10.6 billion) in debt in Europe , beating out a previous high in 2017, according to September Dealroom data. It seems that founders are becoming more comfortable with tapping into credit lines to fund their growth, understanding that you don’t always have to give up equity to grow.

When is debt financing best to use?

• Increase runway to next milestone since it has the potential to increase the runway of companies and increase the probability of achieving the next milestone / valuation driver resulting in a higher valuation at the next equity round thereby substantially reducing dilution.
• Extend runway to cash flow positive, since, instead of raising a large equity round, a company could raise a smaller amount of equity and then leverage venture debt to fund the company until it receives its first revenue from customers.
• As an “insurance” for delays in events of cash shortage in order to avoid launching an additional equity round.

Debt, being more risk averse, is suited to later stage companies or safer assets, while equity is riskier and suited to early stage startups or projects. In order to make the choice between venture capital and debt, startup CEOs should look to finance growth in the most cost-effective way and think about the true cost of capital that’s associated with each funding option.