Authored by: Peter Adams, Executive Director of Rockies Venture Club and co-author of Venture Capital for Dummies
There are many sources of funding available to startups, even during an economic downturn. Smart entrepreneurs know how to adapt their fundraising/financing strategy to ensure that they don’t rely too heavily on investor capital that may be harder to come by or at the very least, more expensive. In the current economic climate, founders should keep in mind that pursuing both angel investors and venture capital (VC) funds for financing may become more complex that it has been in years past, and debt-financing may be a better, cheaper, and more reliable growth capital solution. Here is what entrepreneurs should consider about their funding options during an economic downturn:
Angel investors may become skittish, but will often embrace taking long-term equity investments in startups rather than watch their stock portfolios continue to decline in the short term. Nurturing relationships with these investors may take more time and effort, however, especially if they are newer to the angel investing arena. Entrepreneurs can help newer angels get comfortable by bringing a more sophisticated investor onto the cap table early on. If this individual has insight into your particular industry, that can be leveraged to help reassure greener angels. While this is a smart strategy regardless of the economic environment—it is crucial during a downturn.
Venture Capitalist (VC) funds and groups have a mandate to invest, regardless of the economic circumstances. Unless they’re out raising funds, VCs should be actively investing. However, during an economic downturn, VCs are likely to beat startups up for a better valuation—not ideal for entrepreneurs.
During any economic circumstances, equity funding is the most expensive. Smart startups are well advised to look for non-equity funding sources.
Debt financing options
If a company has revenue and high-quality clients, then a relatively low-cost alternative to investment capital would be to look at asset-backed lending and specifically, accounts receivables (A/R) financing options. These lenders will typically advance a pre-established percentage of your accounts receivable, and you’ll receive the balance once the receivable is paid. This kind of funding is great for growing startups, even during a downturn because:
1. The line often grows along with your receivables. This means that your ability to finance your sales won’t hold you back on your growth.
2. During a downturn, companies are generally slower to pay their receivables. As long as the payment doesn’t exceed 90 days, you can continue to grow your business and pay your own bills with A/R financing, even if your clients are slow to pay their invoices.
3. A/R-based funding can reduce or eliminate the amount of funding you need to get from equity which both reduces your cost of capital and helps you to keep control of your company.
4. Finally, receivables finance is based primarily on the credit of the companies you sold the products or services to rather than on your company. If you’re a startup without a lot of track record, this can be a great way to get funding based on the credit-worthiness of your customers.
Why Receivables Finance is Better than SBA or other Bank Loans
If you’re planning to finance your business with a combination of equity and debt—a strategy most smart entrepreneurs employ—you should know that equity investors almost never want their money to be used to pay off previous debt, regardless of whether it was from a bank or your Uncle Bob. Equity investors want their money moving forward to help grow the company, create value, and build towards a significant exit. If you are able to take SBA or bank loans (which can be difficult for new businesses anyway), you may have painted yourself into a corner that prohibits getting venture capital in the future. Receivables finance, on the other hand, is always paid off as your receivables come in, so you won’t have to worry about long-term loans impacting your opportunity to attract potential investors.
Startups should be aware that there are lots of options out there for funding even during a downturn, but they should “begin with the end in mind” and not take a short term funding option if it closes off long term equity growth opportunities.