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Debt Financing: The Key to Unlocking Long-Term Business Growth
What do these recent headlines tell you about VC funding as a method of financing your business? The terminology used is exciting, and intriguing; companies are raising, attracting, and even winning financing to help grow their business.
Now check out these headlines about companies raising debt to finance their growth:
The language isn’t nearly as flattering now. In fact, when it comes to media coverage of companies taking out loans and financing their efforts with debt, the tone is definitively neutral or even negative. The company is ‘getting’ or ‘securing’ funds–no one is “winning” here. What’s more, we see mentions of the company being ‘carried through’ or even thrown a ‘lifeline.’
Why is it that raising VC capital is applauded as an achievement, but leveraging debt financing to grow a business is stigmatized?
Good vs. Bad Debt
We learn early on that there are good debts and bad debts in life. Your student loans, for example, are a ‘good’ debt. You took on that debt as an investment in yourself and your future, and accumulating that debt yesterday made you a more valuable asset today.
Credit card debt, on the other hand, is not considered good debt. There’s no residual effect from consumer debt that offers any kind of future payoff.
When it comes to financing your business, borrowing funds to hire more personnel, purchase capital equipment, expand your inventory and tackle other growth-positive activities is a solid example of good debt. Each of these expenses is an investment in growing your business, and each offers to increase your company’s profitability in future.
So why is borrowing not seen as a savvy move, too?
Borrowing Business Funds and the Myth or the Failure to Plan
Short-term borrowing is so stigmatized that many entrepreneurs are embarrassed to admit that’s where some of their financing originates. Part of the reason for this is that business owners may equivocate borrowing with a failure to plan. Business media perpetuate this myth in the way they cover debt funding vs. VC financing, despite the fact that these are just two different tactics used to achieve the same outcomes.
Short term financing is not a failure to plan. A lack of short-term funding options is endemic in the SMB and startup community, to the degree that 8 out of 10 SMBs do not get the funding they need to grow.
This false narrative that VC funding means you’re a true hustler, a shrewd business person destined for success, drives the alternative. If you failed to get VC funding, you’re a failure. You didn’t hustle hard enough. Your plan wasn’t good enough.
Don’t let this unfounded stigma drive you to accept funding at less than favourable rates. The pressure is intense; Ben Horowitz was infamously so close to completely breaking down as he faced the very real prospect of bankruptcy that he was literally incapable of dressing himself. As we now know, his startup (Opsware) went on to sell for $1.65 billion, but he teetered on the edge of losing it all more than once.
The fact is, not every business is going to be attractive to VCs. If you were offered 10% of AirBnB for $150,000, would you take it? We’re sure you would today, now that the company is valued at some $31 billion. But back in 2008, AirBnB was just 3 guys renting out mattresses on living room floors. Co-founder Brian Chesky shared their multiple VC rejections in a post on Medium and wrote, “Next time you have an idea and it gets rejected, I want you to think of these emails.”
Why more Entrepreneurs are Choosing Debt Financing to Grow
AirBnB weren’t experiencing a failure to plan, nor were they pitching an unlikely, unattractive idea. In fact, their startup story was so unconventional that it revolutionized an entire industry!
Failing to secure VC funding isn’t a failure at all. Here’s the hard truth: 99.95% of entrepreneurs will never get VC funding (Forbes). We know it must seem like every other entrepreneur on the planet has VCs banging their door down if you read the business news headlines, but it’s simply not true.
For some companies, not getting VC funding is actually a blessing in disguise, as the propped-up valuations inherent to VC funding can make it more difficult to raise money for growth in subsequent rounds. Perhaps this contributed to AirBnB’s decision to secure $1 billion in debt financing in 2016.
Stiffer competition for VC funding, the desire of entrepreneurs to retain greater control and keeping options open for the future are among the reasons more entrepreneurs are turning to debt financing to grow their business–sometimes even after they’ve secured VC financing. From 2008 to 2015, the total number of deals completed by US-based startups that were at least partially made up of debt increased every year.
What’s more, the size of those deals ballooned from $4.3 billion in 2013 to nearly $14 billion in 2016.
When you use debt financing to grow your business, ownership stays with you. Debt can be manageable and a true asset to your growing company, so long as you:
- Understand the cost of your capital.
- Budget for a little more than you think you might need.
- Develop a strong financial record through regular debt repayments and, most critically, a healthy pattern of positive cash flow.
- Use acquired debt to finance the most growth-positive aspects of your business.
Let’s stop perpetuating the myth that debt financing is something of which you should be ashamed. In reality, it’s an excellent way to grow your business while taking advantage of tax deductions on interest and retaining complete control over your startup.
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