What is debt financing for startups? + How to get it

What is debt financing, and does your startup need it? 

This in-depth guide will explain what debt financing is. The goal is to explain why startups use debt financing and how you can secure it for your business.

Here’s what we’ll cover:

• A definition of debt financing for startups
• A list of benefits of debt financing
• An in-depth look at the different types of debt financing options
• A step-by-step guide to acquiring debt financing for startups
• Extra tips to secure debt financing 

Let’s get started.

What is debt financing for startups?

Debt financing for startups is, at its core, a loan designed specifically for young, growing businesses. It's a way for these budding ventures to secure capital without sacrificing ownership.

Instead of selling shares of their company, startups borrow money and commit to paying it back over time, usually with interest. This is in stark contrast with equity financing, which does require selling some of your company's shares. 

Think of it like this: You're borrowing from your future self. So, you're investing in your company today with the belief that it will generate enough revenue to repay the loan later on. This form of financing comes in various forms, each tailored to the needs of each startup. 

Some loans are designed for short-term needs, such as covering operational costs or purchasing inventory. Others offer longer repayment terms for investments in growth or expansion.

Why would startups participate in a debt financing round?

So, we’ve answered the “What is debt financing for startups” question. Now, we’ll dive into why startups seek it in the first place.

Debt financing offers startups several enticing benefits that can be vital in their growth journey. These benefits include:

• Retaining ownership and control: Debt financing lets founders keep their hands on the wheel. 
  
  There's no dilution of ownership, and lenders don't get a say in how the company is run. This is especially appealing for founders who value autonomy and want to maintain their vision for the business.

• Predictable repayment schedule: Debt financing agreements have a clear, structured repayment plan. 
  
  This makes it easier for startups to budget and forecast their cash flow. They know exactly when payments are due and how much they'll owe. This predictability can be a huge advantage in the often unpredictable world of startups.

• Interest as a tax-deductible expense: The interest paid on debt is often tax-deductible. This can help startups lower their tax bill. It can be a significant financial advantage, freeing up more cash flow for reinvestment in the business.
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• Building business credit: Repaying debt can help startups establish a positive credit history. 
  
  This can make it easier to secure financing in the future, both in terms of debt and potentially equity. A good credit rating signals to lenders and investors that a startup is a responsible borrower and a worthwhile investment.

Types of debt financing options under the lens

Just as every startup is unique, so are their financial needs. Luckily, debt financing offers a diverse range of options to cater to those specific requirements. Let's take a closer look at some of the most common types of debt financing available to startups:

Bank loans

Banks offer various loan options for startups, each with its own terms and conditions. Let’s look at two of those bank loan options:

• Traditional term loans: These are the standard loans. A startup borrows a fixed amount of money and repays it with a fixed interest rate over a set period. They are a reliable option for funding significant investments like real estate.
• Small business administration (SBA) loans: These loans are backed by the U.S. government and are specifically designed for small businesses and startups. SBA loans generally have more favorable terms, such as lower interest rates and longer repayment periods, making them a popular choice for businesses that qualify.

Lines of credit

Think of these as a financial safety net for your business. These are two of the most common ones:

• Revolving credit lines: These are similar to credit cards. These loans allow you to borrow up to a specific limit, use what you need, and only pay interest on the amount borrowed. They offer flexibility for managing ongoing expenses or unexpected costs.
• Business credit cards: These cards provide similar benefits to revolving credit lines. They often come with additional perks like rewards programs or cash back. However, they typically have higher interest rates than other lines of credit.

Equipment financing

If your startup needs specific equipment to operate or grow, this financing option is tailored for you. Let’s put two equipment financing loan options under the lens:

• Loans for purchasing equipment: These loans are designed explicitly for acquiring equipment. The equipment itself serves as collateral. This can make them easier to qualify for, and they come with competitive interest rates.
• Leasing options: If you prefer not to purchase equipment outright, leasing can be a viable alternative. It allows you to use the equipment for a set period while making regular payments, making it more affordable for some startups.

Invoice financing

For businesses dealing with unpaid invoices, invoice financing can be a lifeline. Let’s look at two popular invoice financing alternatives:

• Factoring invoices: You sell your unpaid invoices to a third party at a discount. This third party is called factor. The factor then takes on the responsibility of collecting payment from your customers. Think of it as a quick way to get cash flow. 
• Accounts receivable financing: This is a loan secured by your outstanding invoices. Similar to factoring, it provides immediate access to cash. The difference is that you retain control over your customer relationships.

