Debt vs. Equity Fundraising - which is best for your business

Hello friends. Welcome to another edition of my newsletter, where I share growth strategies from having helped companies do over $300M in product launches and over $800M in fundraising.

I’ve been fortunate to have been involved in over $800,000,000 in fundraising for businesses. That kind of volume came from time as a C-level banking executive and time as a startup founder and investor.

Founders go wrong with their fundraising efforts for a lot of reasons. Common mistakes I see include:

• Assuming they don’t have any startup investors in their network. The reality is they just aren’t talking to enough people or asking the right questions. Most people have investors in their network, they just may be levels deep.
  
• Not having their documentation in an “investor-ready” stance. Even if they have a pitch deck or business plan, the document(s) tend to fall flat in explicitly telling the story of the business and making the value proposition of the model clear.
  
• Confusing a lifestyle business, which isn’t interesting to investors, with a high-growth opportunity.
  
• Letting their own bias convince them that they have a winning idea.
  
• Failing to build a strong team of experienced professionals who have a track record for executing. Instead, they bring on family, friend, and co-workers from past corporate jobs.

Those mistakes will cost a founder a lot of energy, money, and time.

But none of those mistakes are as damaging as the biggest mistake I see - not being targeted with your fundraising efforts.

I recently worked with an entrepreneur who was attempting to raise both debt and equity at the same time. They had bootstrapped the business about as far as they could go without outside capital and were in a position of needing outside capital.

My advice, on our first call, was that their model was not right for debt. Yet, on the advice of another professional, who was incentivized to take them the debt route, they wanted to pursue an SBA loan. We spent weeks preparing a business plan, which is an SBA requirement. Only to later agree that equity was a better route at the time.

That mistake cost them the trifecta of energy, money, and time.

While there are some clear cut lines between when each type of fundraising is right for your business, that I’ll talk about, there are times when those lines blur. To be targeted with your fundraising efforts, you need to understand when debt or equity are the best options.

Where the lines blur between debt and equity fundraising

There are a few places where capital is just capital. Meaning there are some common characteristics of each and what it takes to land debt or equity. Some of these are pretty basic.

• Both have to be repaid. The only sources of capital that don’t require repayment include winnings from pitch competitions and grants.
  
• You are losing some degree of control. With equity you may be asked to give up seats on your Board of Directors. With debt you will have a lender reviewing your financial position regularly and instituting covenants that must be met or else the debt is “called” due.
  
• Both come with a cost. Debt costs you in interest and equity costs you in shares of your business.
  
• They each take time to close. Don’t wait until you need capital to start your fundraising activities, because both debt and equity take time to close, upwards of months.
  
• You’ll need documentation that describes your business model. For investors you generally start with a pitch deck and for lenders, particularly SBA loans, you will need a full business plan.

Where the lines are clear between debt and equity fundraising

You’ll notice that the common characteristics above also have distinctions within them, ex. you’ll need documentation, but its a pitch deck versus business plans situation.

There are, however, very distinctive differences between when you should be attempting to raise debt versus equity.

You should be targeting debt if you can check off multiple or all of the following criteria:

• Your business is producing revenue.
  
• Your business is producing enough revenue to cover all of your expenses plus the cost of the new debt.
  
• There is collateral you can offer. Ex. real estate, equipment, or other hard assets.
  
• You have liquidity, i.e. cash, to inject into the deal. Ex. if you are using debt to purchase equipment some lenders will not finance the full amount of the purchase.
  
• Your business is more of a lifestyle business.

Equity makes sense when you can check off multiple or all of the following criteria:

• You are pre-revenue and/or losing money.
  
• Your business model is one that can demonstrate high-growth.
  
• The business has a truly unique value proposition.
  
• If you have any sort of credit issues. Investors won’t love this either, but it’s less of an issue for them than it is for a lender.
  
• There are components of your model where intellectual property can be defended with patents or copyrights.
  
• The founder(s) have successfully ran, and possibly even profitably exited, past ventures.

What much of this boils down to is an overarching concept I try to teach everyone.

Lenders are historical looking and investors are futuristic looking.

Lenders will approve your loan based on what your business has done. Not what it is going to do. Lenders don’t make speculative loans.

Investors fund your startup because they buy into the idea of what you will accomplish. They are much more willing to be speculative.

Lenders = historical; Investors = futuristic

Understand that difference and you will avoid wasting time talking to the wrong sources of capital.

Curious if your startup is ready to raise outside capital?

My growth agency will perform a product assessment for you completely FREE.