It takes money to make money. Deciding where to find the first funds to get a startup off the ground is one of the most important decisions an entrepreneur has to make.
We Asked 12 startup founders what advice they would give an early-stage entrepreneur who’s considering debt vs. equity. (Share your own thoughts in the comments.)
Consider sweat equity first
When you take on any type of investment from someone else,
you’re forfeiting some of your control of the company by default (even if you
don’t do equity, you’re still obligated to your creditor). Because you raise
capital, ask yourself if you can do this without the investment, especially if
the venture is web-based. Chances are, you can. Investment is overrated anyway
— customers matter more.
Try your best at debt first
I’m a big believer in keeping as much control over your business
as possible. Debt — in the forms of lines of credit or loans — is an effective
means to build up short-term capital while keeping 100 percent of your
business. Having investors with equity shares is like having many bosses, and
you risk losing control.
Decide if you’re in this business
forever
If this is it — the big idea that you want to work on long-term
— debt may be the best option. You need to keep control when something is your
baby and you plan to work on it forever. But if you’re looking at building this
business and then moving on to something else cool, equity looks like a better
option. It means people are already interested in your company and may be
willing to buy you out.
Remember, equity is clean
When going through your first round of fundraising, often times
you will come across convertible debt notes versus equity. Equity is the cleanest
term versus a convertible debt because it is risk capital that doesn’t have to
be paid back. With a convertible, you have to pay it back or it gets converted
into equity and comes with extra terms. Cost of equity can be higher though
because of dilution.
Evaluate your position
There are several factors to consider, although I would suggest that
accepting either debt or equity investment is entirely situational.
Sometimes you won’t have a choice, frankly. You should look for strategic
investors that have access to more capital, more investors, and industry-specific connections. I would also hire an attorney with expertise in
structuring investment deals.
Be thankful you have a choice
At the end of the day, when you need money for that next big
step and you have found someone willing to fund you, your say in the matter is
rather limited. Remember the golden rule for startups — he who has the gold
often makes the rules.
There’s no single right answer
Each option has its pros and cons. It’s crucial to evaluate both
the debt and equity options, get formal terms for each, then decide which makes
more sense for the future growth of the business.
Avoid debt if possible
A startup’s break-even point is one of the most important, yet
often neglected measurements. If a company can become profitable early on
through hard work and niche market penetration, a certain type of momentum is
garnered — that is indescribable. Going into debt, on the other hand, forces
the entrepreneur to always be looking backwards at the lenders waiting to be
paid back.
It depends on the terms
Debt vs. equity depends on the terms. If it’s unsecured debt and
even close to near-market rates, the deal would seem pretty attractive.
Share equity for less risk
We bootstrapped for the first 18 months before finally taking on
a few equity investors. We generate a lot of sales, so debt is a great option
(we can use the cash from the sale to pay it down). However, I made a personal
decision that I had taken on enough risk in investing my time and money into my
company. Instead of adding more debt (and personal guarantees), I decided to
share the upside!
Make a big, big pie
Many early-stage entrepreneurs worry about losing control of
their business when taking on an equity investment, but issuing equity can help
your company get to the next level. The right investors aren’t bosses, they’re
partners who are incentivized to help you succeed. They’ll make introductions
or help you with strategy. It’s better to have a small slice of a big pie than
all of nothing!
Do What’s Best for Your Business
The right method to finance the next phase of your company
should come down to the kind of business you’re in. We used convertible debt
early on (via an accelerator), but there are plenty of early businesses in
which that might not make sense. Ask other entrepreneurs for advice (and
mentors, if you have them). This kind of decision is very non-general; make the
decision that’s best for your team.
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