Startup business loans can provide an alternative for entrepreneurs looking for money to scale strategically. Whether you’re a founder or CFO, it’s important to understand how these loans work, who should seek them out and what types are available.
Financial operations can be scary for busy entrepreneurs, but understanding how to take advantage of different types of funding can unlock new possibilities. Let’s explore everything you need to know about loans.
What is a Startup Loan?
Landing a fundraising check from an investor isn’t the only way to inject capital into a startup.
Startup business loans are an alternate form of financing for companies with a limited history of credit or revenue. There are various types of loans, and many of them are specifically designed to be more accessible to new businesses given their less stringent qualifications. In short, a loan is another way for startups to get the working capital they need to scale strategically, without sacrificing equity.
Types of Startup Business Loans
Here are three common types of startup loans:
Most early-stage companies, especially SaaS startups, don’t have the required assets to collateralize a loan against: physical inventory, real estate, accounts receivable, etc. To get around this, investors and banks will offer revenue-based financing (RBF) loans that are collateralized against the startup’s future revenue.
RBF loans can be expensive and contain strict compliance and control measures from the lender. Companies that know they’re not far from a payday, however, won’t mind these drawbacks.
Get your finances straight.
with our in-depth playbooks and templates.
Traditional lending/Line of credit
With a typical loan structure, your business would borrow money from a bank and be required to pay it back with interest over a set period of time. A bank loan offers funds up front with a set repayment schedule, while a line of credit offers a borrowing limit that can be drawn and repaid as needed over the duration of the agreement.
These types of loans will need to be secured with collateral or a personal guarantee. There are typically compliance requirements, called covenants, that must be followed to avoid default or penalties. Covenants could be as simple as submitting regular financial reports, or they could be more robust, with minimum liquidity ratios or other indicators of financial health.
Borrowers need to provide assurance that they will be able to repay the loan when it is due. The loan agreement would let you know exactly what is required and what would happen in the event of default.
Private lending agreement
Also known as “friends and family lending,” these startup business loans often come with the friendliest terms for borrowers. Founders or chief financial officers can seek out previous investors, angel investors or any private party to receive these loans. But be sure the loan is established with agreeable terms for both parties and documented with a fully executed loan agreement, regardless of how close the lending party may be.
When to Seek Out a Startup Loan
There are three typical scenarios for seeking out a startup loan:
As a short-term bridge before a fundraise
Putting together a seed or Series A round can take time. Growing companies can’t always wait around for cash as they work with investors and attorneys to finalize a deal.
A startup loan is a great solution for founders looking to keep operations running smoothly, without asking their investment partners (who are about to write a formal check for a fundraising round) for an extra chunk of change.
Borrowing for something specific
Startups can collateralize their loan against the very thing they’re using the loan money for — similar to a mortgage for a house. Perhaps your company needs to purchase real estate or specific equipment to accelerate a product launch, for example.
When you want to avoid dilution
Fundraising is exciting, but it also means you’re giving up equity in your startup. Startup business loans are a way to inject capital to scale your company without diluting your piece of the pie.
Pros and Cons of Startup Business Loans
Pro: Preserve your equity
You worked hard to build your startup. Loans help you get the money you need without giving up shares of your growing company.
Pro: Give yourself more runway
Startup business loans give your company the capital injection you need for a specific purpose, whether that’s bridging you to a fundraising round or helping you make a specific purchase.
Con: It takes time to analyze your options
Most people wouldn’t sprint out of the shoe store with the first pair of sneakers they try on. Be sure to shop around at different banks and with different investors to see who will give you the most favorable terms on your startup loan.
Con: Be wary of the total cost of the loan
There’s more to the cost of a loan than the initial fee and the interest rate. Factors such as compliance requirements, penalties for covenant defaults and termination clauses can be just as important to the attractiveness of the loan. If you don’t educate yourself before taking out a loan, you’ll risk giving up more than you intended.
Fuel Your Startup Finances
Need more assistance with your startup’s financial operations and capital strategy? Fuel, York IE’s strategic growth platform, offers on-demand templates, playbooks and more to help you build a strong financial foundation. Visit our finance and capital library today!