When it comes to business financing, venture capital gets all of the attention. Not a day goes by without a headline announcing a new round of venture funding for a buzzy young startup.
But for entrepreneurs weaned on the flash of venture capital, debt funding often sounds old-fashioned at best. At worst, it's viewed as a black mark, a last resort for those who can't raise venture funding.
The reality is that both types of capital have their place, and debt's bad rap is totally undeserved. At CardCash, we raised $6 million in Series A funding from Guggenheim Capital in November 2013, then another $6 million in debt funding a year later.
Why the change? Trust me, equity and debt capital are not interchangeable. There were very meaningful, strategic considerations that determined the structure of each of those funding events--and if we had, say, switched the order, it would have completely derailed our growth plans.
The same goes for your company. The fit depends on your business's maturity, cash position, and goals.
First, let's assume you run a fast-growing, scalable business. Venture capital isn't for the mom-and-pops out there. You need to aim to build a company worth hundreds of millions of dollars to make sense as a candidate for venture funding. Assuming that's your business, here's when venture capital works:
- Your cash flow is unpredictable, weak, or nonexistent.
- You don't have any meaningful brand recognition or track record as a business.
In short, venture capital works well when your business is immature.
The obvious reason: If your company is young, without meaningful revenue, it's going to be pretty darn hard to pay back a loan. And if you're not absolutely certain that you can pay back a loan without harming your business, it doesn't make any sense to add that debt to your list of anxieties.
We actually had pretty strong sales back in 2013 when we raised our Series A from Guggenheim. But we wanted capital to invest directly into the company, to expand our staff and inventory, without worrying about diverting cash to servicing a loan. The equity-for-capital trade was perfect in this scenario--an extra $6 million to invest, and I didn't have to worry about siphoning off our cash flow to pay it back.
But the bigger benefit of that Series A was the added credibility. Even though we'd built a strong, growing business, we were still an unknown commodity among corporations with whom we tried to partner. Once Guggenheim came on board we closed deals with Wal-Mart, CVS, United Airlines and InComm, all within a year. This was not a coincidence. Guggenheim's network and stamp of approval led directly to these partnerships, which have been huge for our company.
A year later though, we found ourselves in a very different position, and much more interested in raising debt to fund our business. Here's when debt-funding works:
- Your cash flow is strong and predictable.
- You have the credibility needed to grow your business.
- You have no interest in giving away more equity.
We fit all of the above criteria at the end of 2014, which is when we found ourselves looking for financing. The fourth quarter is by far our biggest sales period, and given the impact of our new partnerships, we expected demand to far outpace that of 2013. I wanted to make sure that we had the capital needed to buy enough inventory for the holiday season.
But raising more venture capital in this scenario didn't make any sense. We had very predictable cash flow and could confidently pay back a loan without anxiety. We just needed to shore up for a short-term increase in demand.
Credibility certainly wasn't an issue anymore, since we had just closed a string of unbelievably beneficial partnerships.
And giving up equity was pretty low on our list of priorities. Remember, holding on to equity isn't just about maximizing your payout down the line. It's about maintaining control over strategy and operations. Equity is precious. Giving it up to capitalize on a short-term opportunity, one that could be funded just as easily with debt, is a shoddy way to run a business.
We ended up taking out a $6 million loan from a traditional bank, Sterling National, and it worked out beautifully. We handled the holiday rush with ease, even as we closed the Wal-Mart deal, which added to a huge spike in sales. We'll easily pay off the loan and grow our business tremendously, all while keeping equity in hand for a bigger opportunity down the line.
Debt funding, I'd say, is underrated.