Is it smart for a start up to take on debt for funding in the early stages of the company? What are the best ways to fund early startups?

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Kruze Consulting Startup Q&A Author
Vanessa Kruze
Founder, CPA

Before joining the Startup CFO firm, Kruze Consulting, I was a partner at Lighthouse Capital, one of the leading venture lending funds. I did about 100m+ of debt deals while at Lighthouse and I do a ton of Venture Debt consulting at Kruze Consulting nowadays.

I believe it’s very smart for a venture backed startup to take a moderate amount of debt, assuming it’s executing well and has clear milestones that it will be able to hit on the incremental debt dollars. The extra debt dollars are very low cost and come with almost no dilution as the warrant coverage rarely even adds up to more than 1% of the company. For that tiny bit of dilution, a startup can buy itself 3 - 6 months of runway, hit its key milestones, and raise a significantly larger up-round.

Debt is for extending the runway of strong companies. Startups that are struggling should never take venture debt because it just compounds the problems. Lenders get anxious when a company is struggling, particularly banks who also hold the startups deposits. There are clauses like Investor Abandonment or Material Adverse Change that a bank can invoke to put a startup into default immediately. At that point the startups cash can be swept.

Lenders will have a security interest in the company and Entrepreneurs should remember that debt must be repaid. There are clear tradeoffs between the cheaper and less dilutive capital and reduced flexibility. This is why I make such a big distinction between strong venture backed startups who are doing great and should borrow a moderate amount, and struggling companies looking for a hail mary.

Debt is a fantastic tool for Entrepreneurs and VC’s, but should only be used in moderate amounts and when a company is executing.

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