Using Debt Financing as a Bridge Into Your Next Round
COO & Co-Founder
COO & Co-Founder
This is a guest post from Meredith Wood, Head of Content and Editor in Chief at Fundera.
If your company relies primarily on equity financing to fuel growth, chances are you haven’t considered debt financing as an option. After all, if you are used to or considering going through the traditional Seed to Series A to Series B and so on, a “small business loan” isn’t something you’d think of.
A question we get often is “What is the difference between a small business and a startup?” Although a detailed debate, it really boils down to this: startups have the intent to become a larger company. Many small business owners set out to open, say, a flower shop, and that’s their goal: to run that flower shop.
You probably don’t think of yourself as a small business. But, especially in the early years, you technically are. In fact, if you look at the definition of small business by the SBA, almost all businesses with up to 500 employees fall under their “small business” umbrella.
Okay, so you don’t have to start seeing yourself as a small business, but it is important to recognize that you have many of the same options out there as they do. Like we said — small business loans.
The one thing all startup founders know to be too true is just how long a financing round can take. It’s a full-time job…on top of your other full-time job running a company. So, if your company’s cash flow is running low and you’re ready for your next round, looking for a loan to hold you over might be your best option.
If a bridge loan makes sense for your business, here is the best way to approach the process:
How much money do you need to get by until the next round? It can be very difficult to define how long a round will take, so it’s probably best to be a bit conservative here, and assume it could take a few more months than you’d ideally hope for.
The other thing to keep in mind is just because you want a certain amount of money doesn’t mean you can get it. Most businesses only qualify for around 8 to 12% of their annual revenue. Do those figures align?
The other thing to think about is when you need the funds by. Is cash flow running out quickly? Then you might need to find a loan product that can close quickly, like a short-term loan (these can take days or even hours to process). However, fast capital is expensive capital, so be prepared that the APR on this type of product will be very high.
If you have some time to wait, then you can look at lower-cost products like an online term loan or a bank loan.
Where should you start your loan search? The bank is going to be where you get the best rates, but the online process is easier, faster, and your chances of approval go up drastically.
First, you should think about timeline. If you need cash fast, you don’t have time to go through a bank loan application. The bank loan process can take weeks if not months.
Second, bank loans are notoriously hard to qualify for. You’ll need to have at least a 700+ personal credit score and your business will need to be in a strong financial position. If you’re bleeding cash, this may not apply to you.
If you have time to wait and strong financials, start your search at the bank. If you need to move quickly, or have less-than-perfect financials, your best bet is to start online.
If you don’t need a bridge loan but think it might be a good option down the road, you should visit your bank and see if you can open a business line of credit. This is the ideal option when you need some bridge financing, as you can pull the funds immediately, you only pay interest on what you pull, and you’ll be getting bank rates.
If you are able to get a bridge loan from the bank, you’re in an excellent position. They offer the most competitive rates in the industry. However, if you decide to go online for a loan, “shopping” is highly encouraged. You might apply with a particular lender because you know their name, but are you certain they are going to offer you the best rate?
Online loans can get pricey, so you want to be certain you are walking away with the most cost-effective option. You can apply for SBA loans online, for example, which offer single-digit interest rates. In most cases, you can expect that the easier the loan application is to complete, the more expensive of a product you’re applying for.
Perhaps you get a bridge loan to cover just 3 months of cash flow, and you hope to pay it off as soon as the round closes. Your bridge loan’s terms probably weren’t 3 months, so you’ll be paying the loan off early.
Be sure to check with the lender to see what their prepayment terms are. Some lenders will forgive all remaining interest, some lenders will forgive none. Many lenders will still have you pay a certain percent of the remaining interest.
If you get a short-term loan, some of these lenders don’t provide a true amortization schedule. Instead, they give you a “payment plan” which tells you the set payment you’ll make everyday. If you decide to pay early, they usually can only provide an overall discount, as they haven’t designated principal and interest.
Either way, if you plan on paying the bridge loan off early, try to find a lender that will forgive your total interest.
If you’re feeling under pressure to make ends meet while planning or waiting for your next round, debt financing might be just the relief you need. And, if you don’t need a bridge loan now, but could see it being a possible need down the road, hop into your bank today and see if a line of credit is an option.
About the Author:
Meredith Wood is the Head of Content and Editor-in-Chief at Fundera, an online marketplace for small business loans. Prior to Fundera, Meredith was the CCO at Funding Gates. Meredith manages columns on Inc, Entrepreneur, HuffPo and more, and her advice can be seen on Yahoo!, Daily Worth, Fox Business, Amex OPEN, Intuit, the SBA and many more.
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