Debt Finance for your Startup

What is debt financing and what are the pros and cons of debt financing?

Siert BruinsSiert Bruins
Debt Finance for your Startup

Debt for the business financing of a startup consists of borrowed money, in other words, this is money that has to be paid back. Attracting debt means that you borrow money to finance your new business. Usually, the borrowed money comes from a bank, but that is not necessary. It is customary for a pre-agreed part of the loan to be repaid in fixed installments. The amount of this repayment (which must take place monthly, for example) is also agreed in advance and fixed in a contract. In addition, or rather, on top of that, interest must be paid for the use of the borrowed money, this is the interest part of the loan. Think of the slogan "borrowing money costs money".

Attract debt capital to finance your tech startup

You can use equity or loan capital to finance your own business. On another page of this website you can find more information about raising equity to finance a startup. On this page, we discuss debt capital for financing your startup. The most obvious provider of loan capital is of course the bank, but it is also quite possible to borrow from family members and friends. This often happens because it is not easy for a starting entrepreneur to borrow money from the bank at these times. If you borrow from family, make good arrangements to avoid arguments. Sometimes there are also local funds that you can use. Consider, for example, your municipality if you want to start from a benefit position. Regional development companies also sometimes lend money to starting entrepreneurs. Be aware that interest rates can vary quite a bit and it can certainly pay off to negotiate. Never settle for the first offer from your bank. The advantage of financing your company with loan capital is that the interest rates are always (should be) lower than the profit distribution that you have to pay to shareholders. Shareholders also have very different rights than a party that has borrowed money. For example, a bank that provides financing in the form of a loan, in principle, has no control over your company. It is true that the conditions will state that they may intervene if you are unable to pay the interest and repayment. If you borrow money from, for example, your father-in-law, you should also agree to this. He lends you money but does not interfere with the day-to-day business. This is of course different if he also has a position in your company. Sometimes a financier of loan capital explicitly stipulates other certain conditions. Of course, financing with debt capital also has disadvantages. You always have to deal with fixed interest costs, even if you do not have to pay them off immediately. You will also have to pay these interest costs if no profit is made (yet).

Debt capital and strange conditions

Always ensure that a party interested in your ideas does not try to impose strange and unfavorable conditions on you. For example, the financier provides a subsidy that must be repaid and on which you must pay also high interest. Moreover, this party also wants shares. It happens and the writer of this story has experienced it himself! Remember that, in principle, a subsidy does not have to be repaid and that an interest-bearing loan (debt) does not have to cost you shares.

A bank does not invest in your startup in exchange for a share of your company's shares, but the bank lends you money. The bank receives a fee for lending the money which is known as interest. The banker's profession is basically to store money for customers (for example at 3% interest) and to lend money to other customers (for example at 5% interest). The difference is for the bank. The golden rule also applies here: the more risk, the higher the interest.

Borrow money from the bank for your startup?

The size of bank loans to companies varies considerably. From 10,000 euros to a one-man business to tens to hundreds of millions of euros to large multinationals. When a banker assesses a company for a credit application, not only the numbers are looked at, but also the entrepreneur and his company. What is the past of both and how have they fared? This gives the bank something to hold on to, but also often causes friction. After all, an entrepreneur is often an incorrigible optimist who firmly believes that his plans will be successful in the future. But if the banker went into business with every optimist, things would soon end badly for the bank. An entrepreneur can earn a lot of money if his company is doing well, but that also involves a lot of risks (for example, bankruptcy). On the other hand, the bank cannot earn more than a few percentage points on the money lent, which in turn entails a limited risk. After all, if the company to which the money was lent goes bankrupt, the loss for the bank is 100%. There must then be a large number of loans with a 5% profit. Because of this principle, the bank always asks for collateral when you request a loan with your company. This collateral often consists of real estate or your house. If you want to borrow a serious amount to, for example, start a shop, the bank will also ask for a business plan. Your store will then be able to be financed based on a sound business plan and a mortgage on your house. If you already have a mortgage, the equity of your home can serve as collateral for a smaller amount. In addition to your past, solvency is also examined. This is the ratio between equity and debt. In other words: solvency is the difference between all assets and all debts and obligations of a company (or yourself). Determining the solvency of a company requires the necessary financial knowledge, but roughly speaking when the share of equity falls below 30%, the company ends up in the danger zone. It is known that the probability of a company failing increases exponentially when solvency decreases. That is also conceivable. If a company without equity just manages to pay salaries, bills, interest, and repayments every time based on what is earned, there is no buffer. When things are disappointing (a little less turnover or the customer does not pay so quickly), the company will immediately run into problems. That is why solvency is a very important parameter on which a financier assesses the credit application. This indicates the resilience of the company.

