Getting the right funding is crucial for startups to drive growth and achieve sustainability. Traditionally, equity financing has been the go-to option for many young businesses. However, amid a significant decline in equity fundraising, they are now turning to debt financing as a viable alternative to fuel their growth. This shift reflects a better grasp of diverse financing strategies that support startup growth without diluting ownership.

Before diving deeper into them, let’s understand the difference between equity and debt financing. Equity financing involves raising capital by selling company shares, which reduces ownership but does not require repayment, while debt financing involves borrowing money without giving up ownership and interest. Must pay along but add financial responsibility on the company.

‘Ownership control, pressure on cash flow’

Avishek Gupta, MD and CEO, Caspian Debt, said debt funds have many advantages as founders can retain control over their decisions and future financial gains. Also, the overall cost is low with fixed interest rates, flexible repayment schedules, and quick access to loan funds, he said. LiveMint.

Gagan Aggarwal, CFO of Clicks Capital, said founders can also deduct tax expenses because interest payments are business expenses. Easier budgeting due to monthly payments and timely repayment of loan debt strengthens the bureau’s score, making it easier to borrow additional loans for growth and at better rates, he said.

However, industry players noted that there are some risks and challenges associated with debt funds. “Excessive leverage can increase financial risk and hamper cash flow. A debt default can damage a company’s reputation and hamper future financing options,” Gupta said. said

“Loans carry interest, which must be paid regularly, even if your business is not making a profit. In a down cycle, this can add to your financial stress. If payments are not made on time, the credit score could be affected, which could lead to higher borrowing costs in the future or potentially limit borrowing capacity,” Aggarwal told us.

‘Ratio of Debt Funds to Equity Fundraising’

Therefore, experts suggest that startups should clearly understand their risk tolerance, cash flow, and growth trajectory to determine an appropriate balance between debt and equity financing for their business models. He said that it is important for entrepreneurs to recognize their cash flow projections and other obligations so that they pay off their debt on time.

“A competent finance head is essential for startups. If not possible, outsourcing to a quality CA or CFO firm is an option. When considering external debt financing, this role is as important as technology or marketing leads. done, which helps in forecasting future cash flows and evaluating appropriate borrowing options for growth stages,” recommends Gupta.

On the other hand, the Clix Capital CFO emphasized that reducing borrowing costs is crucial, as growth often requires substantial debt financing. “Lower costs can increase profitability and overall company health. Benchmarking with peers helps businesses find the right balance of debt and equity to maximize growth and stability.”

‘Bank Loan, Collateral Loan’

He further advocated various types of debt financing for startups, including bank loans, term loans, working capital loans, loans against collateral from NBFCs, vendor financing or invoice financing, corporate bonds, debentures, and trade credits. .

“Banks offer the lowest cost loans but can’t match startups without mortgage collateral. Often, startups get frustrated chasing bank loans. Instead, focus on lenders. Not every lender that is known to fund startups and meet their criteria should be a target,” said Gupta.

“Ideally, loans should go to companies with a profitable track record, ability to pay, and collateral. Startup lenders use proxies for these parameters, so data transparency is critical. Mature Startup Growth may look for term loans or hybrid financing, while early-stage startups often use venture loans, convertible notes, lines of credit, or asset-based loans for flexibility and favorable repayment terms.”

Early-stage MSMEs may find bank loans challenging and should consider term loans, working capital loans, or collateral loans from NBFCs, Agarwal said, adding that if they supply to larger businesses, vendors or invoices. Financing is also an option. “Mature MSMEs have more options, including bank loans, NBFC loans, corporate bonds, debentures, and trade credit.”

‘Reliable Source of Loans Amidst Funding Winter’

Venture debt funds are expected to surpass $1 billion in 2023, while equity fundraising, including private equity and venture capital investments, will decline nearly 35 percent to nearly $39 billion in 2023, according to a joint report from Bain & Co. which was 62 billion US dollars in 2022. The company and IVCA released last month.

Experts believe that debt financing can be a reliable option for entrepreneurs who want to expand their business during the winter months. “In the case of winter funding, where there are limited options available for equity investment, startups can turn to debt capital to support them,” said Gupta.

“Startups can maintain their equity value by using debt to take advantage of strategic opportunities and defer raising equity until it is more accessible. However, they need to ensure That they can repay the debt. In short, startups should not resort to debt because equity is not available, they should do so with a clear repayment plan in mind,” he added.

The Clix Capital CFO said the equity uncertainty environment and rising risk aversion among investors are at risk of falling investment, which could delay startups’ growth plans and hurt business. can

“Debt financing is a faster and more reliable source of funding for businesses, which can help them grow their business without losing ownership of the business. It helps in leveraging, which can make further growth possible, which might otherwise be difficult. So, they should look at debt financing positively during the winter capital,” Agarwal added .

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