In this blog series, we review the most common types of securities used in financing emerging companies, and highlight key issues worth considering for each.  Over the course of four posts, we’ll touch on the sale of (1) equity securities, (2) convertible debt, (3) SAFEs/KISSes, and (4) debt (non-convertible), non-dilutive funding and bootstrapping. In this fourth post of four, we address the financing of a venture through debt, non-dilutive grants and bootstrapping.  

Debt (Non-Convertible)

There are also several options for founders who want funding but wish to avoid diluting their stake in the company. One such option is conventional debt, generally from a bank or other financial institution. The company borrows money now and pays it back later with interest.

While it is often difficult for startups to qualify for a conventional business loan due to a lack of business and credit history, there are a variety of loans specifically targeted at new businesses. These include equipment loans, business credit cards, microloans of very small amounts, and loans from the Small Business Administration (SBA). Many of these loans have more flexible requirements for qualification, and the company may also be able to deduct the interest from its taxes.

Taking out a loan rather than selling equity keeps the company under the founders’ control, provided the loan is repaid, and typically does not entitle the lender to future profits of the company. However, straight debt may be difficult to qualify for, especially for pre-revenue companies. Moreover, as discussed, debt also comes with stipulations such as operational restrictions, protective rights and security interests, which are often more restrictive and harder to negotiate with straight debt than with convertible debt.

Whether taking on a loan makes sense also depends on the company’s anticipated revenues and ability to meet payment deadlines. A targeted loan may be ideal for a startup that expects steady profits. But be mindful that overleveraging your company with debt can be a drag on future valuations of the company. Missing payments can cascade into negative consequences such as payment penalties, difficulty securing financing in the future, and even an impact on the founders’ personal credit scores.

When to use it:

  • You value keeping the company closely held
  • You have predictable revenues 
  • You qualify for a loan that meets a specific purpose

Government and Institutional Grants

Grants are another non-dilutive funding option that can be useful for early-stage companies, to the extent they are attainable. Typical sources include domestic and foreign governments and institutions.

Well-known federal options include the Small Business Innovation Research (SBIR) grants and Small Business Technology Transfer (STTR) grants. While both of these are coordinated by the Small Business Administration (SBA) and targeted towards companies engaged in high-tech and R&D-related ventures, a variety of grants are available through a number of different agencies and target different concerns. An updated list is available on grants.gov.

Foundations and other institutions with a particular interest in a company’s industry may offer grants for technological progress in an area that investors are unwilling to fund. Founders should note that tax-exempt status is often required for grants offered by private institutions.

The key benefit of a grant is that the company typically need not issue any equity or repay the grant. That being said, grants may be difficult to find, require time-consuming research and paperwork, involve processes that move at a glacial pace, and have very specific requirements for qualification or use. Founders should make sure that the pace and restrictions of a grant fit into their business plan.

When to use it:

  • You value keeping the company closely held
  • The timeline and application requirements fit your business plans
  • You have a backup plan if your application does not succeed

Bootstrapping

Last but not least, many great companies were funded by their founders (and their founders’ credit cards). For those who are unwilling or unable to find investors and have the means to bootstrap, self-funding ensures that the founders will remain in the driver’s seat and motivated to succeed. The risks are obvious: if the enterprise fails, a founder’s investment goes with it. The rewards, however, can be great.

When to use it:

  • There is a good fit between your resources and your goals for the venture
  • You are mentally, emotionally, and financially prepared for the financial risks

As you can see above, when it comes time to finance your company, you have options. The financing instrument you choose will depend on a variety of factors, some of which are out of your control. It is always a good idea to understand how each instrument works so you can make an informed decision about which method to pursue. Once you’ve chosen a financing path, focus your efforts on negotiating the terms that will have most positive impact on the future of your company.