More and more startups are choosing business loans over turning to VCs for funding ■
Here are six key rules for doing it right
More and more startup companies should consider financing through business loans, as opposed to venture capital – whether for security or backup, to finance working capital, pay for day-to-day operations or for growth. This, in addition to the instability in financial markets and the uncertainty it creates for companies (i.e. doubts about the availability, timing and scope of the next financing round), has led to a surge in demand and use of business loans.
As a CFO at startups for over ten years, I was involved in dozens of business loan operations, totaling over hundreds of millions of dollars, whether from banks or other financial institutions. These business loans were obtained, in amounts of millions of dollars, for growing startup companies (both with and without earnings), at excellent conditions, and against securities (liens on company assets) – but never through the requirement of securities or personal guarantees from shareholders or company managers.
In its simplest form, a venture loan or term loan (both terms are perfectly interchangeable, don’t let them confuse you), is a loan agreement for a fixed sum that a company can draw upon for a certain amount of time (i.e. ‘grace period’), usually up to a year from the time of signing – and it is repaid with fixed payments (usually monthly) of interest and principle, over a period of 2-3 years (i.e. ‘repayment period’).
In more complex versions, the repayment period can consist of an initial period of interest payments only, to be followed by repayment in equal monthly instalments. Further, the actual loan sum can be adjustable (usually upwards), conditional on certain events occurring (e.g. reaching a predetermined sales target or the company obtaining fresh capital). Sometimes, the duration of the loan and its repayment period also change according to certain other criteria agreed upon in advance.
How to get it right? Here are some tips:
■ Make borrowing a part of your long-term strategy – A growth company will do better if it chooses the right form of business loan ahead of time, and in tune with its long-term financing strategy, and not as a last resort when cash is running out fast and there are no other options left. Taken care of carefully and ahead of time, business loans turn into a very useful tool for financing a company, in addition to or sometimes even instead of raising capital. In my experience, commercial loans can finance a company until it turns profitable, finance several months of operations until the company obtains additional capital, bridge equity gaps, finance the acquisition of other companies, or pay for a company’s rapid growth (e.g. a SaaS company with a short ROI).
■Thresholds to business loans – Several conditions need to be met before anybody will lend money to a startup company. For example, most lenders will not provide loans to startups unless they’ve already received funding from VC funds; furthermore, the company’s financial forecast has to make sense, i.e. the amount of money the company seeks must be in accordance with its stage of development. And of course, the lender must believe in the company – its product, market, and management.
■ Costs and time of obtaining a business loan – Even if you obtain a business loan, doing so takes time and money. Usually, the process takes 3-4 months from the moment the company sets out to seek the loan. In addition, the cost of obtaining the loan, which in itself can reach tens of thousands of dollars (including legal fees and other basic costs), needs to be taken into account.
■ Answering a company’s financial needs – This might sound trivial, but one should ascertain that the loan provides the company with the necessary funds under various realistic scenarios. For example, a company that plans to finance its operations with a business loan for a certain period, but agrees to make a significant part of the funds conditional on reaching 90% of its sales goals, is taking a risk because not reaching its sales goals will not just weaken the company directly, but will also keep it from accessing the loan. Caution is advised!
■ Choosing the lender – The lender needs to be chosen carefully. We are not simply dealing with people, but with the history of institutions, their relationships and the reputations they’ve built over time. Ask and seek advice from other managers or investors. Chances are that over the loan period (several years), the company will experience significant changes, so the lender needs to be able to undergo those changes together with the company and assist it.
■ Keep relations open and professional – Did you obtain a loan from a lender? Keep the lender in the loop. Although usually the lender will not take part in managing the company (the lender has no representative or observer on the company board) you need to maintain an open, transparent, and continuous relationship. A lender who feels that he is being treated as a partner will act like a partner during difficult times (and usually there are difficult times) and will diverge from the protocol and agreements to help the company overcome crises, together.