Merchant cash advances

This is a quick-fix solution for businesses with strong sales projections. For example:

Advances against future sales: These are cash advances based on your expected future sales. You receive a lump sum upfront and then repay it with a percentage of your daily or weekly sales. While convenient, they often come with high fees.

Venture debt

This type of financing is geared towards high-growth startups. Companies can, for instance, take one of these routes:

• Loans from venture capital firms: Venture debt loans typically have higher interest rates due to the higher risks of lending to a new company, and these loans are often used in conjunction with equity investments to provide more capital without further diluting ownership.
  
  Venture capital firms usually invest in startups through equity financing to grab company shares if they’re confident the company will appreciate in value very quickly. After an initial round of equity financing, a venture debt loan can provide more short-term funding.  
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• Convertible debt options: This unique type of loan can be converted into equity in the company at a later date. It's a way for investors to mitigate risk while giving startups access to funding without giving up equity.

How to get debt financing for your startup

Debt financing can give your startup the capital needed to fuel growth and expansion. But navigating the process can seem daunting. Here's a step-by-step guide to help you secure the debt financing your startup needs:

1. Prepare your business plan

A solid business plan is your roadmap to success and is essential for securing debt financing. Lenders will want a clear plan showing your business model, market opportunity, and financial projections.

Be sure to include key components such as an executive summary, company description, market analysis, marketing and sales strategy, financial projections, and a description of your management team and their qualifications.

2. Assess your financial health

Before approaching lenders, take a deep dive into your startup's financial health. Review your personal and business credit scores, as these will be a significant factor in lenders' decisions. 

Analyze your financial statements. This includes your income statement, balance sheet, and cash flow statement. The goal is to give lenders a snapshot of your startup's financial performance. 

Remember to create a detailed budget to track your income and expenses. This budget will also highlight your financial responsibility and help you project future cash flow needs.

3. Identify the right lender

Research and compare different lenders. Try to find one specializing in financing startups that align with your needs. 

Consider factors such as the types of loan products they offer, their interest rates, repayment terms, and reputation. Look for lenders with a track record of working with startups and offering flexible terms.

4. Gather necessary documentation

Be ready to provide lenders with various documents to assess your loan application. 

These typically include your most recent financial statements, such as income statements, balance sheets, and cash flow statements. They also include personal and business tax returns for the past few years and the business plan we mentioned earlier.

Depending on the lender's requirements, you might also need to provide a personal guarantee and additional documents, such as legal documents, permits, or licenses.

5. Submit your application

With your documentation in order, carefully review your application before submitting it to the lender. 

Make sure all information is accurate, up-to-date, and presented professionally. You should also highlight your startup's strengths and potential for success. Be prepared to answer any questions the lender may have about your business or loan request. 

Common pitfalls to avoid include incomplete or inaccurate information, unrealistic financial projections, and a lack of preparedness to discuss your business in detail. This is why being thorough and transparent is so important. 

6. Negotiate terms

Upon loan approval, carefully review the lender's terms, including the interest rate, repayment schedule, and any fees. 

Don't hesitate to negotiate for more favorable terms. But be realistic and respectful. Aim for the lowest possible interest rate, a repayment schedule that aligns with your startup's budget, and minimized fees.

Tips for acquiring debt financing successfully 

So far, we’ve explained what debt financing for startups is and how to get it. Now, here are a few tried-and-true tips that can pave the way to success:

• Build a strong credit history: Lenders want to see a track record of responsible borrowing and timely payments. This applies to both your personal and business credit scores. Pay your bills on time, keep your credit use low, and avoid negative marks on your credit report.
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• Keep transparent and organized financial records: Lenders want to see a clear narrative of your financial performance. Keep meticulous records of your income, expenses, assets, and liabilities.
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• Show a clear path to profitability: Lenders are more likely to invest in startups with a viable business model and a clear path to profitability. Develop a complete financial forecast. It should outline your expected revenue, expenses, and profitability over time. 
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• Seek advice from financial advisors or mentors: They can help you understand the different types of debt financing available and assess your startup's financial needs.

Next steps

You should now have a better understanding of what debt financing is for startups. You should also know that lenders are more likely to approve loan applications from startups that show a consistent cash flow. 

One key aspect of maintaining a healthy cash flow is having a robust billing system. A well-oiled billing system ensures timely invoicing, accurate payment processing, and management of late payments.

That's where Orb comes in. 

Orb is a done-for-you billing management platform. It’s designed to simplify your billing processes. Whether you're struggling with dunning, usage tracking, or invoicing, Orb has you covered. 

Learn how Orb’s billing system can help you.