Using Debt to Grow Your Startup
Debt + Equity can be the equation your startup needs to succeed
While selling equity to raise money is perceived as a valuable tool for early-stage startups, debt is sometimes thought of as a dirty word. However, debt can be a critical tool for startups when used correctly. It can provide the capital a startup needs to grow without diluting the team’s ownership stake and can be a less expensive way to finance operational expenses when compared to equity. This is because the interest rate on your loan will always be lower than the return your investor expects to make on their investment in your company.
A few key reasons why it’s important for startups to leverage debt in addition to raising equity
If capital efficiency is a focus, startups should consider debt to fund their business. When used appropriately, debt can help improve operating leverage by reducing operating costs and increasing margins without diluting ownership.
A prime example of this is using debt as a lever to negotiate better pricing from your vendors, whereby you offer favorable payment terms to your vendor (e.g. paying the full year upfront) in exchange for a discount. When this tactic is used to lower operating overhead it provides an opportunity to improve margins, without disrupting cash flow. Not only that, but the interest paid on your loan is tax deductible and the discount/incentive you may receive for paying upfront may offset most, if not all, the interest paid on the loan.
Why using debt to finance software costs makes sense
Startups should use debt to finance investments that will generate a positive return. Cash raised from investors can be used for longer-term investments that are too far in the future to accurately assess return potential. A great example of an investment that has a clear, positive return is the software needed to operate your business. Assuming you have vetted and researched each software you are looking to add to your tech stack, investing in these tools will naturally yield high returns, as each tool will meet your specific needs for increased growth and efficiency.
Another reason why financing software makes sense is because software is a high gross margin business, and discounting is a common incentive provided to customers. Significant discounts can create a simple way to net a positive return on the investment. So by using debt to negotiate lower prices in exchange for paying these vendors upfront, you can often subsidize, or entirely offset the interest owed on the loan.
Assessing your options to make the right decision for your business
Making the decision between debt financing and equity financing can prove to be a vital decision in the long term success of your business, especially if you are focused on managing burn rate and extending runway. It’s important to assess your options, ask questions, and put a plan together that makes sense for you and your team. Gynger is here to help you navigate the intricacies of software financing, and as you plan around a capital raise, or look to improve your current cash flow, we can help you define and determine your options.
Stay focused, and grow!