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Every founder knows how stressful it can be to raise equity for their company, especially when markets are in turmoil and venture dollars are drying up. When you have finally closed a funding round, all you want to do is get back to running your business. After all, you just spent months gathering all your metrics, pitching to investors to secure a lead and painstakingly negotiating term sheets. Most prefer not to restart that process and lose out on crucial leverage at the negotiating table.
Why don’t founders raise debt shortly after raising equity?
Having advised dozens of founders on successful capital raises during my three years at Hum Capital, I know how much time and effort is required to fully prepare to raise capital for your business. Yet, all too frequently founders wait until crunch time — when they need liquidity like oxygen — to start thinking about their next fundraise.
When raising debt, the process is in many ways very similar to taking out a mortgage on your house. Lenders evaluate your creditworthiness, the strength of your collateral and the likelihood of default to decide on the risk-adjusted terms to offer. If you’re desperate, you have no room to negotiate. But if you’ve just raised equity, you will be putting your best financial foot forward, and you’ll be able to bargain from a position of strength. So, here are five reasons to raise debt just after raising equity:
Related: The Basics of Raising Capital for a Startup
1. You have already prepared all the material
Coming right off a fundraising process, you have your pitch ready to go, and your data room is up to date. This background material for your equity fundraise is very similar to the financial records, collateral and creditworthiness documents you’ll need to raise debt. You’ve just closed on a round, which has hopefully generated media interest, especially if you’ve raised capital from top-tier VC firms. All you need to do is update a few metrics and contact the right debt providers.
2. The best time to approach a lender is right after a fundraise
Your company looks most attractive to the market when you’ve just raised a funding round. Not only do you have new cash on hand, but you also have proof to show other capital providers that some brand-name institutions have a vested interest in your success, a strong indication that you can raise more equity if needed.
Lenders measure the risk of an investment (and the corresponding interest rate) based on how the business will perform in the worst possible scenario. In times of volatility or recession, when businesses are forced to make mass layoffs to manage costs, if you can say “I have plenty of cash reserves and access to equity capital when needed,” lenders will be assured that your liquidity position has plenty of buffer for the bumpy road ahead.
3. You have the power to say no, so you can hold out for the best terms
Always consider the power dynamic at play when negotiating: If you’re in urgent need of capital and can’t afford to say “no,” the lender can set the terms they like, and you’ll have to take what you can get.
Instead, start negotiating your debt round right after your equity round closes. Having plenty of liquidity not only makes you an attractive borrower, it also gives you time to weigh your options and ensure the most favorable deal terms. Once you receive terms you like, take the deal. You may not be desperate for cash now, but once you are, that same offer may not be on the table.
Related: Edtech Startup iNurture Raises $15 Million in a Combination of Debt and Equity
4. It opens up the full spectrum of capital options
Not every lender is the same, and in the venture debt space, lenders consider different elements of your business when deciding whether to provide debt. Some lenders only look at the business fundamentals, while others require you to have raised VC money. In fact, some lenders only serve companies that have recently closed an equity round, so waiting too long after your raise might cost you that subset of capital providers altogether.
Remember that every lender has a unique fee structure with its balance sheet partner. Not every lender has access to bank rates, so even if they love your business model, they may not be able to offer you the lowest cost of capital. Keeping all your options open allows you to choose the partner that makes most sense for your business — whether it’s a bank, private credit fund or someone else — rather than being stuck with one option.
5. You can match the capital source to the intended use
Having access to equity and debt capital at the same time can be a powerful tool in optimizing your capital allocation decisions. According to the Runway Venture Debt Review, “43% of entrepreneurs see debt as a backup option when equity capital is unavailable, rather than a complement to their capitalization strategy.” However, rather than only using one or the other, you can match equity and debt to the various needs of your business.
Use equity for projects with uncertain outcomes, like R&D, where the outcome either vaults the company along the development curve or provides important information on what not to do. Remember that equity is extremely expensive, because you give up part of your company for it. You’re paying a premium to invest in risky projects that answer critical questions about your company’s future, so use it purposefully. Debt, on the other hand, should be used to leverage the parts of your business that have a proven, measurable payback. When you’re acquiring customers profitably, use debt to accelerate sales and marketing, compounding your return on invested capital.
Related: Debt vs. Equity Financing: Which Way Should Your Business Go?
Raising debt will never be easier than when you have just raised an equity round. Build on the PR and endorsement provided by your venture capitalists, update your fundraising materials as needed, and sit down with a few lenders. With debt on hand, you can match your source of capital with the need, saving the expensive equity for value-enhancing strategic investments while the debt funds projects with known outcomes. In addition, debt can give you the final push across the finish line if you’re working toward a milestone, boosting your next round’s valuation. By operating from a position of strength, you can choose the best deal even in harsh funding climates like today, instead of passively accepting what the market dictates.
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