Raising Capital - Consider Debt Financing

Bill Warner Friday, November 07, 2008

Debt can be your friend. It can be used in many ways to strategically fill out your overall financing plan. However, there is no doubt about it, loans have to be backed by some form of collateral and the money has to be paid back over an agreed upon period of time and interest rate. Here are some important possibilities for the use of debt financing:

  • Early market research can be financed with debt. You can use a credit card or borrow against your assets. A nominal amount of money is usually needed to conduct a disciplined market research on your entrepreneurial idea. There is usually no need to buy expense research reports, but some money is needed for travel for testing the market and for the development of materials for your research work.
  • Once you have satisfied yourself that you have a good market opportunity, it is often necessary to develop an early prototype and perform some more in-depth market testing. Again, bank loans are a viable source of financing for prototype development and for filing patent applications.
  • Most businesses in the US can actually be started through bank financing, as long as the entrepreneur has the necessary backing. The backing can come from the founder or from friends, family and business associates. Of course, these people that take the risk to back the loan should be rewarded by the company. Approaching local banks that offer SBA backed business loans is an excellent way to get the money you need to start a company. It is not always necessary to approach angels of any kind. This way, the entrepreneur does not have to sell shares in the business and will therefore own the entire company, keeping control of its destiny.
  • Also for most small businesses, getting loans from other people is very common. Many businesses get financing from family members, friends and business associates without every approaching a bank. These loans have to be paid back with interest but the terms are usually more attractive than with banks.
  • There are several banking institutions that will loan money to early stage companies for them to purchase capital equipment, where the equipment acts as the collateral for the loan along with the company’s cash position after having received its first round of financing. Sometimes personal guarantees are required which founders can consider and perhaps get assistance from their backers to accomplish as well.
  • A fairly common use of debt is for investors to actually loan money to a company that will later be converted to equity at the next round of funding. This helps a company gain some financing without having to declare the value of the company until the next formal round of funding. Other considerations are provided to the debt provider in the form of discounts and warrants.
  • Companies that have ongoing revenue and a good financial track record can get a line of credit from a bank that can serve to plug the drain to cash flow that occurs during periods when accounts are not yet paid and to meet periodic payroll demands. The accounts receivable backlog can often be used as collateral for such loans as well.

Bank financing can be a valuable tool at all stages of company maturity. As with any financing activity, it has to be approached with discipline and a well thought out and managed business.

Filed Under: Financing a Company, Business Operations, Managing Business Financials



Bill Warner is the Managing Partner of Paladin and Associates, a business consulting firm in the Research Triangle Park area of central North Carolina, and is the Chairman of the Triangle Accredited Capital Forum, an angel investor network with over one hundred members throughout the southeast.

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