Startups don’t have any internal cash buildup to spend on developing their product, fixing a problem, and growing their business as they haven’t been operating for long enough to build up a reservoir. If you have a startup and you are looking for funding, you should be aware that you can either use debt or equity to raise funds. They are different things, but debt involves no exchange of shares, so many prefer debt to equity as it allows the preservation of equity. Here are some of the best loan types for young startups.
Banks and traditional loaners offer a short-term loan to those looking to start small businesses. Still, these are difficult for many startups that are launched by young people as they don’t have the credit history and experience to prove that they are a sound investment. Try to get a team member with some grey hair and make sure you have a watertight business plan and an answer to all their questions if you try this route, but without collateral, you may struggle.
Alternative lenders make a business from lending capital to businesses who need it. These are typically based on the viability of the business, whether your idea seems reasonable, secure, and profitable. Without collateral, you’ll need an unsecured loan, which comes with higher interest rates.
Community loans are those given by entities with interest in the functioning of their community. In America, the most common example of a community loan are loans provided by the SBA. The criteria can be a problem depending on your type of startup, but it’s worth giving it a go. You should note that the criteria may get stricter down the line, as once the SBA approves your loan, you will need to go to a commercial lender who actually deliver on the loan.
Depending on how much money you need, microloans might be a good option. These are loans that are provided by non-profit microlenders and can be a great kick-start to your business. They require less paperwork than a bank would ask for and don’t care as much about credit history, but the cost of that is higher interest rates.
This entry might take you by surprise as angels invest instead of offer loans. They require equity. However, there is a clever financing tool that angels are currently using that you might want to consider, an instrument called convertible debt. Convertible debt acts as both a loan and an investment at the same time. It works by you taking debt from an angel in exchange for an equity discount at a later date of investment if you don’t pay the loan back.
For example, an angel invests $100k in your startup. You use this wisely, develop a great product and raise $5m for your Series A. You and the angel agreed to a 20% equity discount, so you can either pay them $120k or give them $120k worth of equity. If you give away 50% of your company for that $5m, you will have to give the angel 0.012% of the company’s shares (0.024% of your equity). Many angels prefer equity, but if you can pay them back, they might be happy to just take the profit.
It’s nearly impossible to resist the allure of the entrepreneurial spirit and the thrill of opening your own company. Consider beginning a crowdfunding campaign or recruiting friends and family to help you raise the money you need if your firm is simply too fresh to be eligible for any type of conventional financing.