There’s no question that equity has a critical role to play in helping founders to meet their business goals. But it is important to recognize that equity is not the only source of startup funding. Using debt to complement your equity funding can be a smart move for stakeholders in a variety of situations, including when they want to:
- Higher valuation. The valuation of business during the equity funding is critical to the success of the business. Higher the valuation lower the dilution. Companies often use venture debt to extend their runway so that they have more time to grow their business before their next valuation.
- Secure greater upside. Dilution is a serious consideration during equity funding. By using venture debt to meet a portion of their financing needs, founders may reduce the dilution of equity and ultimately see more upside when he takes exit from the business.
- Maintain Controlling power Venture debt results in less dilution, providing founders with greater strategic control over the business.
- Extended Runway to achieve milestones. Sometimes founders find themselves in a position where they want to achieve certain milestones before the next round of equity. Using venture debt can help them to accelerate momentum and maximize liquidity thereby optimizing their negotiating position in the next equity round.
- Strategic Flexibility. Bringing on a new investor often require re-setting the clock and committing to a plan that promises to deliver the investor’s target return. Using venture debt can help founders maximize their flexibility when it comes to deciding when and how to exit.
The implications of raising equity
While raising equity fund may be very appealing but the fact is that using equity alone to fund the business for its growth has many serious implications, including
- Leads to dilution. Too much dilution in early-stage results in a loss of control over the direction of the business. Meanwhile, founders and other investors all stand to see a smaller payout when the business is acquired.
- Board Seat: You may require to give board seats. That means that you have to obtain your investors’ consent on important decisions.
- Current Valuation: if the business is about to reach its milestone and it approaches for equity funding, the valuation that business will get will be significantly lower than the valuation that he would have got if its approaches for equity post achieving the milestones.
- Time Consuming: Raising equity generally isn’t a fast or simple process. It may take 6-12 months time to write a cheque.
Perfect Capital Mix
There can not be a fit for all solution to find the perfect Capital mix, it will depend on a specific business. A company that can predict with confidence how the investment will directly drive revenue growth (and how much) or otherwise create value in their business, will generally be better suited to using debt capital than one that struggles to do so. Fundamentally, a company’s capital efficiency will determine how much debt it should use.