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Debt vs Equity Financing
Insight from a16z
Debt financing can be a powerful tool in your arsenal. But it's crucial to understand how it differs from and complements equity.
First things first, debt is not a replacement for equity. Venture lenders use equity as a key validation point when underwriting startups, so founders often raise debt only after they've secured an equity round.
When considering debt financing, there are many tradeoffs to keep in mind. Let's say you're raising a $50M equity round at 10% dilution.
You could either increase the round to $60M at 12% dilution or raise a $10M debt facility to complement the $50M equity round.
a16z
In this scenario, you'd need to weigh the fees, interest, warrant dilution, and repayment terms of the $10M debt against the additional 2% dilution from the extra $10M in equity.
It's a delicate balance, but when done right, debt can offer more flexibility, less dilution, and faster access to capital compared to equity alone.
The key is to find the right mix of debt and equity based on your company's specific circumstances. As a general rule, the more debt you take on, the more accurate your predictions and plans for the capital need to be.
Otherwise, you risk losing out in the long run due to interest and fees.
When comparing debt and equity, there are several crucial factors to consider:
Priority: Debt lenders, instead of investors, have first dibs on your company's assets if things go south.
Cost of Capital/Dilution: Debt is non-permanent capital with costs from interest and one-time expenses. Equity is permanent ownership that reduces founders' stakes and shifts some decision-making power to investors.
Flexibility: Debt offers flexibility with financing options but may come with restrictive conditions
Timing: Raising corporate debt is usually quicker than equity (4-12 weeks vs. 2-3 months), though can take longer (3-6 months).
Covenants: Debt may include covenants that dictate certain conditions you must meet to stay in good standing with lenders.
Remember to consider the tradeoffs! Being on top of your obligations is a priority (while scaling your business).
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