Let’s simplify things.
I’ve worked with tens of founders, many of whom are interested in non-dilutive capital despite the fact that they have zero, or very little actual revenue. So before we dive into the details, let’s make this easier on all of us and eliminate a few options right out the gate:
- If your company doesn’t generate revenue, you can’t take on debt.
- If you don’t have a high-growth business, you can’t take on equity financing.
- Finally, if you want full control and ownership of your company, then don’t take on equity financing.
Put another way, the above three points can also be stated in the affirmative as such:
- If you have revenue, you have the option between debt and equity.
- If you are pursuing a low-growth business or a small market, debt is your only option.
- If you want control and ownership of your company, debt is your best option.
At this point, you ought to understand generally which category your company fits within, and whether or not you even have the option to pursue debt as a method of financing your company. If you are generating a solid amount of revenue (at least $5k/month at a minimum) we’ll dig into the decision-making process in the next post.
And until the next post is published, to save you the time of scouring the internet, I’ve also gathered up the top articles on equity vs. debt and provided the main takeaway from each:
- An example scenario of two identical companies - one that chooses debt, and one that chooses equity financing, and then shows the financial impact on each, which is a useful in demonstrating how the mechanics of each work.
Article: Equity vs Debt Capital Funding: Comparing the Costs
Takeaway: “if you’re looking for a lower cost of capital for startups, venture debt is often the best way to go long-term (as this scenario explained). But, if you’re looking for operational funding to maintain your organization as you scale up or have already utilized debt financing, SaaS equity financing may be the better route for you.” (take this with a grain of salt as it’s a sales pitch).
- A well-written article that essentially explains the different types of equity and debt funding, along with some pros and cons.
Article: Debt vs. Equity Financing: Pros And Cons For Entrepreneurs
Takeaway: “the biggest and most obvious advantage of using debt versus equity is control and ownership.”
- A bullet point list of attributes for both debt and equity that has a number of great points buried within it.
Article: Debt vs Equity in the Startup Venture
Takeaway: “A company must maintain a debt to equity ratio that meets the capital needs of the company while not making the company fiscally vulnerable. An investor will be reluctant to invest in a highly leveraged business (i.e., has lots of debt) because the equity investment is always subordinate in priority of payment to the debt.”
- A bunch of quotes from various founders on their one-sentence opinions of the two options. The quotes are all over the map and not very helpful.
Article: Debt vs. Equity, Which is Right for Your Startup?
Takeaway: None, but it does provide a number of different perspectives on this issue and shows how difficult a decision this can be without access to proper advice and data.
- The first article that even references the actual decision. Finally! and thank you.
Article: The Difference Between Debt and Equity Financing
Takeaway: None. However, this was the first article to at least mention the question of “How to choose between debt and equity financing” - they just didn’t answer their own question, and instead referenced the weighted average cost of capital (WACC) which isn’t relevant for a decision between debt and equity, but instead helps a company compare scenarios where BOTH equity and debt are involved.
- This article just defines the different types of financing, for the 1 millionth time on the internet, but does provide a good point about tenure.
Article: Debt Funding Vs Equity Funding For Startups: Pros And Cons
Takeaway: “In comparing equity fund vs debt funds, tenures are usually longer for equity funds, while debt funds are categorised into short term and long term. Long term debt funds are raised for capital costs which have high-interest rates, and have company assets as collateral. Whereas short term funds are utilised in recurring payments, have lower interest rates and minimal collateral requirements.”
In my next post, we’ll get into the a more nuanced decision-making process for determining the best path forward among all of the financing options available to you - particularly if you’re a high-growth revenue-generating company, which essentially means the world is your oyster.