Bill Reichert / November, 2017
What is debt financing?
Bill Reichert, Managing Director at Garage Technology Ventures explains the two different types of debt financing; convertible note and venture debt.
What is debt financing?
If you’re an entrepreneur and you’re starting up a company and you’re looking for funding, you’re going to hear about equity financing and you’re going to hear about debt financing. We’ve talked about equity financing elsewhere, so let’s talk a little bit of debt financing. So there are two types of debt financing that occur in startup companies.
The first is whats referred to as a convertible note, so frequently when you raise money from friends and family or you raise money from angel investors you won’t actually sell equity, you’ll actually raise a convertible note, which is a convertible debt instrument, that is intended to convert into equity at some point in the future. So technically, when you raise a convertible note, you’re raising debt. So but the intent of that convertible note is always that it will convert into equity, there’s no expectation that convertible note is going to be just paid back when you raise more money. So that’s one form of debt financing, but it’s really not debt financing, it’s a pathway to equity financing.
The other form of debt financing as referred to it as venture debt. And so, once you get to a certain level of success, then there are financial institutions, sometimes banks and sometimes independent financial institutions, that will offer you a form of venture debt. Now sometimes that’s simply a loan against intellectual property and assets of the company. Almost always the venture debt investors what they expect is that there is plenty of equity in the company already and that there are plenty of equity investors that are going to make sure that this company is successful and the assets do not disappear. So you’ve got to have achieved a certain amount of traction in order to raise venture debt.
You can also raise some debt against your working capital, if you have revenues, if you have inventory, if you have receivables, then there are banks who will actually loan you money against that working capital requirements. So that’s also another form of debt. So those are the variations in debt financing for startup entrepreneurs.