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When to raise debt over equity
Founders have long been told two things:
Use SAFEs as long as possible
Don’t go into debt
Today, I’m going to talk about why this advice is misguided and when you should actually consider debt instead of SAFEs or equity investments.
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Don’t overdo the SAFEs - One of the biggest risks of SAFEs that investors rarely talk about is stacking SAFEs. If you raise multiple rounds of investments with a SAFE, you are bearing all the dilution because the previous rounds haven’t yet been converted to equity. To put it simply, if I sign a SAFE to invest in your company, I will get 20% when it converts. If you sell another 20% tomorrow, then in 1 year, when they convert, you’ve given away 40% and keep 60%. If my deal was for equity and I owned 20% then when you sold the next 20% then we share the dilution so I’d be down to 16% and you’d still have 64%. This might seem small but if you add up missed dilution over 2-3 rounds you might be giving away 10-20% of your company more than if you did equity/debt deals.
Solving cash flow issues - If you are raising money because of problems with your cash flow, debt can be an easy (and quick) way to get the cash you need, grow it, repay it, and move forward without giving up equity. Companies like Clearbank have been extremely successful investing “venture debt”. This is especially powerful if you are a company whose primary source of acquisitions is scalable, and more cash = more money. That way, you know you can repay the debt and don’t need to sacrifice any equity.
Flexibility - Making a convertible note can provide flexibility, especially if you can pay it off before it converts. If your valuation jumps significantly between rounds, you can pay off the debt and move forward without that investor. If you don’t have the funds or value the investor (at the price of conversion), then you can keep them on board.
In short, consider all the options on the table. Don’t just follow the “standard” advice. It might not be best for your business.
Would you raise funds using debt? |
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