In recent years, as technology companies have gained more attention from mainstream financial institutions, cheaper debt funds have become available for startups to fuel their growth, along with traditional venture capital funding.
In equity financing, a company uses shares (equity) in exchange for accessing funds for overall business operations. It then ideally pays back investors with the investment multiple by selling its shares (through an acquisition or IPO). In debt financing, the company uses collateral in exchange for accessing funds for a specific business activity and pays it back over a defined period.
Typically, when a founder is deciding to raise debt in order to finance their business operations, there are two key questions to consider:
Understanding which debt instrument is most applicable to you and your company will depend on your answers to the above questions. To help you work through these considerations, we’ve outlined a few hypothetical scenarios in which debt instruments play a critical role in the company’s growth. In each scenario, we describe the situation, the venture’s objective for financing and the types of suitable collateral a venture would require in obtaining debt financing from each loan facility.
Some may argue that these scenarios can be financed by raising equity from venture capital. However, the reality is many startups may not receive venture capital funding in a timely manner because of investors’ subjective judgment regarding the market and/or tech, or the lack of a personal relationship with the founder. Therefore, depending on the stage of your company, debt financing may be a more relevant financing option — as long as you have the right type of collateral.
Hardtech Inc., a two-year hardware startup, has five employees and recently secured a $300,000 contract after launching a minimum viable product last quarter. It takes 15 days to source materials, and one month to manufacture and deliver products. Most of the cash in the company was spent on R&D, and now cash is needed to start the production and deliver on the contract.
|● Deliver on the contract
|● Commercial contracts
● R&D tax credits
|● Accounts receivable
● Purchase-order financing
|● 45 to 60 days
Power Tech is a B2B SaaS company and has five people on the team. They are hoping to close a Series A round in three months, getting soft commitment from VCs, but have not yet identified the lead investor. The current monthly recurring revenue is $10,000 and steadily heading toward $50,000. Customers are continuing to sign up on the platform, and there are several engineers pending to be hired. Competition is strong, and several key functions need to be developed. Cash is tight: there is a three-month runway left in the bank account.
|● Continue fuelling growth while waiting for VC funding
|● Monthly recurring revenue
● Commercialization grants
● R&D tax credits
|● SaaS financing facility
● SR&ED tax credit facility
|● Three months
SuperDeep.ai is a three-year healthcare company spun out of the University of Supercool. The team consists of three people, including the CEO (a well-known researcher), CTO and CSO. The CEO is on the road to raise their first round from angel investors and seed-stage VCs. The company has been benefiting from government research grants to complete the R&D and build a prototype and is now waiting for FDA approval, pre-revenue. There is no other source of cash, other than three projects with a one- to three-year duration in the pipeline that are funded by government grants.
|● Raising funds (pre-revenue)
● Prepare to go to market
|● Fixed assets
● Government grant commitment or contract
|● Term loans
● Equity investment
● Grant financing
|● One to three years
A final take-away is that a founder always has an alternative financing source. It’s a matter of picking the right type of debt facilities that work for each business case. If you’re a tech founder considering raising funds through debt, the first place to start is to think about what assets you will need as collateral for financing.
Produced in partnership with:
About OKR Financial:
OKR Financial is one of Canada’s leaders in providing debt and equity financing solutions to entrepreneurs. OKR operates a family of private funds that provide non-dilutive financing solutions to Canadian SMEs by leveraging Federal & Provincial tax credits and Government funded programs, providing the pathway to equity financing when companies are ready to scale up.