Be smart and compare banks

When you are looking for a bank for a business account, it can be useful to take a tour with your plans in mind. Compare banks. Banks and financial institutions offer a range of products for the business market with which they provide loan capital to companies. This varies from the credit on a current account via real estate financing to mortgage constructions. Perhaps the bank now only wants to provide you with credit on a current account, but that may be very different in five years. Comparing banks can also be very useful when it comes to corporate financing for your startup. Especially since this can make a significant difference in the interest you have to pay.

A bank sells many types of financial products

Large banks often also have various subsidiaries that specialize in certain products. This concerns, for example, leasing companies where you, as an entrepreneur, can lease a company car through your bank. Furthermore, a bank is often associated with several insurance companies. If you open a business account, the bank will want nothing more than to also sell you several business insurance policies. Think of disability insurance, a pension of course, or accident insurance. It is of course very useful as an entrepreneur to be adequately insured and it is fine to do so with the same bank where you have your business account, but remember that the bank will probably receive a bonus if you take out insurance there, and that the bank may also co-owner of the relevant insurance company. So always just ask why the bank employee advises you to insure yourself with that particular company and what they earn from it. And it's always fun to just wait and see if they come up with that information themselves. Gives you an immediate impression of the way business is done. All of this just fits under the heading "convenient doing business". However, it becomes dubious when you want to open a business account and the bank only wants to do so if you also take out your business insurance there. The writer of this piece experienced this himself at a bank with a green-yellow logo and was outside again within ten minutes. Tying is prohibited by law...... Another example of a financial product is the billing companies associated with a bank. This is a smart way of the bank to lend money to companies. In this construction, you hand in your invoices and they are then paid directly by the billing company minus a few percent. He then collects the total amount of the invoice from your customer. Advantage: you immediately receive your money, which you otherwise often have to wait a long time for and complain about because it is advanced, so borrowed, by the bank. Disadvantage: it costs money, but you also have no hassle and no loss of time. So don't just open a business account somewhere, but take a tour and compare not only the interest rates but also what else they have to offer and how they deal with it. Comparing banks can be very useful.

In general, banks do not lend to companies in the very early seed stage. Sometimes it is still possible to get a current account credit. This allows you to be "in the red" up to a certain amount. Even if you don't need it immediately, it is wise to take a serious look at this. It is said that "The bank hands out umbrellas when the sun shines". This means that you can only borrow money from a bank if things are going well and you may not need it so urgently. Then you also have the time and the peace to compare interest rates, for example. That is why it is useful to see what the possibilities are if there is (still) sufficient income, for example, if you are still employed. Then it is often no problem at all to take out a loan or credit (even via the internet or by telephone). As soon as you have become an entrepreneur with an uncertain income, it becomes a lot more difficult and the conditions become a lot less reasonable. As a private individual, you could make such a personal loan available to your starting company. Of course, you also take a risk with this that is at your discretion. As a starting entrepreneur, are you able to meet your monthly payments, in other words, do you have enough confidence in yourself? Of course, you also take a risk with this that is at your own discretion. As a starting entrepreneur, are you able to meet your monthly payments, in other words, do you have enough confidence in yourself? Of course, you also take a risk with this that is at your own discretion. As a starting entrepreneur, are you able to meet your monthly payments, in other words, do you have enough confidence in yourself?

Sometimes the bank's products also include a loan that may involve a little more risk (risk-bearing loan). This can also be used to finance innovative and high-risk projects. The lender will then usually want to cover the risk as much as possible by requesting a government guarantee or asking another institution to participate (for example a regional development agency). After all, they are banks and they always want their money back, one way or another. But because of these kinds of programs, it is always interesting to visit the local bank and inquire about the possibilities. Think of the so-called surety credits. If a starting entrepreneur cannot offer enough security for a certain loan, the government can guarantee it using a surety loan. This is also interesting because, in general, loan capital is much "cheaper" than the capital of an investor. A party that owns part of your company can earn much more from it than a bank that provides a loan. But that party can also lose much more of course. Again, the iron law of risk versus reward applies here. But that party can also lose much more of course. Again, the iron law of risk versus reward applies here. But that party can also lose much more of course. Again, the iron law of risk versus reward applies here.

A loan for a tech startup?

Is it still possible, a loan for a starting entrepreneur? It is common for entrepreneurs who want to invest to go to the bank for a loan. However, for many entrepreneurs, it is currently very difficult to get a loan from the bank. There are plenty of stories about the "bank that is difficult", even from entrepreneurs with companies that have been healthy for years and have well-thought-out plans. The requirements for own capital and sufficient collateral in the form of buildings and machines are being increased further and further. A loan for a starting entrepreneur is even more difficult and we are not even talking about a technostarter who wants to start a company with an invention or a good idea. Then it is virtually impossible to attract business financing for your startup. In such cases, it can help to try to use one of the various schemes and platforms that the government has to support the start-up. Starting companies and companies working on innovations can count on additional opportunities. And that is exactly the target group we are talking about on this site!