As plenty of startup owners can attest, sometimes your runway just isn’t long enough.
Whether that’s because of an overheated burn rate or unexpected growing pains, companies that have raised money from venture capital or angel investors often discover that what they’ve raised is simply not enough. While another round of funding might be the ultimate answer, sometimes it makes sense to bridge the waiting period between investment rounds with an outside loan.
Let’s take a closer look at the benefits of bridging funding rounds with a business loan—and when it makes the most sense for you to pursue one.
Small businesses, by their very nature, need to be nimble and responsive.
Because of that, a prolonged cash shortfall can have devastating consequences. Without access to funds, a young enterprise wouldn’t be able to seize opportunities before they disappear or maintain a much-needed cushion for unexpected setbacks.
This need for fast capital doesn’t always square up with the standard equity financing schedule, since the typical funding round will usually take at least 3 months to complete.
Investors must be identified, a term sheet must be drawn up, and extended negotiations often follow. If the round needs more than one investor, the term sheet will usually be shopped to additional investors, who then agree to put money in under the same terms.
In other words, it’s not a quick and simple process.
This means short-term financial needs aren’t always best filled by pursuing a new funding round as quickly as possible. There are too many variables and potential complications—and even in the best-case scenario, new funding is months away.
Plus, attempting to accelerate the funding round process to fill immediate needs can create some unnecessary risks.
Operating with this kind of urgency opens up the process to mistakes and might make a business more likely to settle for less-than-optimal terms. After all, if you’re in desperate need of money, you’re naturally more likely to accept less than your preferred valuation.
While raising money from your current investors can streamline this process, it still requires a significant time investment.
Securing a loan as a bridge between rounds, however, can be a solution to the pressing need for capital.
Instead of waiting for months and potentially accepting a new investment on less-than-favorable terms, business owners can strike quickly. A conventional small business bank loan can be processed in as little as month, typically, depending on the complexity of the deal.
Other lending options, like a non-traditional online business loan, can be processed much faster. In some cases, funds can be secured in a day or two.
The amount of capital that a business requires is another key consideration between funding rounds.
If a company’s financial need is relatively small, it doesn’t make sense to kick off a new funding round—investors typically won’t be interested in such minor stakes, and the time and effort involved isn’t justified.
Also, surrendering equity in a company to raise a modest amount of cash isn’t a sound decision.
Loans, however, can be taken out for even the most modest amounts.
If your financial requirements are on the smaller side, it makes sense to pursue a loan. It’s also important to remember that while venture capital and private equity have a high profile, the majority of money raised by companies occurs via the old-fashioned route: debt.
Business owners should be aware of another option, a kind of hybrid between equity and debt-financing: convertible debt.
With convertible debt, business owners raise cash from investors with the expectation that the loan will either be repaid or converted to an equity stake at a later date. This approach, which offers investors added flexibility, is often favored by startup owners who need to move a little more quickly and who don’t yet have a firm valuation.
Along with speed and size, there are two more common concerns that might prompt business owners to opt for a loan between rounds: control and timing.
Equity-based financing comes with a couple of significant benefits: there’s no debt-based repayment schedule to hamper growth, and small business owners can tap into the experience (and, more importantly, the professional networks) of well-established equity partners.
But these advantages come at a serious cost.
In order to reap these benefits, you’re trading away a piece of your company.
Investors will often expect to have a strong voice with regard to company management and strategy in return for their financial support. If you’re not ready to cede even more control over to investors, a bridge loan might be the right choice.
Finally, funding rounds need to be timed just right.
Starting a new round prematurely to address a financial shortfall isn’t a great approach. Business owners who pursue a round because it’s the right time to accommodate growth are better positioned than those who start a round because they need to fill a cash shortage.
Equity funding rounds offer several benefits, including a lack of debt and the ability to leverage professional guidance and connections. Sometimes, though, companies experience financing gaps between rounds that can be best served by a loan.
By following the advice outlined above, your company can safely navigate this often tricky situation.