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4 Debt Financing Sources for Pre-Venture Capital Backed Startups

debt financing startups

Venture capital funding can seem like the ultimate vote of confidence for growing startups. Clinching that series A round can mean not only a huge influx of growth capital but also enhanced bona fides that you can leverage in other ways, such as securing debt financing in the future from other sources.

Yet what if you’re growing your business without venture capital funders behind you? How do you seek debt financing when it’s just you, your good idea, and your startup’s (hopefully) solid financials to prove your worth? The good news is that there are plenty of quality sources of debt financing.

In fact, there are excellent arguments for seeking debt capital instead of venture funding. After all, venture funding really is best for early-stage startups with unpredictable cash flow, little brand recognition, and a goal of growing quickly to a valuation of hundreds of millions of dollars. Companies that don’t meet this description may well do better by seeking alternatives to Venture Capital, so startup founders can focus on growing the business at a pace that better fits their goals.

Sources of Debt Financing

1. Friends, Family, and Co-Founders

sources of debt financing

A common source of debt funding for startups is those you know: friends, family, yourself, your co-founders, and your board members.

These loans work well when they’re structured as convertible debt, which carries low interest and converts into equity at a certain date, usually at a time when you anticipate being able to raise a round of equity financing. The danger of structuring debt in this way is that you will be on the hook to pay people back from your own pocket if you aren’t able to raise equity by a specified time.

2. Bank Debt and Online Lenders

Bank Debt and Online Lenders

There’s always the classic source of debt financing: tech investment banks.

Unsecured and secured personal and business loans can support your startup’s needs, though bank loans aren’t necessarily geared toward encouraging growth and they can be an uncomfortable fit for SaaS startups. If you have short term or emergency needs, a wide array of alternative online lenders now compete with traditional banks for your business. Online lending is faster and more convenient than bank lending, but it often comes with much higher interest rates. These types of loans should ideally be used sparingly and aren’t the best option for use as growth capital.

3. MRR Line of Credit and A/R Factoring

MRR Line of Credit and A/R Factoring

A monthly recurring revenue (MRR) line of credit is a better source of debt financing for SaaS businesses that tend to have stable monthly revenue due to using a subscription model. Lenders see the “stickiness” of subscription services as potential collateral for lending, and may provide working capital at a level three to five times your MRR.

Another debt financing option, accounts receivable (A/R) factoring, provides advanced funding using your accounts receivable as collateral. If your subscription service allows customers to pay at varying intervals, A/R factoring can be a way to even out your cash flow and allow for more predictable growth.

4. Revenue-Based Financing